My second year as a Private Equity Associate in Large-Cap Private Equity - A Long Thread

We talk about PE all the time, but how does it look like from the inside? Today, I will cover the following topics:

1)Where I was right last year

2)Where I was wrong last year

3)Why Private Equity is such a good model

4)Key Trends I am seeing (Retail, Returns, AI)

5)Is the grind in PE still worth it?

6)Figuring things out, what I am doing next

The beautiful thing about being anonymous is that I can be 100% honest. Be aware, this is as real as it gets!

Let’s get into it ⬇️ ⬇️ ⬇️

1)Where I was right

What I love about writing and posting content online is that I get to crystallize my thoughts. Last year, after my first year in large-cap PE, I wrote down many thoughts which I encourage you to read before diving into this new writeup (I have not repeated myself, and this post serves as a follow-on, building on what we discussed last year).

Looking back, I was at times naive, but my opinion is largely unchanged on a variety of topics, including:

i) PE is just such a good model

Last year, I wrote: “Sometimes, the private equity model seems too good to be true. Where else can you find a model where: (a) you can screw up for years and investors cannot leave you (as capital is locked up), and (b) you mark your own portfolio companies until you sell them whenever you want them?

Everyone always talks about the illiquidity premium, but I think that the positives of illiquidity are often overlooked. There is a certain comfort of looking at a 20% market pull-back knowing that (a) you are not going to charge the multiple of your portco (because private market multiples are more stable - big surprise lol), and (b) every public target just got 20% cheaper.”

Early this year, markets crashed 20%+ and this felt so true. No one was particularly scared, our marks stayed really flat (lol), and it was much easier to make the math work on many public names. While I never experienced a long recession in private markets, no one can argue that this lock-up structure is extremely advantageous and also prevents GPs from panic-selling.

ii)The hard part is getting in

From the outside, large-cap Private Equity can seem intimidating. Everyone has an MBA from HBS/GSB, went to a top undergrad and top-tier banking program, etc. etc. - the cream of the crop

My view is that large-cap PE really attracts above-average smart, insecure, and money-driven individuals.

Maybe this is a bit harsh, but I just really want to share that the average IQ is not 160. These are (mostly!) a bunch of people who generally like investing, really want to get rich, and are not willing to take a risk (there are many fantastic individuals I work with who I consider brilliant, but these are the exception, not the norm).

What should you do with this piece of information?

Firstly, you should not be intimidated by someone just because they are a Principal at a Mega-Fund, it is really just a job.

Second, you should not despair if for some reason, you don’t get one of these firms. There is a large number of variables you cannot control when the recruiting process is so selective, so just don’t sweat it, this is not the best job in the world.

Finally, if you get a job and want to spend your career there, this can be done. I often hear complaints that all these Large-Cap PE programs are two-and-out. My view is that if you are actually smart and really want to get a promotion, there is room. It is up to you to get it (and decide this earlier than later).

iii)You are not an investor

I love when people update their LinkedIn profile to “Investor at [Insert Mega-Fund]” because it is just so cringe when you look at what the job actually looks like.

If you define investing as doing models to backsolve to a 20% IRR, make twenty-page, nicely formatted decks, and help a deal get through and manage advisors, then yes, you can call yourself an investor. But if you think about investing in a more classic way, I am sorry to break it to you, but you will not be one until you are much more senior.

This creates a lot of friction at the junior level because people get frustrated that they are still Excel monkeys and no one wants to ask you what you think about the business.

In PE, the Investment Committee makes a decision, and the Partner makes a recommendation; you are just there to help him pitch the company. Just something to understand before having your dreams crushed.

2)Where I was wrong

At the same time, I realized how some of the things I said could be corrected or at least better explained. In particular, I would like to spend some time on:

i)Fake work is not that fake after all: last year, I was particularly frustrated with the large amount of work done on deals that everyone knows are never getting done. While these suck, I was particularly shortsighted in not understanding that the work is not wasted at all.

Sure, maybe doing 15 slides to tell everyone why you are killing a deal is a bit too much, but I came to appreciate the work done to understand a business (and more broadly, an industry) even if we all knew the company was not actionable. In a few months, you might have the opportunity to invest in a very similar business, and you will then be extremely grateful that you spent a few weeks understanding the space. Very often, banker auctions are extremely rushed, and having three weeks of industry work can be a massive advantage during the process.

ii)Most people in MF are good investors, they are just afraid to speak up: if you asked me last year what I thought about my Principal / Vice-President, I would have told you he/she is a mediocre investor who is incapable of independent thinking. This is because, from my perspective, this person is the Partner’s puppy who will just push the process forward without really expressing any interesting or relevant investing insights (maybe not zero, but a lot less than what you would expect from a 30+ year old investor at a Mega-Fund).

Over this year, I realized this view should be slightly modified. These people are above-average investors, but they never get to share their views because that’s not their job and they NEVER want to annoy the Partner. So, even if they disagree, there is no point in speaking up, the risk/reward is not really there. If you are confused why, you should understand that at Mega-Funds, a Partner can like a deal, but Investment Committee can still say “No” (unless the Partner wants to put his career on the line, but most of the time this does not happen). Therefore, why should a Principal bother to push back to show his investing acumen? This will not happen, and his job remains to tell the Associate how to tweak my model to show what the Partner wants to see.

