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Risks in Private Equity
Key Risk Factors
As with all asset classes, investing in Private Equity involves certain risks. Some of these risks are common to most investments, while others are specific to PE. The European Private Equity and Venture Capital Association has identified the following four categories of key risks an investor in a PE Fund faces:
- Funding Risk
The unpredictable timing of cash flows poses funding risks to investors. Capital commitments are contractually binding and defaulting on capital calls results in adverse economic consequences for the LP and the PE Fund.
- Liquidity Risk
The illiquidity of LP interests exposes investors to risks when selling such LP interests as there may not be a secondary market for such sale. LP interests are also usually sold at a discount to the reported NAV.
- Market Risk
The macro-economic environment and the fluctuation of tangential markets such as public equity, debt, interest rate and currency markets have an impact on the value of the investee companies held by the PE Fund.
- Capital Risk
The realisation value of any investee company can be affected by numerous factors, including the quality of the fund manager, equity market exposure, interest rates and foreign exchange movements.
Diversification and Capital Risk Mitigation
PE Fund of Funds
Fund of Funds ("FoFs") are investment vehicles, which make investments in various PE Funds as opposed to making direct investments into underlying companies. PE FoFs can generally be categorised into the following two subsets:
1. Primary Fund of Funds
Invest in individual PE Funds at their inception through primary capital commitments. Depending on their strategy, a typical Primary FoF may develop a portfolio of between 20 to 50 PE Fund investments over several vintage years. Primary FoFs tend to demonstrate a similar J-Curve to that of an individual PE Fund.
2. Secondary Fund of Funds
Invest in individual PE Funds by acquiring LP interests through a secondary market purchase. Secondary FoFs provide investors with exposure to a seasoned portfolio that is generally more diversified than Primary FoFs. They also tend to demonstrate a shortened J-Curve compared to that of an individual PE Fund.
Market Evidence of Diversification
Diversification as an effective tool to minimise capital risk can be demonstrated in the capital preservation performance of PE FoFs relative to that of individual PE Funds. Based on a Preqin dataset of approximately 4,764 PE Funds and FoFs with known performance and vintages ranging from 1990-2017, both Primary and Secondary FoFs have demonstrated superior downside protection when compared to investing in a single PE Fund while still generating competitive risk adjusted returns (see Fig. 8). This analysis examines the percentage of PE Funds (by count) which have reported total value to paid-in multiples ("TVPIs"), of less than 1.0x (signaling a capital loss), equal to or greater than 1.0x but less than 1.5x, or equal to or greater 1.5x (a TVPI of greater than 1.0x signals a capital gain).
Fig 8: TVPI Breakdown by Fund Type (1990-2017)
The information regarding private equity and the private equity industry has been derived from general information which is publicly available as well as the specific sources cited in the endnotes to this section or were obtained from various external sources, and have not been verified with such sources. The information is included for information purposes only and has not been independently verified by the Issuer and its affiliates and should not be regarded as an indication of the future performance or results of the Fund Investments, or private equity funds or the private equity industry generally.
The information contained in this section includes historical information about private equity funds and information on the private equity industry generally that should not be regarded as an indication, promise or representation as to the past or future performance or results of private equity funds or the private equity industry generally.
Other topics in
- What is Private Equity?
- What is a Private Equity Fund?
- Investing in Private Equity Funds
- Risks in Private Equity
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- Fitch Ratings Special Report - PE CFOs Stable After Coronavirus Recovery
- Fitch Ratings – PE CFO Update: 3Q21
- McKinsey Global Private Markets Review 2021
- Bain & Co Global Private Equity Report 2021
- Bain & Company Global Private Equity Report 2020
- McKinsey Global Private Markets Review 2020