Everything Is Private Equity Now
bloomberg.com
bloomberg.com
Instead, it's the fact that over the past 25 years, these vehicles have only managed to beat an S&P 500 index fund by 1-2% after fees. And that over the past 10 years, more than half of them are underperforming a passive index fund.
Even if I had a few extra billion dollars lying around, I wouldn't get involved with private equity firms. This audience comes across like a combination of insolvent pension fund managers desperate for a way out, and wealthy individuals who just enjoy the feeling of being in an exclusive club. With dubious "financial engineers" fleecing them all through fees, and hollowing out thousands of private companies to make the whole system possible.
The website you posted this sentence on is owned by a private equity firm.
Private equity is just an investment of capital in a non-public company in exchange for equity. YC makes capital investments in non-public companies in exchange for equity.
The structure of PE deals can vary from the simple cash investment in exchange for company stock all the way up to incredibly complex leveraged buyouts and everything you could imagine in between.
At the high end of VC you get some overlap with PE, like SoftBank investing $X00 million in hot “startups” but PE does not chase 100x returns on investment. They’re in the business of taking a company worth $100 million and turning it into one worth $500 million.
Across private equity there is a spectrum from small cap to large cap with increasing leverage. The small cap funds do a combination of the leverage tricks available to PE investors as well as the deal structure tricks available to VCs (preferred, etc).
Then there is also the question of fees, if the fund is beating the S&P by 1-2% after fees, and their fees are 2 and 20 then the strategy is significantly beating the market. The problem is that there is so much money chasing PE, and that leverage means they don't need that much in client funds, that there isn't a push to lower fees that you see in the equity market.
Yes, but... Vanguard's S&P 500 fund isn't the only index fund on the planet, either. You can include a broad international fund, a region or country-specific fund, or any other number of factors. Diversification and passivity are orthogonal.
> "if the fund is beating the S&P by 1-2% after fees"
Yes, but:
1. You're taking on a higher degree of risk, because the information available to you is much more opaque and unregulated (e.g. EBITA as a valuation metric, when it's so easy manipulated). Bubbles are hard to time, even when you do have decent data available. But investors in that world are just completely flying blind. And historically received only a small net premium for that additional risk.
2. Even that historical premium seems to be gone now. As I pointed out from the article, that "1-2%" is looking back over a quarter-century timeframe. Over the past 10 years, half of PE has UNDERPERFORMED the market. The direction of the trend does not look favorable.
Whilst your comments are valid for public equity - this is simply one of several types of "asset classes" someone with billions of dollars has access too. Different, non-public asset classes can have properties distinct from bubble risks or liquidity.
One of the key benefits of holding a variety of asset classes, particularly the more exotic ones - is that their performance can be uncorrelated with the performance of the stock and debt markets.
Some examples of PE asset classes:
- Venture Capital (very high risk, but over a long period of time is supposed to generate 20-30% rates of return)
- Angel Investing (higher risk still, and you need many companies but also generating 20-30% returns with a big enough portfolio)
- Commercial real estate (uncorrelated to global equity market performance - rather its connected to local market performance, pretty sure around 10% can be typical for offices)
- Infrastructure projects (uncorrelated again, lower rates of return but you are locking in those returns for decades)
There are tonnes of course, but when you start talking about personally investing such large sums of money - diversification means a lot more than just buying investments in the public markets (either bonds or stocks).
Found this: http://www.industryventures.com/2017/02/07/the-venture-capit... And: http://www.angelblog.net/Venture_Capital_Funds_How_the_Math_...
But given there are many different flavors, sizes, vectors etc of VCs, and given many keep their numbers hush, hush - I wouldn't even know where to look for any kind of "official" numbers on it.
If you add the averages of each category(75x for the last category) in this source, you'll end up with an annualized return of 9.4% over the 10 years mentioned in the image.
That is not far of the average return of the SP500.
That's why you see the 80/20 stock/bond split recommended so often. Even though bonds underperform stocks, the 80/20 split regularly rebalanced outperforms 100% stocks. Rebalancing is an automatic "buy low / sell high" strategy. After a stock market crash your 80/20 split might be 50/50 so you take that 30% and buy cheap stocks...
https://personal.vanguard.com/us/insights/saving-investing/m...
And quite often you can look at the discount and do arbitrage on that I certainly did very well with Electra Private Equity (ELTA)
I assume you can't hand Electra one of their shares and get back its constituents. And I assume because it's private equity, you can't do the obverse either, or do a long/short type trade.
You presumably could short a quoted trust or us CFDs or buy warrants but that's a bit rich for me.
The public listing is of the company, whose business happens to be investing, so though I've never looked I don't see why CFDs & derivatives wouldn't be available.
