
(I figured that picture would get some clicks!)
When I first started vetting investments for a single family office, the one asset class that mystified my team was Private Equity.
We all knew we needed to be invested in it. But how does one start investing in PE?
How does the investment really work from the viewpoint of the investor?
(clearly not like Public Equity, but how so?)
Why are the returns supposedly "so good"?
Is there extra commensurate risk?
After all the fees, lockups, tax implications, is it really worth it?
How do I diligence this stuff?
Basically, explain to me how PE investing works from the viewpoint of the investor, including all the bumps and warts and explain why (if) it is worth the learning curve and large dollar commitments and long lockups?
This is the five trillion dollar question.
And even after I really dug in, I was even more confused because the numbers where very underwhelming even for a "great fund."
I'll give a scenario that could work.
You call your Wall Street Brokerage firm and tell them that you have money that needs to be deployed into PE and you want them to start showing you funds that are raising capital.
They invite you into the Private Bank office and make you fill out the docs to qualify for their platform. Depending on which bank you choose, the minimums are different.
The deals and fees are also different. Usually there is a placement fee, a management fee and carried interest fees.
Huge wall street banks all theoretically have the best access to the best deals that you "can't access yourself" either because of high investment minimums and lack of connection to fund management. And the fact that you just don't know who is raising money right now because it's an opaque market.
This is or isn't true, it depends on the situation, but funds are usually looking for family office investors (low strings attached).
To diligence PE you need to meet with management, analyze prior returns, analyze present investment mandate etc. This is requires time and effort, and access to data.
They also have large diligence teams, which you presumably do not.
So, you tell them what you're basically looking for, and they show you a fund with 16% IRR in previous funds.
This is supposed to be a $5B fund with Net after fees IRR of 16%.
You commit $1M to the fund.
The first three years they email you periodically and require that you wire funds to them to invest.
After 3 years they have asked for $500K and report that they are likely finished investing, but maybe not.
At year 7 you break even and get original $500k plus a profit.
By year 9 you have realized a profit of $543,478.
If you think about it, on the $500k investment,you made $60,386 per year. That is 12% per year.
Not bad, but not 16%.
However, if you think about needing to keep the entire $1M on hand just in case the fund requests it from you, the return is much lower. 6% per year. And this is supposed to be a world class fund!
You check out the statement and you see a cashflow chart like this:

Here's another problem:
Fine, my PE fund starts returning money to me after year 3. What do I do with it now, just buy stocks?
Theoretically this money is in my "PE allocation" so I should reinvest in PE, but the cash flow is so chunky, that means that I must find another fund raising money and calling capital at the same time and in the same dollar amounts. Highly unlikely!
So is there a way to invest in this stuff properly to make it a completely game changing investment class that every large family office commits a large portion of its investable capital to? Or is everyone making a huge mistake?
To be continued.
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