The long view, a key performance driver in private equity
Summary
Written transcription
Damien Hélène: I'm now joined by Dimitri, Investment Director at Altaroc. Hello Dimitri.
Dimitri Bernard: Hello Damien.
Damien Hélène: And Eliott, Key Accounts and Partnerships Manager.
Eliott Vincent: Hello Damien.
Damien Hélène: Eliott, you had a first question for Dimitri.
Eliott Vincent: Dimitri, I'd like to take advantage of this third part to review some of the specific features of the private equity asset class. It's an investment typology that has been used for decades by sophisticated investors, mainly institutional investors and large families. In the end, they have mastered all these characteristics and use them in their allocations, notably because it's an asset class with significant performance potential, low volatility and, above all, resilience, particularly in the Growth Equity and buyout segments, which are of interest to us at Altaroc. These specific features, however, are sometimes overlooked by private investors, quite simply because many of them are just discovering the particularities of this asset class. So, I'd like us to start our focus by concentrating on one of the main characteristics, which is a particular one, namely the pace of deployment of commitments. Could you please explain why private equity funds apply deferred calls and what implications this has?
Dimitri Bernard: You're right. One of the main characteristics of private equity funds is the time it takes to deploy them, which is reflected in the time it takes for investors to call for funds, where the commitment is called for progressively, and therefore calls for funds are deferred. If you want to build up a diversified private equity portfolio, you generally need four to five years. For a start, let me remind you that a listed manager investing in listed assets can buy his assets at any time. A private equity fund cannot buy what it wants when it wants. Private equity funds must first identify targets, i.e. companies that meet their criteria, approach the management team, get to know them, convince them to take a stake, define a price and structure an entire operation. So just one private equity investment, one operation, already takes several months. That's why, if you want to build up a diversified private equity portfolio, it's generally said to take between four and five years. The reality is that this is a long time, but it's a good thing, because the manager will invest with discipline in a portfolio of convictions. He won't invest everything too quickly in a single cycle. And it's this patience that also explains the historical performance of private equity, since you have a natural smoothing of your investments, so you have different entry points over several macro-economic contexts, which is a good element in terms of diversification and risk management. You need to accept this time to choose and prepare your portfolio for its performance.
Eliott Vincent: Well, that's very clear. Thank you, Eliott. Now, I'm getting back on track because you're talking about long time horizons. Could you remind us why a private equity fund generally has a target life of ten years?
Dimitri Bernard: So, within the fund's ten-year life cycle, there are three phases. The first is the preparation phase, the investment selection phase. This takes between four and five years. We've just talked about that. The second phase is the business plan phase. The business plan is the roadmap agreed between the private equity fund and the company's CEO, with objectives generally set for the next five years. This is a crucial stage, because this is really where all the work of transforming the company takes place, with active governance by the fund. And the fund is going to help the company on a number of fronts: key recruitment, operational improvement of the company, improvement of processes, improvement of margins, the whole consolidation phase where you can have M&A with the integration of a dozen or so companies that will be bought to strengthen. These stages are fundamental, with very active governance on the part of the fund. You need this time to reap the rewards of your investments. The fruits of the investment, both financial and human, made between the fund and the managers. And, of course, you'll generally want to achieve your objectives before thinking about reselling. And the third stage is actually the sale of the company, i.e. the disposal phase. So, in the end, a fund that invests over five years will be making its last investment. In year 5, it hopes to sell its last investment five years later. So you arrive in year 10. And as we were talking earlier about smoothing your entry points, you also have a mechanical smoothing of your exit points. Which, once again, is a very good thing in terms of diversification and risk management. So this characteristic of the long term, this ten-year cycle, is essential to have all this discipline and to bring together all the conditions for performance.
Eliott Vincent: Well, it does have some beneficial aspects for the investment side, but it also has an impact on the liquidity of the investor's investment.
