Investment Strategies

PE's new source: Wealth managers

Helping investors sort through and make private investments is a differentiator for advisers

Feb 3, 2013 @ 12:01 am

By Ryan Caldbeck

Investors know all about The Blackstone Group LP, The Carlyle Group LP and TPG Capital LP. They expect these giant private-equity shops to reap outsize returns on bold, imaginative deals.

What stokes the envy of individual investors, however, are the kinds of PE investments made by secretive deal makers such as Raymond Debbane of the Invus Group LLC, who turned a $224 million investment in Weight Watchers International Inc. into a $5.2 billion fortune.

A lot of barriers have kept ultra-affluent and high-net-worth investors out of the PE arena, primarily minimum deal sizes and adequate deal flow. The passing of the 2012 JOBS Act, which eased regulations on solicitation and added a new exemption for private offerings, will effectively remove these barriers and give rise to a new industry known as crowd funding.

Investor appetite for PE deals was one factor that drove me to start one of these crowd-funding companies, CircleUp Network Inc.

At the broad-brush level, realistic and easy access to private equity is a positive development. Investors will now be able to achieve realistic diversification into an important asset class, position for PE returns and, at the same time, dampen volatility in their portfolios.

INVESTOR APPETITE

While online investing platforms will provide individual investors access to private investments, what is needed is more active participation of wealth managers. There is a tremendous case to be made for this.

First, investor appetite is so strong that clients are likely to invest anyway, but perhaps in a way that isn't consistent with the rest of their portfolios. Second, from a practice development perspective, helping investors sort through and make private investments appropriately is a huge differentiator for financial advisers' practices.

Here are the key areas in which individual investors could benefit from help from their advisers with respect to making PE investments in emerging-growth companies:

Education. PE investments for individual investors represent, for many, a new asset class at the forefront of changes in wealth management. Beyond knowing that “1 percenters” make a lot of money in private equity, your investors may not know much else.

Allocation. Investors with $500,000 to $1 million in investible assets realistically can buy into PE investments, but they need guidance on how much to allocate.

Due diligence. Investors can benefit from an arbiter to help them determine the quality and appropriateness of individual PE investments.

Diversification. Investors who want to earn Carlyle Group-type returns need to take a page from its playbook and look at many different industries. Acting on their own, investors likely will seek investments in industries where they have some knowledge, and not necessarily where the best opportunities are.

Staying the course. It seems that the rocket scientists actually buying and selling investments that earn the returns should be reaping the rewards. But that isn't the case, primarily because making sure an investor sits still and doesn't panic and sell at precisely the wrong time is hard work.

Reinvestment. Investments in private companies can produce real returns, and the happy problem of reinvesting proceeds is something with which individual investors could use help. Only a subjective analysis can reveal who needs to take funds off the table and who needs to reallocate some or all their proceeds into other PE investments.

According to research funded by the Ewing Marion Kaufman Foundation, angel investments return on average 2.6 times invested capital in about 3.5 years. Among consumer products companies, where CircleUp focuses, the returns can be even higher, averaging 3.6 times over 4.4 years.

These data, while encouraging, don't suggest that PE investing is a panacea. The data reflect average returns across a wide pool of investments; half the time, these investments produce negative returns, proving the importance of guidance and picking the right private-placement deals.

Easy access to PE investments is in its infancy, and today's wealth managers have an opportunity with an asset class that could equal — if not dwarf — traditional investments.

Advisers who take the time and effort to weave this new opportunity into their practices will be able to differentiate themselves in a crowded market and serve their clients by providing prudent access to the kind of investment opportunities that they have always envied.

Ryan Caldbeck is founder and chief executive of CircleUp Network Inc., a crowd-funding company.

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