Time to Embrace Private Equity (2022)

For decades, investors with traditional portfolios have relied on a steady bull market in stocks and bonds to meet their financial goals. And for the most part, they have been rewarded. The average return from a 60/40 portfolio over the last 10 years has been 7.1%.1

But that’s not likely to be the case going forward. Volatility has dominated public markets this year and is unlikely to ease up until there are signs the Federal Reserve is winning its battle against inflation, without pushing the U.S. into recession.

U.S. public equity returns are expected to be modest at best, with our Capital Market Assumptions forecasting annualized average returns of less than 6% for the next 10 years. For investors with traditional portfolios, it means the time has come to consider private equity.

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“We believe exposure to private equity and venture capital will be a key driver of outperformance within a well-diversified investment portfolio going forward,” says Joanna Berg, senior alternative investments strategist at BNY Mellon Wealth Management. “Private equity's illiquidity offers protection against public market volatility, as well as historically better returns.”

In February, we reduced our public equity weight in client portfolios to neutral, by cutting back on exposure to small capitalization stocks. We have been advising qualified clients, including those with traditional allocations, to consider redirecting those funds into private equity.

Many investors question the years it can often take to see returns from a private equity investment, and the lack of transparency. But for those with the funds and a long-term investing horizon, adding private equity can help reduce portfolio volatility, diversify return streams with an asset class with low correlation to public markets, and potentially improve returns.

It also keeps an investor’s allocation mix aligned with structural changes in the dynamics of equity markets.

Structural Changes in Equity

The past decade has seen a steady shift by investors and companies away from public equity markets and into private market strategies. The basic strategies include private equity (PE) funds, which typically buy majority stakes in existing companies, and venture capital (VC) funds, which provide seed and other early-stage funding to startups.

Today there are more private companies than public ones.2Most initial public offerings (IPOs) of stocks are now initiated by private equity firms,3 and the majority of a company’s value creation occurs during the private phase of its life, rather than in the public markets.

Exhibit 1: Companies Are Staying Private Longer

Time to Embrace Private Equity (1)

It used to be that young companies would have to issue an IPO to raise enough funding to scale operations and grow market share. That gave public equity investors the opportunity to invest in innovative startups at the ground floor, by purchasing small-cap stocks.

However, after decades of low interest rates since the 2008 financial crisis, investors have steadily increased their allocations to private markets to achieve greater returns. Global assets under management (AUM) in private equity strategies grew 37.7% in 2021 to $6.3 trillion, and made up nearly two thirds of the total AUM across all global private markets.4

Such enormous inflows into private equity have irrevocably changed public market dynamics. Rather than having to raise funds in an IPO to scale, companies are staying private for much longer, getting all the capital they need to grow and even become dominant market players.

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Uber and Airbnb, two of the largest ever tech IPOs, waited 10 and 12 years respectively before going public, at high multiples and long after they had disrupted their industries. Both were so large that they skipped the small cap sector altogether and went straight into large-cap indexes.

The number of unicorns (private companies valued at more than $1 billion) hit 1000 globally for the first time in the first quarter of this year, and rose 70% in 2021, on the back of record venture funding across industries.5

“This is one of the reasons why we recommended clients reduce exposure to small caps earlier this year and redirect that money into private equity,” says Berg. “Small cap stocks used to be the sector where startups began. But now startups can spend over 10 years in the private markets and are multi-billion-dollar large cap stocks by the time they IPO.”

Staying private for longer has numerous advantages for companies and investors in private equity strategies. PE firms are prepared to spend years nurturing portfolio companies with funding, and by applying their industry expertise and operational experience. Companies can test new products and build market share without being subjected to short-term investor sentiment driven by quarterly earnings.

While volatile public markets may hurt IPO timing and multiples, private equity portfolio managers have complete control over when they buy or sell and are not subjected to investor capitulation as public stocks are. Volatility also creates industry dislocations that managers of PE and VC funds can take advantage of.

