An Inconvenient Fact: Private Equity Returns & The Billionaire Factory


Abstract:

Private Equity (PE) funds have returned about the same as public equity indices since at least 2006. Large public pension funds have received a net Multiple of Money (MoM) that sits within a narrow 1.51 to 1.54 range. The big four PE firms have also delivered estimated net MoMs within a narrow 1.54 to 1.67 range. Three large datasets show average net MoMs across all PE funds at 1.55, 1.57 and 1.63. These net MoMs imply an 11% p.a. return, which matches relevant public equity indices; a result confirmed by PME calculations. Yet, the estimated total performance fee (Carry) collected by these PE funds is estimated to be $230 billion, most of which goes to a relatively small number of individuals. If all vintage years are included to 2015, Carry collected is $370 billion, with a performance similar to that of small cap indices, but higher than that of large cap stock indices. The number of PE multibillionaires rose from 3 in 2005 to 22 in 2020. Rebuttals from the big four and the main industry lobby body are provided and discussed.

https://papers.ssrn.com/sol3/papers.cfm?abstract_…

PDF link - https://poseidon01.ssrn.com/delivery.php?ID=33911…

Thoughts?

 
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To borrow a page out of Howard Marks memos, over a longer period of time all you need to know is how fast the manager deployed capital and how much total value did they return dollar wise vs. how many dollars you committed i.e. MOM and not trying to exclude/hide mgmt fees / search or fund fees / consultant fees / portfolio mgmt fees / subscription line costs and all that other crap.

It feels like every PE under the sun pitches 2x MOM net as their investment goal but the end up on average significantly underperforming which the data shows, and more concerning that the trendline over the last two decade shows that private equity returns have come down significantly...people like to point to "I work at the top quartile" this or that, but in reality, top quartile HFs vs. top quartile PE are probably pretty similar while the majority of us get doomed to being just average no matter in PE or HFs.

Even using the Calpers database which is pretty extensive, you can layout all their fund data and the summary stats paint the obvious picture (259 funds, of which 53 are ignored in the IRR/MOM)

https://i.imgur.com/UIhRQMB.png" alt="Summary Data for Calpers 259 Funds as of July 2, 2020" />

I work at a hedge fund that typically runs "unlevered" while many of my peers utilize strategies that will run a levered version of the main fund (i.e. Third Point Ultra vs. Third Point Offshore...Maverick Long Enhanced/Maverick Levered vs. Maverick Fund LDC etc.). It is almost entirely inaccurate to compare a levered HF to an unlevered HF...I think private equity suffers from much the same issues where they are inherently using leverage both at the GP level (sub lines) and at the investment level, and comparing such returns to an unlevered public equity or long-only HF is somewhat apples to oranges. That's what makes this comparison even more startling...what would be considered an underperforming, unlevered HF that annualized 6% over 7-yr period is spitting out MOMs in the 1.5x context as well.

Private equity is inherently advantaged due to its super long lockups and non-mark to market model which eliminates volatility not because it doesn't exist, but because the pension managers agree to participate in that racket. But to say that PE is hugely alpha-generative vs. the alternatives isn't as clear cut as some would like to think. HFs are getting their asses handed to them in terms of fee compression due to lack of alpha, that time will eventually come when no PE fund can differentiate their return profile.

 

To be fair pubcos do use leverage... your position maybe unlevered but the underlying is levered. They might be less levered than pe but is that reflective of the public market’s (potentially irrational) lower appetite for leverage? In which case increasing leverage is actually efficient (given tax shield). Additionally pe isn’t underperforming post fees which was actually the issue with active mutual funds and even hfs. But agree fees will come down over time

 

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