Beverly Goodman

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Private Equity Is No Safe Haven

Beverly Goodman

Closed-end funds, hedge funds, exchange-traded funds -- all are attempting to reinvent themselves. At the same time, private equity firms are looking for ways to draw new funds into the anemic market. Sound like a serendipitous match?

Hardly. The one area that fund companies are backing away from is private equity.

Vanguard is just the latest to scuttle plans to offer accredited investors access to private equity investments. Investors for certain products are required to be accredited by the Securities and Exchange Commission. An accredited investor must have a net worth of more than $1 million, or have earned more than $200,000 in the past two years with a reasonable expectation that this will continue.

No Thanks

But private placements lost their luster when the stock market crashed and the initial public offering market dried up. Now accredited investors are more interested in hedging strategies than taking a chance on a company not likely to provide a payoff in less than five years, as is the case with even most late-stage private investments.

As a result, institutions that had toyed with the idea of granting their clients easier access to private placements have slowly backed away from the idea. Vanguard, for instance, announced in late May that it has suspended its plans for a private equity investment program. The firm -- which in October 2001 announced a partnership with private equity firm Hamilton Lane Advisors, based in Bala Cynwyd, Pa. - couldn't work up the level of investor commitment to make such a fund cost-effective, spokesman Brian Mattes said.

Vanguard had planned to run its private equity fund the same way it operates its mutual funds -- with razor-thin fees. Using this "at-cost" structure, in which Vanguard passes on to investors only what it costs to run the fund, the private equity fund wasn't able to garner enough commitments to make it worthwhile. "We thought it made sense for the smaller investor to have access to the private markets," Mattes said. "But when we took a closer look, the interest wasn't really there."

That assessment, while late in coming, surely is accurate. Fidelity Investments held discussions with the private investment firm the Carlyle Group, but now has no plans to offer a private equity fund. The same goes for Century Capital Management, an investment firm that specializes in the financial services, insurance and health care sectors for both public and private investments.

"We looked at offering a hybrid product about a year ago," said managing director Patrick Carolan. The fund would have been structured as a continuously offered closed-end fund that held roughly 40% in private equity. (Most closed-end funds don't continuously offer their shares for sale; instead, investors buy and sell the shares as they would stocks.) "But private equity just isn't that attractive right now."

Century Capital hasn't abandoned its plans altogether, but Carolan said that the IPO market needs to rebound before private equity looks more attractive to anyone -- particularly smaller investors. "Even hedge funds have greater liquidity and shorter duration periods" than private placements, he said.

Wiser Now

Surely some lessons have been learned from the abysmal performance of venture capital firm Draper Fisher Jurvetson's attempt to bring private equity to the masses. The closed-end fund -- named Draper Fisher Jurvetson Fund I, but better known as (MVC Quote)meVC -- launched in June 2000 in a public offering that raised $312 million.

The fund's share price, though, has lost 52% since its inception. And that belies the real (and unknown) performance figure of all the fund's investments, because the fund's high cash levels mitigated its losses elsewhere. The fund, for instance, marked down the value of its investment in Internet content manager Mediaprise from $2 million to zero in January of this year.

That high cash level is the source of an investor lawsuit, led by private money manager Millenium Partners, meVC's largest shareholder. Essentially, Millenium alleges that meVC was charging a 2.5% fee for managing its cash position. That's a pretty expensive money market fund, particularly since the cash was actually managed by Fleet Investment Advisors for 0.10% of the assets.

This may be a roundabout way of saying simply this: No matter how fed up you are with the public equity markets, private equity is not the alternative.