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By M. Isi Eromosele
Private
equity remains a strong investment in a period of market instability, and the
next few years are likely to mark a substantial migration towards real assets.
There
is continued stability of private equity investments. Although deal flow
recently has been hindered by a general slowing of credit and fewer exit opportunities,
mild market distress can be a boon to private equity investments, as it permits
managers to acquire companies at lower valuations.
Yet
in order to take advantage of these opportunities, managers of all asset
classes, including private equity, must re-evaluate their use of leverage. The
prudent use of leverage will be a key factor in the success of private equity
funds going forward.
Clearly,
turbo-charging returns through excessive leverage can no longer occur in this
environment. As a result, managers with a value orientation and heavy
operational focus, for example, may be best positioned to capitalize.
When
compared to other alternative investments, private equity’s use of leverage is
prudent. Leverage is applied differently in private equity structures, which
can offer several advantages.
Private
equity leverage is generally applied on an individual company basis, with
little cross-exposure. If a portfolio is composed of 15-20 companies, for
example, the collapse of one may not severely affect the future of the fund.
Private
equity investments made through funds-of-funds can provide even more
diversification and further reduce risk. Furthermore, most funds of funds do
not apply leverage on the FOF level, and therefore risks are not increased by
using this structure.
Although
private equity firms must value their companies on a quarterly basis, the funds
are not marked-to-market in the same way that stocks are. Therefore, a manager
is generally only required to finance borrowing, and not declines, in assets.
This is in contrast to investments in stocks, where falls can trigger a
restriction of leverage and require ill-timed sell-offs.
Private
equity fund managers build their investment forecasts, strategy, and timing
around long-term investment cycles. Therefore, private equity may be better
prepared for downturns and recessions, particularly if the firms are in a
position to make investments during weak markets.
Firms
with a longer-term focus and a patient investor base can play offense in this
market environment, buying weaker competitors and strengthening their
businesses in order to exit at higher valuations in the future.
M. Isi Eromosele is the President |
Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance
Copyright Control © 2012 Oseme Group
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