The Changing Landscape of Private Equity: Pros and Cons

Written by Sloan Smith, CAIA, CPWA®
Sloan is a Vice President at Innovest Portfolio Solutions

The private equity investing environment has witnessed major changes in the last dozen years. Valuations, dry powder (i.e. unused capital), and fundraising all have increased to levels not seen since the years leading up to the Global Financial Crisis of 2008. From 2006 to 2007, the private equity asset class invested large amounts of capital at high asset prices, which led to lower returns in subsequent years. Some investors worry that we may be experiencing a similar situation today. However, it is important to take a deeper look at how the current private equity investment environment compares to that of a dozen years ago. An assessment of the advantages and disadvantages of the current environment will help investors to make prudent decisions for their long-term portfolios.

Advantages of the current private equity environment:

1. Less leverage

In 2008, the average U.S. private equity transaction was levered at 7.5x debt-to-earnings before income, taxes, depreciation and amortization (EBITDA).1 In 2018, the average private equity deal was levered at 6.2x Debt-to-EBITDA.2 Also, the ratio of debt to equity is more moderate today than ten years ago. In 2009 the average percentage of equity that private equity managers were committing to their deals reached a low of 30%, meaning they had a lot less skin in the game. Today, private equity firms are investing, on average, close to 50% of equity into their transactions, which is a significant improvement.3

2. Prudent and cautious investment process

Private equity investment activity is running at a significantly lower level than that of 2006 and 2007. Private equity deal volume was close to 40 percent lower in 2017 than its peak in 2007.4 Volume has been mainly from larger funds and their significant deal sizes. However, the greater private equity space has been cautious in a higher valuation environment and has been more thoughtful in identifying opportunities and investing capital.

3. Avoidance of club deals

A club deal is when numerous funds work together to make a large private equity transaction. In 2006 club deals made up more than 50% of private equity purchases that were greater than $1 billion.5 However, during the Global Financial Crisis of 2008, private equity managers were faced with joint control hindering prompt decision making, especially in the board room. The size of these deals also made it difficult to complete the transactions. Though club deals still exist, they recently represented only $50 billion of the aggregate private equity deal value, versus $300 billion in 2007.6 Currently, private equity firms tend to favor institutional limited partners eager to potentially co-invest on deals, or corporations providing some strategic value.

Disadvantages of the current private equity environment:

1. Valuations

In 2018 the median private equity EBITDA multiple was 11.1x .7 This multiple is the highest level in the last eleven years (see Chart 1). One reason for these expensive valuations is that private equity strategies value their deals based on valuations in the public markets, which have risen significantly since 2008. Additional reasons for the valuations are low interest rates and the cost of debt. Access to cheap financing has encouraged some private equity firms to make aggressive purchases at higher prices.

2. Dry Powder

Dry powder is the amount of capital that is sitting in cash or similar securities waiting to be invested by private equity managers. Private equity dry powder has grown, on average, about 20% a year since 2012, accumulating to $1.2 trillion as of mid-20188 (see Chart 2). This growth is due to heavy amounts of fundraising and investors becoming increasingly interested in private equity for its return potential.

3. Competition

Growing competition for private deals has been pushing up prices in private equity, particularly in competitive auctions. This trend may tempt private equity strategies to reduce their due diligence criteria in order to invest capital and keep up their pace of calling capital. Private equity firms are not paid large management and incentive fees to sit on the sidelines. Their limited partners expect them to allocate capital and could grow impatient if their committed dollars are not invested.

Over the past 15 years private equity has outperformed the S&P 500 by an average of 400 basis points per year.9 There are mixed reviews of today’s private equity environment and whether investment returns will be as strong in the future. Some investors are not only worried about valuations, but about the flood of capital is waiting to be invested. Others point to reduced deal volume and fewer club deals as positive indicators. It is essential that investors understand the asset class’s current environment when considering its merits for their long-term portfolios.

Top 10 Areas of Focus in IRS Investigations of Retirement Plans

“At any point an IRS agent may contact a plan sponsor that its plan has been selected for audit. Audits are never pleasant, but to minimize the pain, a plan sponsor may consider a compliance self-review to ensure that the plan is operating correctly, its plan documents comport with plan operation, and plan records are complete and organized before the IRS comes knocking.”

Click here to read more about the IRS focuses during audits.

Source: JDSupra

The Society for Resource Management's 2019 Survey Reveals Most Popular Employee Benefits

“SHRM conducts the survey annually to gather information on the types of benefits employers are offering their employees and to report on trends. The survey revealed that employers were more likely to increase, rather than, decrease, their benefits offerings.”

See what trends managers are moving towards by clicking here!

