Hey y'all -
Wondering if anyone has seen studies/charts on how PE generates returns? Looking for something along these lines:
From 20xx to 20xx, PE returns have been driven by:
-X% multiple arbitrage
-X% operational improvements
-etc.
Thanks
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no one actually tracks their performance like that... they may analyze the multiple arbitrage impact, but certainly wouldn't report it
best option would be to aggregate fund performance, and assume a certain strategy for each one
I have seen these these studies before. You're referring to something that investors call a "value bridge" or "value creation step-chart." If you google around can probably find some more. Here's one from KPMG: https://assets.kpmg/content/dam/kpmg/pdf/2016/06/evaluating-private-equ…
Multiple expansion and lower borrowing costs /end thread
Firms love to overplay their “operational improvements” but full stop, if you bought almost any asset, a house, land, a company, a stock, and held it from 08 till now, you’d look like a genius due to the constant decrease of interest rates. Especially if you added leverage and the leverage you had, you could pay less with less strict borrowing terms each year.
Think about it on a income statement level—are they going to be able to massively grow the business more than the current owners could? Prob not, unless the current owners are terrible, unsophisticated, or the company is very immature (this is likely more common at lower mm shops, but more unlikely the more sophisticated the initial seller is) Are they going to be able to improve the margin? Depends the business, but likely margins are going to be constrained at some level to the product that’s being made/ whatever gross margin is it’s unlikely you can decrease your cogs that much more than the current cost of service/ goods sold of each product, so that’s more or less your ceiling give or take a little.
Most importantly, take an identical company 5 years ago and sell it, compared to today and it’s likely 2x or 3x the cost. Even if you made 0 improvements and were stagnant growth wise, you could potentially get a 25% compounded annual return. That’s why PE professionals think they are geniuses and why real estate clowns believe they somehow the next Albert Einstein.
I have seen the likes of AQR and Bridgewater construct these value bridges. Their conclusions are that a lot of PE returns can be explained by leverage and size (read: multiple arbitrage). The operational element is more than offset by fees. HFs benefit from this narrative as they can create a more leveraged, lower size listed portfolio for their clients.
My observation having been in the industry for some time, when the industry first began (which to be clear I wasn't around for) financial engineering probably did drive a lot of returns. But the reason PE companies have higher leverage than public markets is because they are governed tightly. Imagine a public market Board being across the numbers enough to be comfortable with 6x or more leverage.
PE owned companies do a lot of M&A through add-ons and most of that will come through on the value bridge as leverage and multiple arb. Building an acquisition engine in a PortCo that hasn't done M&A historically takes a lot of effort.
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