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| Private Equity |
Wisdom & Fair Warning
Laurence Neville
04/01/2004
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Dead Reckoning
Deciding whether any asset meets our risk-and-return
target—or whether it will work alongside our other investments—requires data.
Unfortunately, as with other alternative asset classes, such as real estate and
hedge funds, the risk, liquidity and return parameters of any specific private
equity fund are usually hard to pin down.
The consensus among private bankers and investment advisors is that most of us
should look to invest between 5 percent and 15 percent of our portfolios in
private equity. Those of us with assets of $50 million to over $100 million can
boost the top figure to 30 percent, as we have more liquid assets to call on
should an emergency—or an investment or entrepreneurial opportunity—arise,
according to Thane Stenner, a wealth advisor and author of True Wealth: An
Expert Guide. |
Private equity performance
information differs from other asset classes in both type and frequency. Unlike
other asset classes, returns are expressed in Internal Rate of Return (IRR).
Funds typically only report information to investors every three months.
“Private equity data relies on either appraisal valuations, which can vary
according to fund, or book value,” says David Rosenberg, managing director, head
of U.S. investment solutions at the Citigroup Private Bank in New York.
Alternatively, some funds hold investors at cost until exit. “If any of these
return valuations are put into a return series [used for asset allocation], the
outcome is questionable.”
These problematic valuations are used to model
return volatility, the most basic measure of an investment’s risk. But these
figures are also incomplete: While historical data for the public stock markets
goes back to the 1800s, recorded data for the alternative investment market has
only existed since the 1980s. That absence of information over more than a
handful of economic cycles means we still know little about how private equity
behaves in certain economic climates.
“There is a tendency among clients to
consider volatility simply as it impacts the balances on their monthly
statements,” says JP Morgan’s Stewart. These figures are only snapshots: If a
fund reports a similar value in two consecutive quarters, it may draw attention
away from what could be wide swings in value. “If investors don’t see that
volatility—which they may not as valuation may only be quarterly—then it is not
there [in their decision-making],” she says. “We try to help clients understand
that private equity can experience substantial volatility, and that they should
factor that into their thinking.”
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