The perception of risk management in private equity has changed dramatically over the last few years. Until fairly recently, while the majority of investors were dazzled by private equity’s seemingly unlimited return potential, only a handful of large investors (supported by their advisors) made an effort to analyse the risk of private equity portfolios.
Many investment practitioners even argued that risk management in private equity was not necessary because they saw their selection skills as the main value driver and trusted their gut instincts. However, the financial crisis has put this perception into question and increased the awareness of risk management in private equity.
The increased interest of investors in risk management is not only based on intrinsic motivation but also on the upcoming changes in the regulatory environment. Banks are regulated under Basel II and the insurance industry will now be regulated under the Solvency II rules, which will sooner or later have to be applied to pension funds as well. Unfortunately, compared to public equity and other asset classes, private equity is treated unfavourably under both frameworks.
