Editor’s Letter

The Fall 2019 issue of The Journal of Private Equity arrives at a time of continued global economic uncertainty about the future of Globalization. Only the US, India, and China among major countries are recording continuing, albeit slower, real GDP growth. Europe, the remaining BRIC, and most of the emerging market economies are suffering from the effects of increased tariffs on US imports depressing their exports and the impact of Brexit uncertainties. The age of globalization and expansion of interlinkages among nations (at least from a political perspective) are in a state of disruption with an uncertain future, at a time when global issues increasingly demand cooperative actions (e.g., pollution control). At the same time, new technologies, including artificial intelligence, blockchain, big data analysis, cloud computing, watchful satellites, and expanding internet access, are making global communications, product and services delivery, and sustainability easier between global consumers and producers. The result is a reduction in the physical and temporal distance between countries and thus a more interdependent world.

Global money or liquidity, which continues to be primarily in US dollars, is becoming increasingly mobile. Two factors are aiding in promoting this increased mobility: advances in technology and the growing wealthy investor search for alpha. First, innovations in the technology of cell phones, improved internet speed and security, the entry of new non-bank Fintech secure payments systems, and lower cost fund transfer services are expanding the availability of funds globally. Digital technology is enabling large global banks to become even larger and more global as they expand along with new Fintech startups into new markets via the low-cost internet. Second, with the daily explosion in the growth of new billionaires and millionaires globally, more individuals and families with their family offices are dominating and driving the search for alpha. As reported in the June 15, 2019 issue of The Economist, referencing Forbes and the IMF, the number of billionaires measured in US dollars is over 600 in the US; more than 300 in China; exceeds 100 each in Germany, India, Russia; and is between 50 to 100 each in Hong Kong, Brazil, Britain, Canada, and France. Many of these new and old billionaires are family fortunes and have their wealth managed by “family offices.” These offices consist of investment advisors and wealth managers that are hired by a wealthy family or a couple of families to manage only their wealth according to the objectives and instructions of the family. This concentration of wealth management in family offices historically has been focused primarily on the multi-generational preservation of family wealth and thus emphasized long-term investment in real estate. However, these investment objectives are beginning to change as younger new additions to the family fortunes favor less conservative preservation and introduce new wealth generation objectives and their investment managing to family offices. Specifically, millennials and next-generation family members are more focused on sustainability and impact investing. This transition is expected to persist into and perhaps beyond the next decade of generational succession and transfer of wealth.

This shift in the investment objectives of family offices will have significant implications for private equity funding and investment. First, let’s explore a little background information on family offices and their performance. UBS reported that the average family office returned over 15% in 2017, up from around 7% in 2016. There are an estimated 10,000 single-family offices, about 10 times the number that existed in 2008, according to Ernst & Young. Most of these family offices are in the US, but the number outside of the US is expanding rapidly. Campden Wealth estimates that family offices in total presently control assets exceeding $4 trillion. Currently, generations 1–2 are leading about three-fourths of family offices, while generations 3 and beyond account for the remaining 25% of investment decisions, and these shares will shift significantly, especially for inherited family business wealth. Less than half of wealthy families still own the original wealth generating business while a growing share manages the residual wealth through family offices. Approximately 20% of family office investable assets exceed a billion dollars while the average holdings are around $800 million.

In 2018, family offices had an investment preference (28%) for public equities driven by the strong bull market. However, alternatives account for about half of the investment portfolio, rising rapidly with the improved performance in the private equity space, currently accounting for about a 22% share of the average portfolio and delivering roughly 18% returns. The outlook is for a continued reduction in the share of investments allocated to hedge funds and a continued increase in the share allocated to private equity. In “The Global Family Office Report 2018,” in late 2018 by UBS and Campden Wealth Research, over 300 responding family offices indicated an increase in their direct investment in private equity and private equity funds. Regarding sustainable and impact investment, which nearly half of the respondents say they will be increasing, the most common targets are education, housing and community development, and agriculture and food. Family office direct investments focus on real estate, second operating companies, and underdeveloped land. Families continue to source direct investment through their networks or other families with industry expertise, co-investment with private equity funds, and professional advisors. There was no specific mention of venture capital investments. There was an expression of increased interest in investing in emerging market equities.

