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.