What is a private equity fund?

A private equity fund is a pool of capital invested in companies that are not typically publicly traded. The investors in a private equity fund agree to make contributions of capital over a specified time period. The manager of the fund calls on the investors’ commitment as the funds are needed.

There are a number of strategies that private equity funds use. They may be involved in leveraged buyouts or management buyouts of existing, mature companies. They may provide venture capital financing to start-up companies, or to companies that have not yet had an initial public offering. They may provide mezzanine or subordinated debt financing, either when the owners of a company want to limit dilution of ownership, or when a company is in financial difficulty.

Individual private equity funds sometimes focus on a specific industry, such as life sciences, but often broaden their scope to several industry specialisations. Generally, they require a minimum investor commitment of US$5 million to US$10 million.

What are the benefits and pitfalls of private equity funds?

Private equity funds have historically provided a greater return on investment than investments in public companies. In addition, returns are not highly correlated to the stock market, so they provide useful diversification.

While returns are not guaranteed, the 20-year average is currently about 14% to 15% per year. In the early years, however, an investment return is likely to appear negative while cash contributions are made to the private companies before they achieve measurable results.

The main drawback is the length of commitment. Investors who choose a private equity fund should be prepared for a commitment of 10 to 12 years. The commitment is irrevocable: there is no organised secondary market for private equity funds and there are no withdrawal windows.

What type of investor should consider private equity funds? Private equity funds are suitable for patient investors who understand the investment’s long-term nature and who can afford to let their capital develop over a few years without seeing any initial return on investment. Whether it is an appropriate investment depends on the individual investor’s tolerance for risk and level of investable assets.

One of the best ways to reduce investment risk in this category is through a “fund of funds” approach. A fund of private equity funds invests in 10 or more private equity funds in different industries, creating a more diversified portfolio. In addition, it provides the investor with professional fund management, including access to investment data that may be unavailable to individual investors. It is also a more affordable way to properly diversify an investment in private equity funds.

What role should private equity funds play in an investor’s portfolio?

Investors should always focus on their overall investment goals and should consider how a private equity fund will interact with the other investments in their portfolio. It’s important to recognise that an investment in private equity funds will be the longest-term portion of an investment portfolio.

Private equity funds typically represent 5% to 10% of a wealthy investor’s portfolio, although investors who are themselves entrepreneurs may be comfortable with a greater share of their portfolio in private equity funds, including investments in the equity of their own companies.

Fixed-income in a portfolio?

Fixed income traditionally appeals to people looking for conservative investments that offer security of capital. Over the past three years, investors have also seen fixed-income investments as an attractive alternative to poorly performing equities.
How much of a portfolio should be invested in this asset class really depends on the individual investor’s tolerance for risk.

How do interest rates affect fixed income?

Interest rates in the developed markets have been at record low levels, so we’re expecting rates to rise. The U.S. economy grew 8.2% in the third quarter of 2003. If that strong growth continues, the U.S. Federal Reserve will likely raise rates to control inflation.

The U.S. growth will stimulate the Eurozone economy, enough perhaps for the European Central Bank to also raise rates, although probably less aggressively.
With rates so low in recent years, bond prices have been relatively high. But all things being equal, when interest rates go up, bond prices fall.

What are some ways to manage fixed-income investments in a rising interest rate environment?

Fixed-income investments make money either in absolute terms or relative to other fixed-income investments. In absolute terms, bond investors can make more money in a rising rate environment by holding defensive investments such as floating rate bonds. These have a coupon that moves with short-term interest rates; if rates go up, so do your payments.

Another example is a Treasury Inflation Protected Security (TIPS), which adjusts the principal value of the bond in step with inflation every six months. Its semi-annual interest payments are then calculated on this inflation-adjusted principal, which means you also receive more interest as inflation rises. At maturity, you receive the par value or the inflation-adjusted principal, whichever is higher.

