Private Equity: Chasing Returns Will Lead To Disappointment

by: Golden Goose

Summary

Institutional investors have been aggressively adding dollars into private equity.

The bull market over the past 7 years has given investors a false sense of security in the asset class.

Roger Lowenstein's article "Private Equity's Paper Tigers" in the December 15th edition of Fortune is a must read for people considering adding to the asset class.

Over the past year many institutional investors have cut back their hedge fund exposure as recent hedge fund returns have disappointed. Where is the money being allocated? It seems the answer every time is: "private equity". Investors seem to love PE. Why? "Look at these returns" is the reason I constantly hear.

What I don't hear talked about: In a 7 year bull market, have private equity funds created value? Are their returns providing investors an illiquidity premium over liquid equity exposure that you can get from Vanguard? What are the risks? