A year from retirement, a medical industry executive spoke about an idea for a private equity investment that her financial advisor had mentioned. Her initial reaction was favorable: She saw a chance to get in on the ground floor of a good idea, as well as an opportunity to capitalize on her knowledge as an accomplished professional in the medical industry.
Still, while she might be able to take advantage of this potential industry-changing investment, hesitation crept in as she considered her lack of understanding about the potential risks associated with private equity investments.
Private equity's risk profile is complex — and not for everyone. Depending on the quality and reputation of the investment sponsor or issuer, there can be challenges ranging from naturally private or "opaque" practices to higher fees and less-than-hoped-for returns.
Sophisticated investors have understood private equity trade-offs for years. Higher potential rewards typically come with higher risks and, perhaps, higher fees. An individual with exposure to 10 different investments may find that only one — or even none — turns out to be a winner.
As it is with other asset classes, the concept of diversification is critical to investing in private equity.
Still, even with these inherently higher stakes, investors have amped up their commitments to private equity from $30 billion in assets in 1995 to $4 trillion 20 years later. Over that period, private equity's annual asset growth rate broadly surpassed traditional long-term mutual funds 28% to 10% respectively, according to the 2016 SEI Private Equity Survey.
Going Mainstream
Institutional investors have been a prime contributor to this niche asset class evolving into more of a mainstream investment. At the same time, more advisors seem to be encouraging their retirement-minded clients to take a closer look at using their own expertise in tandem with their advisor's knowledge to seek out tomorrow's potential private-sector winners.
Managing Director Charles Petrie of ARS Investment Management LLC is seeing growing interest in this nontraditional asset class. "Many advisors I speak with tell me their clients want to diversify their retirement portfolios with private equity," he said. "They see it as an opportunity to pursue returns that may be above average with acceptable risk."
Taking Ownership
Like any investment with the promise of higher return, higher risk is a part of the calculus.
"When it comes to private equity, investors and their advisors must take the time to really understand what they own," Jeffrey Kelley, senior vice president of Equity Institutional, said recently. His firm, through Equity Trust Company, offers IRAs, qualified retirement plans and non-retirement custodial accounts for private equity and other alternatives.
While a growing number of private equity opportunities may be accessed through tax-advantaged vehicles like self-directed IRAs, Kelley added, "It's still important for investors and advisors to undertake their own due diligence carefully."
In Search of Transparency
Ironically, one of the category's main attractions, exclusivity, may lead to a potential drawback: a lack of transparency.
Private equity investors may dislike finding themselves in the dark about what their investment is actually doing. With a private investment that requires no public disclosure and less regulatory transparency, private equity may lead to occasional surprises.
Some steps, though, are underway to temper the shock factor.
In 2008, national accounting standards were implemented to create a "fair value" standard, which still provided general partners with wide discretion in their calculation assumptions, the Center for Economic and Policy Research (CEPR) pointed out. "It will continue to fall to the SEC's compliance and enforcement units to police the behavior of private equity firms and protect investor interests, as well as the retirement savings of workers."
To help with screening and qualifying private equity choices, a wide variety of online private equity platforms and research companies have also cropped up to offer tools for evaluating and comparing investments.
Upgrading Technology
Inadequate technology to handle the complex nature of privately traded investments has contributed to inefficiencies that may result in missed opportunities and underperformance.