The flexibility afforded by private equity’s inherent illiquidity and long-term investment horizon has underpinned the asset class’s ability to provide better returns than public markets.6

Exhibit 2: Private Equity Performance vs. Public Equity

Time to Embrace Private Equity (2)

Lower Portfolio Risk

Investing in PE or VC typically requires commitments of as much as $5-10 million to gain entry to the best funds. Unlike a mutual fund with daily liquidity, an investor must also commit those sums for as long as 7-10 years. It can take 3-5 years before receiving a return on investment through a company sale.

Yet, as the exhibit below shows, it can be worth the wait. Private equity investments have historically added significant value to diversified portfolios over the long-term, due to their low correlation, higher returns and lower volatility.

Investors (called limited partners) who are just beginning to build a private equity allocation, can integrate private equity secondaries into their portfolios to mitigate theJ-curve return effect. PE secondaries are investments in mature interests held by limited partners and are characterized by earlier cash flows that shorten the time it takes to see returns.

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Exhibit 3:Private Equity Adds Value to Portfolios

Time to Embrace Private Equity (3)

How to invest in Private Equity

Finding the best-performing PE and VC managers is easier said than done, and critically important for private equity investing success. The exhibit below shows a 25% difference between the performance of the top-quartile managers and the bottom quartile.

Exhibit 4:The Importance of PE/VC Manager Selection and Access

Time to Embrace Private Equity (4)

The difficulty lies in the lack of real-time information on the performance of PE and VC funds and their portfolio companies. Another issue for individuals is that funds run by the best managers are often closed to new investors.

Many individual investors instead turn to institutions like BNY Mellon Wealth Management to gain access to the top funds. Our private equity team, for example, has experts with an average of 20 years’ experience in private markets. They have the deep industry networks and relationships necessary to gain access to the best funds.

BNY Mellon Wealth Management’s private equity team provides its core clients with a fund of funds, or multi-manager approach to private equity investing, so that investors can spread investment risk across a range of top-performing PE and VC fund managers. Our largest clients can build a private markets portfolio through a core-satellite approach, with the multi-manager fund providing the diversified core PE exposure, supplemented with highly sought-after single manager funds as satellite investment strategies.

The multi-manager approach achieves diversification across PE and VC investment strategies, the sectors they are targeting, as well as geographies. BNY Mellon Wealth Management clients are given a choice of concentrating their exposure on just PE or VC managers, or a combination of both.

Having a mix of vintage years is also an important factor, and one which can be achieved through a fund of funds.

“Because of the long-term nature of private equity commitments, economic conditions can vary during the investment horizon,” says Paul Vittone, head of private markets at BNY Mellon Wealth Management. “Since no one can predict the market, it’s prudent to invest across a complete business cycle with investments in several vintage years to diversify risk and potential returns.”

Having exposure to the best fund managers is even more critical at a time when rate hikes and higher inflation could increase the cost of leveraged buyouts and reduce valuations when private companies are taken public.

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“PE fund managers and their companies will need to increase their focus on building revenue growth of portfolio companies, and effectively managing them amid rising rates and inflation. They will not be able to rely on the expansion of multiples that has buoyed the industry’s returns to limited partners in recent years,” says Vittone.

Finding the Sweet Spot

Bigger is also not always better. After 10 years of strong inflows, private equity funds now have $3.4 trillion of dry powder globally,7 much of which has poured into the biggest global PE firms. The mountain of unspent capital puts pressure on general partners of large funds to invest in ever larger deals. This concentrates private equity market competition among the biggest players.

“Having so much money to put to work means they have no choice but to compete with one another for the largest companies, which continues to put pressure on valuations,” says Vittone.

Vittone believes that leaves better opportunities for smaller PE and VC fund managers specializing in small and mid-sized deals, where big global PE firms don’t typically play, and valuations are less inflated.

