Why investors are embracing private equity

Investors are increasingly harnessing private equity investing to boost returns while minimising volatility and downside risk, says Claire Smith of Schroders Capital.

The big end of town has embraced private equity investing for a while, with Australia’s $4 trillion local superannuation industry perhaps the most prominent local example. However, sophisticated investors are also increasingly backing fund managers focused on this space rather than traditional stocks – and for good reason. 

Private companies are not priced with the same frequency as their listed market peers, and as a result are not subject to the same swings in daily investor sentiment typical of listed markets like the ASX, Nasdaq or London Stock Exchange. 

“You’re also getting access to companies of different sizes and at different stages in their lifecycle,” says Claire Smith, Schroders Capital’s head of business development, private markets, Australia. 

She points to venture capital as one part of the private equity space many investors are aware of in the context of unlisted companies. However, the Schroders fund focuses on more established private companies with an established runway for growth. 

“They’re not new companies but are smaller than can often justify being listed,” Smith says. 

Schroders Capital’s approach differs from that of other private equity funds by concentrating on small to mid-sized companies rather than large ones. As Smith explains, typically 60% to 70% of its assets are previously founder-led or family-owned companies. 

“We take companies that have been around for several decades and are he market but have just been run as family-owned operations,” she says. 

“Often we’re the first institutional capital they’ve had, which we deploy to professionalise the company, put in place governance processes and compliance teams and phase out the founder by bringing in professional C-suite executives. We may also use the capital to help them expand into additional products and/or geographical regions.” 

For Schroders and their investors, this approach delivers the benefit of increased company earnings during their period of ownership. You also get what’s called a ‘multiple expansion’ [a higher valuation multiple] because someone will pay you a higher multiple for that company once you’ve professionalised and grown it,” Smith says. 

‘Punching above its weight’ 

A key appeal of private equity lies in the asset class’s more stable returns over the longer term.  

In the past quarter-century, the volatility of the MSCI All Country World Index – one of the most comprehensive global equity indexes – has experienced several instances where volatility was above 25%, as discussed in a recent Schroders report. 

As Smith notes, industry-wide private equity data shows the asset class over the long-term beats listed markets by 4% per annum on average. 

But when you look at periods when volatility is above 25%, PE outperforms by an average of 8% per annum. So, you’re getting double the outperformance when volatility is higher, which is when PE punches above its weight.” 

Why PE? Why now? 

While many market watchers believe an equities correction is imminent as prices consistently break all-time highs and valuation multiples soar, Smith believes that significant upside remains in private equity. 

“People who’ve sat on the sidelines thinking equities are overpriced have missed a lot of the upside as equity markets continued to deliver. 

“This analysis shows that with private equity, you can still capture that upside – and over a longer time horizon, more than you would in listed markets.” 

An added benefit private equity brings to your portfolio is extra downside protection. 

“If volatility does return or some crisis arrives, PE may still generate a negative return, but much less so than in listed markets where you’ll feel the full force of that drawdown,” Smith says. 

Interested in learning more about private equity? Visit the Schroder Specialist Private Equity Fund page to find out more or scan the QR code below: https://www.schroders.com/en-au/au/adviser/seriously-invested-in-private-equity/ 

Schroder Investment Management Australia Limited AFSL 226473. All investments carry risk. Past performance is not a reliable indicator of future performance. Before investing, you should obtain and read a copy of the product disclosure statement from schroders.com.au