After the three pillars of public equities, fixed income and real estate, private equity was a natural asset class Nicola Wealth wanted to give our clients access to. It offers steadier, and over long periods, higher returns than the stock market, along with diversification benefits to your portfolio.
Why is Private Equity so hard to invest in?
But even for high net-worth investors, it’s a hard nut to crack. Private equity funds typically require minimum investments of $10 million and lock-in periods of seven to 12 years. Since it takes time to source and execute deals, investors dealing directly with PE funds can expect on average, only half their funds committed to actually be deployed over that period. Then there are the fees: 2% per year on funds committed, plus 20% of the return is an industry-standard. And the 2% is charged on the full $10M from day one, regardless if the manager has found an investment or not.
When we started the Nicola Private Equity LP in 2012, it was essentially a fund of funds. We invested with six PE managers we liked, which together provided our clients with a well-diversified portfolio of up to 100 private companies. In time, Nicola began co-investing in companies directly alongside these managers, enabling us to get direct exposure to the most attractive businesses we invest in, and reduce the management fees we were paying. As the companies we held matured, divestments boosted the fund’s liquidity. We were able to shorten the minimum holding period; now, should they need to, our clients can withdraw from the fund with six months’ notice.
Today we have built up our internal expertise to the point we are beginning to invest in companies directly and independently of external PE partners. That brings us still more advantages, for example, the flexibility to hold companies indefinitely if we see the potential for continued strong returns.
“With scale, you can do a lot more interesting stuff,” says Nicola Wealth portfolio manager Kazuki Nohdomi. “Our opportunity set grows. We can drive down fees, provide more diversification. More deals come to us because sponsors and companies see us as a prospective partner.”
Supporting independent businesses
The companies we target have good profit margins, strong cash flows, moderate levels of debt and ideally low exposure to economic cycles. Kazuki uses the example of Decowraps, a Florida-based designer and supplier of floral packaging for large US retail chains. After building the company for 20 years, the founder needed help to bring it to the next level. Nicola invested with a general partner with extensive contacts in retail that was able to help it expand faster.
“Here is a business that is economically resilient,” Kazuki says. It didn’t matter that the U.S. economy was in a nosedive in May 2020 as the pandemic took hold—people still wanted to send flowers for Mother’s Day. Since the wrapping is such a small part of the overall cost of a bouquet, and they do a phenomenal job with the design, we didn’t see too much margin pressure from input cost inflation.
“You wouldn’t be able to find a company like that in the public markets,” Kazuki says. In this way, private equity offers exposure to companies and sectors that aren’t well represented in the public markets or sometimes at all. And the resulting returns? More business fundamentals, less sentiment-driven roller coaster ride.
In the posts to come, we’ll explore why you might want to consider adding private equity to your portfolio, and how it can help it transcend today’s market volatility.
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. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities commissions.