Private equity offers numerous attractions to investors. The primary benefit is the potential for returns that, over time, have been shown by numerous studies to outperform other asset classes – (and revealed by our recent client survey as the number one reason our clients invest in the asset class). However, a particular advantage is often overlooked: reduced volatility compared to public markets.
Volatility is a hallmark of public markets. While it can create value for some investors, such as hedge funds, it can also lead to damaging consequences for companies due to wild swings in investor sentiment. For private investors, who often cannot exploit liquidity options in rapidly shifting markets within hours or even minutes, this volatility can be alarming. Studies indicate that private investors typically hold listed equity funds for an average of 3.6 years1, meaning few take advantage of constant liquidity opportunities. During stock market shocks, they may feel they have missed the ideal moment to sell.
Private equity offers a solution to this volatility by allowing investors to take a longer-term view while still reflecting public market events to some degree.
At Connection Capital, we provide our clients with quarterly investment reviews and valuations of their portfolios. This organisation-wide process involves many colleagues producing valuations for our direct investments and collating those from the numerous third-party managers we support in direct businesses, co-investments and funds. We incorporate these into consistent and informed investment reports for our clients.
Our latest quarterly investment review process has already begun, and we are awaiting the delivery of management accounts to 30 June to finalise the valuations. Producing quarterly investment reports for nearly 100 individual investments is a continuous process, akin to 'Painting the Forth Bridge' - once one quarter's workload completes, the next begins. Although, as an aside, the Forth Bridge now uses a new type of paint that only requires repainting every 25 years! Nevertheless, it feels like we have only just completed reporting the previous quarter's results (to 31 March).
As this next cycle commences, I have reflected on the contrast in volatility between public and private markets. The basis on which our past quarter's valuations at 31 March were computed was just two days before President Trump announced his latest tariffs on what he termed 'Liberation Day.' The early part of the intervening period saw dramatic fluctuations in public equity, government gilt, and bond markets as investors adjusted their perspectives on the impact of these tariffs. The S&P 5002, NASDAQ 1003 and FTSE 1004 fell by more than 11% from their close on 31 March over the following 10 days. US 10 Year Treasury yields gyrated from 4.01% to 4.47% in the same period5. Most of these markets have since recovered, and while the issue of tariffs remains, the initial shock has subsided.
Meanwhile, as we prepare our work for our 30 June private equity valuations, I estimate that, overall, these will show little change since 31 March. This reflects the longer-term approach to private equity valuations. While marking-to-market (i.e. applying comparable public company and sector ratings to company earnings) is a component, many other considerations feed into valuations. These have been highlighted in the recent FCA review of Private Market Valuation Practices, published in March. The review identifies yardsticks such as comparable company transactions and future cash flows as other means of valuation and emphasises the importance of consistency in methodology.
Private equity ownership is inherently long-term, allowing managers and investors to adopt a cautious and planned approach. Exits are managed to maximise value opportunities. The journey will inevitably have its ups and downs, as there are risks with investing in private equity, but these are more akin to bumps in the road, rather than the vertiginous daily swings public markets can see.
The initial private equity investment and due diligence process requires significant effort, typically followed by the implementation of a 100-day plan post-completion. Finally, longer-term value creation strategies, which may include bolt-on acquisitions or capital investment to expand, are implemented. This long-term view on value optimisation ensures that valuations reflect market conditions and company performance but are not subject to the severe fluctuations seen in public markets.
Ultimately, this approach is proven to optimise value. Additionally, the absence of unbridled volatility has the added advantage of benefiting the health and perceived wealth of the private investor!
Sources:
- Encouraging retail investment in the stock market - House of Lords Library
- SPX500 Index today - eToro
- NSDQ100 Index today - eToro
- FTSE 100 FTSE overview - London Stock Exchange
- US 10 year Treasury Bond, chart, prices - FT.com