Guide to Private Equity: Key features and how to gain access in Singapore

What Happened?

The issuance of the Astrea 8 Private Equity (PE) bonds has led to questions on what is private equity.

While many investors are familiar with public equity through stocks, the concept of private equity may be relatively new for most.

As such, I decided to delve deeper to find out more about private equity to find out what are the features and risks, as well as how investors can get exposure to private equity.

What is Private Equity?

Private equity is a type of investment where a private equity firm buys or invests in privately held companies where they see potential in. 

The private equity firm will try to increase the value of the companies through restructuring or expanding the business of the current company. 

Eventually, the private equity firm profits through selling the company to another business or through an initial public offering (IPO), where the company becomes publicly traded on the stock exchange. 

You might be wondering how private equity firms get so much funds to invest or buy off companies. The structure can be explained with 2 parties. 

One is the private equity firm, primarily responsible for managing and adding value to the companies. 

The other party is known as a limited partner, which includes institutions and accredited investors. They will inject funds for private equity firms to undergo all the purchasing and investing, and the funds cannot be abstracted afterwards for normally 10-12 years. 

The private equity firm charges annual management fees. On top of that, they may also receive a share of fund profits if returns exceed what they were promised to the limited partners, known as hurdle rate. 

What are the different types of private equity? 

There are several types of Private Equity firms, each with its own strategy, target markets, and stages of investment. Here are two of the most commonly seen equity funds:

1. Buyout Fund

Buyout funds concentrate on acquiring mature companies with stable cash flows. 

Their investment strategy involves acquiring majority control of these companies, implementing operational improvements, and enhancing efficiencies to increase profitability. 

By leveraging their expertise and resources, buyout firms aim to generate significant returns through strategic acquisitions and effective management of mature enterprises.

2. Growth Equity

Growth equity firms focus on investing in mid-stage companies that are more mature than startups but still in need of capital to expand. 

They usually target businesses with proven business models and established revenue streams. 

The investment strategy typically involves injecting capital to fuel growth initiatives, such as entering new markets, expanding product lines, or increasing sales and marketing efforts. 

How is Private Equity different from Public Equity

Private equity involves investing in companies that are not listed on public stock exchanges. These companies are privately owned, and their shares are not available to the general public. 

Public equity refers to investments in companies that are listed on the public stock exchanges, such as the New York Stock Exchange or NASDAQ. These companies are publicly traded, like Nvidia and Apple.

Here’s are some of the other differences between public and private equities:

1. Liquidity

Public shares are highly liquid, meaning you can buy and sell them easily any time the market is open.

Private equity investments are illiquid, meaning that they cannot be easily sold and are usually locked up for a long period of time.

2. Regulation

Public companies are heavily regulated and financial information must be disclosed regularly to ensure transparency.

Private companies are less regulated and do not have to disclose detailed financial information publicly.

3. Access

Anyone can buy public shares through stock exchanges but typically, only accredited investors or institutions can invest in private equity funds.

What are the advantages of Private Equity?

1. Private markets have relatively low correlation with public markets

According to research by Global SWF, there is a strong positive correlation between annual returns of fixed income and public equity. 

However, there is only a weak relationship between public equity and private market assets such as private equity, real estate and infrastructure. 

This means that private market assets might be an option for investors looking to diversify their portfolios away from public equity assets. 

2. Private markets offer diversification

In a study by the Callan Institute, a 60/40 equity and bond portfolio has a concentration risk of close to 99.9 percent, as measured by the fall in portfolio value when assets move in the same direction. 

However, when alternative assets such as hedge funds, real estate and high yield bonds are included into the portfolio, the equity risk concentration declines to about 79 percent. 

This suggests that bonds alone may not be enough to offer diversification. Including alternative assets like private equity, private debt and hedge funds may bring about further diversification.

What are the risks of Private Equity?

1. Risk of using leverage

Private equity managers often use significant debt when acquiring or investing in companies. This helps them to use less of the fund and to potentially gain more from the investment. 

However, it is possible that the fund will be challenged during an economic downturn, especially when the interest rate soared high. Private equity managers may fail to generate sufficient cash flow to pay off the debt or interest, which will cause the value of the fund to drop significantly.

2. Risk of external factors

Different external factors like economic downturn, regulatory changes, geopolitical risks, and natural disasters can all affect the value of private equity investments. 

If a private equity fund has to sell its investments during a time when asset values are low, the distribution to investors might be less than expected.

3. Long investment horizon

When you invest in private equity funds, you will need to set aside your money for a long period of time and not know when you will start to get paid or when you could get your money back. This investment also doesn’t guarantee regular income like other investments. 

Private equity funds generally make money by selling their investments after several years, so you might not see returns for a long time. This makes timing of cash distributions unpredictable. 

4. Illiquidity of Fund Investments

Although having low liquidity is an advantage, it could also be a double edged sword. 

Investors who are seeking immediate liquidity may not be able to sell their funds as easily as in public markets, and will potentially face significant losses.

How to gain access to Private Equity?

Private equity funds are a type of private market investment that are available only to accredited investors in Singapore. 

This is because of the greater complexity of the product and risks associated with private equity funds. 

To access private equity funds, you will need to qualify as an accredited investor and purchase the funds through a platform such as ADDX. 

Retail investors in Singapore can also gain access to cash flow generated from private equity funds through the Astrea Bonds. 

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