Private equity is ripe for change. As political scrutiny, questionable fund performance, and increasingly complicated LP-GP relationships take a toll on existing funds, the JOBS Act is simultaneously opening a new frontier. However, many equiteers may be missing out on this watershed moment by focusing on the wrong developments.
The JOBS Act, while offering private equity to the (accredited) masses, does not guarantee that investors will jump into this alternative asset class. Bob Rice, Managing Partner of Tangent Capital, fears that new investors may be hesitant to add private equity to their portfolio, jeopardizing the opportunity afforded by the JOBS Act. The reservation will have little to do with political stigma or IRRs — instead Rice fears that investors will shy away from private equity because they have no easy way of understanding the investment opportunities.
“The lingo used in the space is so arcane and out of date that investors have no context for the discussions,” said Rice. “The failure to establish a clear, effective communication system has been the biggest sin private equity has committed.”
He added, “Private equity is such a bad way of talking about private equity. There are so many different flavors and styles of private equity that to generalize the investment type would conflate so many different approaches and strategies.” The industry-specific vernacular will likely only become more of a hurdle as firms begin promoting private equity and their fund through general solicitation. If dozens of firms are constantly repeating the same message, it could risk solidifying the confusion.
“The only way you can mainstream alternative investments — like private equity — is to explain them clearly,” commented Rice. “If investors cannot fully understand the investments, there will always be an uphill battle. As a result, the need to demystify private equity — and alternative investments in general — has become increasingly important recently.”
In his new book, Alternative Assets: The Nontraditional Investments That Drive the World’s Best-Performing Portfolios, Rice lays out what he believes is a much more effective communication strategy: speaking to investor goals. “Instead of relying on confusing phraseology, a simpler framework needs to be implemented for private equity to attract new investors. Instead of discussing the space as an entire asset class, I believe it would be more efficient and clearer to discuss it by desired investor outcome.”
The four common investor goals Rice suggests are:
- Increase current income
- Reduce risk of loss
- Increase returns on accepted risks
- Protect wealth against inflation and currency devaluation.
Speaking to these ends, rather than to the performance of a specific fund or asset class, could “serve as a tool for people in the industry to communicate more effectively with the outside world,” said Rice. The outside world is not limited to investors either. Rice continued, “It could help facilitate communicate with regulators as well. I have already heard some private equity professionals have been passing the book onto regulators to help give them better insight into the purpose and strategy of the industry.”
Although Rice envisioned the four categories as a means of discussing all alternative investments, they are particularly appropriate for private equity. “Private equity runs the gamut of the types,” explained Rice. “Private equity from a debt perspective belongs to the income section, while growth equity may sit in risk reduction and diversification.”
Rice believes that the firms that are able to better communicate with investors will not only be able to better capitalize on the opportunities presented by the JOBS Act, but that they may likely to adopt a more creative and forward thinking strategy. He explained, “One of the biggest drivers of change in private equity will be the dispersion in manager performance. As the performance gap builds, firms that are smaller, nimbler, and more specialized will be more equipped to drive top-line revenue growth.”
As these smaller firms begin to outperform competitors, they will be the model for an ideal firm. “A larger number of smaller, specialized firms is where the renaissance will really occur,” said Rice. “I think the total dollars flowing into the industry will increase as the industry becomes more nimble.”