Venture Capital Trusts (VCTs) are similar (perhaps a subset?) but focus on earlier stage companies (clearly) in exchange for a tax advantage for the initial investors - but not for those who subsequently purchase shares in the VCT itself from them.
Most private equity companies use substantial debt leverage to acquire companies and flip them as fast as possible. Berkshire is just the opposite. They use mostly their own capital and leverage from insurance float. They buy businesses permanently. They hire good managers, enforce good corporate governance and the business is free from short term performance goals.
Hedge funds always love to claim that they fix companies and make them healthier, but most of them have a reputation for looting them, loading them with debt, and then dumping them at a temporary profit. It's good to see that Warren Buffet actually tries to make businesses healthier.
Obviously, this isn't universally true, but, not all troubled companies can be saved, or really, need to be saved. The standard pivot model just doesn't work on most businesses, while deferred investment and cash flow problems are always fatal.
There are a small number of funds that do growth equity (where they buy a small business and grow it), but so much of it just depends on financial engineering in the way you mentioned in your comment.
Most private equity that uses leverage actually destroys businesses. Just look at what happened to toys r us for example. That's extremely common.
The problem is that when private equity buys a company, it usually uses lots of loans to do so. Then the most experienced people in the business are removed or deincentivized (the previous owners). Finally, this now poorly run and heavily in debt company struggles to survive and goes bankrupt in the next recession.
You will see this pattern repeated over and over with private equity.
It can’t be as simple as that because who is making these loans to companies that are about to go bankrupt? Why would they do it?
When the parasite finishes the digestion of the host and it goes bankrupt, they get to write down the losses against the money made on those fees, and the actual losses are distributed amongst the partners in the syndicate.
The genius of PE is convincing the public that all the bad things they do are actually done by “hedge funds”.
https://www.seattletimes.com/business/real-estate/minorities...
From a follow up article by [one of the] same writer:
> Buffett said the interest rates are influenced by things such as credit score, down payments, earnings and whether the customer owns land. It has “nothing to do with your religion or your color or anything of the sort,” he said.
https://www.seattletimes.com/business/buffett-not-true-that-...
My comment stands:
> Yeah, you've gotta hand it to them, they really commit to the long-term hollowing out of the economy and the wringing of money from poor stones: none of this short-term loot 'em and flip 'em mentality for BH!
In general, if you see some complex/bullshit sounding financial vehicle that doesn't make sense to you, it likely exists to avoid taxation.
The main driving force behind private equiy are the returns where the best funds have out performed the S&P 500...private equity funds are typically limited partnerships where the investors pay tax on income.
"Beating" the S&P500 doesn't necessarily mean earning higher returns. Earning the same returns with lower risk/volatility would also be widely accepted as "beating" it as most people are more afraid of losing their fortune than they're ambitious to increase it.
I'm curious whether taking that into account changes how many private equity firms beat the S&P 500.
The phenomenon you're describing is definitely true to some extent. Look at when in their lifecycle companies went public prior to 2008 compared to now: far more of the value created is now captured by private capital. This is why, ironically, PE is the largest source of alpha to vehicles like pension funds - they can't capture the same kind of yield in public markets anymore and have mandates about the types of investment they can make.
Figuring out a better way to democratize access to the potential yield that used to be available in public markets would be excellent, but I'm not sure how to do it without pretty massive side effects.
From the article: "Over the 25 years ended in March, PE funds returned more than 13% annualized, compared with about 9% for an equivalent investment in the S&P 500"
When you are dealing with exponents small differences become enormous over time. Remember: y = y0*e^kt where y is money later, y0 is money now, e is 2.71, k is the interest rate, and t is time. So assuming 9% annualized return in the SP500, after 10 years, your million dollar PE investment will yield 2.5 million in the stock market, but 3.7 million in PE or a 1.2 million dollar difference. In addition, they maximize y0 by leveraging.
Ignoring the terrible social costs (e.g., Shopko from the article) and the fact that their accounting and tax practices are suspect, I'll take the PE any day.
There’s a couple of things wrong with this argument so let’s go over it:
1) Low or uncorrelated return streams are very valuable due to the central limit theorem. As you add these return streams together, they form an increasingly tighter normal distribution. This gives us two advantages: we can convert non-normal distributions into normal ones, and we reduce our standard deviation with every stream we add as long as the correlation is less than one.
2) Returns aren’t the defining factor of whether a strategy is worth it. Instead institutional investors measure investments by their Sharpe ratio: the slope of the line between return and risk (the axis is the risk-free rate). The reason for this is that since these kinds of investors can not just lend, but borrow at the risk-free rate, they can lever up their returns to anything they want. This is called risk-adjusted returns.