Given wealthy families and family offices’ expressed continued and growing interest in investing private equity, the first article in this Fall 2019 issue, by Gregory W. Brown and Steven N. Kaplan, should be of special interest to them. Here the authors show that private equity vintage year returns continue to be better than public market returns since the “Great Recession” in 2007-08. Furthermore, the second lead article, by Joe Milam, should be of special interest to wealthy families and their family offices as it reveals and details the sustainable and impact benefits of the large city, regional Legacy Venture Fund that Milam and associates are currently launching throughout the US. Additionally, he explains the significant tax benefits that make new venture investment by wealthy families and their family offices a win-win opportunity.

The Fall 2019 issue of The Journal of Private Equity presents a series of articles covering private equity developments and prospects worldwide. The issue begins with an important article by Gregory W. Brown and Steven N. Kaplan asking, “Have Private Equity Returns Really Declined?” as suggested by some other recent research. The authors show that returns in vintage years since the financial crisis have consistently been better than public market returns and better than returns from the 2006 to 2008 vintages. By using a variety of benchmarks and adjustments, the author’s analysis supports that the historical perspective is more positive than other studies have suggested.

The next article by Joe Milam focuses on the venture capital aspect of private equity in “Venture Capital—Patronage to Apprenticeship to Profession.” He argues that there has been limited innovation in the funding mechanism of entrepreneurial finance, with the result that there is a critical shortage outside of the existing four centers for early-stage risk-capital in various regions around the US. These areas are often where historical “blue collar” jobs became disintermediated by technological advancements. The capital was not available in these areas to support new digital jobs that would replace the jobs lost and support new venture investing in creating new jobs and hope for the next generation in those communities. The author analyzes some of the innovative initiatives to improve and broaden the effectiveness of venture capital to fund more startups more efficiently, in more communities, while delivering better risk-adjusted returns for legacy families residing in those cities.

Philip T. von Mehren takes us to South America in “Private Equity Investment: The Outlook for Latin America.” He examines how over the last 25 years, the industry grew enormously despite the impossibility of anticipating regional booms and busts, making predicting the future difficult. The author analyzes and examines in detail the economic and political factors at the global, regional, and national level that will shape private equity investment in Latin America in the coming years. He includes in his outlook the emergence of venture capital investment and family offices investing in the region.

Transitioning from Latin America, Ritesh Jayantibhai Patel explores “BRICS Emerging Market Linkages: Evidence from the 2008 Global Financial Crisis.” BRICS includes Brazil, Russia, India, China, and South Africa. The study finds that the BRICS emerging markets cointegrated with each other during the pre- and post-2008 financial crisis period and that the markets are moving toward greater integration after the 2008 financial crisis. From the Granger causality and Johnsen co-integration tests, the author finds that stock markets of China, India, and Russia have a strong short-term and long-run relationship. He also finds in the factor analysis that the BRICS markets became more closely integrated after the financial crisis. Brazil, Russia, India, and China appeared to have close causal linkages running among them, which have increased as all of the markets are increasing in trade and geographical closeness with advances in transportation and communications.

Peeyush Bangur undertakes a closer examination of India and analyzes “Investment Certainty and Demonetization: Evidence from India.” The demonetization announced by the Prime Minister of India on the evening of November 8, 2016, 8:00 PM, the 500 Rs. currency note and 1,000 Rs. currency notes would no longer be legal tender as of midnight. As a result, approximately 86% of the currency in India became worthless. The main aim of demonetization was to curb inflation, black money, corruption and evasion, and to support digitalization. Demonetization had a significant effect on all sectors of the economy, as the government of India placed a limit on money supply growth. The author focuses the analysis on the volatility of the Indian stock market and assesses the investment certainty in India after the event of demonetization. The results show that, after the demonetization, risk related to market price decreased and the certainty of investment increased in the Indian stock market. Also, the degree of volatility in the stock market declined in comparison to the pre-demonitization period.

