Private side investors must consider absolute performance, also relative to the public shares, and any misalignment of interest due to the IPO
Public investors must consider performance relative to other public investments
Both need to consider the potential conflict of interest between them, which the PE manager must continuously address
For my part, I have yet to hear a truly compelling argument as to why I should invest in the private funds of a listed manager, if I can buy the liquid public shares of the same manager.
This view is further underscored by my experience that management fee growth, once the manager is listed, vastly outpaces carried interest. At the very least indicating some misalignment of interest!
Nordic PE powerhouse EQT is planning their IPO later this month
With its listing EQT is set to join the ranks of 3i, Apollo, Blackstone, Carlyle, KKR, and others. For investors, both public and private, this raises a natural question – whether to invest or not?
A far-ranging question, which certainly requires more in-depth analysis, and a bit much for a blog post. But, more generally, let’s nonetheless take a look at some of the various considerations investors should have.
What’s the motivation for listing?
Investors can, and obviously should, read the IPO prospectus. But, like private placement memorandums, these are also marketing documents. In other words, buyer beware!
There are plenty of good reasons for a PE manager to IPO
Proceeds can be used for further growth
Easier to share ownership and incentivize key employees
Facilitates a generational transition
Increases oversight and from that hopefully governance
A more murky reason for an IPO is to generate a potentially very lucrative exit for founders and senior people. An exit that might otherwise be very difficult to achieve and would normally require junior partners buying them out over several years.
With an IPO senior people can in one quick and easy sweep exit their own otherwise locked-up, highly illiquid equity. The same equity that was meant to ensure strong alignment of interest with their LPs.
Performance is a key investment criteria for private investors
Aside from absolute performance of the private side funds, private side investors should post IPO compare the private side returns with a public market equivalent of the listed shares of the manager.
If there is not significant outperformance, there is obviously little reason to invest in the private side funds when the listed shares offer liquidity.
Unless you are investing in or doing due diligence on a manager, this data may be somewhat harder to access. But the analysis is key to make.
(Mis)-alignment of interest for private side investors
Private side investors further need to consider the impact of an IPO on alignment of interest
Management fees, as the main support of the share price, will become increasingly important to the manager, possibly at the expense of performance fees
Asset gathering to grow the fee base may lead to a proliferation of strategies and geographic expansion at the loss of focus
Share price focus instead focus on driving value to drive performance
Cashing out, senior people may no longer have sufficient ‘skin in the game’
Also worth considering is, that an IPO is in stark contrast to one of the core arguments that PE managers themselves make, not least when taking public companies private:
“That by being private, they can operate with a long-term focus and without the pressure of quarterly reporting and analysts, thus more easily driving long-term value”.
Public performance of PE managers lags the general market
As for private side investors, performance is obviously also key for public investors.
A simple but illustrative proxy for analyzing the performance of individual managers compares the performance of the iShares PE ETF, which includes many well-known PE managers, with S&P 500, see Figure 1.
In this case, public investors would clearly have been better off simply investing in the S&P 500, which over 5 years returned almost 50% compared with 24% for the private equity ETF. Also, correlation, while not 1:1, is not a reason in itself to invest in the PE ETF.
Figure 1: Listed PE ETF underperforms the general market
Source: Bloomberg, 19 September 2019
Note: Past performance is not indicative of future results
Worth bearing in mind in this context, is also that investors in listed PE managers do not benefit from the ‘illiquidity advantage’ that I discussed in this post. And consequently may fall foul of the general market herd mentality when it comes to selling and buying and market timing.
Public and private investor pros and cons
Clearly, for both public and private investors, it is not a straightforward decision whether to invest in the public shares and / or the private funds of a listed PE manager or not. There are several considerations and pros and cons that must be carefully considered.
Figure 2: Pros and cons for public and private investors investing in PE managers
Source: PE Compass, September 2019
Returning briefly to EQT, of whom I am a great admirer. The above is neither for or against any investment. Merely some things that should be considered.
I look forward to seeing how the IPO unfolds and following this interesting new chapter of the EQT story.
Sources: Bloomberg, September 2019, EQT, September 2019, FT, September 2019
Note: 1. iShares ETF ticker IPRV SW