Sunday, August 12, 2018

"...Since 2006, Private Equity Has Produced Only S&P 500 Returns While Reaping $400+ Billion in Fees"

The discussion of hydraulic models of the economy in this morning's "If The FT's Izabella Kaminska Doesn't Start Posting To Alphaville...." reminded me of William Banzai's take on the Phillips model but with bonus receptacles and fee siphons:


Genius squared.from a post on GE's Mark I nuclear reactor at ZeroHedge!

which in turn reminded me of a story from Naked Capitalism that was in the queue:

August 7, 2018
Oxford Professor Phalippou: Since 2006, Private Equity Has Produced Only S&P 500 Returns While Reaping $400+ Billion in Fees
The premise that private equity delivers returns better than that of public stocks has fallen apart as more and more money has chased a not-comparably-expanding universe of deals. Private equity as a share of the global equity markets has more than doubled since the early 2000s. Despite private equity funds having record levels of “dry powder,” meaning committed but unspent cash, more and more investors are throwing money at the strategy out of desperation to achieve higher returns.

We’ve also pointed out that fiduciaries like CalPERS have continued to be fanatically loyal to private equity even when its own metrics have said private equity isn’t earning enough in the way of returns over the last ten years to justify its extra risks.

Recent work by Oxford professor Ludovic Phalippou, one on the few academics not beholden to the private equity, paints an even grimmer picture of how the private equity industry has performed since 2006. As described in the Financial Times, Phalippou ascertained, using what he describes as conservative (meaning private equity industry favoring) assumptions, that the private equity industry only matched the S&P 500 benchmark. This is particularly damning, since as we have described repeatedly in past posts, the use of the S&P 500 is flattering to private equity by virtue of its average company size being much larger than typical private equity portfolio company sizes, hence you’d expect a higher growth rate. And for newbies, do not forget that the rule of thumb is that private equity should outperform the relevant public equity benchmark by 300 basis points (3%).
From the Financial Times:
US private equity managers have extracted $400bn in fees and expenses from investors since 2006 but on average they failed to beat the returns from an S&P 500 tracker fund, according to a new analysis.
The findings are an analysis by Oxford Saïd Business School based on the Burgiss database…
Ludovic Phalippou, a Saïd finance professor, said the funds launched in those 10 years have, on average, performed in line with the S&P 500, the main US equity benchmark. This delivered annualised returns, including dividends, of 8.6 per cent between January 2006 and the end of March 2018.
Nine out of 10 of these private equity funds also beat the 8 per cent annual return “hurdle” that allows their managers to claim performance fees, which amounted to an estimated $200bn.
A further $200bn was paid in management and other expenses, but there was less certainty over this data. The estimate could be conservative…
In fact, if you read Phalippou’s blog post, which gives a more detailed description of his analysis, he did indeed bend over backwards to be fair, and arguably more than fair to private equity managers. However, part of being “fair” meant using PME, which means “public market equivalent,” which is widely acknowledged to be the most accurate way to compare private equity returns to public market returns. It’s no accident that the private equity industry on a widespread basis instead uses IRR, or “internal rate of return” which is flattering. From his site:
Burgiss is perceived as one of the most comprehensive and accurate database of private equity fund cash flows….

Fact and matter is that for many years, people kept on saying that PE funds outperformed the S&P 500 by 3-4% p.a. and that was great (see a related blog). Over the last 10-12 years the S&P 500 has been doing well and now people tend to use other indices as benchmarks (e.g. MSCI world); this still has little to do with the type of companies helped by PE funds but MSCI world has the advantage of having low returns over the last decade.

To keep it simple and focused, let’s keep it to the tradition and compute PMEs with the S&P 500....