Some deals are not for everyone. High-net-worth investors may prefer to have some of their money in private placements--offerings exempt from registration under the federal securities laws. The lure, of course, is potentially superior returns but seeking those returns means taking on some risks.
“We’re very concerned about illiquidity, which is common in private placements,” says Paul Jacobs, Atlanta-based chief investment officer for Palisades Hudson Financial Group, headquartered in Scarsdale, N.Y. “During the 2008 financial crisis, even some very wealthy investors were clobbered by a lack of liquidity.” Jacobs says that his firm typically keeps private placements to no more than 10% of an HNW client’s portfolio, because of liquidity risk, although that allocation might go as high as 20% or 30% for clients with substantial means and a willingness to bear that risk.
Private placements may be offered in many asset classes; real estate and energy exploration offerings historically have been widespread. According to Jacobs, though, the likely returns there may not be as great as they are in private equity. “We like stocks,” he says. “Long-term, that’s where you might find the highest payoff.”
Although some private equity sponsors have attempted to provide liquidity features in their offerings, Jacobs urges HNW clients to be patient. Investors may have to wait for many years for a fund’s portfolio companies to have a liquidity event such as a buyout or a public offering. “With the leverage used in private equity offerings, a manager who does a good job can deliver excellent results,” says Jacobs.
Indeed, the manager’s experience and expertise may be especially critical because many private equity offerings are blind pools. That is, a manager will raise money without specifying the portfolio companies to be targeted. Investors are betting on the manager’s ability to find the right company at the right price and provide the necessary operating support to deliver successful paydays.
When asked for an example, Jacobs mentioned a blind pool aimed at small-cap companies. “We’ve worked with the manager,” he says, “and we like his approach to such companies. The program is designed to own 20 companies in multiple industries and we were concerned that he might see only, say, 40 possible companies to buy. However, the manager said he sees 50-100 possible companies a year, so we think there will be many good opportunities for investments.”
In this program, Jacobs adds, the minimum investment is $50,000, to be paid after capital calls. “We thought this was a good opportunity for accredited investors,” he says.
Among individual investors, accredited investors typically are those with over $1 million in net worth or steady income north of $200,000 a year (having a spouse who brings joint income over $300,000 also can help someone qualify). By contrast, a “qualified purchaser” is someone with over $5 million in investments, individually or together with a spouse. Generally, private equity offerings for qualified purchasers have higher minimum investment requirements than those for accredited investors.
For all wealthy clients suitable for private placements, advisors should look closely at the offering’s manager before making any recommendation. Past performance is important, naturally, but Jacobs also evaluates the manager’s support network (is the infrastructure in place to follow through successfully after acquisitions?) and at the manager’s commitment to providing transparency to investors over the course of the venture.
“We also consider diversification within a client’s private equity portfolio,” says Jacobs. “We want to avoid too much emphasis on one sector, one manager, or one type of strategy.” Private placements have enough risks without adding overexposure to one egg in this basket.