4) The biggest risk in investing is exposure to Beta, “the market,” which in the US is usually measured by the S&P 500. Reducing exposure to Beta is often goal #1 of institutional investors. Maybe not a 100%, you should definately not be exposed to a 1.0 Beta coefficient. This is especially important for endowments, pensions, and other funds that have monthly or yearly pay-outs. The auto-workers would be super pissed if the economy tanked and they no longer got their retirement pensions. After all, that’s one of the things that pensions are supposed to hedge against.
Before I started working in finance, I definately had the same questions and theories as you. After all, the field is very baroque and complicated and the explanation of the industry being stupid is very simple and straightforward. Chesterson’s Fence is a good way to view a lot of things. Understanding is always a prerquisite for change.
Leveraged buyouts however are starting to become a serious problem. They allow the hollowing-out of functional but low-profit companies into debt-ridden shells. The most recent example in the news is Pizza Express: what is a restaurant chain doing with £1bn of debt? https://www.bbc.co.uk/news/business-49957551
This is bad for staff and bad for creditors.
Creditors are lending their own money. If they make a bad bet that’s on them, should have done better due diligence.
What PE is good for is increasing economic efficiency more generally which redounds to the benefits of consumers in the long run.
[0] Pro Rata https://www.axios.com/newsletters/axios-pro-rata-ed716a8a-37...
It really depends on the PE firm and the company. In the software space, there are large PE firms which have a tendency to cut headcount because in their view, public market CEOs focus on growing revenue at the expense of profitability. This tends to lead to excessive full time employees over and above best practises...so if the previous CEO overhired and the PE firm fired people....then it's the PE firm that's in the wrong right...end of story? I'm not saying you are saying this but this is the underlying vibe I get in these kind of discussions....
PE firms essentially made TRU borrow shit tons of money from them at ridiculous rates to buy itself from public shareholders, then eventually they couldn't keep up with the interest payments.
At the time of the buyout, Toys R Us was in a sales slump, but they were still making a profit and continued making a profit until the very day they closed their doors.
A business that was adequately servicing investors, employees, and customers, has been destroyed because a small group tried to extract more wealth from the company than it could sustain.
* Buy a working company.
* Borrow a ton of money, siphon it out.
* Bankrupt the company which is liquidated for much less than the amount borrowed.
* The lenders are left holding the bag.
A business that was adequately servicing investors, employees, and customers, has been destroyed because a small group tried to extract more wealth from the company than it could sustain.
But I would probably agree with you that just because something feels sinister, doesn't mean that it actually is. And "Toys R Us" would have been destroyed by Amazon within the decade no matter what. Gary Vanderchuck talked about how terribly poor the management was, and their failure to do any significant innovation or participate meaningfully in any of the trends around children's entertainment.
Bain, KKR, and Vornado borrowed money to "buy" the company then saddled the debt with the purchased company. So in a way, they did force them.
The shareholders and board members prior to the buyout made out like bandits, which is all they wanted.
Toys R Us couldn't keep up with the interest payments on loans from Bain and KKR. Not to mention "advisory fees" and whatever bullshit they charged Toys R Us with. That's what put them under. Not lagging sales. Not bad business. Being "bought" by sinister people.
Remember that every supplier and every employee of a business is also a creditor.
It’s not like suppliers of a chain this large aren’t big savvy corporations too.
I think this particular case there might be late payment but the business is going to remain in operation and they'll eventually get paid. Thomas Cook on the other hand incurred a lot of externalised costs.
I'm really not a fan of post-hoc "ah, people deserve to lose their money because they should have known (nonobvious XYZ)". There's even a surprising sentence in the BBC article:
> its auditors were happy to conclude the chain is a viable going concern when it signed off its accounts in April this year despite the company's debts being worth more than its assets
If the auditors (chartered regulated specialists!) think it's fine, who would say it wasn't?
> despite the company's debts being worth more than its assets
Doesn't mean much if you're just comparing Book Value...
What does scare me though as only the most successful locations are worth that much debt per restaurant. They better not have any locations that are not in the highest performing locations. Of course their returns can be difference from McDonald's. I don't have any insight into their business to know if it is reasonable for the or not, but it passes the smell test of could be reasonable.
LBOs create long-term value for society by disciplining managers (see Nabisco) and allocating capital more efficiently. Debtors are not forced to lend, shareholders are not forced to sell (unless the offer is so objectively great the company has a fiduciary duty to sell), so everyone is a consenting adult.
People who get fired go work for a different company eventually, and the pool of companies workers can work for only improves in a competitive society.
LBO's require buying a healthy cash-rich business, loading it up with debt, an then forcing repayment and management fees to the PE fund through cost cutting, dividend recaps, and other measures to transfer cash. Plus since the PE firm themselves puts in 1-2% of their own cash, they face little risk and huge upside for taking on large debts on their PortCo. LBO firms aren't responsible managers because they don't have the same capital stake that a real owner would have.
