Why should anyone go into private equity

"Private equity has changed"

Jochen Butz, Head of Alternative Investments at HQ Trust, explains what investors should look out for in private equity investments, how he and his team find the best managers and why the grasshopper debate is out of date.

You are alluding to the grasshopper debate that was triggered by the SPD chairman at the time, Franz Müntefering. The picture conveyed here by private equity funds comes from the 1970s and 1980s, when the US market first emerged. Back then, it was part of the fund's business model to put acquired companies into extremely high debt. If it went well, the managers made an enormous profit.

Then the company was wound up. There is even a book that deals with this period: “Barbarians at the gate” by Bryan Burrough and John Helyar.

Private equity has changed: Today, private equity is an entrepreneurial investment that is about making capital available to a company for growth. Leverage still exists, but to a much lesser extent: We are talking about a rate of around 50 percent.

The quality of the staff: A significant part of the employees today consists of managers who have already proven that they can work successfully. They are now making their know-how available to other companies in order to develop them further, to make them better and more efficient. Today it's about expansion into new products or regions. Or about succession planning and not about selling an inflated company for maximum profit. That would be very short-term and a professional buyer would no longer fall for it.

Further development of private equity vs. listed stocks: Private equity with significantly higher returns

Our offer is aimed at professional and semi-professional investors. One of the biggest hurdles is the minimum investment amount, which is 200,000 euros. If an investor wants to build a portfolio, it is of course a multiple. He must also have a certain amount of experience in this or a comparable asset class.

Above all, we invest in profitable companies: companies that already have established products or technologies and need growth capital to expand or bring a new product to market. We also invest in turnaround funds and on the secondary market, where shares in existing private equity funds are traded. When selecting private equity funds, we also work with our sister company HQ Capital, whose main focus is on private equity investments and which has experienced staff in all relevant regions (Europe, USA, Asia).

We can assess the funds well because we have worked with the managers over many cycles and we know who is doing a good job. On average, private equity managers are in the market every four to five years to raise money for a new fund, and HQ Trust has been investing in private equity since the early 1990s.

The spread between the best and the worst managers is very large in the private equity sector. Here the differences can be up to ten percentage points per year. In addition, the rankings do not change permanently here: A stock manager who has delivered above-average results for a year or two may be completely wrong next year. With private equity, the probability that consistently good returns will be generated is up to two thirds.

This is due to the staff. When an entrepreneur sells his company to a private equity fund, it often goes to a manager who has already proven that he is good at developing companies in this industry. In addition, when someone switches to the private equity industry, they prefer to go to a manager who has achieved above-average results in the past. In other words, the best people go to the best funds.

It is exactly like that. The funds therefore rely on long-term investors. Those who also invest in times of crisis and do not behave cyclically and quickly leave the market again. That would also be a mistake in terms of performance, because the additional income that private equity delivers compared to the liquid asset classes comes primarily from the crisis years. In addition, thanks to our long-standing presence, we have very good access, including to funds with restricted access.

In times of crisis, it is a great advantage to think long-term and not in quarters or with a view to stock options. When buying a company, there is an extensive examination, the due diligence. It's about figuring out what needs to change in order for a company to be more successful. And that with experts from the industry who are good at analyzing and measuring increases in value.

A plan is made during the due diligence and is implemented. In addition, the manager is not under pressure to sell, even in times of crisis. In the liquid market, investors lose their nerve and sell at bad prices. That is not possible with private equity. And, as a rule, there is also a liquidity buffer.

The share of private equity in the global merger and acquisition market is only around 10 percent. So we're talking about $ 500 billion a year. That's not that much. I see further growth potential here.

About the author:
Jochen Butz has been working as Managing Partner at HQ Trust since 2011. He works in customer service and is responsible for the alternative investments department, which includes private equity, private debt, real estate, infrastructure and hedge funds. Mr. Butz has 27 years of experience in the financial sector.

About HQ Trust:
HQ Trust is the Harald Quandt family's multi-family office. We take care of the assets of private individuals, families and foundations. We provide advice to institutional investors, pension funds and pension funds. Our team offers services in the areas of family office, private asset management and alternative investments.

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