Another strategy is to hold only short- and long-term bonds in your fixed-income portfolio (called a “barbell” strategy). If 10-year bonds are yielding, say, 4.5%, and short-term bonds (less than two years) are yielding 1.5%, you can get a fairly good average rate of return.

Performance?

Holding corporate bonds that offer higher yields than government bonds can help boost performance. If the yield “spread” (the difference between the rates) gets smaller, you’ll end up with a positive performance relative to the government bond, no matter what interest rates are doing. But you need to identify those bonds that are trading at wider-than-normal spreads.

What are structured notes?

A structured note is a form of security or deposit instrument issued by a variety of issuers. These notes can be fixed or variable-income instruments. Structured notes can also offer a rate of return linked to the performance of some other financial benchmark, such as the value of an equity index, the direction of U.S. interest rates, or the price of a commodity.

In part due to the use of options, fixed-income structured notes typically offer a higher potential rate of return than current market rates. They have proved popular with investors looking to maximise returns in today’s low-interest-rate environment. In addition, equity-linked notes are popular with clients who want to invest in an equity market, but retain a level of capital protection.

How do they work?

Suppose that you buy a structured note linked to the Standard & Poor’s 500 Index when it stands at 1,200. For every year the index stays above, say, 1,300, the note will pay 4.5%, a rate of return higher than the prevalent interest rate. If the index does not stay above 1,300, then you will receive no return.

In many cases, a structured note offers protection for an investor’s capital by guaranteeing to pay back the original investment when the note matures. Still, they are considered to be riskier than conventional fixed-income investments because there is a greater potential for investors to receive no return.

Who are they suitable for?

There is a wide variety of structured notes available. They range from conservative fixed-income or equity-linked investments that have their principal protected, to more aggressive equity-linked or fixed-income-linked notes that pay a rate of return based on the performance of an equity index, a basket of shares, an individual commodity such as silver or gold, or the direction of a rate index. In some cases, a structured note will be created to meet the needs of an individual client.
The suitability of an individual structured note depends on the investor’s financial circumstances and tolerance for risk, so it’s important for investment advisors to fully understand the objectives of their client.

What role can a structured note play in an investor’s portfolio?

It depends on how the note is created. In our example, where the structured note is linked to the performance of the S&P 500, the note allows the investor to diversify into equities with principal protection. The investor gains exposure to the potential returns offered by equities, while protecting his or her initial investment.
Structured notes can be customised to fit your unique situation, and serve as a hedge to reduce overall investment risk.

For example, let’s say you own a distribution company and ship most of your items over land. Your financial situation depends a great deal on the price of oil. You could purchase a structured note with a rate of return that is linked to the price of oil.

If the price of oil rises, the structured note pays a higher return, which can help offset the negative effect that higher fuel prices would have on your trucking business.

What are the potential risks?

Because they can be customised, structured notes also tend to be less liquid than conventional fixed-income investments. Though they can be traded on some equity markets, there may not be an active trading market in them before their maturity date.

A structured note offers some participation in other markets, but the exposure may be limited, which also means the potential upside may not be as great as it would be if you invested directly in the market, although this depends on the path the index takes to maturity. If you are considering this type of investment, you need to keep in mind that different types of notes are subject to different regulations depending on the country you live in.

Life and circumstances are always changing. No matter how sound your financial plan was when it was created, revisiting it periodically will help ensure that it meets your current needs.

Schedule an annual review

An annual review is an opportunity to revisit your strategy and make sure that your plans are still on track. You can take stock of how your investments have performed over the past 12 months, and make any necessary adjustments if there have been any significant changes in:

Your personal circumstances. Changes in your life situation, such as getting married, pursuing a career opportunity in a different country, or receiving an inheritance, can have a huge impact on your financial strategy.

Your objectives. The mere passing of time can change your investment outlook. For example, if you are within 10 years of retiring, you may be less able to tolerate the risk of a capital loss. You might decide to increase the conservative investments — such as fixed-income securities — that you hold.

