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Investing in private equity may be a bad idea [video]

Investors need to be cautious when considering this kind of investment approach

    Private equity is gradually becoming easier for ordinary investors to gain exposure to...

    But does that mean it's a good idea? 

    Professor Phalippou from Oxford University offers his insights based on the studies he has done in this area...

    RP: There’s been a growth in interest in recent years in private equity — and it’s gradually becoming easier for ordinary investors to gain exposure to it. But it’s not necessarily a good idea. For a start, private equity is currently unregulated. It’s also very hard to work out how much you’re paying in fees and charges.

    LP: First for a long time people have said it does not matter how much I have shown you because I gave you twelve percent return net of all fees and it is not a problem to know whether I took five or eight or ten or one on the number. What matters to you is the net of fees and I do not see why you are asking that question about how much I took on the way. So it is still very much the mindset for a lot of people in employed market space. A key issue is that fees are not well defined when somebody is in control of the asset. Even if somebody was well intended and really wanted to give you all the information, it will comparable from one fund to be over because fees are not well-defined.

    RP: Another problem investors in private equity face is working out how a particular fund has actually performed. There are all sorts of ways of making performance appear better than it actually is.

    LP: It is transparent to the investors in the sense that the investor is given the number and are given the cash flows often to double check the numbers. It does not exactly always coincide because there are all kinds of complexities but it is roughly there. So in that sense, there is not really a problem of transparency - they get numbers, they get the underlying cash flow. The problem on the performance front has been that a wrong measure of performance has been used and it is a measure of performance that can be gained. That will in most cases show a number that is way too high compared to the actual performance.

    RP: Ludovic Phalippou is an academic, not a financial adviser. But he would caution ordinary investors against investing in private equity at all.

    LP: Now you could say it does not matter whether they know or not. The performance has been okay in private equity and we would be okay, it does not matter whether they know all the details or not. They do not need to know the recipe for the soup to enjoy the soup. So we might as well offer private equity to small investors so they can enjoy maybe some diversification benefits or some extra performance. Maybe because I am a teacher I prefer when people know what they are doing and what their money goes towards when they invest.

    RP: You can find out more about Professor Phalippou’s work on private equity on his website, PELaidBare.com. That’s PELaidBare.com.

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