Private equity investments portfolio construction has become an increasingly popular way for investors to achieve high returns. Private equity funds are typically structured as limited partnerships, with the private equity firm serving as the general partner and the investors serving as limited partners. The general partner manages the fund and makes investment decisions on behalf of the limited partners.
Including private equity in a portfolio can have powerful diversification benefits. Seasoned investors will appreciate the level of thought and analysis that goes into selecting which assets to include in a portfolio, and then rebalancing asset classes periodically to ensure that the portfolio remains close to its intended asset mix.
Introduction to Private Equity Portfolio Construction
Private equity portfolio construction involves the creation and management of a portfolio of private equity investments. The goal of private equity portfolio construction is to achieve high returns while minimising risk. The process of constructing a private equity portfolio involves several steps, including identifying investment opportunities, conducting due diligence, negotiating terms, and monitoring investments.
Private equity portfolio construction service takes analytical approach to portfolio construction and proprietary tools and applies them to this highly specialised asset class. With their ability to mitigate risk through increased diversification unlisted investments continue to play an important role in building robust portfolios. These service helps ensure accurate evaluation of these asset types through precise valuation, specialised modelling and carefully curated data.
Identify your portfolio strategy and current needs
Before you include a new asset in your portfolio, it’s necessary to have a clear picture of what overall strategy you’re aiming for and what your immediate objectives are.
Define your overall portfolio strategy:
- Risk-return appetite. What is your overall target return and how much risk are you willing to accept to achieve that return?
- Cash flow. What is your ability to fund the investment’s anticipated cash requirements and what are your needs for cash distributions later on?
- Liquidity. What is the range of time you are comfortable being invested without access to your capital?
- Other constraints. Do you have tax issues with private investments or are there any legal constraints limiting your exposure to certain strategies?
Examine your existing portfolio:
With your overall strategy and needs in mind, consider your portfolio as it is now compared to how you want it to be. This guides your asset selection going forward, with the goal of optimising diversification to meet your strategic goals.
- Is your current portfolio overconcentrated in a particular sector or region? If you are too heavy on technology or the US, then a shock to that market could have negative effects overall.
- Is your portfolio underweight in particular sectors or regions? If so, it is worth considering whether they have a positive effect on returns without increasing overall risk.
- Is there an asset type that could decrease overall risk? (By including an asset that is negatively correlated to your portfolio, it can reduce overall risk while stabilising returns.)
- How diversified is your portfolio, and are there any other characteristics that you should be aware of, such as being overconcentrated in funds with a similar vintage or managed by the same General Partner?
Use the answers to these questions to define your immediate objectives and determine the benefits and risks of adding a new asset to the portfolio. You should return to this step periodically to rebalance your portfolio and ensure that your objectives are still being met.
Identifying Investment Opportunities
One of the key challenges in private equity portfolio construction is identifying investment opportunities. Private equity investments are typically only available to accredited investors, which limits the pool of potential investors. Additionally, private equity investments are often illiquid, which means that investors may not be able to sell their shares for several years.
Despite these challenges, there are a number of strategies that investors can use to identify investment opportunities. One approach is to focus on specific sectors or industries. For example, an investor might focus on healthcare or technology companies. Another approach is to invest in funds that specialise in specific types of investments, such as growth equity or distressed debt.
Conducting Due Diligence
Once potential investment opportunities have been identified, the next step is to conduct due diligence. Due diligence is the process of evaluating an investment opportunity to determine whether it is a good fit for the portfolio. Due diligence typically involves a thorough review of the company’s financials, management team, and market position.
Negotiating Terms
If an investment opportunity passes the due diligence process, the next step is to negotiate terms. Private equity investments typically involve complex legal agreements that govern the relationship between the investor and the portfolio company. These agreements cover issues such as governance, management, and exit strategies.
Monitoring Investments
Once an investment has been made, the final step in private equity portfolio construction is to monitor the investment. Monitoring involves tracking the performance of the investment and identifying any potential risks or issues. Monitoring also involves working with the portfolio company to help it achieve its goals and objectives.
Consider your private equity allocation
Your overall allocation to private equity should balance your strategic objectives in the context of factors such as:
- The desire to diversify existing asset classes in your portfolio
- Your ability to allocate capital to less liquid investments for a period of years
- The amount of capital immediately available for PE allocation
- Your overall target allocation between equity, fixed income, and other asset classes
- The minimums required for PE funds of the type you are interested in
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Conclusion
Private equity portfolio construction can be a complex and challenging process, but it can also be a highly rewarding way for investors to achieve high returns. By following the steps outlined in this article, investors can create and manage a successful private equity portfolio.