Source: Xpert HR Blog

Kitces & Carl Ep 13: The Better Way To Send Market (And Other) Commentary Emails To Clients

“Michael Kitces and financial advisor communication expert Carl Richards sit down to discuss why it’s important to send regular commentary, provide a specific example of an easy and effective way to let clients know that you are thinking about them and their challenges, and why it matters so much that it ultimately comes from you (versus any number of white-labeled, off-the-shelf offerings).”

Click here to check it out!


Christine Hudek
Think Twice about Equity Indexed Annuities

By Rich Todd, Managing Principal, CEO and Jared Martin, CFP®, AIF, Vice President

Equity-Indexed Annuities (EIAs) are complicated financial products with considerable disadvantages. However, EIAs are often sold by annuity salespeople who may be motivated by sizable commissions, rather than their client’s best interest.  It has become increasingly clear to us at Innovest that many people who have invested in these products will not receive what they expect.  In this article, we will review EIAs and how their earnings are calculated, explore the issues that arise from salesperson compensation, and examine a recent case study.

What is an Equity Index Annuity?

With an annuity, you exchange a certain amount of principal up front for payouts by an insurance company in retirement. The payouts for EIAs, sometimes called “index annuities”, are somewhat based on the performance of an equities index, like the S&P 500. If stock prices rise during a specific time period, EIA owners receive an interest rate based on the partial rise in stocks. If stocks fall, EIA owners earn a minimum interest rate. FINRA (the Financial Industry Regulatory Authority) describes EIAs as “having characteristics of both fixed and variable annuities. Their return varies more than a fixed annuity. EIAs offer a minimum guaranteed interest rate combined with an interest rate linked to a market index.”

How are earnings for EIAs calculated?

Earnings for EIAs are calculated somewhat differently than traditional annuities.  Generally, the insurance company that sells the EIA will declare an index participation rate—or a percentage of the index’s gain—that is promised to the annuity owner.  If the participation rate is 80%, the investor will be credited with 80% of the index return. Also, many EIAs have a maximum cap that limits how much gain can be received over a defined time period  Importantly, dividends are typically not included in the return calculation of the index. Dividends are a key component in total market return and help to reduce volatility.  The exclusion of dividends is a real cost to the investor.  The recent S&P 500 dividend rate is 2%. As Ethan Schwartz of The National states, “the S&P 500 isn’t’ travelling at full speed” when dividends are excluded.

The second component, like a fixed annuity, is the declared rate component. This rate is typically paid  on at least 87.5% of the investment and is usually a 1% to 3% interest rate.

The third component is the “spread” per cost, a deduction against the return, which typically ranges between 1.5% to 3.5%.

Here is the formula:

Index Returns (without dividends) + Declared Rate - Spread = Earnings

How are earnings taxed?

Earnings are deferred until distributed to the annuity owner. Distributions are taxable at ordinary income tax rates.  There is no tax advantage to owning an annuity in a retirement plan or an IRA.

What about the costs?

Spread – 1.5% to 3.5% per year

Dividend elimination – for the S&P 500, it was recently 2%

Surrender charges – if the annuity is sold within the first five to 10 years, the owner pays a charge of 4% to 10%

Salesperson Compensation
The salesperson earns a commission from the spread of the product, either front-loaded with a typical commission of 5% to 10% of investment. The higher the spread, the higher the commission to the salesperson– a significant conflict of interest.  Further, these salespeople are not legal fiduciaries.  Fiduciaries offer advice only in the best interest of their client, while non-fiduciaries do not have this obligation. In addition, the surrender charges are in place primarily to compensate the insurance company for the commission paid to the salesperson.

Two regulatory bodies – the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) -- have offered instructive notices on EIAs.  FINRA, predecessor of  NASD (The National Association of Securities Dealers), has noted:  “NASD is concerned about the way an associated person is marketing and selling unregulated EIAs, and the absence of adequate supervision of these sales practices.  For example, FINRA has heard the following claims:

  • ‘What if the market goes down and you would lose nothing? The market goes up, you gain!’

  • ‘A win/win Investment vehicle’

  • ‘How your retirement funds can have security of principal, higher than CD rates of interest, opportunity for growth (no losses)’

  • ‘Pick up where Social Security leaves off with new tax featured annuities…  featuring… two indexed accounts linked to a popular market index’

  • ‘If you’re looking for upside potential and no market downside, look no further than (name of EIA). This fixed annuity… enables you to make the most of S&P 500 index gains…’

  • ‘Growth potential without market risk’”

According to FINRA, investors are being misled by these sales tactics.

Case Study

A participant in a retirement plan recently took a lump sum distribution out of the plan to invest in an EIA instead of keeping her assets in the plan.  The total investment and recordkeeping costs in the retirement plan were less than 0.70%.  It was explained by the salesperson that there would be “no fees” in the EIA and that it offered protection that she did not have in the plan.

