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Private Equity: Where Smart Money Invests

We often hear reference to “Endowment Model” investing when people speak of portfolio diversification. It’s no surprise that pension funds, family offices, endowments, and the super wealthy invest differently than most of us. The question is what do they invest in and why?

To answer this question, we must first consider their investment objectives. Most institutional investors have long time horizons for growing the value of their portfolio. This is often measured in decades rather than years. This long term view affords these forward thinking investors to focus their investments on asset classes that have a greater likelihood of generating higher risk adjusted returns over an extended period of time. Large endowments like Yale University have taken this approach and have chosen to invest the largest portion of their portfolio into private equity. In fact, as of its last published report, Yale has invested more than 30% of its endowment in private equity.

Like all asset classes, private equity has good years and bad years. However, because it is a long term ‘investing’ business for private equity sponsors, they are able to measure their performance over the hold period for an investment rather than modifying their plan to meet a quarterly earnings target. This is why private equity tends to have a low correlation with the public equity markets.

Most experts believe that the strong and stable economy we have all experienced over the past few years sets the table for private equity investors today. As a matter of fact, a recent CNBC article stated, “it’s boom time for private equity.” Jeff Davis of Eaton Partners says, “Private equity allocations amongst pensions and endowments are at great levels. Pensions will continue to drive those allocations as so many are more comfortable these days with increased risk and taking exposure to private equity to meet these long-term liabilities.”

Steve Judge, head of the Private Equity Growth Capital Council, the industry’s main trade association, recently commented, “We are seeing positive indications for a strong 2015. Within both the private equity environment and broader economy, there is enthusiasm for investment and putting capital to work in the coming year.”

One reason investors are bullish has to do with what happened last year. In 2014, PE funds invested nearly $1 trillion in over 5,305 deals. This was the highest number of transactions since 2007, according to data tracker PitchBook. Also, funds netted a record $445.7 billion on their 1,671 “exits” of companies through a sale or IPO, up 46 percent from 2013. Lastly, PE funds have about $750 billion in capital or “dry powder” to invest, according to published reports.

Private equity deals are happening with more frequency today. The reason behind this is cheap credit, a stable economy, and significant growth potential in sectors such as healthcare and finance.

A robust M&A market is also allowing for attractive exit opportunities for private equity firms. The company I work for, Los Angeles-based Triton Pacific Capital Partners, has taken advantage of this dynamic by selling several of its portfolio companies over the past year, with plans to exit several more this year. As an example, the recent sale of Custom Credit Systems to Misys generated an overall return of approximately 6x what it had invested.

“As long term investors, we have the luxury of time to apply our trademark Value Enhancement Program™ to increase the value of these companies with a multi-year plan and without worrying about next quarters earnings release to the public,“ said Craig Faggen, Triton Pacific’s Chairman and CEO.

This is the power of being ‘private’ in private equity.

There’s still plenty to invest in today. Many private equity managers comment that they are finding high-quality companies to invest in. Even though pricing may be relatively high, it’s not to the point of making the deal unattractive because the companies fundamentally have solid strong growth prospects ahead.

Faggen added, “There are approximately 3,300 private equity firms today with headquarters in the US that have access to over 170,000+ U.S. based private companies with revenues in excess of $10MM.”

Smart money from pensions, endowments, ultra-wealthy families and other institutional investors are pouring in. However, until recently, individual investors have had few if any options to access private equity. A crop of non-listed business development companies (BDCs) have come to market to offer investors access to investing in the debt and equity of non-public companies.

Most BDCs are focused on income, while we at Triton Pacific Investment Corporation, a private equity focused non-traded BDC, have a hybrid approach that targets both growth and income. Investors are looking for more from their alternative investments. They need alpha, they need growth, and that’s what we target to deliver.

With cheap credit, plenty of private companies to invest in, and a healthy appetite exhibited by investors, the year ahead for private equity looks exciting. Much like the fabled story about the tortoise and the hare… it’s slow and steady that always wins the race.