Managing VIP Money

A lot of wealthy folks piled into venture-capital funds at the peak of tech mania two years ago, and they have seen nothing but red ink. Last year such funds declined about 40% on average. The other pillar of what’s known as private equity–leveraged-buyout funds–has had problems too, losing about 20% in 2001. Together, these are the worst returns on record for an exclusive class that often carries investment minimums of $1 million for access to the best managers. When the game goes this bad, what’s a well-heeled investor to do?

The short answer: hang tough. Boutique investment firms catering to the wealthy offer all kinds of fancy alternatives, from timberland and drilling partnerships to market-neutral and hedge funds to buying a vineyard in Italy. But the wisest course may be to hold your nose and reinvest in private equity.

Yes, the stock market was a safer place to hide last year, when the S&P 500 fell 12%. But private equity has outperformed publicly traded stocks for the past three years, with an average annual return of 16.9% vs. 2.4% for the S&P 500; 10 years, 18.8% vs. 11.9%; and 20 years, 16.9% vs. 12.9%, Thomson Financial reports. Last year’s losses, though, have been the focus. New cash flowing into private equity fell 43% last year. “A lot of people are still running,” notes Stanley Pantowich, CEO of New York City-based TAG Associates. “I think it’s time to get back into the fray.” Venture-capital managers are doing just that. Last quarter they made more investments than in the previous quarter, for the first time in a year and a half, reports PricewaterhouseCoopers.

These managers view the recession as a classic opportunity to invest near the bottom–and with less money pouring in, those who do invest get better terms. Venture-capital managers who had been demanding fees equal to 30% of profits–up from the normal 20%–may not be so cocky going forward, notes Steven Galante, president of Asset Alternatives, a Wellesley, Mass., research firm. And for those who put their money in private equity, the corporate books allow the kind of transparency that stock-market investors crave post-Enron. To secure seed money for start-ups and spin-offs, companies grant private managers broad disclosure.

Wealthy individuals now have some $5 billion in private equity, less than 10% of a pie that remains dominated by pensions and endowments. An investor with less than $3 million may not get decent diversification, and advisers caution that private equity should be no more than 10% of a portfolio. “That level doesn’t add a lot of overall risk but can juice returns,” says Don Weigandt, a wealth adviser at J.P. Morgan Private Bank. The perfect candidate, then, is worth $30 million or more.

But even if that’s out of your league, plenty of high-net worth advisers will work with you. Most require $100,000 to $1 million of investable money to open an account, and they will provide personalized tax service and mutual-fund investing. For VIP treatment, $10 million is the threshold. Firms usually charge about 1% of assets each year and negotiate down for larger portfolios.

What do you get? TAG, which counts as clients several Fortune 500 CEOs–will literally run the family finances, setting up cash flows to pay taxes, insurance, the gardener and vacation-home staff. It will also help you buy or sell a company and manage stock options. “We’re in the business of our clients staying rich,” says chairman Gary Fuhrman. That means minimizing risk through diversification and special vehicles like TAG’s relative value arbitrage fund, which takes virtually no market risk yet profits by capturing tiny price discrepancies between, say, a company’s convertible bonds and its common stock. That fund rose 10% amid last year’s market slump.

Many boutique firms manage separate accounts for pairs trading, which minimizes market risk by, for instance, selling Lowe’s and buying Home Depot. They will help you buy, lease or share a private jet and have intricate strategies for dealing with a large concentration of stock. Through an exchange fund, a single-stock millionaire may contribute stock to a diverse partnership. After seven years, the partnership unwinds and each partner gets a slice of a broad portfolio. That way the partners can diversify without the tax hit that comes from selling shares. Sometimes, as with private equity last year, the exclusive tools don’t work right away. But in the long run they must–or the advisers are out of business.