Public attention around a handful of heavily traded stocks has drawn more attention to the short-term volatility around individual public equities. Some of the resulting coverage has blurred the lines between public and private markets. The reality is that private equity firms are responsible, long-term investors (over 4-7 years) in private companies across America that are seeking capital, management expertise, and support to grow and succeed.
Here are the basics to know about the private equity’s industry’s business model:
Most PE-Backed Companies Are Not Traded on the Public Markets – For starters, “private equity” generally refers to privately managed pools of long-term capital sourced from sophisticated investors that are used to acquire controlling stakes in businesses whose stock is generally not traded on public exchanges.
Long-Term Investment Horizons – Funds typically invest in these private businesses for four to seven years. Private equity managers often add value by monitoring management, serving on the boards of directors, and offering input in major strategic decisions.
Building Better Businesses Across America – Private equity investors helped revitalize or unlock additional value from recognizable brands, including Hilton Hotels, Dunkin’, Popeyes, and Dollar General, as well as build thousands of much-smaller businesses. In total, the industry invested $561 billion in 4,335 businesses in 2020, according to a recent report by the American Investment Council. That included 2,108 businesses with 500 or fewer employees, such as Black Rock Coffee, a growing chain of coffee bars that started in Oregon with big ambitions, and Victory Innovations, a manufacturer of high-grade disinfectant sprayers whose products have been used to clean schools, airplanes and other public spaces during the pandemic. Click here to learn how private equity is investing in your state.
Long-Term Investors Seeking Long-Term Gains – Investors know private equity generates long-term gains over a defined period of time. Most of these partnerships are closed-end funds with defined lives of 10 to 12 years. Investors are not permitted to redeem their investments in the fund until the fund sells its interests in the underlying portfolio companies. At that point, investors receive their original capital, a hurdle rate of return on the investment (typically 8%), and their share of the remaining returns on that investment. This gives the fund time to build businesses and generate long-term gains.
Private Equity Outperforms the Public Markets – This steady investment strategy helps explain why private equity outperforms other asset classes. Private equity delivered a median annualized return of 13.7 percent over a 10-year period for public pensions, making it the best performing asset class for these public-sector workers and retirees. This long-term investment strategy also makes private equity more resilient. A study from JPMorgan Asset Management and Hamilton Lane showed private equity funds held up significantly better than public stocks during the Great Recession. Another study by Harvard, Stanford and Northwestern Universities found PE-backed businesses were less likely to go bankrupt than companies traded on public markets.
Differences from Hedge Funds – Private equity is often confused with other investment vehicles that have very different structures, strategies and time horizons. For example, hedge funds are a popular investment tool that attract many of the same investors as private equity, but they observe very different rules and investment strategies. A “hedge fund” typically describes a pool of private investment capital sourced from sophisticated investors that are administered by professional investment managers who actively trade various types of securities (stocks and bonds), commodity futures, options contracts, swaps and other investments. In contrast, private equity invests in illiquid securities (i.e., operational businesses) over the long-term. Hedge funds generally invest in liquid securities and contracts that usually have a readily identifiable market value. These positions can be held for long- or short-term periods. Hedge fund managers seek to construct efficient portfolios of publicly traded securities that match investors’ risk and return preferences. Similarly, they offer investors very different time horizons to return capital and distribute investment gains. Unlike private equity, hedge funds generally allow their investors to redeem their interests on a quarterly basis. After an initial “lock up” period that usually lasts one or two years, investors can typically withdraw some or all of their investments, plus their share of investment returns, by simply submitting a request to the manager.
Private Equity is an Important Way to Diversify an Investment Portfolio – The multitude of tools and investment vehicles available to investors is generally a good thing, allowing them to diversify and take risks that are appropriate for their needs. We are proud of the role private equity plays in generating strong returns over a longer period of time for pension plans, charitable foundations, university endowments, and other investors.
Investors seek out private equity because it generates long-term gains over pre-set investment windows. In many ways, it is the opposite of the public-market equities that capture the most media coverage. Private equity investors are looking for superior returns, not headlines.