Here’s why the world’s richest are pouring billions into private equity
Stock crash, cryptocurrency tumbling, high-interest rates… 2022 has been marred by a few disastrous economic events. Despite the hardships, however, there are many, such as oil companies, that have profited through adversity.
One group that’s always worth looking at is the world’s billionaires. So where are the wealthiest 1% investing their significant gains?
Private equity on the rise
The world’s wealthiest families are pumping billions into private equity, reveals an annual report by Swiss bank UBS. The company published a survey report of 221 family offices overseeing $493 billion in assets.
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The report shows that the world’s 1% put far more funds into private equity than traditional asset classes such as fixed income and stocks during 2021, reports UBS.
Investments into private equity by the world’s wealthiest families increased from 2019 and 2021.
According to UBS: “Private equity a favored source of return Attracted by private equity’s potential for higher returns than public equity markets and a growing opportunity set, more family offices than ever are investing in the asset class.
They’re allocating their capital between direct investments and funds, typically making direct investments where they have the expertise and using funds for diversification or to scale investments across geographies and sectors.”
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Private equity boom
Private equity saw incredible returns in 2021 as trillions of US dollars in the form of pandemic-related stimulus resulted in a record surge in deal-making.
Conversely, fixed-income investments saw poor returns with near-zero interest rates. This removed the traditional attractiveness of a “safer” investment. The market volatility and sky-high valuations in equity markets attracted the world’s richest families and investors.
Fixed income investments declined by two percentage points in 2021 to 11% promoting many financial managers to advise that clients move money out of those investments despite the risk. Real estate investments, a traditional favorite for billionaires, experienced a loss, slipping to 12% in 2021.
Globally, the private equity industry has more than $6tn in assets under management, according to a McKinsey report published in March. Equity investments reporting returns of 24% in 2021, reports McKinsey.
The report highlights where billionaire investors are putting their money.
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According to UBS: “Private equity’s potential for higher returns and its broad opportunity set is proving more and more popular. Eight out of 10 family offices now invest in the asset class, as the number rises steadily year after year.
“Typically, family offices invest across both direct investments and funds. While the former is often an extension of the beneficial owner’s business activities, the latter effectively diversifies risk across managers, strategies, and vintages.”
Equity vs traditional markets
The private equity industry has enjoyed its strongest start to the year yet as 2022 sees vast profits accumulated during the pandemic. Buyout groups backed $288bn worth of deals in the first quarter of 2022. This equates to a 17% rise compared to the first three months of 2021.
More mainstream investors and traders are seeking lucrative opportunities in this space as many public stock markets have appeared overvalued and bond yields have been historically low.
Josef Stadler, UBS Executive Vice Chairman, said: “Amid continued inflationary pressure and low expected returns, family offices are seeking both additional sources of return and alternative diversifiers.
“Private equity stands out as an asset class with high expected returns and is the only asset class that has attracted higher allocations year after year. Family offices invest directly where they have an edge, often as an extension of the beneficial owner’s business interests.
“Funds are typically used as a way of complementing these direct investments by spreading the risk. However, direct investments are gaining traction, albeit from a lower base.”
Red flag – potential Ponzi scheme?
Despite the appeal, some such as Vincent Mortier, Amundi Asset Management’s chief investment officer, believes that the gains from the equity industry are too good to be true.
Europe’s largest asset manager says parts of the private equity industry operate like a “Ponzi scheme”. Amundi has €2tn in assets.
Mortier said that within the industry you’re capable of selling assets to another private equity firm “for 20- or 30-times earnings”.
Public stock and bond markets are highly regulated and leave little room for investment managers to hide their performance. Any fluctuations in asset prices are easily tracked in real-time through an SEC-regulated process known as marking to market.
Private equity firms, however, lock up their client’s funds for several years. Information about whether their target companies have increased or decreased in value becomes public only if they choose to list the business or disclose the price, they sold it for to another buyer.
Private equity groups sell assets to other private equity groups; in 2021, the equivalent of $42bn worth of deals was stuck in which they sold portfolio companies to themselves.
The reason? Mortier said their incentives for private equity firms to transfer/sell assets between each other at inflated prices.
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