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A long-term investment that transforms companies

JamesBy James Crisp on 19 March 2013
A long-term investment that transforms companies

A private equity fund is a long-term investment vehicle that uses its capital to provide stable financial resources to its portfolio companies, in order to build them into better businesses.

Investors such as pension funds and insurers need access to such long-term, illiquid asset classes to get strong, stable returns so they can meet their future liabilities.

Europe’s economy and the companies that drive it need access to the long-term patient capital that private equity provides.

Long-term family ownership of companies is obviously a good thing but there is only a limited amount of of this “perpetual capital” available right now.

Long-term holdings by institutional investors in publicly listed companies are also desirable but in reality the average holding is now less than a year.

Private equity funds are tailored to the needs of institutional investors like pension funds and they also accelerate companies’ growth, which can help the economy.

How does private equity build better businesses? The secret is that private equity managers are active owners, making hands-on strategic decisions to transform firms, over a number of years.

Generally speaking, private equity investment in a firm lasts from about three to ten years; the average holding period varies between five and seven years, depending on the life-cycle of the company and the nature of the investment. This is patient capital, working to prepare companies for ownership by other owners in the future.

In order to get these new owners interested in buying the company, its business has to be improved and additional value created.

Dozens of independent studies have shown that private equity ownership accelerates growth and transforms companies into stronger, more profitable and sustainable firms. Private equity backed companies are more resilient and profitable then non-private equity backed firms, according to academic research. (See here).

Private equity managers are able to take their skills and expertise and apply them to a wide range of firms, helping them to grow. Hopefully, this growth will help the European economy restructure and recover.

While private equity funds invest in a diverse portfolio of companies, spreading the risk, institutional investors like insurers and pension funds, invest in a number of private equity funds.

This partnership lasts for ten to 12 years, practically an eternity in a world where public stocks are sometimes traded every 0.01 seconds!

Investors agree to a partnership from which they cannot withdraw during the life of the fund.  Private equity funds also can’t be traded like short-term liquid assets, which offers stability and less risk.

Private equity funds are held to maturity, but unlike many other investment vehicles, are designed to deliver returns that beat the markets. This is crucial in helping pension funds meet their long term promise to current and future pensioners. Mike Powell at the Universities Superannuation Scheme, one of the UK’s largest pension plans, talks extensively about this in the Invest Europe Briefing on pensions funds.

Long-term investments like private equity funds can stabilise financial markets while still funding long-term corporate growth and developing infrastructure.

All in all, it’s a great relationship with real benefits for the investors, the companies and the economy.

Unfortunately too much of our current regulation and accounting standards requires long-term investors to price their investments as if they could be sold that day.

That ignores the creation of value that occurs over the long-term. This unintended virtual volatility that certain regulation can create in the value of investment portfolios could steer investors away from long-term asset classes.

You can read more about our work in this area in our Briefing: Long-term investing: the route to sustained growth or my blog What has a private equity fund manager got in common with a medieval seafarer? For more technical information see our research paper on risk calibrations in private equity.




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