Limited partners investing in private equity funds must resist investing in “hot” strategies and increase diversification by vintage year.
This was the message delivered by Russell Steenberg, global head of BlackRock Private Equity Partners, the fund of funds group within BlackRock Alternative Investors, at a breakfast with reporters Tuesday morning.
“It’s very, very difficult to time the private equity cycle,” Steenberg said. “Dollar averaging by vintage year is very, very important. Having something in your portfolio when the market gets hot so you can sell into it is how we’ve always made money, and I think we will going forward.”
As an example, Steenberg pointed to Facebook’s recent initial public offering and disappointing stock performance for new investors in the company.
It's very, very difficult to time the private equity cycle.
“Even with all of the problems with the Facebook IPO, which everyone loves to talk about, Accel Partners, who did the first round, is still sitting in 100 to one on their money. So when it works, it can work spectacularly well,” he said. “However, you need to have invested in the mid 2000s in order to get that kind of return. Chasing it today is not how you’re going to make your money in venture capital.”
Still, in private equity LPs can benefit from shorter term opportunities by participating in co-investments, according to head of BlackRock Alternative Investors Matthew Botein.
“You can time the market much better because you can control which co-investments you participate in [and] when, and you can put more money to work when you deem it to be more attractive,” Botein said. “There are implementation challenges for many investors in getting the benefit of the co-investment bargain but it’s an important part of the puzzle that many LPs are beginning to really appreciate.”
In terms of specific strategies to increase diversification, Steenberg said investments in timber, farmland and commodities can act as “hedges” for private equity investors.
“People are starting to look at these [strategies] and to put more money in to make sure that they’ve got the hedge in their diversified portfolio,” he said, adding that drug royalties have been a consistently well-performing niche strategy.
“It’s a nice play,” he said. “It’s something that you should probably have in there with other things as well. It’s not a huge growth area.”
While mezzanine debt has been a popular strategy recently, Steenberg warned investors of “following” the market.
“Mezzanine is a very cyclical play in the private equity world right now, but like the venture capital analogy, the time to have had your mezzanine players lined up was three to four years ago so they’re sitting on the money today to take advantage of the opportunity,” he said. “To put money into mezzanine players today is a question of how long you think that cycle will play to your favour.”