“Private company valuations correlate with two variables: one is size, and one is growth rate,” Vittone explains. “When you peel back the onion on the rise in purchase price multiples for private companies, you will see that it’s the larger companies that are selling at 13-15x earnings, while smaller companies are still selling at 6-10x. We see the opportunity in funds that focus on the latter.”

BNY Mellon Wealth Management's VC fund of funds also allocates roughly 20% of its capital to non-U.S. fund managers, to capture the global nature of technology disruption driving thematic investing opportunities. Fund managers are often focused on innovation arising from secular macro trends, like digital transformation in the wake of the pandemic, aging demographics, climate change, global connectivity, and deglobalization.

Given the structural shifts in markets, private equity strategies offer the best way to gain early exposure to future disruptors in climate change mitigation technologies, precision medicine, software, automation, blockchain-based “Web3” developments, and cybersecurity.

“Clearly in the current geopolitical environment, cybersecurity is a huge trend that is offering significant investment opportunities in cloud security startups,” says Vittone. “We also see opportunities in precision medicine and real-time health data, artificial intelligence, automation and Web3 developments.”

Investing in private markets is more complex than buying stocks, and higher returns do come at the expense of liquidity. But companies are staying private for longer, now that private markets have attracted a flood of investors looking for better returns. That means the biggest investment opportunities are more often found in the private equity market rather than public stocks. These market shifts, along with expectations that public equity returns could be muted in a higher rate, higher inflation environment, makes a strategic allocation to private equity a wise choice.

Next step: For those interested in learning more about private equity, BNY Mellon Wealth Management’s private capital team have answered frequently asked questions from our clients. Please download them here.

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FAQs

How do you answer private equity? ›

What to Include in Your Answer to “Why Private Equity?”
  1. Highlight that you have some transaction experience.
  2. Express an interest in a sector that the PE firm invests in.
  3. Position yourself as a long-term thinker or investor.
  4. Show that you know what the PE firm has invested in.
11 Nov 2020

Why is private equity so important? ›

Private equity firms raise money from institutional investors (e.g. pension funds, insurance companies, sovereign wealth funds and family offices) for the purpose of investing in private businesses, growing them and selling them years later, generating better returns for investors than they can reliably get from public ...

Why do you love private equity? ›

You prefer PE because it's a blend of both operations and finance and because you can help Founders with well-established businesses make them even better via solid analysis and research rather than just guesswork.

How do you gain access to private equity? ›

You can purchase shares of an exchange-traded fund (ETF) that tracks an index of publicly traded companies investing in private equities. Since you are buying individual shares over the stock exchange, you don't have to worry about minimum investment requirements.

How can I impress in private equity interview? ›

Good answers suggest to the interviewer what you can bring to the company. Check out recent deals, target companies, and say something that shows a genuine interest in the company you want to work for. “Summarize your experience in the context of their firm – why are you going to be useful to them?” advises McManus.

What is private equity in simple words? ›

Private Equity refers to shares of a company that represents its ownership. An individual who wants to take partial ownership of a company can make a private equity investment in that particular firm. These companies are not listed or traded on any stock exchange.

What is unique about private equity? ›

Unlike public markets, a private market investor can have information advantages, such as access to management and greater visibility into a potential portfolio company. Private equity is an inefficient market compared to public markets, and thus provides additional opportunities for attractive valuations.

What is life in private equity like? ›

People in private equity are older, more professional and tend to have young families, so most people care about having good weekends. When you're in the heat of a live deal, you'll most likely be working 80+ hours per week. By live deal, I generally mean that you have exclusivity with a specific company.

How does private equity help a company? ›

Maximize your growth.

Private equity investors bring process improvement, margin enhancement and margin improvement expertise. Plus, they utilize mergers and acquisitions by buying other companies that are similar and combining them to scale faster.