Continuing with the analysis of India, R. Renu Isidore and P. Christie create a “Model to Predict the Actual Annual Return of the Investor with the Investors’ Behavioral Biases as the Independent Variables.” The authors examine the return by the investor in equity investments in the secondary market and find that there is an influence by the behavioral biases exhibited by the investors, using a sample of 436 secondary market investors residing in Chennai. The study measured eight behavioral biases, including representativeness, overconfidence, anchoring, gambler’s fallacy, availability bias, loss aversion, regret aversion, mental accounting, and optimism bias. The authors were able to identify the biases that have a positive influence on the return and those that have a negative influence on the return. The study would help financial advisors and wealth managers guide clients to earn better returns by avoiding negative biases.

Shifting now to Europe, Mihai Precup explores “The Exit Behavior of Private Equity Firms in Eastern Europe: An Empirical Analysis of the Main Exit Strategies.” The author examines two main exit routes that were preferred by private equity funds: initial public offerings (IPO), and merger and acquisitions (M&A). The author, using quarterly data for the Eastern European countries covering the period 2000–2014, confirmed the existence of a positive correlation between the number of IPOs (in the year t) and the willingness of institutional investors to allocate funds to private equity firms (in the year t + 1). Additionally, the research studies merger and acquisitions (M&A) as a second exit strategy for private equity investors. The results show that Eastern European private equity firms prefer M&A exits, followed by IPOs. The Granger causality test shows the existence of a unidirectional causality of the number of M&A to the volume of private equity investments in Eastern Europe.

We next go to Africa, and Grant Chivandire, Ilse Botha, and Marise Mouton study “The Impact of Capital Structure on Mobile Telecommunication Operators in Africa.” The study adopts a panel regression approach and examines the impact of capital structure on financial performance for mobile telecommunications operators based in sub-Saharan Africa. It considers eight companies with publicly available annual reports for the seven year period from 2010 to 2016. Return on equity, return on assets, and operating profit margin measure financial performance; while the capital structure is measured using short-term debt to total assets ratio, long-term debt to total assets ratio, and total debt to total assets ratio. The total number of subscribers and size are measured by revenue and tangibility as the controlling variables. The study provides evidence of a mixed impact of capital structure on financial performance and shows that mobile operators prefer short-term debt to long-term debt. The findings suggest that mobile telecommunication operators need to focus on other factors that have a direct and stronger influence on financial performance, while regulators and governments must ensure a stable operating environment to support the industry’s long-term commitments. Furthermore, operators must develop a profitability mindset and shift their focus from average revenue per user toward profitability per user metrics to have a complete value creation picture that considers the costs associated with these revenues.

Moving on to Asia, Imtiaz M. Sifat and Azhar Mohamad analyze the “Randomness for Asset Prices Constrained by Price Limit Regimes: A Malaysian Case Study.” Empirical works testing the randomness of stock prices are abundant. Such findings, however, can be challenged if the time-series datasets we are examining are subject to price limits, which, ex vi termini, enforce bounded movements. This article examines the random walk hypothesis for the Malaysian equity market under three price limit regimes from January 1994 to September 2017. The authors identify a sample of 407 actively traded instruments that triggered limits on 5,843 occasions, and employ parametric (Ljung-Box, Lo & MacKinlay, and Chow-Denning) and nonparametric (Wald-Wolfowitz Runs and BDS Independence) tests to investigate whether prices under different circuit breaker regimes follow a random walk path, an indicator of market efficiency. Upon comparison with the composite FBMKLCI index and sectoral indexes—the bulk of which reject the random walk hypothesis—the study finds considerable support for randomness across all regimes for upper and lower limit-hit stocks. The progressive tightening of the price limit appears to correspond with a lower proportion of limit-hit stocks following a random path. The findings carry implications for regulators and academia. First, the unusually wide price band in Malaysia appears to outperform the tighter limits studied earlier. Second, the findings furnish direct evidence of price randomness and price discovery to financial economics literature, as well as indirect evidence of circuit breaker efficacy to market microstructure literature.

F. John Mathis

Editor

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