A high-stakes game for the wealthy

If a US trend towards the opening up of private equity funds to high-net-worth individuals is replicated in Australia, ASIC had better be on its toes.

Private equity firms are about to become a little more open to the public.

In a move that echoes the way hedge funds lured individual investors in the mid-2000 boom years, some of the giants of the private equity world are exploring ways to open their doors to wealthy individuals.

For the big-name buyout funds, this promises a lucrative new avenue of funding as some pension funds and other public funds shy away from private equity because of its high fee structure.

However, the move is fraught with risk for investors, who may be lured by the cachet of the buyout firms such as Blackstone and Carlyle.

Washington-based Carlyle Group has been travelling across the US pitching to high-net worth investors for its new vehicle, Carlyle Private Equity Access 2014, which will allow access across four of the group’s funds. The funds have investments in the US, Japan, Asia and Europe.

A private equity firm typically targets a company that is underperforming due to mismanagement or lack of strategic focus, owns the company for three to five years while the business is made more efficient, and then looks to exit at a massive profit.

But private equity partners can’t necessarily sell the company when they would like to. The complete shutdown of IPO markets from 2008 until late last year is a case in point; private equity owners were unable to sell via IPO, and similarly risk-averse trade buyers were also out of the picture.

The flood of private-equity backed IPOs this year – 264 floats globally through September – reflects years of pent-up desire to sell.

So capital can be tied up for years – often up to a decade – before any return is realised. For the typical sophisticated institutional investor, the lack of liquidity is not an issue, but it may prove problematic for individuals needing access to their funds.

Private equity uses debt to finance about two-thirds of a deal, with equity making up one-third. Heavily leveraged deals can, and do, go wrong, particularly when the price of debt changes abruptly.  Many PE firms went broke after the 2008 financial crisis. 

Earlier this year, the Texas power utility formerly known as TXU went bankrupt under the weight of debt piled on by its three big-name private equity buyers. Buyout firm CVC posted the biggest ever private-equity loss in Asia when it lost Nine Entertainment in a debt-for-equity swap in 2012.

And yet, financial advisers are now looking at investments in private equity firms to help diversify their clients’ portfolios as typical hedge fund returns have diminished in recent years.

They are being aided by new products such as iCapital Network, an online platform launched this month and backed by a consortium that includes Blackstone Group and Credit Suisse which aims to connect individual investors with private equity fund managers.

With investment thresholds as low as $100,000 for wealthy investors, iCapital is being accessed by investors that have some $450 billion in assets.

The pitches to individuals searching for yield in a low-return world have only just begun in the United States and it will be interesting to watch whether the local counterparts of big buyout firms follow suit.

The industry lobby group AVCAL says the amount of capital invested by Australian super funds into domestic private equity is relatively small at 1 per cent of the current savings pool, compared with an average allocation in the US of close to 10 per cent. So perhaps firms will start to cast the net more widely as they look to bolster management fee income.

Meantime, the corporate regulator ASIC says one of its strategic goals this financial year is to monitor risks associated with the gatekeepers for investment into the opaque world of hedge funds.

ASIC has its hands full watching high-risk entities such as managed investment schemes, advisers working at financial advice institutions, and hedge funds. But it may need to add individual investments into private equity funds to its remit in the future.