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The top 9 points to understand before committing to a private equity fund manager

Private equity fund managers are longer-term investors but temporary owners of assets. They typically invest in companies for around 3–5 years. This 'How to invest' article summarises the top 9 points to understand before committing to a fund manager.

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Private equity firms raise capital from institutions and wealthy individuals and then invest that capital by purchasing businesses or assets during the investment period of the private equity fund concerned. Divestments can start within the investment period, but usually the liquidation of the fund (by selling assets in the portfolio) is ongoing throughout the life of the fund, which is usually a preset period of ten years. The limited partners (LPs) own a majority percentage of the fund and have limited liability, whilst the GP (the fund manager) owns a minority of the shares but has full liability and the responsibility for executing and operating the investments.

In the following, we have summarised the top 9 points to understand before committing to a private equity fund manager:

1. Dedicated private equity managers raise capital and manage funds

These funds have a finite life of usually ten years. A manager invests into companies or assets in the early years of the fund during the investment period and monetises those investments through distributions in the later years of the fund’s life.

2. A commitment is made at the outset

This is a fixed amount of capital that will be called over the investment period, which may extend up to 6 years and be called incrementally to make portfolio investments.

3. During a fund’s life, capital is invested and returned

As a result, a two-way cash flow develops. Remember that private equity managers are temporary owners of businesses and assets.

4. Private equity funds are not traded assets and therefore should be viewed as longer-term investments,

with capital set aside in a portfolio to accommodate such investments.

5. Private equity assets are revalued only four times per year.

This is a sufficiently frequent amount that results in far less asset volatility when compared to public instruments.

6. Private equity managers align themselves with their investors by investing alongside them and owning the underlying companies in the majority of cases.

A private equity manager only earns a performance fee, known as the carried interest, when a pre-defined profit level has been attained for investors.

7. Private equity owners of companies usually exercise majority control or some degree of influence over the development and management of a company.

The private equity firm is an active manager, and their investors benefit from this ‘hands-on’ approach.

8. The private equity fund investor is wholly reliant on the investment choices of the managers.

This ‘lifts the weight of decisionmaking from the investor’s shoulders’, for the manager decides what and when to buy and when to sell. This ‘passive’ investment approach can be beneficial to an investor, especially during periods of market turbulence.

9. Accessing private equity managers is difficult for two main reasons:

1) identifying the better managers in the business and securing capacity can be hard, and
2) minimum investment amounts can start at USD5m or more. Contracting out private equity fund investing to a team that is dedicated to finding the better managers, securing capacity, and offering investment commitments at lower amounts makes sense for the majority of private clients.

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