I work in private equity, and I’m fed up with whingers and their half-baked comparisons of the returns we offer to those of listed stocks and index tracker funds. Their criticisms show up their own lack of insight into the buyout sector (forgivable) and basic knowledge of investing and portfolio allocation (unforgivable).
The idea that returns from P.E. are equivalent to (or less than) increases in the stock market is ludicrous. We deserve our performance fees just as much as the average halfwit fund manager deserves their much smaller salary.
The studies themselves contradict one another: an M.I.T report claims underperformance of stocks by P.E., another by London Business School and H.E.C. of Paris says we’ve outperformed by almost 20%. A third by Cambridge Associates, Thomson Reuters, Preqin and State Street agrees.
Private Equity is fundamentally a different asset class. Money goes in at the start and comes out several years later. Unlike shares which pay dividends, you don’t get a drink along the way (dividend recaps were largely an exhibit of the credit boom and won’t happen anymore). Investors deserve, and get, a premium for that illiquidity.
“Leverage risk” is a ridiculous premise. Borrowing, if used properly, enhances equity returns due to significantly different views of “reasonable returns” on debt (low) & equity (higher). Therefore greater returns follow greater risk. That is Portfolio Management 101.
Additionally, risk depends entirely on the underlying asset one decides to lever up. Consider whether you prefer an unlevered bet on a Lebanese cotton factory, or a 3x levered investment in a German utility?
The value of Private Equity is in finding neglected & unloved sub-sectors, ones better suited to higher contractual returns (interest payments) than the scrutiny of quarterly stock market reporting. It takes persistence and insight to find these assets, especially when they’re not covered by the equity research analysts that fund managers rely on.
Public equity managers are unwilling to fully dig into the balance sheets and income statements of the stocks they own. Notwithstanding that their stakes are smaller, how many of them really understand their investments in the way P.E. managers do?
Fundamentally, it is the institutional investors who are lazy. They were captivated by the allure of “absolute return.” Ask them to roll up their sleeves and calculate their actual returns excluding transaction costs, or taking into account entry and exit timings, and it “all seems a little too much like hard work”.
Public markets need Private Equity and vice versa -portfolio company exits via re-listings return cash to investors and the takeover premiums paid in buyouts boost returns to fund managers’ portfolios.
However, I’ll leave you with a final observation: I sit next to my boss and I see him log into his stock portfolio several times a day – the irony of a P.E. principal hedging his bets in the public markets is not lost on me.