Note: while I changed my mind and now see most of my colleagues under a positive light, I still believe that there are many very mediocre professionals that are terrible investors and just good at playing the politics game. Hard to distinguish these where there is so much room to hide and you don’t call the shots until you are a Partner.

3)Why Private Equity is here to stay

The overall sentiment about Private Equity is generally very bearish online. People often call out things like: lot of capital flowing in, higher interest environment, maturing firms, etc.

While this is all very true, I think people often overlook how great the PE business model is and how there is no alternative structure that can compete with it.

People can hate the private equity model all day long, but what I really came to appreciate this past year is the alignment of interest and upside for management teams that buyouts can generate if things go right.

Let’s see a simple example.

PE Fund buying Company ABC for $1Bn with $500mm of Equity.

Management gets 20% of profits above 20% IRR

Deal goes well and returns 3x MOIC or $1.5Bn of equity, resulting in $1,000mm of profits.

Management gets to keep $200mm ($1,000mm*20%)

CEO usually keeps ~30% of the pie or $60mm for ~4 years, that’s ~$15mm/yr (and that is excluding any equity appreciation that management would roll in the deal). I was very surprised how so many leaders at portcos get 100bps of promote, which results in life-changing money for so many of the employees.

If you compare this figure with a company under a non-PE ownership, you can easily see why management (and leadership teams in general) will always like the PE route.

4)Key Trends I am seeing

So many things to talk about, but if I have to pick the top three things, I would mention the following:

i)Focus on retail capital: the hype is real, I have seen a massive shift in attention towards retail capital and working on creating retail dedicated vehicles over the last two years. When I started, I honestly never heard about this topic. Today, it is frequently discussed.

PE firms have realized the huge opportunity of this pocket of capital and are spending time creating vehicles that appeal to these buyers. In particular, it is worth calling out that these vehicles target lower IRRs, which is perfect considering where the industry is going (see subsequent point). It will be interesting to see if these funds are the group of funds that is left holding the bag, but I think these vehicles are still attractive today, considering how expensive public markets are.

ii)Return compression: when I started working in PE, I thought most deals were underwritten at a ~25% IRR. Then, I quickly learned that ~20% is more realistic. Now, I am really not that surprised if we underwrite ~17% returns. This is generally a function of generally less leverage (you will rarely see 65%+), higher cost of debt, and higher multiple paid upfront.

While a 17% IRR might not seem horrible, it is not pretty.

Let’s not forget that if all portcos get a 17% IRR, the entire fund will likely get a ~12% net IRR, which is not that impressive when you consider the capital is completely locked up.

iii)AI Interest: this is the first year where the AI hype is starting to show up in my workflow. My PE firm is trying many tools, and I am actually start to see some increase in efficiency in my work process. This is very exciting. I can now ask a tool a question, and it can go through a very large data room in seconds, and I get a very helpful first cut, this is massive. I can put in five legal documents and ask it to create a detailed summary highlighting whatever I ask.

Do I trust these tools blindly? Not at all. I still check very carefully every source, but having a first draft is a massive help when needing to process large amount of work.

We have already started to see Investment Banks that rely very heavily on AI, will we start to see Private Equity firms that do the same? I think so.

There is a massive level of inefficiency in private equity firms, and having AI to go through data rooms and create simple models could create a new firm structure where the layer of junior talent can be massively slimmed down.

5)Is the grind in Private Equity still worth it?

Bit of a provoking question, because I clearly do not have the answer 🙂

For me, it was not (more on this in the next section), but for many, it will be.

I still think that no other career path provides such high downside protection that will see you become a deca-millionaire as long as you keep advancing (and your fund does well).

Getting promoted is definitely getting harder, but do not think that just because someone is a Principal at a Mega-Fund they are the next Henry Kravis. These people are just as smart as someone at a smaller fund, they just played their cards right when it mattered most (and at times got lucky, I definitely got lucky to get where I am) so if you want to outwork them, everyone has a shot.

The real question is whether you are willing to dedicate two decades of your life (25 to 45) to your job. People who get promoted and become Partners at Mega-Funds sacrifice their lives to it. Be very aware of that before being jealous of their third house in The Hamptons.

This is not to say that everyone in PE sacrifices their life to become a Partner. If you want to raise your own fund and swing big, best of luck. But if you want to guarantee financial success and become a Partner at a Mega-Fund, know what you are getting yourself into.

6)What I am doing next (and why)

If you thought PE was not my dream career after reading last year’s and this year’s writeups, you are in fact, correct.

You are also correct if you think I am not ready to quit investing to go full-time on the Pari Passu Newsletter.

If you think I actually really enjoy finance and investing and that’s what I want to do all day, you are also correct, and that’s why I joined / will join a hedge fund

The reason behind this move is easy to explain: I want to spend every second I spend working on actual investing work, not on whatever process you need to get a deal done in PE. I want to be evaluated based on my results, not based on the subjective review of my leaders and peers.

I am very glad I did PE, I understood how a business works to a depth that I did not achieve while in banking, I learned to interact with management teams, and came to appreciate the amazing aspects of this asset class, but after two years, I learned what I need and it is time to make the jump.

Will this choice maximize my expected earnings over my career? Definitely not.

Will this choice make me excited to go to work? Yes! So is there really anything else to discuss?

Thank you for reading, I would love to hear your thoughts if you made all the way to the end.

I will see you in 12 months with my “My first year as a Hedge Fund Analyst at a Single Manager - A Long Thread”

Follow along for the ride.