Why Does a Savvy Public Stock Fund Manager Choose Private Equity?

I have encountered a wide range of investors over my 25 years in the investment management industry. While they often differed in their investment philosophies, time horizons, and risk preferences, they agreed on the importance of diversification, transparency and growth when investing for the long term.

From a public investing standpoint, the goals of diversification and transparency can be relatively easy. The investments are typically in publicly traded equities with daily pricing. I was an investment manager of a fund focused on public growth equities, where the primary objective was capital appreciation. The fund provided transparency and liquidity while generating significant capital appreciation over a long term time horizon.

I utilize the same philosophy in my personal investing. Hence, the traditional “blind pool” private equity funds held little allure to me, as I often didn’t know what I was investing in, the potential return and the specific time horizon.

However, one of the major trends in private equity today is that more individual investors are eschewing the traditional “blind pool” funds, and are engaging in direct investment in Private Equity deals. As a direct investor in several private equity transactions as well as a career money manager in a public equity fund, it is interesting to note that the advantages of the direct investment model in Private Equity can mirror some of the advantages of investing in public stocks as highlighted below:

  1. Better control over each investment

Unlike the committed funds, where individuals are bound to participate in all investments of the fund, irrespective of the risk profile and personal choice, direct investing allows the investors to understand each investment on its own merits. Thus, they are able to invest a higher or lower dollar amount depending on their knowledge of the industry, risk profile of the particular transaction, and their personal capital management.  This allows investors like me to be in control of the decisions such as; a) Where to invest (specific company) and b) What to invest (debt/equity).

  1. Diversification

Committed funds often choose to invest in a particular industry, geography or size. While that may work for some investors, it may not work for others who may be looking to invest a limited amount of capital across a wide range of criteria.

Conversely, a direct investment allows the investors to choose and invest based on the sector, business life cycle (growth, acquisitive, mature, etc.), and capital needs (growth, turnaround, acquisitions and/or financial restructuring), balancing the current risk and return of their portfolio.

I have found this to be particularly helpful as it encourages me to take a deeper look into a variety of industries and sectors, encouraging a more thoughtful approach to my overall investment portfolio.

  1. Current income and future growth

As mentioned earlier, individuals can invest in various levels of the capital structure thus providing for capital appreciation (equity) and/or current income (interest/dividends). The flexibility in investment structures with both debt and equity components provides another method of diversifying one’s investment portfolio.

 

All the above also leads to greater transparency since the individual investor has a lot more say over how and where their money is invested.

Important aspects of direct investing include trust, competency of the financial sponsor, and the ability to communicate regularly and honestly. The sponsor needs to identify appropriate investments and be clear about what would make the investment successful as well as what could go wrong. Regular, periodic communication is key to ensure that the investors are aware of how the investment is performing – during both positive and challenging periods.

As an investor in several transactions of Cave Creek Capital Management (CCCM), I find that well-structured and competent managers like Cave Creek Capital Management, work hard through active involvement on the Board and provide additional support through sales introductions, team augmentations, business planning as well as other skills to grow an investment and mitigate potential losses early. They also provide me with regular updates on all my investments so I stay informed. The team at CCCM is always available to answer questions.

Ideally, a direct investor should be very familiar with the investment manager over an extended time period before investing. I’ve known Kevin Fechtmeyer and CCCM for several years, and the average investor in his group has been investing with CCCM for over 15 years. This is vital to proving a track record of performance and communication, which gives me greater comfort in my investment decisions.

Meighan Harahan has more than 25 years experience in the investment management industry. Ms. Harahan managed the Driehaus Mid Cap Growth Strategy with over $1 billion in assets generating a top 1% rating among peers over a 10 year period. Driehaus Capital Management, LLC, an institutional investment management boutique in Chicago, Illinois focused on small and mid capitalization growth companies utilizing fundamental and technical analysis.

The views expressed are personal. As told to Vibhuti Nayar