Private Equity Rewards Consistency

Diversification is crucial in a private equity portfolio, with consistent investments over many vintages the foundation on which success is built

How the Downturn Will Affect Private Equity
The private equity model is unique. First, GPs buy and hold a company over many years. In contrast with public markets, they can avoid panic selling at below market value during a downturn and wait for optimal conditions to exit investments. For example, funds raised and invested in the boom that preceded the Global Financial Crisis (GFC) generated positive returns, with even the worst performer, 2005 vintage funds, generating a median net IRR of 7.6%, according to Preqin Pro.

Moreover, a downturn represents an opportunity for private equity managers to deploy capital on terms that are often more attractive. They can use available dry powder for new acquisitions or add-ons, as well as help their firms better weather the storm, and have historically generated the best returns. Private equity funds raised in 2009, 2010, and 2011 have median net IRRs of 11.9%, 14.5%, and 14.7%, respectively.

Finally, private equity managers tend to have a hands-on approach to running their companies and are better able to maneuver corporate initiatives without the short-term pressures that affect listed companies.  

How to Build a Robust Private Equity Portfolio  
Diversification is paramount when preparing for the worst and should be the priority in any private equity program. COVID-19 is a perfect illustration of a highly unpredictable event, hitting healthy companies that were simply operating in the ‘wrong’ sector. Diversification must take sectors, geographies, managers, and vintages into consideration.  

Many studies have shown the importance of building a multi-manager portfolio, and our own analyses have shown that vintage diversification has a much greater effect – a bad year can have an overwhelming influence on performance. Using a 20 year sample period (1988-2009) and randomized trials, our studies have shown that a portfolio exposed to at least three vintages with three funds in each vintage has a theoretical probability of losing capital close to 0%. Therefore, investing regularly should be prioritized over market timing and this is particularly true for private equity, where investors do not control capital deployment.  

In addition to diversification, we also believe that a private equity investor will generate better performance through cycles by investing in hands-on strategies, such as growth or buyout. In a benign economic environment, this control is used in different ways to grow and improve the company’s bottom line. In turbulent times, these strategies prove their resilience as they are nimbly able to react to market movements by cutting costs, reorganizing operations, and engaging in strategic partnerships.

About Hermance Capital Partners
Jacques Chillemi is Co-Founder & Managing Partner of Hermance Capital Partners, a Swiss private market investment platform backed by a strategic partnership between three private banks. Hermance Capital Partners provides a wide range of investment solutions across high-conviction strategies with attractive risk-return profiles, enabling qualified investors to build a diversified portfolio of high-quality private assets.