LBO's wouldn't exist if funds were responsible for the financial liabilities they place on their PortCos.
Most PE activity is about finding a cash-rich company with steady returns, having said firm take out large loans to service the debt, and using fees/dividend recaps to transfer company wealth to the PE fund. PE acquired companies have a much higher bankruptcy rate than the benchmark
You're simply arguing investors are dumb for throwing their money at PEs somewhat indiscriminately rather than only investing in high-quality PE funds with investments that do not go bankrupt as often.
Moreover, one could argue that the mere existence of LBOs forces managers to be more disciplined and act on behalf of their shareholders, which marginally reduces the challenge that agency costs pose on public corporations
The whole idea that shareholders are the only ones that matter is both recent and poisonous to the long-term health of the economy.
They are not the only ones who matter, just the ones who matter the most. My point was more about corporate kleptocracy and whimsical managers running wild. I did not claim shareholder value trumps everything else.
In fact, the agency costs of appointing managers to run a business affects not only shareholders but every other stakeholder.
But for the record, Unocal v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985) established that takeover offers ought to be evaluated in the context of all stakeholders – "shareholders, creditors, customers, employees, and the community"¹ – with Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986)² later modifying this test to put shareholder value above all other stakeholders in certain circumstances ("Revlon duties").
Whether that is "poisonous to the long-term health of the economy" is most certainly not a foregone conclusion and a bold claim to make, particularly given that we're currently in the longest period of prosperity³ and LBOs are everywhere to be found
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1. https://en.wikipedia.org/wiki/Unocal_Corp._v._Mesa_Petroleum...
2. https://en.wikipedia.org/wiki/Revlon,_Inc._v._MacAndrews_%26....
3. https://www.cnbc.com/2019/07/02/this-is-now-the-longest-us-e...
As an example, I've seen private equity save companies. One group acquired a company that was losing millions with a plan to return it to profitability and keep jobs....these kind of deals are never discussed in articles like this because all we hear about are the bankrupticies because they go through court...
Growth equity has seen some success, but the vast majority of PE activity is based around financially engineering a PortCo to transfer value from the PortCo to the fund, regardless of how it wrecks all other stakeholders or the long-term health of the PortCo.
It depends on the size of manager and I've seen GP commits range from 1% to 10%. The largest dollar commitment I've seen is in the ~$500m ballpark....either way what matters is whether the GP commit is meaningful in terms of their own net worth due to alignment of interest. Again this is not a black and white issue....some GPs do have skin in the game.
Most people do not understand debt including the author...at the moment, debt is so darn cheap, tax-effecient and covenant-lite that it's almost free money.... I would rather be on the equity side of the equation then be a lender....whether that would be a bank or high yield/junk bond investor.
I would argue that raising a PE fund is asymmetric for the manager since heads: I earn plenty of carried interest....tails: I get fat from the management fees and hold onto the portfolio companies for as long as I can (~10 years).
Which segment of the PE market are you refering to? What do you mean by financial engineering? I've spent a lot of my time in the US LMM and I see plenty of value creation/professionalization of small businesses. That said, I appreciate the fact that that kind of work is harder to do at the larger end...and it's more about the leverage, buying right with the right secular trends etc. Again not black and white....
For example on job creation:
"We find that the real-side effects of buyouts on target firms and their workers vary greatly by deal type and market conditions... This conclusion cast doubts on the efficacy of 'one-size-fits-all' policy prescriptions for private equity."
If I was to use an analogy with regards to the article, its as if someone tried describing the entire software industry to an outsider by only refering to Microsoft, Google and IBM...what about the rest of the industry?
[0] Pro Rata https://www.axios.com/newsletters/axios-pro-rata-ed716a8a-37...
"QE turned your savings account into your checking account, the bond market into your savings account, the equity market into the bond market, the VC market into the equity market, and crypto into the VC market.
Holding periods are also much longer for PE than VC, with some holding for 30+ years.
Is there a better way to handle (as a user) scaling content? Maybe custom CSS to change the font size that's remembered per domain?
It works that great I usually don't even try to read articles in their newspapers own layout.
There's probably a chrome/Safari equivalent.
View > Zoom > Zoom Text Only
and then zoom in/out as you desire.
The setting is unfortunately global, so you can't zoom in the page on some sites and zoom in the text on others. (You can toggle the setting, though, and the "zoom amount" is remembered per-site, irrespective of toggling.)
There are probably also some extensions that would be more flexible and work on more browsers. (I'm pretty sure that Vimperator (RIP) had an option to separately change text size and overall zoom.)
> the "zoom amount" is remembered per-site, irrespective of toggling.
I'm pretty sure it isn't with stock Firefox - I use an extension for that.