Alternative To An Alternative: Active Microcap Vs. Private Equity

Ian Cassel Blog, White Papers Leave a Comment

The current market environment is creating potential opportunities for investors seeking alternative options. These investors can benefit from a discussion comparing active microcap investing and private equity. The topic is a timely one, especially as it pertains to longer-term investment approaches.

Investors look to microcap investments for possible alpha generation tem- pered with risk management, much like other market sectors. However, they approach the sector with a higher tolerance for some of the unique factors inherent in the microcap space: lower liquidity, longer investment horizons, minimal analyst coverage, ‘lumpy’ return streams, and a higher risk/reward ratio than has been typical for larger-cap equity strategies.

The returns and underlying investments of microcap securities provide many similarities to private equity. However, the access, liquidity, trans- parency, low fee structure, and flexibility of the active microcap fund structure may provide a significant advantage for many investors. In a February 12, 2013 article by Bloomberg reporter David Carey, “Buyout- Boom Shakeout Is Seen Leaving One in Four to Starve,” the private equity market’s current difficulties are explained:

[Private equity] Firms that attracted an unprecedented $702 billion from investors from 2006 to 2008 must replenish their coffers for future deals and avoid a reduction in fee income when the investment periods on those older funds run out, typically after five years. As many as 708 firms face such deadlines through 2015, according to London-based researcher Preqin Ltd.

The combination of underperformance and funding needs has set the stage for a purge as investors pull the plug on the weakest firms. Only the scope of a shake-out is a matter of debate. “The shakeout will be rather massive,” said Antoine Drean, chairman of Triago SA, a Paris-based firm that helps private-equity firms raise money. Drean estimates that as many as a quarter of private-equity managers will see their funding pulled by 2018.


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