If you’ve been reading the business section of your newspaper over the last year, you’ve probably noticed a recurring subject: private equity. Recently there has been a lot of talk about the possible sale of BCE Inc., the largest telecommunications company in Canada, to a group of private equity firms. And in May, the news that Chrysler, the third largest American carmaker, had been sold to a U.S.-based private equity group made headlines.
Although private equity has been consistently evolving in the United States over the past few decades, Canada’s market is fairly new, with most investors and fund managers entering this asset class during the last 10 to 15 years. Today, with investment amounts reaching new records — $9.2 billion in 2005 in Canada and US$110 billion in 2004 in the United States — private equity is considered an alternative asset class for investors.
In general terms, private equity represents investments in private companies, typically in equity securities issued by those companies. These types of investments can be made at different stages of the life cycle of the company. Investments made at the development stage are referred to as venture capital, whereas the hot-off-the-presses deals we hear about are usually buyouts of companies that are already well established in their industry and have an interesting potential for return on investment. If the company bought was public, it becomes private and therefore will no longer be listed on the stock exchange, thus reducing the investment options of equity mutual fund managers and individual investors with stock portfolios.
The advantages associated with private equity are surely in great part responsible for its rising popularity over the years. When a company is listed on the stock exchange, it incurs various business and compliance costs. A private company doesn’t have all those obligations. It doesn’t have to meet analysts’ expectations on a quarterly basis or give guidance, which can sometimes have a negative impact on stock prices, so its managers have more time and money to focus on growth. That in part explains the better return that has been seen over many years in the private equity sector compared to publicly traded stocks.
So why doesn’t everybody invest in private equity funds? The main reason is simply accessibility. Typically, to be able to invest in a private equity fund, the minimum investment required varies from $5 million to $50 million and more. That is why mostly institutional investors participate in these funds. However, although individual investors may not have such amounts available for investment, they may be exposed to private equity indirectly.
The big pension plans have taken notice of the potential of private equity and have started to include this asset class in their portfolios. The Canada Pension Plan Investment Board, the Ontario Teachers Pension Plan, the Caisse de dépôt et placement du Québec, and the Ontario Municipal Employees Retirement System (OMERS) all have investments in private equity funds that may benefit their members. We are also starting to see private equity firms that offer private equity funds that are more accessible to the retail market. One Canadian outfit offers a fund with a minimum investment requirement of $25,000, a far cry from $5 million! Another way for individuals to participate in the growth generated by private equity firms is to buy their stock on the stock market. Canada’s largest private equity firm, Onex Corporation, is listed on the Toronto Stock Exchange.
We have not seen the last of the headlines about private equity firms buying large corporations. With large amounts of money already available in private equity funds just waiting to be invested, company buyouts will continue. Just as real estate, private equity is considered an alternative asset class that investors should explore to see if it fits in their overall investment strategy.
Denis Losier is President and CEO of Assumption Life. He prepared this article in collaboration with Marc André Castonguay, marketing and financial planning specialist with Assumption Life.