Here were the characteristics of the EIA sold to the participant:

  • Spread cost of 2.25%

  • Surrender charge starting at 9% for the first four years, then declining by 1% per year for the next five years

  • The declared rate was 1% on 90% of the investment

  • The future dividends of the index would not be included in the investor return

  • “The insurance company pays me,” the salesperson said.  On a $200,000 investment, the salesperson made either $14,000 up front or $2,000 per year for nine years ($18,000), paid directly from the investment.  The compensation came directly from the insurance company’s profits created with the annuity purchase.


The low returns of EIAs combined with high costs typically don’t make EIAs worth it.  By having a sound process for portfolio design and prudent asset allocation, downside risk can be reduced through much lower costs than EIAs.  At Innovest, we believe that most EIA purchasers have expectations of higher earnings than they receive because of the dividend elimination and high costs.  Further, annuities do not offer any tax advantages as compared to a traditional retirement plan—withdrawals from both are taxed at ordinary income rates. Assets invested outside of a retirement plan can help defer taxes through low-turnover investments, and eventually asset sales should be at a long-term capital gain rate, not ordinary income like an annuity or a retirement plan.

Salespeople prey on retirement plan participants looking for big sales with a “product that a retirement plan can’t offer.”  These participants are better off taking advantage of plan education services that lead to a sounder and much lower cost approach.


1.      Notice to member.  NASD August 2005 Guidance.  Equity Indexed annuities.

2.      Investor Alert. FINRA Equity Indexed Annuities: A Complex Choice

There’s No Such Thing as a Free Lunch–Looking Under the Hood of Structured Products

Written by: Christian O’Dwyer, CFA | Vice President

Investors should always be wary of promises of risk-free returns from their advisors and the products they recommend or sell. All investments carry a degree of risk, except for those rare cases of pure arbitrage. Successful long-term investors find opportunities where risk is garnered only when it is accompanied by a commensurate return. Structured products, which are typically designed and issued by financial institutions and sold by broker-dealers to individual investors, are a good example of strategies that frequently promise upside market participation alongside capital preservation. This article reviews the definition of structured products, how they work, how to analyze them, and their role in a diversified portfolio.

What Are Structured Products?

Typically, structured products are debt securities with a fixed maturity and include two components: a bond component and a derivative component. The bond portion of the note is the majority of the investment and provides principal protection. The embedded derivative may be linked to the performance of an asset, index, a single equity security, a basket of equity securities, interest rates, commodities, and/or foreign currencies. The notes are used to modify market exposure, or otherwise manage market risk, credit risk, or both. The type of derivative embedded in the note will affect the performance characteristics of the note and the complexity of performance calculations. The products typically employ a degree of leverage.


How do Structured Products Work?

The below image provides an example of a theoretical structured note. Consider a simple, three-year, S&P 500 index-linked structured note with 100% principal protection promising preservation of capital, 80% participation with the index and a capped return of 20%. The various return scenarios are depicted:

How to Analyze Them?

While our example was (hopefully) useful from a conceptual standpoint, it was very basic as compared to most structured products in the market. As features are added to the products, complexities mount making appropriate levels of due diligence more difficult. In response, the U.S. Securities and Exchange Commission issued a 2015 bulletin that plainly stated, “While structured notes may enable individual retail investors to participate in investment strategies that are not typically offered to them, these products can be very complex and have significant investment risks. Before investing in structured notes, you should understand how the notes work and carefully consider their risks.” Additional considerations are listed below.

  • Know the fees and other costs associated with the investment.

    • Structured notes are highly complex and carry low fee transparency; it is important to fully understand both the stated and embedded costs associated with the product.

  • Know whether the product is appropriate for the intended investment objective.

    • Are the risks associated with a particular structured note within your tolerance for risk, or are your investment needs better served by investing in another product?

  • What other investment choices are available to me? Are other products available that provide investment exposure to similar assets, indices or strategies? If so, how do the costs of these other products compare to those associated with the structured note?

    • Carefully consider what might be a suitable investment for you, and whether there are better alternatives to the structured note you are considering. For example, can I purchase some or all of the components of the structured note separately for a better price?

  • How long will my money be tied up?

    • Many structured notes are meant to be held to maturity. If you need your money back prior to maturity, you could lose a significant portion of your investment.

  • Are potential returns limited?

    • Some structured notes have caps on the returns that can be earned based on the performance of the reference asset or index. This is an example of a potentially significant embedded cost.

  • What is the credit risk of the issuer of the structured note?

    • Remember that any payoff on a structured note is subject to the creditworthiness of the issuer. Be sure to understand the financial condition of the issuer and read its disclosures as carefully as you would for any other investment.

