In recent years, private equity has become a hot word in the investment field. More and more investors are paying attention to private equity investment. According to relevant research reports, private equity has continuously brought excess returns to investors in the past decades. However, while pursuing high returns, investing in private equity also faces many challenges. This article will analyze the growth opportunities and challenges faced by private equity investment.
Private equity provides a premium over public markets
Many research reports show that private equity can provide significant excess returns over public markets in the long run. For example, a Cambridge Associates research shows that between 1995-2020, private equity returned 13.6% annually, beating public equity by 5.5% and fixed income by 9.1%. The illiquidity premium and value creation ability of private equity enables this return premium. However, the premium is likely to decline as the private equity market grows massively in size.
Low cost and portfolio diversification benefits of co-investments
An effective way for LPs to access private equity is through co-investments with GPs. Co-investment provides benefits like lower cost and diversification. According to Preqin, 80% LPs have earned higher returns from co-investments than normal fund investments. Co-investments also charge little or no fees, significantly reducing costs. However, LPs need to evaluate adverse selection risks and invest only in quality co-investment opportunities.
Direct investing capabilities are challenging to obtain
While co-investment diversifies an LP’s portfolio, direct investing provides more control and certainty. But direct investing requires sourcing quality deals and making quick decisions, which are hard capabilities to obtain for LPs. Also, GPs may not provide the best deals for direct investing. So LPs should carefully evaluate each direct deal.
Domain expertise is required for successful investing
Whether co-investing or direct investing, LPs need to have domain expertise in specific sectors to make good investment decisions. If not, they need to work with external advisors. Without expertise, investing blindly often leads to poor returns. LPs should realize they are both competitors and partners with GPs and ensure interest alignment for access to the best investments.
Though private equity provides growth opportunities, LP investors need to evaluate challenges around declining excess returns, adverse selection risks, capability gaps, and interest misalignment. Success requires domain expertise, rigorous due diligence, and alignment with top GPs.