So far equity markets have behaved very differently from 2021, serving as a reminder of how volatile securities markets can be. That’s despite the fact most publicly traded companies’ profit outlooks generally haven’t really changed all that much.
As Nicola Wealth Portfolio Manager Kazuki Nohdomi sees it, public equity investors face two major drivers of their returns: the actual performance of the businesses they invest in, but also market sentiment. Thankfully, there is a form of equity investing that avoids a lot of the drama: private equity. Yes, private company valuations can be affected by things like COVID-19 lockdowns. But the daily swings in fear and greed? That’s less appliable to the private equity space.
“When I hear the Dow is down for the day for no real economic reason, I couldn’t care less,” Nohdomi, portfolio manager in charge of the Nicola Private Equity LP says.
Granted, there is some correlation between public and private equity. But holding private equity, Nohdomi says, is “less emotionally taxing –it’s much more long-term oriented without the big short-term swings.”
Returns tend to not be as volatile as public equity
The first thing investors should expect investing in the Nicola Private Equity LP, then, is that the returns will not be as volatile as their public equity holdings. Down years are rarer, and double-digit gains not as common as in the stock market. That reduction in volatility goes both ways, Nohdomi notes. “When your neighbours are making 50% in the stock market, it may not feel so good” making 10% or even 12% with your PE fund.
Over long periods, private equity tends to outperform
The second is that, over long periods, private equity tends to outperform. Economists have long grappled with exactly why that is. Nicola Wealth’s own fund, now approaching its 10th birthday, has an annual return since inception (May 18, 2012) of 9.3% (as of March 31, 2022), easily topping the S&P/TSX total return of 5.7% over the same period*.
As we explored earlier in this series, since its holdings seldom change hands, the Nicola Private Equity LP is valued at any one time based on metrics including earnings multiples. It generates a return in two ways: primarily by growing earnings and the quality of those earnings, as well as expanding those valuation multiples.
Buy at seven, sell at nine
“We try to buy at seven and sell at nine,” Nohdomi explains. That means the fund might buy a business at a price equivalent to seven times its annual cash flow. If we manage to grow sales and earnings over the holding period, prospective buyers will gain confidence in the company’s potential, and therefore become increasingly willing to take it off our hands for nine times its cash flow.
Strengthening the business
“We expect the quality of the company to improve during our hold period,” Nohdomi explains. That means growing the business, diversifying its source of earnings through new lines of business and acquisitions. Prospective buyers will be more willing to pay a higher multiple for a company that is professionalized, larger scale, with a more diversified customer base.
That kind of methodical wealth-building didn’t look so sexy last year. This year, however, private equity is proving its worth as a steadier yet still robust source of returns for our clients’ portfolios. Best of all, the Nicola Private Equity LP makes it relatively easy, by breaking down some of the barriers most investors face in accessing this asset class. If you’re ready to take that next step and make private equity part of your nest egg, talk to us.
This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Past performance is not indicative of future results. All investments contain risk and may gain or lose value. Returns are net of fund expenses charged to date. This is not a sales solicitation. This investment is intended for tax residents of Canada who are accredited investors. Residency restrictions apply. Please read the relevant documentation for additional details and important disclosure information, including terms of redemption and limited liquidity. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required securities commissions.
*Comparisons of the historical performance of Nicola Wealth funds or models to the historical performance of indexes, mutual funds or other investment vehicles should only be undertaken with consideration of the differences that exist between the underlying investments that comprise the compared investment vehicles. Indexes may be primarily composed of a single asset type/asset class (i.e. 100% equities or 100% bonds) whereas Nicola Wealth funds may or may not contain a combination of exchange-traded equities, marketable bonds, private investments, other alternative investment classes and exempt products. When making any comparison of historical performance, these differences and their impact on the performance of each comparable should be taken into account. Returns for the Nicola Private Equity Limited Partnership as of March 31, 2022 are as follows: 1 Year – 23.1%, 3 Year – 13.8% and 5 Year – 13.0%.