For more information, please visit:

What is the Role of Structured Products in a Diversified Portfolio?

While the capital preservation feature and the customization of structured products can make them attractive for potential investors, the complicated payoff profile, opaque expense structure, lack of liquidity, and associated credit risk decrease their usefulness within a broad portfolio context. Investors should also consider opportunity costs associated with forgone investments in their overall strategy. In sum, the time-tested qualities of remaining patient, keeping costs low and being well diversified are most likely to drive long-term investment success.

About Innovest

For more than 20 years, Innovest has provided excellent client service as well as forward-looking, innovative investment solutions for endowments and foundations, retirement plans, and families. We are an independent provider of investment-related consulting services and work on a fee-only basis.

SECURE Retirement Act: Ten Potential Impacts

The U.S. House of Representatives made a significant step toward retirement reform by passing the Setting Every Community Up for Retirement Enhancement (SECURE) Act in May. While the act has not been taken up by the Senate or signed by the President, it points to some significant changes impacting individuals and plan sponsors. Click here for a three-page overview from Plante Moran.

Source: Plante Moran

Innovest Launches Innovest Family Office

“Longtime Denver investment manager and consultant Innovest Portfolio Solutions has united with Denver-based CPA and multi-family office firm Elevation Management Group to create Innovest Family Office. The office will be owned jointly by Innovest Portfolio Solutions and Elevation Management Group founder Karen Winkelman, who will be the new group’s CEO.” Click here to learn more.

Source: Denver Business Journal

Innovest's 23rd Anniversary

We are excited to celebrate our 23rd Anniversary today on July 1, 2019. At Innovest, we are not just an investment firm, we are stewards to our clients, employees and community. Everyone knows about the problems on Wall Street.  Things were no better in 1996 when the co-founders of Innovest left their Wall Street firm because of the conflicts of interest and tainted objectivity to start their own firm.  They started the firm with five employees, 25 clients, and a Ryder truck full of used office furniture (driven by President Wendy Dominguez).  With relatively little except for the desire to be stewards for our clients, Innovest was founded.  The firm has come a long way since that day in July – today, Innovest has 49 employees and more than 260 clients.  Innovest consults more than $23 billion in assets. We have a client-based culture, a fee-only model and we are completely independent with no conflicts of interest.

Rich Todd, CEO, reflects, “Wendy and I were tired of the conflicts of Interest on Wall Street and decided to start our own conflict-free firm with tenets: independent, team-based, and research-focused doing completely custom work. We have grown from 25 clients, 5 employees, and 250 million in assets under advisement to over 200 clients, 49 employees and almost 25 billion assets under advisement.”

While Innovest has grown significantly, a major strength of the firm is to make Innovest a rewarding place to work.  Pensions & Investments named Innovest among the Best Places to Work in the nation in 2018, 2017, 2016 and 2014.  This achievement has allowed us to hire and retain top quality talent with the highest integrity who are committed to our clients. Our employees are people who put others first and work for the best outcomes for our clients and community.

We have promised clients that they will benefit from our growth through our continued hiring of high quality, experienced professionals, and the acquisition of top-notch research.  Our success is attributed to our strategy of building community within our clientele and developing them into a great sales force.  It is important to Innovest to build strong relationships with our clients, but also provide educational settings in which they can enhance their knowledge about the economy, capital markets, and fiduciary/compliance issues.  Innovest founded the Rocky Mountain Nonprofit Conference, Rocky Mountain Benefit Plans Conference, and the Colorado Public Plan Coalition, all of which provide education to hundreds of investors, trustees, and investment committee members – both clients and non-clients.

Around the Firm

Innovest wouldn’t be the firm it is today without its dedicated employees who are committed to providing great service to our clients.  Beyond service, Innovest employees are known for being diligent, collaborative, honest and for seeking continual development.

We’re excited to celebrate the recent accomplishments of several Innovest employees!


Kathy Lalone, Kyli Hanson and Kenny Senour were all promoted to Manager positions.

Cheryl Wilks, Christine Hudek and Jordan Rice were named Lead Senior Analysts.

Eileen Pohs was promoted to Senior Analyst.

In addition, Zach Heath and Brooks Urich were elevated to Analyst. 

Speaking Engagements:

Vice President, Jared Martin, spoke about Financial Wellness for Plan Participants, at the College and University Professionals Association Annual Conference in Arizona on 6/21.

Marianne Marvez, RPA, Vice President, gave a workshop on What to Expect from your Service Providers at the PlanSponsor conference.

Continuing Education:

Congratulations to Kenny Senour and Jordan Rice for passing their CFP exam!  Earning the CFP designation involves meeting requirements in formal education, performance on the CFP exam, relevant work experience, and demonstrated professional ethics.