For high net worth investors, the sustained growth of private equity markets in recent years is providing an attractive proposition. Out have gone the hedge funds that seemed to be more in vogue with investors before the global financial crisis. And in comes the private equity market; buoyed a generation of start-ups with significant growth potential that can be bought low and sold high. But it’s foolish to suggest that, even for the most experienced traders, it is risk-free.
As with all forms of investment, there is a risk-reward dynamic that can drive high returns. But it can also lead to significant losses – especially when external factors exert their influence. The good news is that you can protect yourself against some risks – for example, political instability – with specialist insurance from dedicated brokers such as Gallagher. For those other risks and threats, however, it requires a proper risk management strategy to protect your position.
The main risks to private equity investments
It is an attractive alternative asset class, of which there can be no doubt for budding investors. But it’s important to be sure the rewards are worth the risks you’re prepared to take. From the outset, the high barrier to entry means the minimum investment is often higher than for other forms of asset classes. And that means there’s much more at stake.
In terms of funding and liquidity risk, investors must be prepared for all of the capital invested to be called upon at some point for the duration. Private equity investments are often locked in for at least five years. If the financial position of an investor changes for the worse in this time, it can mean losing status as a limited partner or selling an asset that hasn’t achieved its value.
Market risk is another factor that needs to be considered in any private equity investment. You can’t control these external forces – consumer demand, commodity prices or interest rates. It’s more than possible that broader economic and political forces can decide the degree of market risk you face. And it’s why some rightly now ask what Covid-19 means for private equity.
How do political factors increase risks for UK investors?
For UK investors, there are obvious factors to be aware of. Away from the impact of Covid-19, Brexit remains a constant opportunity or threat – depending on how you decide to look at the UK’s changing relationship with the European Union (EU). What cannot be overlooked, though, is the impact it is having on market risk within the UK market and for UK investors abroad.
The value of the British Pound has been up and down like a rollercoaster since the decision to leave the EU was confirmed. With hopes of a Brexit trade deal back on an upward trend, so is the value of the Pound. But it will remain exposed to the fragility of negotiations until we have the agreement signed, sealed and delivered. The same goes for business confidence too.
Protecting you and your investment from political risk
“Private equity is in the middle of one of the most profound shifts in the capital market since the 19th century,” says E&Y. And such shifts will always attract new converts in search of the benefits on offer. But flocking to an asset class without a proper understanding of the risks in play could leave investors counting their losses – instead of their gains.
A thorough risk management strategy needs to consider the worst case scenarios that you’re able to predict. It also means taking account of the factors you either can’t control or foresee. That is why the most effective strategies include political risk insurance. It is, after all, the old adage of hoping for the best and preparing for the worst in order to protect your position.
This approach to risk management can also give you the confidence to make new investments and pursue fresh opportunities without overplaying your position and leaving you exposed.