Ultra-high-net-worth (UNHW) investors have a problem. They want to access private equity investments but the vehicles available are not necessarily well adapted to the needs and requirements of wealthy families and individuals. The result is that it can often be difficult for non-institutional investors to meet their desired level of exposure.
With a paucity of suitable investment opportunities, and money being returned to investors faster than it can be called, individuals who want to get into private equity are being dragged back out
The dearth of compelling uses for private capital today, combined with the fact that, at this point in the economic cycle, the private equity industry is returning significant amounts of money to limited partners, means that private investors are struggling to reach their target asset allocations to private equity.
This has been described as the ‘reverse Al Pacino effect’, a reference to the actor’s Godfather quote: ‘Just when I thought I was out, they pull me back in.’ In this case, with a paucity of suitable opportunities, and money being returned to investors faster than it can be called, families and individuals who want to get in are being dragged back out.
UNHW investors find this particularly frustrating, as many made their fortunes through building a family business and, therefore, are often keen to get involved in the nuts and bolts of private equity. Many retain an interest in buying and growing businesses, and feel they understand private equity better than other investment types.
Beyond this natural affinity with private equity, however, many wealthy families are looking to invest more in private markets, as, when done correctly, this can offer an attractive real rate of return, outperforming other asset types but with manageable volatility for long-term investors, which is exactly what wealthy families are.
At the heart of the issue is the fact the vast majority of private equity funds are built around the needs of institutional investors, using a limited partner or general partner structure that lasts for ten years and has the aim of holding individual assets for three to five years. This means funds are normally built around short-term liquidity events that allow the fund manager to return capital to investors and earn a performance-based fee.
Normally this is a good thing, but there is not a huge pipeline of attractive private equity deals in the market at present. This means investors are increasingly making new commitments to funds that are not drawing the capital down to invest. Combined with the recent uptick in private equity firms selling assets, this is actually reducing investors’ net exposure to private equity.
How to attract UHNW investors
In order to get beyond the reverse Al Pacino effect and to attract more capital from UHNW investors, the private equity industry needs to develop a new product that fits their unique long-term needs.
Most investors view the private equity fund model as an illiquid long-term investment, but, for a family that is preparing to pass on its wealth to future generations, it is not necessarily long-term enough. The ideal investment horizon for families or individuals looking to create a multi-generational legacy can be infinite.
This creates several challenges for the private equity industry, however, as one of the good reasons for having regular liquidity events is to allow the fund manager to realise value and collect performance fees. Without such liquidity events, the private equity fund manager would have to be incentivised in a new way.
Some UHNW investors are turning to direct investment in private markets, without a fund manager involved, in order to get past these issues. But this is not as straightforward as it may seem and, for many wealthy families, allocating to private equity via funds, as imperfect as it may be, remains the most sensible and the least risky option.
But, if private equity funds want to attract more capital from UHNW investors, the industry needs to consider a longer-term solution. It must develop a new way of investing that allows a fund team to be incentivised by performance, but in a structure that is designed for much longer-term investment opportunities.
The challenge is there to be met and there remain many questions for private equity firms to answer. A failure of the private equity industry to offer a tailored product could result in more wealthy investors becoming further frustrated with the impact of the reverse Al Pacino effect and perhaps even disillusioned with private equity altogether.