How does money committed to Private Equity earn interest?

How do you get the most out of the money you have set aside for real estate and private equity - from commitment to investment? How much risk does it make sense to take during that period in pursuit of a good return?

Here's how to find out.

Investing in a private equity fund - an example

In private equity investments, it can take several years from the time the investment agreement is signed and all the money is paid in until the fund has invested the money. For simplicity, this example assumes that the fund is paid into the fund over five years.

Stable choice

If you leave the money in cash during the deposit period, combined with a portion in government and mortgage bonds with low default risk and short maturity, the expected return on the money is naturally low - perhaps a few percent. The same can be said about the risk. The risk then increases when the money is actually invested in private equity. Your risk and return ratio changes quite a bit along the way with this approach.

On the other hand, you don't have to sell other assets - which may have fallen in the meantime - to make the deposit. This solution probably offers the most peace of mind. In practical terms, you start paying into the fund with cash in the early years, and in the later years you sell or mature the bonds to best match the payment dates.

Balanced selection

If you want a higher return on the committed capital during the contribution period, a larger proportion of the money is invested in bonds and a portion in shares. Payments to the fund are made, for example, in the order of cash, sale of bonds and finally shares.

The Growth Model

The more risk-averse investor who wants a higher return can sell out of listed stocks and bonds to pay into the fund. Or invest any amounts left in cash to maximize the opportunity cost of the money during the pay-in period. With this approach, the risk and expected return does not change as much along the way as if you leave the money in cash. The downside, of course, is if the value of the investments falls.

Alternatives such as private equity and real estate generally have a higher expected return than listed stocks and bonds - partly because alternatives are often leveraged with loans. Since the money set aside for these types of investments is not "out working" all the time, this indirectly reduces the return.

That's why it's valuable to have a clear plan for what to do with the money before it's actually invested - and of course after it's returned many times over. The more different alternatives you invest in, the greater the complexity. This is where a simple and personalized investment plan is more useful; it ensures a clear overview and a higher expected return overall.

With Assure's merger with Assure Fondsmæglerselskab, you are more than welcome to contact us if you want to discuss investments of funds committed to alternatives.

Also read our article on how to get a complete overview of your assets - including private equity funds, even if your investments are widely diversified.