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LMM Compass Edition 7 / 2nd Quarter 2018

In the past years, after the setbacks in the years following the financial crisis Private Equity-Funds experienced a record high inflow of capital from investors. Mainly, institutional investors are able to benefit from the advantages of this asset class. Reason enough to have a closer look at Private Equity investments and discuss its hurdles and particularities. Read more about it in our latest «Compass» edition.

Peter Indra Peter Indra

Director

Martin Frick Martin Frick

Director

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INVESTMENT STRATEGIES

In the first three weeks of the new year, equity markets kept rising until they were dampened by a major correction at the beginning of February. Market participants were surprised by an unexpected rise of volatility (VIX-index). At the same time, bond yields went up in view of the good global economic outlook and the announcement by the US Federal Reserve of interest rate increases.

In the first quarter, negative returns were recorded across the investment strategies. The two major asset classes, equities and bonds, were down and therefore all investment strategies were affected. The rise in interest rates at the beginning of the year has slowed down towards the end of the quarter, moreover interest rates tended downward after the highs of January. Thus, the quarterly loss of investment strategies with a high bond exposure was significantly smaller compared to strategies with a high equity exposure.

Calculation LMM; Period 31.12.2017–31.03.2018 (before costs)
Please note: Performance figures gross (Custody- and management fees not included)

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WHAT MAKES PRIVATE EQUITY SO SPECIAL?

The year 2016 was a record breaking year for Private Equity Funds. In Europe alone, they collected commitments of EUR 73.8 Bln, the highest value since 2008. The market is dominated by institutional investors. Merely 9% of inflows come from Family Offices and private investors1.

Under the term «Private Equity», a wide range of investment opportunities are found in practice. These can differ not only with respect to their legal form but also with respect to risk, return and costs.

«Private Equity» is generally understood as an investment into non-listed companies. Depending on their specialisation, funds are investing in different development stages of companies (for example Venture, Buyout or Turnaround). Fund of funds or secondary funds offer additional opportunities for diversification.

We would like to describe some particularities of Private Equity to you:

Low correlation to liquid asset classes
Due to the low correlation with equities, the allocation to Private Equity shall result in a positive effect to the risk/reward ratio of the portfolio. But it is also the deferred and less frequent evaluation of Private Equity-assets, which has a dampening effect on the volatility. This effect is often not achieved by investments in «Listed-Private Equity».

Higher returns
The returns of successful Private Equity-funds are in the long-term higher than the returns of funds of liquid asset classes. This premium should compensate the investor for the long-term capital commitment.

The following table shows the long-term returns of different strategies:

Long-term capital commitment
Private Equity-funds are normally closed-end funds with a previously defined term (10 to 12 years) that can be extended by the manager subject to certain requirements. The investor commits him- or herself to investing a certain amount. Due to the typical capital calls and distributions, normally no more than 70% of the committed capital is tied up in the fund.

Higher entry threshold
Renowned and successful fund provider often require a substantial minimum commitment. This makes it difficult for private investors to have access to topfunds and to build-up a diversified portfolio.

Higher costs
The fees for Private Equity-funds are normally significantly higher than the ones for equity funds. Besides the management fee a performance-related fee («carried interest») is normally charged as well. The costs for selecting a top-tier manager are higher as well. The quality of the manager is finally the crucial success factor.

Conclusion
Investing in Private Equity requires expert knowledge and experience. The selection process (Manager-Due-Diligence) requires more time and costs as is the case with an investment in traditional asset classes. Private Equity-investments offer the opportunity to generate additional returns. Therefore, Private Equity-investments can be interesting for certain investors, not only in the current market environment.

 

1 Invest Europe: 2016 European Private Equity Activity, July 2017

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VOUCHER CHECK

62 099 – that is the number of bank vouchers, that we checked in 2017 for our clients. Part of our activity as Investment Controller is the continuous control of all transaction vouchers. Besides the fee statements, we also have executions of purchases and sales of financial instruments as well as currency transactions thouroughly checked. Thus we ensure, that the asset management is carried out conform to the contract and in line with the market.

Additionally, the Investment Controller «senses» the changes in the portfolio of his clients. This proximity to the mandate allows us to inform our clients about developments in a timely manner. Our clients benefit from this proximity to the mandate.

The processing of this enormous amount of vouchers is only possible with technical support. Based on daily business requirements we are forced to continously improve our systems. Our know-how in the field of data processing, analysis and storage is a key success factor.

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LMM Investment Controlling

LMM Investment Controlling Ltd. is an independent provider of Investment Controlling services and represents the interests of private and institutional clients towards banks and asset managers. Apart from the head office in Vaduz, LMM has branches in Zurich, Dubai and Vienna.

Disclaimer: LMM takes the utmost care in compiling the information. We don’t grant any warranty, including liability towards third parties, with respect to the accuracy, relevance and completeness of the information and opinions published in this newsletter.