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Private Equity Takes a Stroll Downmarket

By Taylor Smith March 21, 2014

Jeff Spears, CEO of Sanctuary Wealth Services in San Francisco, figures about 5% of his firm’s clients had private-equity investments five years ago. Now he pegs the rate at around 20%, and rising.

The difference? Now, with low interest rates weighing on fixed-income gains, investors are drawn to private equity by the promise of outsize returns and diversification from their stock holdings. In addition, while private equity used to be for direct — read that as rich — investors only, investment companies now offer retail investors funds that tap into private-equity deals, with minimums a tenth or less of what’s required for direct investments. That’s a contrast between millions of dollars for direct plays and hundreds of thousands to buy into one-off private-equity funds.

“We’re seeing the democratization of private equity, and we’re only in the early innings,” says Spears, whose firm manages around $3 billion.

Though well shy of prerecession highs, fundraising in private equity has more than doubled since 2009 and investing has tripled, according to the Private Equity Growth Capital Council.

But Spears is careful to give clients a rounded view of private equity. First, the vig can be hefty, with management fees of 1% to 2%, plus additional expenses that can raise the total to around 4% or 5%. And, even in a fund, it’s an illiquid investment. “Clients need to understand that illiquid really means illiquid,” he says. “They can’t have access to this money even if they really need it.”

Jeff Spears

To keep things on the safe side, Spears usually reserves private-equity investments for his higher-net-worth customers, and he keeps it to under 10% of a client’s portfolio. And while minimum investments have come down, Spears says it may take $1 million to build a well-diversified private-equity stake for a client. “So if you back into that, that’s talking about a client with $10 million” in his or her portfolio, he says — and that’s a bare minimum.

Patricia Farrar-Rivas of Veris Wealth Partners, a firm in San Francisco with $665 million under management, says advisors need to consider their clients’ temperaments before putting them in private equity. For instance, clients who reflexively check stock prices and account balances are likely to get anxious about an asset class that doesn’t generally offer frequent price updates. “They need to be comfortable about not having valuations at their fingertips,” she says.

Warning to Clients

But some advisors aren’t fans of private equity on any terms. H.M. Payson, a wealth-management firm in Portland, Maine, recently e-mailed clients a pointed research note on why it’s not biting on alternative investments, including private equity.

“We thought this was a good way to just let people know where we stand” on “these types of investments,” says David Hines, H.M. Payson’s director of research.

The firm, which manages around $2.5 billion, thinks private-equity fees are hard to justify and wonders about the real diversification benefits of private equity. “If you really need to reduce volatility and add diversification, there are cheaper ways to do that through the public equity and bond markets,” he says.

Getting this message through to clients can be hard, especially with so many clients asking about alternatives as the stock market comes off last year’s big gains.

“We think we’ll start getting more calls from clients asking how they can juice returns,” says Hines. “I’m sure the alternative conversation is going to keep coming up.”