Conversations with Mike: Who invests in Private Equity?

by goksor

Rasmus: Hello again, Mike. Let’s dive right into our next topic.  Did you know that more than 90% of the capital going into private equity comes from institutional investors (LPs)?

Mike: Hi Rasmus, yeah that sounds about right.  Institutional investors are focused on investing large amounts of capital with an extended time-horizon, so the asset class makes a lot of sense for them.  One interesting point here – there is a major misconception in the general public that private equity and venture capital managers are investing their own money, and that they are getting rich off the efforts of others.  That is true only to a very limited extent.  Most of the money comes from these institutional investors.

Rasmus: How would you break down the various institutional investor groups?

Mike: There are ten distinct personas that we’ve identified that make up this group of institutions:

• Public pensions
• Private pensions
• Endowments
• Foundations
• Sovereign wealth funds
• Single family offices
• Multi-family offices
• Fund of funds, who play both sides of buyer and seller
• Asset managers including banks and wealth managers / consultants
• Economic development agencies (like the World Bank)

These institutions are all seeking to make money off of the money they have and a lot of them do it for a good end goal. For example, the pensions help provide the quality of life for retirees, endowments provide university budgets as well as additional funding to go towards special programs, scholarships, and buildings.  Also, six of the ten largest foundations are medical research foundations.

Rasmus:  What you are saying is that there is plenty of money being granted, contributed, and donated to these institutions, yet they have to make more money on top of the money they have?

Mike: Exactly. They need to outpace inflation and spending to remain relevant.

Rasmus: Is there anything in particular that private equity offers these investors compared to other asset classes?

Mike: First it is noteworthy that institutional investors have long-term investment horizons.

Also, the opportunity in private equity is for information arbitrage.  The fact is that there are private companies out there that might be doing something revolutionary or simply better than the large public companies that have already hit their mature phase. Here are these private companies that are doing something different, or challenging the status quo, and that is where the opportunities for high returns are and where the capital essentially gets put to work for these institutions.

That being said, there is some disconnect in the public markets for institutional investors. The returns in the public markets can run up quickly, and go down even faster. These institutions look for consistency.

Rasmus: You could say that private equity investments allow the investors to avoid some of the volatility of the public markets, such as the news of quarterly earnings, and then also gain access to a bigger opportunity for a more long-term gain.

Mike: Yes, the higher returns can be there, but do not forget the higher risk. With public companies, they are more heavily regulated than the private companies. There is a risk/reward ratio that holds true – you have a greater potential for bigger loss, but you also have a much larger potential for returns.

Rasmus: Awesome. To summarize, Private Equity is funded by institutional investors, which make up 90% of the market. These institutions primarily invest in the asset class for access to higher returns as well as for diversification in the portfolio.

Well I think next time we should discuss what it is you invest in when you invest in private equity.

Mike: Sounds good. Speak to you again soon, Rasmus!