925 4th Ave - Suite 3700
Seattle, WA 98104
Phone: 206.204.0320

October 15, 2003
Issue 7
Past Issues 1 | 2 | 3 | 4 | 5 | 6

 In This Edition

Private Equity
Market Highlights
Private Equity

In the spirit of continuing education we would like to devote this issue to the topic of private equity.

What are the definitions and origins of private equity?

Simply defined, private equity is any equity or equity-linked security which is not “publicly” registered under applicable laws. This category includes venture capital, mezzanine financing and leveraged buyouts (LBO’s).

The term “private equity” dates back to 1946 when the American Research and Development agency (ARD) was formed to assist new and growing U.S. businesses. Congress continued to support this effort through the 1950’s and 1960’s. When the fruits of those investments began to appear in the form of a strong initial public offering market in 1968 and 1969, the enthusiasm for private equity was well underway. In addition to laying the seeds for future businesses, these same funds began looking at the possibility of buying out divisions of large U.S. conglomerates. The late 1970’s saw regulatory and tax changes which allowed large U.S. pension funds to invest in this unregulated asset class for the first time. The combination of these events resulted in a boom of fundraising and hence fund flows, into private equity.

The mid to late 1980’s saw a boom in leveraged buyout funds. From Levi Strauss to RJR Nabisco, the culture of the buyout was memorialized in film with Oliver Stone’s Wall Street and in print by Brian Burrough’s and John Halyar’s, Barbarians at the Gate. However, the buy and bust mentality soon gave way to those advocating the buy and build approach and the term “leveraged buyout” gave way to the 1990’s friendly term ”private equity”.

In general, private equity funds are limited partnerships with a General Partner (GP) and up to 499 “qualified purchaser” Limited Partners (LP’s). The LP’s are investors into the partnership. Typically, an investor subscribes into the private equity partnership, with an agreement to commit a specific amount over the life of the fund. An investor will typically contribute 10% at inception, with the remaining funds drawn down over the next few years. There are also fund of funds structures where the fund buys into multiple underlying private equity funds. These fund of funds structures make private equity available at lower minimums, and provide for additional diversification.

The Arguments for using private equity

The primary reason to incorporate any asset class into a portfolio is for further diversification and enhanced returns and this certainly holds true for private equity. Within this class there exist many options for investors. In general, however, all of the funds are looking to introduce some new element which can unleash the earnings power of a private entity. These elements may include new technology, new management, or the addition or affiliation of complimentary companies.

The Arguments against using private equity

Just as in our discussion of hedge funds in our last newsletter edition, private equity funds also have features that a potential buyer needs to be aware of. The funds themselves typically have expected lives of ten to twelve years with little in the way of liquidity or transparency. In addition, many of these funds were established in the late 1990’s when expectations for returns were clearly much higher than they are today. With such a torrent of dollars pouring into the funds, it can be difficult for managers to put money to work thoughtfully. Fees for private equity funds tend to be much more expensive than traditional asset classes, with a typical fee structure for private equity funds of 2% with an additional 20% incentive fee. The aforementioned fund of funds structures generally carry an additional layer of management fee.

Certainly, there are private equity funds in the marketplace that provide exceptional returns. The experience and vision of the investment management team are key to the success of the funds. Private Equity funds can also provide a forum for an investor to invest in targeted areas that are of personal interest to the investor.

 Market Highlights

  10/14/03 9/30/03 6/30/03 3/31/03 12/31/02
DJIA US 9812.98 9275.06 8985.44 7992.13 8341.63
S&P 500 US 1049.48 995.97 974.5 848.18 879.82
Nasdaq US 1943.19 1786.94 1622.80 1341.17 1335.51
EAFE Int'l Equity 1179.34 1103.39 1025.74 868.55 952.65
5 Yr Treasury 3.22 2.865 2.41 2.71 2.74
5 Yr AAA Muni 2.5 2.300 2.17 2.50 2.59
10 Yr Treasury 4.311 3.932 3.52 3.80 3.82
10 Yr AAA Muni 3.87 3.670 3.30 3.75 3.72
30 Yr Treasury 5.208 4.857 4.56 4.82 4.77
30 Yr AAA Muni 4.86 4.680 4.50 4.66 4.69
EUR Currency 1.1689 1.1686 1.1425 1.0899 1.0488
JPY Currency 109.28 110.36 120.06 118.67 118.69
If you would prefer not to receive future newsletters, or if you've changed your email address, please click here or send mail to information@huntingtonsteele.com