Thane Stenner is portfolio manager and director of wealth management of StennerZohny Investment Partners+ within Richardson GMP. He is a founding member and chairman emeritus of TIGER 21 Canada and author of True Wealth.
One of the most notable trends of the past decade has been what I call the private equity "renaissance" – an increasing interest in direct investment in operating businesses not publicly traded on a stock exchange, and in private early stage venture capital companies in particular.
With the advent of private equity funds and other products, private equity is no longer the exclusive domain of pensions and ultra-wealthy individuals. The broader high-net-worth (HNW) population is becoming a lot more interested in this asset class, as are investors of more modest means.
While allocations to stocks, bonds and cash have waxed and waned, allocation to private equity has been straight up, from 12 per cent of the portfolio in the fourth quarter of 2007 to more than 23 per cent of the portfolio in the most recent quarter.
I recently spoke to Mike Cegelski about this trend. Mr. Cegelski has been a highly respected and accomplished start-up or "angel" investor for about 16 years, most recently as Managing Partner of 500 Startups Canada, an early-stage venture fund providing capital and mentorship to promising young companies across the country.
To Mr. Cegelski, the appeal of private equity and venture capital (VC) investing is easy to understand. "It's not magic," he says. "Bonds are creating little value and the stock market is unpredictable. Meanwhile, private equity and VC can potentially increases returns and reduces some volatility."
But aren't these traditionally considered high-risk assets? "They can be, but the risk isn't as high as it's perceived," Mr. Cegelski says. "Proven track records – high teens performance – and well-known successes in the VC world have really changed how investors see the risk/reward equation."
As Mr. Cegelski explains, being a private equity or VC investor is more about mindset than net worth. "You need a high tolerance for risk, for sure," he admits "But the real key is patience. You have to be the kind of investor who can wait for an idea to bear fruit."
Mr. Cegelski recommends only a small portion of net assets devoted to private equity and I wholeheartedly agree. An allocation of 10 per cent to 20 per cent of the portfolio is a good target for most HNW investors (maybe half that for those with average portfolios), of which only a quarter would represent early-stage VC or angel investments.
Even then, you want to be well diversified. "Less than 10 per cent of our portfolio companies' account for 80 per cent of returns," Mr. Cegelski points out. "You will lose more than you will win – but if one of your winners is the next Airbnb, the returns can be amazing."
Interested? Here are three things to keep in mind:
It's about diversification
Returns on private equity can be impressive. That said, the big appeal of private equity is non-correlated performance – the ability to "zig" while traditional assets (particularly public equities) "zag." In an era in which traditional asset classes seem to be getting "toppy," this kind of diversification is a very good thing.
Think (very) long term
Most private equity investments take at least seven to 10 years to come to fruition. Nearly every private equity manager recognizes this by stipulating some sort of strict lockup period (lasting at least a year, and as many as five). Most managers also have redemption fees ranging from 1 per cent to 5 per cent in the first five years following the expiry of the lockup.
Respect the art
Most investing is the stuff of science: analyzing balance sheets, applying logic and discipline, limiting emotions and so on.
Private equity investing isn't like that. Sure, you need to look at the numbers. But you're investing primarily in people – this is particularly true of VC investing. That makes it extremely subjective, relying as much on intuition and judgement as facts and figures.
The implication: Most of us should trust in professional managers with proven track records rather than trying to evaluate opportunities on our own. Even successful entrepreneurs (as many HNW investors are) can quickly be overwhelmed by how much there is to know.