There's riches in niches, but only if you know which private capital corners to look in

It’s no secret that the private capital universe is heating up, with both private equity and now private debt surging at different times to stand out as must-have asset classes in investor portfolios. For decades it was private equity leading the charge, but in the last five years private debt has fought off venture capitalism to become the new incumbent.

Both debt and equity have their merits, and for advisers, as ever, the skill lies in selecting the right managers. According to two contrasting managers at The Inside Network’s Investment Leaders Forum in New Zealand, the secret to that is finding a manager who not only specialises, but knows how to excel at their particular style or niche.

“There’s riches in niches,” said Nick Miller (pictured), managing partner at Brisbane-based private equity firm Fortitude Investment Partners. It may have been tongue-in-cheek, but the alliterative quip “really epitomises” how Fortitude looks at investment, Miller explained.

Fortitude invests in the small-to-mid size company market, with investments in the $10 million to $50 million range for companies that have an enterprise value between $10 million and $80 million.

“In a word, it comes down to competition,” he said. “One of the fundamental economics laws is that excess returns gets competed away after time. I want to invest where there is less competition, and that’s one of the key tenets of ‘riches in niches’ – how do invest in high quality, hidden gem businesses that exist in smaller markets with fewer competitors?”

“We’re not talking about investing in fish and chip operators and mum and dad shops. We’re talking about investing in businesses that have the potential to be much, much larger than what they are today,” he continued. “Historically, what we’ve seen is low, mid-market private equity has outperformed other areas of private equity.”

Not only is Fortitude homing in on a relatively under-invested slice of the market, but they invest in niche businesses. It’s what Miller calls a niche “double dividend”.

“Not only are we investing in businesses that have fewer competitors because they’ve typically got a leadership advantage or a strong market share within their chosen niche, but from a capital allocation perspective you’re also investing in a market that has relatively few managers chasing after a significant number of opportunities, so you’re stacking the deck in your favor.”

Also at the forum, Craig Brooke, founder of private debt purveyor KeyInvest, commented on how difficult it is for investors to find the right private debt provider for the niche they’re looking for. “It constantly gets referred to as ‘opaque’,” he said, adding that the KeyInvest team had spent two years sifting through all the private credit providers in Australia to identify quality commonalities.

“What we started with was 308 private credit managers in Australia, 308 but every, every time we look up, there’s another one, there’s another one that pops up as well,” he said.

What they found, he explained, was an interesting dichotomy. Private credit firms are either good at loan origination, or good at raising capital, but rarely good at both. Of the 308 they studied, he said, only 82 managed to return every dollar to investors since inception.

There are quality providers, however. After KeyInvest applied a proprietary 16-factor filter to 30 of the best managers in the country, 12 of which made it through the quality filter.