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Tim Melvin

Tim Melvin is a value investor, money manager and writer. He has spent the last 27 years as in the financial services and investment industry as a broker, advisor and portfolio manager. He has also...

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A Better Way To Get Into The Private Equity Mindset

Most investors would be better served by adopting the private equity mind set. Private equity funds have been one of the best performing asset classes for decades.

There fund managers tend to buy during difficult times and favor out of favor inexpensive assets and earnings streams. They tend to hold for much long periods of time than most investors whit an average hold time of more than five years right now. They tend to favor smaller companies with almost 70 percent of private equity activity focused on firms of less than $1 billion in value.

As multiples of assets and earnings rise they tend to become less active buyers and are more likely to be selling into the rising market. Adopting that mindset would improve the investment returns of most individual investors by leaps and bounds.

It is instructive to look at what is going on in the private equity arena right now to get an idea of where opportunities and dangers may lie for investors. The most important t observation that can be taken from reviewing private equity activity is that they are buying less and selling more as the market has risen.

See also: The Key To Mining Private Equity

Deal flow fell by 14 percent in 2013 as rising valuations made it more difficult to put money to work on advantageous returns. The Co-CEO of Industry leader Carlyle Group (NASDAQ: CG) William Conway recently told investors "It was a challenging year to invest, particularly in the United States. This was the flip side of robust public markets and low interest rates."

They are doing a fair amount of selling as the markets move higher. Private equity selling started slowly in 2013 as tax changes had prompted a wave of year end selling in 2012 but it picked up pace quickly as the markets moved higher and valuations continued to increase. As valuations for private equity exits increased sharply in the second half of the year the selling really picked up pace. At one point during the year Leon Black, the head of Apollo Global (NYSE: APO) said “We think it's a fabulous environment to be selling. We're selling everything that's not nailed down, and if we're not selling, we're refinancing."

This attitude seems to be widely shared across the industry. There were 58 P/E backed initial public offerings last year that raised a total of $21 billion. This was the highest level of selling since 2006 and 2014 could surpass those levels. There are already roughly 60 deals filed by private equity firms looking to raise $14 billion this year. Twenty-three private equity backed IPOs have already been completed in the global markets this year. Assets purchased back in 2009 and 2010 at low valuations have now increased substantially and the PE firms are using the strong exit markets to cash in and take profits.

It is not all selling in private equity land. Sector like materials, mining and metals have seen double digit percentage increases in private equity buying activity. More energy funds have been popping up to take advantage of inexpensive assets in North American oil and gas companies. The shipping industry continues to see high levels of interest and activity from private equity buyers as well. Interestingly, these sectors have been among the worst performing in the stock markets over the past several years, although shipping saw a strong rebound in 2013.

See also: What You Need To Look At To Find Exceptional Returns

Private equity funds are selling assets bought at low levels during the crisis and appear to be focusing much of their buying efforts on out of favor industries where assets and cash flows sell at low multiples. They are not buying them to trade out in a month or two based on a chart pattern forming but they intend to hold then for several years until industry conditions improve dramatically. This is the exact opposite of what most individual investors do when approaching the equity markets. This is the single biggest reason that private equity has historically earned very high returns and individuals have earned far less than overall market itself.

Investors should adopt the private equity mind set and look to buy undervalued assets and companies and sell them when they are back in favor. Tracking activity in the private equity industry can help locate those sector where conditions are ripe for new investment and when we should be selling certain sectors and assets.

Tags: private equity firms

Posted in: Education M&A IPOs General