There’s Less to Private Equity Than Meets the Eye

https://www.bloomberg.com/opinion/articles/2018-11-12/there-s-less-to-private-equity-than-meets-the-eye

by petethomas • 8 years ago

43 20 8 years ago

shaqbert• 8 years ago

Gist of articles: Private equity returns are more explained by overall bull market that individual talent.

My 2 cents:

Private equity is a key winner of the ever increased "cost" of going public. Enron, Worldcom and other scandals made the legal pendulum swing hard in investor protection. Quarterly calls, getting hounded by analysts, making the number, lawsuits, short sellers... live is tough for a public company CEO.

As a result, private equity has grown so much, displacing the public markets. With this outsized footprints, it is only natural that returns zone in on the market returns.

moorhosj3• 8 years ago

The carried interest loophole has certainly helped as it keeps costs artificially low.

It also short changes social security and Medicare.

travisoneill1• 8 years ago

Maximum taxable earnings for SS is $128,400. Everybody who takes advantage of the carried interest loophole draws a regular salary too, and it's much higher than 128K, so no effect.

JJMcJ• 8 years ago

more explained by overall bull market that individual talent

Old Wall Street saying, that everyone is a genius in a rising market.

alexhutcheson2• 8 years ago

Life doesn't sound that easy for the CEO of a private company owned by a PE firm either: Lots of debt to service, high pressure to deliver, and bosses that are much more direct and demanding than a public company board would normally be.

z2• 8 years ago

If a tree falls in a forest and nobody is around to hear it, PE funds would love for you to believe it doesn't make a sound! That said, besides the lack of real time mark to market reporting and thus lack of measurable volatility, perhaps there is some value in long term investing that's forced by the lock up period?

mruts• 8 years ago

I think many people are missing the point by measuring everything against a single benchmark. The fact that many different investment vehicles (alternatives, indexes, mutual funds, PE, etc) produce very similiar returns is a sign that the markets are working properly. If every investment dollar was just mindlessly plowed into SPY or vanilla public markets then other kinds of investments would generate huge returns (like hedge funds in the 90’s). The spread between different investments should be low, because that’s how we know the market is efficient.

As an aside, I also think it’s silly to just take into account returns. For example, many managers add positions that are predicted to have a net negative on the returns of the portfolio compared to some other position, because it adds diversification or is thought to decrease the variance of the portfolio as a whole.

luqven• 8 years ago

Skip to third from last paragraph for any reference to the actual study.

Otherwise, enjoy commentary like “Those magic words apparently always get you far on Wall Street.”.

Sometimes I wish the researchers were actually quoted in these.

inputcoffee2• 8 years ago

It would be more interesting to see if the top Private Equity firms are consistently the top firms. note: if private equity matches the market, the top firms beat it.

I am not surprised that mediocre performers will enter any market and drag down the average. In order to tell if it is "skill", you have to see consistency.

To put it another way: Is it more likely than average that Sequoia's next fund will beat the S&P?

sonnyblarney2• 8 years ago

This is all fine and good ... but PE as a class should still be able to beat the S&P and if not, then we need to possibly change our view of these things.

I don't doubt any of this a bit.

inputcoffee2• 8 years ago

Well, if you accept the premise that this is "fine and good", then why should[edit:n't, as in why shouldn't] the PE class beat the S&P.

Let me tell you a story that may or may not be true. We would need a study to tell us.

There are some very smart people who have noticed that debt is much cheaper than equity. They go into a company and borrow against the cash flows of the company. They borrow enough to buy the company and have cash leftover. Essentially they find money for free. In order to do this, they have to know the bankers who trust them, know how to value the firm and so forth. They go out and make a killing year after year.

You and I look at this and think, how hard can it be? We put up a shingle, and we try to do the same thing. Now we don't have the same relationships so we put everything on our credit card. We can't value the company properly and make a few mistakes. We lose a lot of money for a few years and shut down.

Let's say that when you average your and my performance with the other company, we get the S&P 500 average. And we conclude there is nothing in private equity and that there is no skill involved.

Is that the right way to look at it? Or should say that there is PE as "properly" practiced?

I suggest a simple test: if that other firm makes money year after year then there is skill. If their company is up one year and down the other, and you and I have a good year and then a bad year, it may be luck.

miobrien• 8 years ago

Link to paper: https://fisher.osu.edu/sites/default/files/pe_index_-_sep_24...

dmurray• 8 years ago

the big returns investors think they are getting from private equity funds are really just the result of leverage and the bull market

This suggests one way PE firms can beat passive indexing.

In bull markets, capital, and therefore leverage, is easier to obtain for niche or exotic investment firms (citation needed) and therefore for PE firms overall. And if they manage to get 10x leverage in bull years and 3x leverage in bear years, they end up comfortably beating the S&P even if they have zero or negative alpha.

I'm skipping over a bunch of details here, but doesn't this seem plausible?

alexhutcheson2• 8 years ago

This would require that changes in lending constraints precede the transition in the equity markets between bull and bear markets. The reverse seems much more likely: equity markets drop a lot, and banks/debt investors respond to that by tightening up their lending requirements.

jmcqk6• 8 years ago

The big problem in that scenario is how to do you switch between the two?

jgalt212• 8 years ago

My two cents:

PE has been a huge home run because stocks have rallied, but also because their funding costs have been minimal, and returns have been supercharged due to leverage (no such thing as Reg T in PE land).

And yes, the carried interest loophole is a disgusting abomination that cannot be undone in an orderly and democratic fashion because the chief beneficiaries of this loophole are now all billionaires and can/have bribed all the politicians of both parties.

People like Sanders and Ocasio Cortez can undo this, but they are socialists who are probably also keen on undoing a bunch of other stuff the the center/left, center and center/right support. e.g. free enterprise, low taxes, and minimal government interference in our business and personal lives.

rvn1045• 8 years ago

consider a private equity company that can borrow money in the us at extremely low rates, take this money and invest it in an emerging market country like India or china or wherever. even if they don't add any value to the company they acquire 'on average' it is growing at 6-7 percent, now if your levered by 70-80 percent youre going to get about 30 percent returns for doing nothing. on top of that the stock market is doing well and providing returns on top of that.

There’s Less to Private Equity Than Meets the Eye

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