Your financial situation. If you’ve recently finished paying off a major expense, such as a property or business, it can have a substantial effect on your cash flow. During your annual review, you can revisit your current cash flow needs, allocating any increase to meet your long-term investment objectives.

Your estate plan. Ask yourself if your estate plan still meets your needs. For example, does your will need to be updated to take into account children or grandchildren or additional assets you have acquired since your last review?

Your immediate future. You can also look forward to the coming year, helping to plan suitable strategies to deal with anticipated events, such as a marriage, birth of a child, or move to another country.

Leveraging, or using borrowed funds to increase your invested capital, has the potential to significantly increase returns. But there are risks, as well. This type of strategy works and when it might be suitable for the sophisticated investor.

How does leveraging work?

Suppose you have a portfolio of equities and fixed-income securities worth US$1 million that earns a rate of return of 4.5% annually, or about $45,000. Using these assets as collateral, you might borrow, say, $600,000 to invest in additional bonds and equities. If you continue to make 4.5%, your overall portfolio will then earn $1.6 million X 4.5% = $72,000 annually.

Obviously, there is an increased cost, because of the interest payments on the loan. But depending on the size and term of the loan, the interest you pay may be relatively low. In this example, if it’s 3.0%, then your annual interest costs on the $600,000 loan would be about $18,000. You’d still make $54,000 in a year, for an annual return of 5.4% on the $1-million you have invested.

Does leveraging have any other uses?

You can also use leveraging to increase the diversification of your portfolio without selling your current holdings. For example, if you have a portfolio of primarily fixed income-based investments, you can leverage it to invest in equities. Similarly, if you wish to expose your portfolio to the potential returns in foreign markets, you can do so by investing the borrowed amount in foreign securities.

Leveraging can also help you adjust your asset mix as your investment objectives change over time. For example, if you are approaching retirement and want to preserve more of your capital, you may consider leveraging your equity portfolio to add more fixed-income securities rather than selling your equities and possibly incurring tax consequences.

What risks are involved?

Along with higher potential gains, leveraging carries the risk of magnifying potential losses. If the value of your portfolio drops, not only do you lose the rate of return, but you may be issued with a margin call. This occurs when the value of your securities falls below the minimum collateral required by the lender. You’ll have to make up the difference by supplying additional cash or securities to your account or sell some of your securities, possibly at a loss.

For what kind of investor is leveraging most suitable?

Leveraging typically appeals to sophisticated investors who are concerned with preserving their wealth while also seeking potentially higher returns. But they need to understand the way leveraging works and must be aware that the increased potential rewards are accompanied by greater potential risks.

Individuals and corporations – Protect Your Strategic Capital and “go offshore” (place assets outside of their home countries) for three simple reasons: privacy, protection from lawsuits, and regulatory advantages.

Privacy

Financial privacy has become a thing of the past. Every transaction made at a bank or ATM, by law, must be recorded and filed. Credit agencies maintain enormous databases of sensitive information that is used and shared by other organizations and agencies. Asset collectors routinely advertise their ability to locate bank accounts, brokerage accounts, real estate and business holdings. Should asset collectors find substantial wealth, the individual or corporation becomes an easy target for a lawsuit.

Unless deliberate steps are taken to insure privacy, sensitive and confidential information could easily get into the wrong hands. Placing bank and brokerage accounts offshore will keep them off the asset collector’s radar screen. Credit agencies and government agencies don’t have access to foreign account records or transactions. Domestic property may be titled in the name of a foreign corporation or trust. This insures that asset collectors can’t find it. By taking advantage of these methods an individual or corporation becomes a smaller target and the likelihood of being sued is reduced. Utilizing offshore tools to protect privacy could mean the difference between keeping versus losing what is rightfully yours.

