Private equity is an illiquid, long-term asset class which should outperform public market benchmarks by approximately 300 basis points over time. There are a number of structural factors which enable outperformance of the asset class. Below we have outlined the basic tenets that contribute to outperformance, and in future posts we will take a more granular look at how Diversified Trust employs them in the selection of investment managers.
Operational Focus: When appropriate business strategy and adequate resources are applied to a company with a fundamentally sound business model, the company’s value should increase over time. The investment managers we choose should provide strategic guidance for companies and serve as valuable coaches on Board seats – not merely serve as financiers who provide capital. Capital is typically plentiful for good companies to fund growth, but skill and expertise to help build companies is scarcer.
Long-Term Asset Class: Private equity managers have the luxury of holding portfolio companies over time in order to execute investment theses which ultimately realize value. Private companies are not beholden to the whims of public markets movements or stock analysts’ quarterly earnings estimates in order to establish their valuation. Accordingly, they can invest in producing revenue growth for the long term while perhaps sacrificing profits in the short term as they make investments in people, research and development, new product design, expansion of distribution channels, etc.
Opportunistic Deployment of Capital: Private equity managers need to “buy low and sell high,” just as public equity investors do. However, private equity managers have the ability to opportunistically deploy capital over time throughout various market cycles when they can optimize purchase value. When private markets are frothy or overvalued, managers may choose not to deploy capital. In fact, some of the managers selected by Diversified Trust have occasionally gone 18 months or longer without making an investment when they felt companies were overvalued. Alternatively, managers may choose to pay relatively higher acquisition prices for companies with higher growth potential. Their expertise must dictate the appropriate time and price at which to buy and sell a company.