The Diversification into Private Equity Investments

Have you ever come across an individual product that you wished you could own a share of that company but only to find out it was held privately? Perhaps it has already been a part of your investment considerations but you are still trying to weigh out the options?

Adding private equity to your portfolio can be potentially a good way to earn a higher return on your investment, and one way to efficiently diversify your portfolio.

Many Canadians are still unfamiliar with private equity—or PE. However, Canadians are active private equity investors through institutions and boutique investment dealers.

Private equity and debt assets

Private investments have their own sets of benefits, wherein most publicly traded funds carry restrictions on their investment activities as well as being subject to market volatility. The opportunity for potential higher income at stable returns ​is a stark contrast to watching publicly traded funds have to rise and fall through the roller-coaster events of the financial market.

Recently, there has been a significant increase from 39% in 2015 to 50% in 2018 in the number of investors who are adding at least three to four alternative investments to their portfolios.These investors are considering alternative investments as a form of diversification in addition to seeking higher yields from alternative asset types including private mortgage instruments.

Diversification is one of the primary forces that drives investors to seek alternative investments, as they can sometimes offer less volatility. The recent market conditions favour the rise of real estate investments trusts or REITs and mortgage investment corporations or MICs.

MICs, while sometimes public, are most commonly privately-traded funds that can offer stable income.

The Rise of private equity

Many Canadian businesses look for private equity capital to fund future growth by means of internal expansion and new acquisitions. Private equity may also be an option to restructure failing businesses.

Some private equity firms achieve strong returns by adequately implementing strategies involving restructuring the business to position it for improved growth.

Getting into the private equity market varies according to the securities regulations laid out in each province. More prominent institutions and pension funds often deal with capital ventures, debt, and infrastructure assets and are responsible for the various infrastructure projects all over Canada. The Canadian Pension Plan, for example, marked 2.16% in returns in Q2 of this year.

Canadian Pension Fund asset allocation:

Here is a closer look at the Canadian pension funds’ asset allocation:


                 A Sample Portfolio Performance by Asset Class as provided by CPPIB

Based on the recent performance percentage, it seems that pension funds are seriously investing their money into real estate, infrastructure, and utility investments locally and internally. These funds have contributed a large part in the recent infrastructure plans of the Canadian government.

In fact, according to the Canadian Pension Plan Board, it gained 11.6% total net returns from the last fiscal year wherein private equity was the top-performing asset at 19.5% and the public markets ended at 18.6%.

Mortgage investments

The next contributing private equity asset involves mortgage investments. There are ways to diversify your portfolio into Canadian mortgages. But first, let’s take a more strategic look at the Canadian mortgage and real estate market at large.

The Canada Mortgage and Housing Corporation (CMHC)’s mortgage loan insurance portfolio stayed strong with a decreasing overall arrears rate from 0.29% to 0.27% during the first half of 2018.

According to the Ontario Real Estate Association President Tim Hudak, “There are not enough starter homes in the marketplace and baby boomers are a very healthy generation that are holding onto family homes longer.”
He continued on to say, “The big lesson on this today is we need to increase housing supply particularly around starter homes and the missing middle.” This only further supports an increase in demand for housing a​ nd in turn places a firm demand on credit across the entire real estate vertical from commercial financing and trickling down to residential mortgages.

This demand increases the demand for mortgages across Canada, and gives sophisticated investors the opportunity to partner with a mortgage fund to diversify their investment portfolio.

How to invest in private equity

Investors who wish to venture into private equity must have a sound understanding of the asset management firm’s culture to determine if is a good fit. Look for a competitive company with excellent management skills.

Large private equity investors hire the best fund managers exclusively while the average investors may choose from different exempt market dealers to take care of their money. It is all about whom you entrust your money to.

The CMI MIC, for example, provides a way for individuals and corporate investors to access Canadian real estate markets and take advantage of economies of scale not available to them as individuals. Investors pool their money by buying shares in the CMI MIC, when invests these funds in mortgages. Yield is then generated through interest rates and fees charged to the borrowers. Here are some highlights of the CMI MIC:

  • Targeted annual returns of 8-9%
  • Fixed interest rates allow for more predictable cash flow
  • Monthly cash payments or dividend re-investment for compounding, available
  • Diversity through the pooling of funds with other investors into multiple mortgages
  • RRSP, RRIF, RESP, LIRA, TFSA eligible

Again, understanding the criteria for the private investment you are looking for and find the best company to work with. An exempt market dealer with access to a strong collection private investments may be the best choice to be able to diversify amongst more than one private investment.

The Growth of private investments in Canada

The Canadian economy has been sustained through strong consumer demand as well as the housing market in recent years. With this trend, private capital markets are gaining a positive impact on the providing more liquidity to the market especially when recent rule changes for Exempt Market Dealers have been laid out giving the small to medium-sized businesses access to a vast pool of private financing.

Although the evidence supports positive results for private equity, there are still a few considerations investors should be keen to consider including which sector of the PE industry an investor would feel comfortable participating in and how much of their entire portfolio should be comprised of PE investments.