Protection From Lawsuits

Tens of thousands of lawsuits are filed PER WEEK in the U.S alone. Juries award ever-increasing sums to successful plaintiffs. Ex-spouses, ex-business partners, disgruntled employees or predatory attorneys may file suit if they believe a potential defendant is an attractive target. Losing such a lawsuit could cause a lifetime’s worth of savings, investments and real estate holdings to be lost. In light of this, placing assets offshore is a wise and effective means of protection from ruinous lawsuits.

Regulatory Advantages

Domestic businesses and operations are often plagued by excessive regulation. Valuable resources are diverted away from the productive process in order to monitor compliance with a myriad of restrictions. Curing this problem is as simple as moving to friendlier shores. Offshore jurisdictions are intentionally business-friendly and have regulations that are straightforward, simple to understand and inexpensive to comply with. Moving a business offshore and enjoying a more pleasant business climate may require nothing more than forming an offshore corporation and transferring assets from the domestic corporation to the foreign one.

Utilizing offshore tools to protect privacy could mean the difference between keeping long estate planning flexibility and loosing it. Individuals and corporations “go offshore” (place assets outside of their home countries) for three simple reasons: privacy, protection from lawsuits, and regulatory advantages.

Tax Neutrality

Often monies are earned from trade or sales overseas either by a single party operating in their own name or through a company organised outside his country of residence. Similarly, groups of individuals or companies from various nationalities often engage in such business together. In these cases, it is beneficial to receive income in a tax neutral environment before distributing profit. Equally important is the growth of capital to finance future activities without the burden of immediate obligations.

Regulatory Advantages

Domestic businesses and operations are often plagued by excessive regulation. Valuable resources are diverted away from the productive processes in order to monitor compliance, and/or the myriad of restrictions and inefficiencies connected with conducting trade and commerce in some domestic environments. This is the second reason as to why money, which earned abroad in tax neutral environment, is often better maintained abroad. Curing this problem can be as simple as moving to, or retaining funds in, a neutral international commercial offshore environment. So called offshore jurisdictions are intentionally business-friendly and have regulations that are straightforward, simple to understand and inexpensive to comply with. Moving a business offshore and enjoying a more pleasant business climate may require nothing more than forming an offshore corporation and transferring assets from the domestic corporation to the foreign one.

Privacy

In most jurisdictions, financial privacy has become a thing of the past. Every transaction made at a bank or ATM, by law, must be recorded and filed. Credit agencies maintain enormous databases of sensitive information that is used and shared by other organizations and agencies. Private Agencies routinely advertise their ability to locate bank accounts, brokerage accounts, real estate and business holdings. The individual or corporation becomes an easy target for a lawsuit.

Unless deliberate steps are taken to insure privacy, sensitive and confidential information could easily get into the wrong hands. Placing bank and brokerage accounts offshore will keep them off the radar screen of those not intended to have them. Private Third Parties and other unauthorized persons do not have access to foreign account records or transactions when held in the appropriate geographical and legal environment. In such an environment an individual can earn investments dollars with tax neutrality. Furthermore all kinds of domestic assets may be titled in the name of a foreign corporation or trust. This insures that undesirable third parties cannot find it. By taking advantage of these methods an individual or corporation becomes a smaller target.

Protection From Lawsuits

Tens of thousands of lawsuits are filed every year in Europe alone. Juries award ever-increasing sums to successful plaintiffs. Mean spirited ex-business associates, disgruntled employees or predatory attorneys may file suit if they believe a potential defendant is an attractive target. Losing such a lawsuit could cause a lifetime’s worth of savings, investments and real estate holdings to be lost. In light of this, placing assets offshore is a wise and effective means of protection from unwanted attention.

Safety – will my money be safe with an offshore bank?

The factors to consider include:

1. The political and economic stability of the jurisdiction(s) in which a bank is headquartered, located and regulated.

2. Reputation and substance – Standard & Poor’s, Moody’s and Fitch rating reports are useful, as are a banks ownership and history. For example the Liechtensteinische Landesbank has a rating of AAA, is more than 140 years old and is majorily owned by the Government of Liechtensteinische. Also, quality of regulation and access to deposit and investor protection insurance schemes ought to be taken into consideration.

