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Created on 20.03.2019

Private equity – alternative investment with a long-term investment horizon

If investors do not just wish to put their money into traditional shares and bonds, they can also opt for alternative investment products. These include hedge funds, derivates and tangible assets, such as real estate, raw materials, art and jewellery. Private equity also provides the option of an alternative form of investment with a long-term investment horizon. The comparatively low liquidity, the long investment term and other aspects must be taken into account, however. We explain what private equity investment is all about and who it’s suitable for.

Private equity investments are made in companies that do not wish or are unable to raise finance on the stock exchange. These companies may nevertheless be listed on a stock exchange. Depending on the company’s stage of development, private equity capital can be used for three purposes:

  • Starting capital for start-ups: venture capital
  • To finance rapid growth: growth capital
  • For corporate acquisitions: leveraged buyout

The level of risk for investors varies depending on what their capital is used for.

Getting carried away with anticipated returns

There is often a particularly high default risk with start-ups. If the company goes bankrupt, then the capital invested is lost. Investors sometimes weigh up this risk against the dream of investing in the next Google or Facebook. They may plan to withdraw their money from the company after a certain period, by which time they will have generated a high return.

These anticipated returns are based on the investment horizon: the average investment term for private equity investment is seven to ten years. However, private equity investment cannot be sold just like that. Investors want to be compensated for relinquishing the ability to trade at any time. Long-term investment – in contrast to the acquisition of shares – often involves a more direct influence on the management. It also means high expectations in terms of how the company performs and its profitability.

Specialist knowledge required due to high degree of complexity

Precisely because private equity is a long-term and capital-intensive commitment, investors should analyse the relevant company in depth.  Private equity therefore requires specialist knowledge. Investors also have the option of allowing private equity firms with specialist expertise to manage their money and to invest in this investment class. This usually requires significant levels of permanent capital.

Lower risks with private equity funds

Other alternatives are the acquisition of units in closed-end funds (private equity funds) or shares in private equity companies. As these investors diversify their risk capital through various investments, this reduces the risks compared to a single direct investment, but also the level of potential returns. It is nevertheless still generally a high-risk investment, even in this form.

Due to the low correlation with other asset classes, private equity investment is an ideal way of complementing a broad-based portfolio. This form of financial investment mainly appeals to qualified investors, however. High levels of capital are usually employed and investors should have sufficient expertise, a long investment horizon and a high risk appetite.

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