Is private equity a fulfilling job? ›

A career in private equity can be highly rewarding, both financially and personally. Private equity managers often take a great deal of satisfaction from successfully guiding their portfolio companies to new high levels of profitability.

What makes a good investment private equity interview? ›

Technical and transaction questions require you to have solid financial modeling and valuation experience, with a strong understanding of how to make good investments. Firm and fit questions are more soft skills type questions and require being prepared to speak in detail about the firm and about yourself.

Is private equity exciting? ›

Overall, I think it is clear to say that working in the Private Equity industry is an exciting career path, and will always stay interesting, no matter what portfolio firms or investment deals you work on. About Raw Selection: Raw Selection favours a meticulous approach to candidate research.

What knowledge do you need for private equity? ›

Key skills required for private equity jobs

Nevertheless, your degree should show that you have analytical ability; usually, finance and science degrees are favored. A strong professional background in investment banking, strategy consulting, corporate development, or restructuring is what recruiters seek.

What is private equity looking for? ›

In short, there are many reasons why a private equity investor may be interested in your business, including your sector, the stage in your business lifecycle, the location of your business, the valuation of your business or the financial position of your business.

At what age do people get into private equity? ›

Age Range: You're unlikely to reach this level before your mid-to-late 30s, so we'll say 36+. But that's just the minimum – most Partners are likely in their 40s or beyond.

Are PE interviews hard? ›

Private equity interviews can be challenging, but for most candidates, winning interviews is much tougher than succeeding in those interviews. You do not need to be a math genius or a gifted speaker; you just need to understand the recruiting process and basic arithmetic.

How can I impress the interviewer with answers? ›

How can I impress the interviewer with my answers?
  1. Be passionate. Have a positive attitude and be enthusiastic when talking about yourself and your career. ...
  2. Sell yourself. ...
  3. Tell stories. ...
  4. Ask questions. ...
  5. Ask for the job.

Why is it called private equity? ›

Private equity firms are, as their name suggests, private — meaning they're owned by their founders, managers, or a limited group of investors — and not public — as in traded on the stock market.

How do you use private equity in a sentence? ›

The company is in talks with several private equity and investment firms.

What makes a good private equity target? ›

The target company's facts and figures must support those forecasts. Even more specifically, private equity firms want to see at least 20 to 25 percent annual profit, which may require the company to improve EBITDA, obtain economies of scale or synergies, and earn high margins.

What is the main objective of private equity firms? ›

The purpose of private equity firms is to provide the investors with profit, usually within 4-7 years. It comprises companies or investment managers that acquire capital from wealthy investors to invest in existing or new companies.

Is private equity stressful? ›

It's extremely difficult to get into private equity, and once you're in, the job is stressful and requires long hours and sacrifices, especially when deals are in their final stages.

How hard is it to move up in private equity? ›

Landing a career in private equity is very difficult because there are few jobs on the market in this profession and so it can be very competitive. Coming into private equity with no experience is impossible, so finding an internship or having previous experience in a related field is highly recommended.

What questions do they ask in a private equity interview? ›

Fund strategy & positioning
  • How many funds and/or product lines does the firm operate? ...
  • Which kind of assets does the company invest in? ...
  • What is the fund's investment strategy? ...
  • What is the size of the fund? ...
  • Which stage of the company's lifecycle does the fund invest in? ...
  • Where is the fund present?

What do you actually do in private equity? ›

Private equity operates with investors and uses funds to invest in private companies or buy out public companies. By doing so, general partners can obtain control over management and other operational changes to increase profitability in hopes to later sell at a successful rate.

How do you discuss a private equity interview? ›

We suggest you structure your answer in 5 parts: Deal Background. Your Role. Business Description & Financial Parameters.
...
Deal Background
  1. Type of transaction (buy / sell / merger / other)
  2. Your bank's role.
  3. Who the buyers / sellers are.
  4. Your Perspectives.
  5. Size of the transaction.

