Pictet’s Pierre-Alain Wavre sees opportunities in private equity’s countercyclical nature

AFTER 35 years of investing in private assets, Pierre-Alain Wavre has learned a few lessons: take valuations with a pinch of salt, differentiate economic risk from volatility risk, and remember that economic cycles are precisely that – cycles.

He is head of Pictet Wealth Management’s Pictet Investment Office, which invests for very large wealth owners or families, with fully discretionary mandates starting at 100 million Swiss francs (S$150.4 million).

His investment experience has taken him through alternating periods of excess and dearth, which have given him the necessary perspective to take longer-term views.

When sentiment is overly optimistic – as it was during the dot-com boom and the recent venture-capital boom – people “forget fundamentals”, he said.

This means assets can get sold at very high prices, pushing paper valuations up a great deal. A valuation based solely on the last price at which an asset was sold, however, may not necessarily reflect its true value.

Valuation should be less about what was paid, and more about cash flow, he added.

On the flip side, valuations can be heavily marked down in tough times. The recorded performance for private equity as an asset class has recently been below trend, but Wavre said this “doesn’t mean anything”.

“Valuations are an indication, and some are more conservative than others. We have a large portfolio, and we sometimes own the same company through different funds. Sometimes, there are different valuations,” he said.

“You know the real value only when you sell the asset,” he explained. “If you haven’t sold it, you don’t know if the valuations are wrong or right.”

Of course, valuations have their use. They represent a means for fund managers to present their funds and report on their performance.

As an investor, however, looking only at performance might lead to mistakes, Wavre said. “I always joke that all the funds’ managers who come to see us are in the first quartile. Who is in the second quartile?”

When it comes to private equity investing, therefore, he is in favour of patience and letting the investment cycle take its course.

His advice to clients has always been this: “We know those companies. They will be exited. We will get the return when they exit.”

Thankfully, clients accept that advice, and are rewarded.

The steady returns that private equity can achieve are “not a miracle”, he noted. “It’s the way you invest.”

Private equity funds using the “classical leveraged buyout model” first determine the required internal rate of return, then work backwards to see how that can be achieved with a combination of cash-flow growth and leverage.

“If you repeat that over time, as an investor you will get your 15 per cent,” he said, adding: “People underestimate the fact that the good groups work really hard on those assets and make them better, with the objective to sell it after five years and realise (profits). This discipline is good.”

In public markets, similar levels of leverage tend not to be acceptable. Returns on equity will be lower, which will weigh on performance.

Given the steady performance of private equity, should more retail investors be allowed access to it? A movement to democratise private markets is underway – partly in response to superior performance and partly because private equity fund managers are looking for growth.

Wavre said that there are merits to private equity investing for retail investors – but only if they fully understand the risks.

Private equity investing is sometimes portrayed as less risky than investing in publicly traded equities because private equity valuations aren’t as volatile. But this view confuses volatility risk with economic risk.

When investors shift into private equity because they are attracted to the lower volatility risk, they may forget about the economic risk – and may even be unprepared for it.

“When things are booming, people say retail investors should be able to access that boom. But when things get more difficult, you have complaints,” he said.

Wavre is also “strongly against” the semi-liquid options that are hitting the market as part of the democratisation trend, as these products give the “image of liquidity” to investors who maybe should not be investing in illiquid products in the first place.

“If you want to have some liquidity, usually you are penalised. That’s the way it is,” he noted, adding that in tough times, this liquidity probably won’t help investors either.

“If retail investors understand private assets and are able to stay invested through the cycle, that’s a good thing.

“My worry is that maybe it’s not explained so well sometimes, or the asset allocation is not correct, or people need more cash than they thought, then they sell at the wrong time.”

Yet, private equity is, in some ways, a countercyclical asset class. “A difficult environment is when you can pick interesting companies and create a lot of value,” he said.

“When public market valuations go down… you start to see public-to-private (deals),” he added. “That’s something that speaks in favour of private equity. When valuations are high, that’s your exit. When valuations are low, then you can buy those companies and make them better.”

The private equity market is in a public-to-private phase now, Wavre pointed out. “We’ve seen a lot (of take-privates) and I think we’re going to see more.”

He said that the best investment decisions are usually the ones that “make you uncomfortable at the beginning” because they go against the consensus.

His investment approach is therefore to try not to be influenced by short-term trends or by forecasts. “They prove many times to be wrong, and our mission is to invest money and compound over time, not to guess over a short period.”