3. The business focus of the bank. In general the banks we work with seek to provide services to some or all of these types of clients:

• Private banking clients.
• Expatriates.
• International commercial activities, project finance etc.,

These services are provided from both offshore banking and international locations

Private Banking Clients

The definition of “private banking” varies from bank to bank but is generally taken to mean investment management offered on a personalised basis by a bank to an individual with disposable wealth of more than $500,000 (although some banks do not offer private banking services to clients with disposable wealth less than US$ 1 million). Private banking is normally synonymous with “offshore“, although the costs of a personalised relationship generally only begin to be worthwhile to a bank at the $300,000 + level, in order to allow a bank to invest the adminsiatrative respources necessary to produce the superior benefits described above which are achieved from offshore banking. Private bankers generally prefer themselves to be approached and considered as discretionary financial advisers rather than as an investment-provider and advisor to an active party, and consequently private banks may not be the most effective choice for a reasonably sophisticated investor who wants to play an active role in the management of his investments. Therefore, consider Swiss asset management companies who have custodial relationships with some of the largest banks in Switzerland. Strategic Capital Partners Portfolio Management AG based in Zurich (Ramistrasse) is one such company. You get a “one on one” personalised approach with the advantage of having access to the custodian banks products, services and/or research and advice services. An asset management company will not limit you to one set of “branded” products, and fees for custodial and other services can also be lower because asset managers generally have relatively large pools of clients and money under management.

News has been emanating out of Zurich (Ramistrasse to be exact) that Strategic Capital Partners Portfolio Management AG, has been involved with a company (for which the Swiss asset management group has been working a placement agent with their early funding) that may have found the answer to a growing question within the broadband industry, i.e. what can we do about the bandwidth dilemma?

You may well have noticed that we live in a world where impatience is the norm. Non of us seem to be willing to wait for anything, stand in line, or tolerate anything that we deem to be second best.

‘Wait three months for my new car to be delivered? Forget it! I’ll take that one over there…’

’ Wait fifteen minutes to be seated at your favourite restaurant? No thanks, we’ll eat elsewhere! ‘

Don’t shake your head, I bet this sounds like you!

Anyway, can you imagine the intense frustration of saving up and spending out on the latest all singing-all dancing High Definition TV, only to find that there are still very few channels with the capacity to broadcast in HD! (By the way, a word to the wary, if you’ve never watched HD TV – don’t ! … at least not yet, because doesn’t seem to be any going back to normal, grainy TV after your first experience without being overcome with feelings of immense frustration and loss.)

So what’s being done by our broadcasters to provide more HD channels? Well, unfortunately, at the moment they can do very little. ‘Surely, you must realise how much bandwidth is taken up by an HD channel compared to a regular channel,’ they cry. But do you? No, probably not; we just want to watch! Let’s just say you could squeeze three regular channels using the same space taken by that one big fat HD channel – and this is the problem which has so far left the broadcasters scratching their heads … at least it has until now.

After hearing from Strategic Capital Partners AG, we had a look around and the whispers in the technology industry tell us it may well be true! That we are shortly going see the launch of the IBM Bladecentre QS21 server. A server which is to be targeted directly at the video streaming and broadcasting industry. These new servers will finally be able to live up to the claims on the box because of a revolutionary, new technology called CodecSys from Broadcast International Inc. (BCST.ob).

The combined IBM/BI product line will provide encoding and transcoding solutions for worldwide broadcast, cable, satellite, IPTV, telco, wireless and streaming customers, as well as applications for business/enterprise communications, training and digital signage. For example, a telco will be able to deliver HDTV over DSL connections, and, where cable/satellite operators now have one HD channel, they will be able to deliver six different HD channels at the same quality – great stuff!

