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Alternative investments: A look at private equity

Buying stock market shares isn’t the only way to invest in companies. Jonathon Curtis explores the risks and potential rewards of private equity investing.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

In the third of this four-part series on alternative investments we’ll lift the lid on investing in private equity.

Please note that this article is not personal advice and if you’re unsure that an investment is right for you, seek advice. All investments fall as well as rise in value, so you could get back less than you invest.

Read part one – commodities Read part two – property

What is private equity?

Private equity is investing in companies not listed on the stock market. And it can take several forms:

  • Leveraged buyouts - buying companies with the aim of improving them, for example by changing the management or cutting costs.
  • Venture capital – providing funding to develop young businesses. Companies like Google and Facebook grew from small beginnings thanks to venture capital.
  • Distressed funding - investing in troubled companies to try to help them recover.

Private equity investors aim to make money by selling their stake in a company for a profit. This could be to other private equity investors, or by listing the company on the stock market (known as an initial public offering or IPO).

Private equity investors normally invest for longer than stock market investors. That’s sometimes because private equity investing is conditional on staying invested for a minimum number of years. But it’s also because it can take time for a private company to reach a point where a profitable sale is possible.

Isn’t it risky?

Investing in private equity isn’t suitable for most people, and it carries a number of key risks investors should consider before investing.

Young or distressed companies are higher risk than large, established ones. There’s not as much information about private businesses as there is for those on the stock market. This makes them harder to research and increases the chance of you missing a red flag.

Liquidity can also be an issue. The private equity market is much smaller than the global stock market. This limits the opportunities to invest and makes selling more difficult. This means sellers could be forced to sell at a discount to achieve a sale. The limited number of investors also makes it more difficult to value a private company, as there’s less of a market-pricing mechanism.

Private equity can be expensive too. There can be large initial charges, high ongoing costs and complicated performance fees. They all eat into returns, with no certain gain at the end.

So why would anyone want to invest in private equity?

Arguably the main reason is the potential for larger gains than have been achieved on the stock market, though there are no guarantees. And as with most alternative investments, private equity can perform differently to stock and bond markets, so could provide portfolio diversification.

Private equity vs the global stock market

Past performance is not a guide to the future. Source: Lipper IM to 31/01/2020

How to invest in private equity

Private equity investing usually involves large sums of money to kick start or accelerate a business’s fortunes. That’s why most direct investors are big institutions like pension or university endowment funds, or wealthy individuals.

But there are ways for smaller investors to invest.

Some investment trusts specialise in private equity companies. They’ll invest in a broad range of companies to try and spread the risk around. Investors buying and selling investment trust shares don’t affect how much money the manager has to invest. That means the managers are never forced to unload potentially hard-to-sell investments.

Venture Capital Trust (VCTs) also invest in a number of early-stage companies to help them grow. They offer investors generous tax breaks too, but that shouldn’t be the main reason to invest, and there are conditions attached. Investing in VCTs is higher risk and should only be considered by sophisticated, experienced investors who can take a long-term view and are comfortable with higher risks.

Search for private equity investment trusts

Find out more about VCTs


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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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