Private equity has become the subject of extensive debate here in Europe. In particular, much has been made of the tussle between the unions and the large buyout funds. Little of the criticism is justified, although there is widespread recognition that disclosure by private equity firms, and their portfolio companies, can be improved.
There has also been significant discussion about private equity as an asset class having a perceived unfair advantage in the public markets – ‘stealing’ value from the public markets, then re-presenting companies having stripped them of the fundamentals required to survive in the longer term. The unions, led by the GMB, have championed this argument.
Clearly the vast majority of private equity investing has nothing to do with taking companies away from public markets. However, private equity appears to fall victim to a range of negative perceptions. At the heart of them all is the view that private equity funds use cheap debt to achieve the kind of radical business transformations – both on and off the stock market – that are simply unachievable in the public markets and that, in doing so, private equity funds generate the kind of superior returns that are denied to public market investors. Whilst pension funds can invest across a range of asset classes, retail investors are limited to the stock market. So, the logic goes, nearly three million people in the UK may be employed by companies in private equity hands but, as retail investors, they can’t access the spoils.
So what is the comeback? Clearly one could point to the ability of private equity-backed companies to outperform those on the public markets, thereby guaranteeing the employment of many thousands of people and their longer term economic security. Or the fact that private equity helps fuel economic growth, often whilst keeping companies in UK ownership. But also, retail investors can access private equity through a variety of means, both indirect and direct. If retail investors were more aware of these, whilst understanding the risks of private equity, would that foster a better understanding of, and trust in, private equity? The answer has to be “yes” – the concerns of the unions are another matter.
The commitment by pension and life funds to private equity is substantial and growing, as we know from high profile statements by Hermes et al. Given the relative lack of transparency within the private equity community, particularly as to specific portfolio company performance, and the increasingly complex funding structures employed, the risks for private investors are material. However, increased access to private equity, as part of a balanced investment portfolio, has to be attractive.
Retail investors have a range of options for investing directly in private equity:
- Through funds such as Candover and Electra Investment Trust
- A limited number of PEITs such as 3i and SVG Capital offer limited direct access to the market
- VCTs (arguably at the riskier end of the market)
- Through a limited group of listed private equity fund of funds e.g. those of Foreign & Colonial and Pantheon
Although the UK public markets are highly liquid and are seen as creative and evolving, the Listing Rules do not make it particularly easy, or straightforward, for private equity funds to list. Particular barriers to listing include the need for Board independence, the desire of many private equity funds to understand and “control” their investee companies, and the historic difficulties surrounding the ability of primary listed investment entities to take control of the companies in which they invest.
However, with the likes of Blackstone, as well as certain hedge funds, coming to market these blockages are likely to be removed. Recent fundraisings reflect the current strength of the public markets but also demonstrate that there is considerable investor appetite for alternative assets. Particularly relevant for the larger private equity funds, the ability to raise “permanent” capital to fund expansion and provide liquidity for senior partners and founders is very attractive. Despite the protections built in to Blackstone’s structure post IPO, the fact that a fund as successful and well-known as Blackstone will have to provide increased information about their business can only be constructive for the sector as a whole.
Perhaps the most significant issue, which will drive further evolution in the private equity world and its relationship with the public markets, is the concern that the growth of private equity, combined with the capacity of the leveraged finance providers, will drain the public markets of quality assets and liquidity. Particularly when set in the context of the increasing regulatory burden of the public markets, private ownership is a very attractive, and often remunerative, alternative to a listing.
It is clear that private equity and the public markets each have their place. Given the amount of money being raised by private equity firms and the high profile deals increasingly targeted, the debate about private equity is positive if it helps stimulate greater awareness and therefore understanding. If the natural outcome of the current debate is better reporting and greater transparency, it will help secure the longer term future of the private equity industry and should improve relations with the naysayers including the unions.