So how does it work? Well, rather than relying on any single of the latest codecs to transform our viewing pleasure, the CodecSys technology uses a multi-Codec approach, employing a real-time artificial intelligence system to manage libraries of standard and specialized codecs. This fully patented system dynamically changes codecs or codec settings – on the fly – on a scene-by-scene or even frame-by-frame basis. And it would seem there are a multitude of applications waiting for this holy-grail technology that may finally unlock the blockage in our bandwidth-hungry age. It will allow a plethora of companies to create excellent quality video and audio transmission at a fraction of the bandwidth that, until now, has been traditionally required.

As an application its future appears rich and varied, however, the boffins in Broadcast International have firmly set their sights on the video streaming and broadcasting market as the first area to conquer, teaming up with no less than ‘Big blue’ to establish a joint development team and shortly the launch of the QS21 server.

While IBM’s cell blade technology looks set to turn the traditional server market on its head across their new range, the CodecSys technology in the QS21 server will provide the ultimate, highest quality in full-screen, full-motion video at the lowest possible bandwidths allowing the broadcasting and video streaming industry to finally expand along with consumer needs.

All of which means of course that you may begin getting a lot more High Definition channels on that huge great HDTV of yours!

For many individuals, using one of Switzerland’s registered Asset Management companies (such as Strategic Capital Portfolio Partners AG, Encore, SAM or Everest as an example) might be extremely advantageous. The role of a good asset manager is not only to introduce a client to establish a banking relationship with a banking group within Switzerland for tax reasons but also (and more importantly) to oversee a full range of banking and investment services.

These services may include:

Introduction to ‘Triple A’ rated guaranteed investment products possibly offering a greater balance to a portfolio.

Seeking and advising on the best balance for a portfolio, designing placement within a specific client’s needs, with access to a diversified field of banks and fund managers.

Once funds have been placed, the Asset Manager monitors the development and/or evolution of the client’s portfolio with appropriate advice regarding its performance.

Your Asset Manager will be ‘pro-active’ as an intermediary between the client and the banks and fund managers.

Another service of growing importance in today’s financial world is the role of the Asset Manager acting in its client’s best interests should any disputes arise between the client and the bank or any another third party.

The very best Asset Managers will also have a range of exclusive ‘in-house’ opportunities that may well not be found through any other institution.

In Switzerland, a bank often prefers an Asset manager to act as intermediary because;

Should any dispute occur regarding alleged money laundering, then the bank is not directly libel, they are more easily able to fall back on the asset managers due diligence of that client.

An asset manager provides a steady stream of qualified investors to their door.

In certain areas where the bank is active in seeking new clients, they are restricted by local laws in the methods they can employ to advertise their services. By working through an asset manager, who is unimpeded by the banking restrictions, the bank can draw more clients to its door.

The price of Gold has smashed through the $800 per ounce level and now seems set on achieving $850 per ounce before year-end. That is where we stand today, but who was it that saw the meteoric rise of this precious metal about to happen back when it was languishing below $300 per ounce? Of Switzerland’s many private equity groups, several groups can claim they saw it coming and made early moves to ‘ride the wave.’

In 2003 Strategic Capital Portfolio Partners AG of Zurich came out and said they were seeking and reviewing many junior mining companies with potential, while Investec was actively aiding Harmony with their acquisition of Avmin and its 42.2% stake in Avgold. Household names have also been active: CSFB Private Equity, a unit of Swiss banking behemoth Credit Suisse Group, had been turning its attention to mid-cap gold companies as early as the year 2000.

The ability to see the next “big thing” is essentially what private equity groups look for.All investors want to be part of that next big thing. Some of these private equity groups actively seek new investors while other are more select and will only allow a limited number of new “members”.

In forthcoming articles we will seek to discover the secrets of some of Switzerland’s foresighted Private Equity groups who seem to have the power of looking into tomorrow.

To be continued….