What questions do private equity ask? ›

9 Questions to Ask Every Private Equity Firm
  • 1) How large is your fund? ...
  • 2) What is your target return profile and strategy? ...
  • 3) What role will you play in the relationship during and after the transaction? ...
  • 4) How many investments will the partner have active at one time? ...
  • 5) What is the typical board composition?
10 Jun 2021

What do people in private equity actually do? ›

What Do You Actually Do In A Private Equity Job? Private equity firms raise capital from outside investors, called Limited Partners (LP), and then use this capital to buy companies, operate and improve them, and then sell them to realize a return on their investment.

What skills does private equity need? ›

There are a number of key skills that the most successful players in the private equity business have in common.
...
Key Skills for Succeeding in Private Equity Jobs
  • Financial modeling.
  • LBO modeling.
  • M&A modeling.
  • General financial analysis.
29 Mar 2021

What is life in private equity like? ›

People in private equity are older, more professional and tend to have young families, so most people care about having good weekends. When you're in the heat of a live deal, you'll most likely be working 80+ hours per week. By live deal, I generally mean that you have exclusivity with a specific company.

What is private equity in a nutshell? ›

Private equity, in a nutshell, is the investment of equity capital in private companies. In a typical private equity deal, an investor buys a stake in a private company with the hope of ultimately realising an increase in the value of that stake.

How difficult are private equity interviews? ›

Private equity interviews can be challenging, but for most candidates, winning interviews is much tougher than succeeding in those interviews. You do not need to be a math genius or a gifted speaker; you just need to understand the recruiting process and basic arithmetic.

What makes a good investment private equity interview? ›

Technical and transaction questions require you to have solid financial modeling and valuation experience, with a strong understanding of how to make good investments. Firm and fit questions are more soft skills type questions and require being prepared to speak in detail about the firm and about yourself.

What should a woman wear to a private equity interview? ›

And make sure not to wear French cuffs, a pocket square or a spread collar dress shirt. Women should wear a black or dark blue suit that is not too tight and a conservative length. The shirt should be a light color, preferably white or light blue. Make sure to take it easy on the make-up and perfume.

What are the 5 questions to ask before you invest? ›

5 questions to ask before you invest
  • Am I comfortable with the level of risk? Can I afford to lose my money? ...
  • Do I understand the investment and could I get my money out easily? ...
  • Are my investments regulated? ...
  • Am I protected if the investment provider or my adviser goes out of business? ...
  • Should I get financial advice?

What are the most common questions investors ask? ›

10 Common Questions Investors Ask Founders
  • Why is now the right time to start the company? ...
  • What trends do you see in the market? ...
  • Why is the team uniquely capable of executing the plan? ...
  • Why do users care about your product? ...
  • How did you come up with your business idea? ...
  • Which competitor is doing the best job and why?
28 Jan 2022

What are the problems of private equity? ›

7 Problems with Private Equity that Contribute to Wealth Inequality (And How to Fix Them)
  • But first, how does private equity work?
  • Higher valuations, lower returns.
  • Outsized influence.
  • Debt, debt and more debt.
  • Inequitable compensation structures.
  • Inequitable profit distribution.
  • Barriers to entry.
28 Sept 2021

What makes private equity attractive? ›

Unlike public markets, a private market investor can have information advantages, such as access to management and greater visibility into a potential portfolio company. Private equity is an inefficient market compared to public markets, and thus provides additional opportunities for attractive valuations.

Is private equity a stressful job? ›

It's extremely difficult to get into private equity, and once you're in, the job is stressful and requires long hours and sacrifices, especially when deals are in their final stages.

How long do people stay in private equity? ›

Age Range: You're unlikely to reach this level before your mid-to-late 30s, so we'll say 36+. But that's just the minimum – most Partners are likely in their 40s or beyond. Many MDs and Partners stay in private equity indefinitely because there's no reason to leave unless they're forced out or the firm collapses.

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