The Case Against Private Equity: What Investors Need to Know About Risks, Rewards, and Realities - Ep. 88

FPO&G: Financial Planning for Oil & Gas Professionals

For more information and show notes visit: https://www.bwmplanning.com/post/88

In this episode of Financial Planning for Oil and Gas Professionals, hosts Justin Brownlee and Jared Machen dive into the case against private equity. Private equity investments can be an enticing option for investors seeking higher returns, but they come with a distinct set of risks, fees, and liquidity challenges that warrant careful consideration. Here are some key points to keep in mind when evaluating private equity as part of your investment strategy:

Unique Risks

Private equity often involves investing in smaller, less established companies compared to public market investments. This different risk profile means these companies may be more vulnerable to market fluctuations and economic downturns. The episode highlights that private equity can be viewed as "leveraged small-cap investing," which inherently carries more risk than investing in larger, more stable public companies.

High Fees

Private equity typically has a fee structure that includes a management fee (often around 2%) and a performance fee (commonly 20% of profits above a certain threshold). These fees can significantly erode returns, especially when compared to the low fees associated with public market investments. We illustrates how high fees can diminish the net returns that investors actually receive, making it crucial to understand the fee implications before committing capital.

Liquidity Issues

The timing of cash flows in private equity can be unpredictable. Investors may find that their capital is tied up for years while the fund seeks out and invests in companies. This contrasts sharply with public market investments, where investors can buy and sell shares almost instantaneously. We discuss the concept of the "J-curve," where initial returns may be negative as capital is deployed, making it essential for investors to understand the cash flow dynamics. The lack of liquidity can also create behavioral challenges for investors. If an investor's portfolio is down significantly but not marked to market, they may not fully grasp the extent of their losses. This can lead to complacency or poor decision-making during market downturns, as the investor may not feel the immediate impact of their investment's performance.

Conclusion

In summary, while private equity can offer attractive returns, it is essential to approach these investments with caution. The unique risks, high fees, and liquidity issues associated with private equity require a thorough understanding and careful consideration. Investors should weigh these factors against their financial goals and risk tolerance, ensuring that they make informed decisions within the context of their overall investment strategy.

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Thank you for tuning in, and we look forward to bringing you more insightful episodes in the future.

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Disclosure: This information is for informational purposes only. Nothing discussed during this video should be interpreted as tax, legal, or investment advice. If you have questions pertaining to your specific situation, please consult the appropriate qualified professional.