How to Play the Private Equity Game Without a Million Bucks

Tim Melvin

Last week, we looked at how financial companies are feeling the pain of lower fees.

But I hinted at one group of financial companies that is not feeling the pain.

It's one of my favorite groups to own – so when the market sold off last month and these stocks began falling towards a Cost of WAR of less than 1, I was pretty excited and ready to break open some bubbly.

Unfortunately, the decline halted and stocks have rallied back, so I did not get a new opportunity to buy them. The numbers are getting there, and I hope that before too much longer I can send Heatseekers members the call to arms with buy recommendations on these powerhouse firms.

These financial companies are private equity firms.

It's hard for most of us to invest directly in a private equity fund, since most require you to be an accredited investor and have minimum investment levels of millions of dollars. However, we can buy shares of private equity firms and reap the benefits of the high returns they earn.

Let's take a look at exactly how to do so…

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There has been talk over the years about private equity firms lowering their fees. Most of them get a 2% management fee and 20% of the profits generated by their portfolios of companies.

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The private equity firms themselves pretty much ignore the call to lower fees, and the investment community has had to go along with them for one simple reason: Private equity firms make more money than anyone else in the game.

Consider the results announced a few weeks ago by the biggest private equity firms. The lowest performance was turned in by Apollo Global Management LLC (NYSE: APO), who reported that their largest private equity fund returned about 13% over the past year. That's about twice the return of the S&P 500. The Carlyle Group (Nasdaq: CG) reported that their funds averaged 17% across the board. KKR & Co. LP (NYSE: KKR) turned in a one-year performance of 19%. And the big winner in 2018 is The Blackstone Group LP (NYSE: BX), where CEO Stephen Schwartzman reported returns in their private equity funds of over 30%.

Private equity firms are not lowering their fees for the same reason Manny Machado and Bryce Harper are not looking for pay cuts anytime soon. They perform at a very high rate, and if you want the returns, you have to pay them the money. Private equity has been outperforming for decades, and they should continue to do so for decades to come.

But when we buy shares of private equity firms, we take mutual part in these high returns.

The management and incentive fees are earnings, and most of the firms distribute a very high percentage of these earnings as dividends to their shareholders. When one of their funds cashes in big, so do we as investors.

We also benefit in another significant way. All of the big private equity firms invest their own money alongside their fund investors. That builds the asset value of the company and helps drive the stock prices over time. Since we are shareholders, their money becomes our money too. And thus, the value of our investment goes up when these companies double and triple their money over a few years.

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When we buy shares of private equity firms, we become significant investors in buyout strategies, commercial real estate, private credit businesses, energy ventures, and infrastructure projects. We are owners of hotels, insurance companies, food service companies, and an incredible range of businesses. In fact, we own a huge chunk of the American economy, as private equity firms own thousands of companies and employ millions of people.

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Tim Melvin

About the Author

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Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of "Max Wealth" and Heatseekers.

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