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Public vs. Private — No Returns For More Risk?

16 July, 2010

Private equity has been one of India’s fastest growing alternative asset classes, particularly with high net worth individuals, who have an increasing number of PE funds in their portfolios.  Once an esoteric asset class, private equity is now real competition to public equity. But has private equity delivered on its high risk-high return mandate?

Relatively few private equity managers in India have an exit track record, and it is unlikely to be as watertight as the well-regulated track record of a public equity mutual fund.  Global studies, such as one done by Preqin, on 4900 private equity funds (representing 65% of the AUM in private equity globally), shows that over the long term private equity has had limited success compared to public equity, and in the last year, private equity managers have underperformed public equity managers on the aggregate. This is especially likely to be true in Indian markets, where private equity is more “perfectly priced”, with everyone chasing the same handful of deals and promoters that don’t leave very much on the table. Moreover with private equity managers charging large carry and most public equity managers operating on a fixed fee model, private equity is likely to be behind net of fees, unless PE managers are truly delivering 4x or 5x returns on their entire portfolio.

Near perfect pricing, perhaps, is driving more and more private equity managers to include public equity as a significant part of their portfolio, and we may soon see private equity firms raising complete public market funds in India.  Given the current environment, moreover, adequate liquidity and the ability to take advantage of volatility are critical, and public equity managers are in a better place to do that. Public equity managers can move swiftly in and out of securities in volatile markets, exploiting dislocations that private equity may not be able to. The combination of these factors – agility in volatile markets, regulatory transparency, and strong performance by public equity makes a strong case for public equity over private equity.

Interestingly, private equity sales have been very strong in the last year, more so than sales of public equity mutual funds, particularly where investments from HNIs are concerned. This is more a reflection of the distribution landscape rather than the investment merits of private equity – private equity is almost certainly one of the highest commission paying offerings, ahead of insurance and mutual funds. The long lock-ins allow private equity managers to pay large upfront commissions to distributors, making for great sales.

In the Indian context, if an investor looks at private equity, perhaps the best form is when an HNI takes a concentrated bet in an upcoming individual company (a GP rather than LP role).  An influential HNI with a large stake in an early or mid-stage venture has the ability to shape a business as a GP, if he chooses a business that is the right fit. 

(Radhika Gupta is a Founder Director with Forefront Capital Management, a SEBI registered portfolio manager, and India’s first specialized quant manager. Prior to co-founding Forefront Capital Management, Radhika was a portfolio manager at AQR Capital Management, a twenty billion dollar asset management firm in Greenwich (Connecticut) where she built quantitative models to trade developed and emerging equities, currencies, and fixed income. Radhika graduated from the Wharton School (University of Pennsylvania.)

 

 


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3 Comments
Manoj Gautam . 6 years ago

PE players follow the sector trends just as their public counterparts and many of these sectors are still in nascent stage. The companies in such sectors have to reach the scale which PE funds prefer. There is and will be a clamor for handful of quality transaction till the growth becomes all pervasive. About the Public and Private debate, if the yardstick is listed peers for private players then PE funds are investing at 20-25% discount with significant rights which they normally dont get in listed companies. PE market in India is not for the faint hearted and trust me, the kind of returns even tier 2 and tier 3 funds have generated in India are un-matched. With time, as the challenges for growth arise once the honeymoon period is over for Indian companies, PE funds will be in more demand as most of these funds are run by talents who are not available to these companies otherwise.

Subir Nag . 6 years ago

“in the ‘last year’, private equity managers have underperformed public equity managers on the aggregate” – this kind of spoils the build up of the logic here. Private Equity and Private Equity are different asset classes with different investment horizon. PE is not to be marked to market on a YOY basis, thus such comparisons are fallacious. one can of course make a great annualised return in, say, a 15 day trade; but that is not the thesis of large institutional LPs or family offices. “money at work for a longer period of time on a specific investment thesis” is PE is and not day to day mark to market of widely available financial assets.

Having said that, it is true that globally at median level, there is not much to choose between the two. But at the right end of the curve, the spread is really very wide. And as Manoj has said above, Indian experience, fortuitously for a lot of medicore people, has been great 😉

Subir Nag . 6 years ago

and, yes, PE is not for the small, uninitiated “artificial” HNIs. I think minimum ticket size for an Indian LP should be Rs. 5-10 cr. Below that, you will know that the manager is just playing the AUM and fee game.

Public vs. Private — No Returns For More Risk?

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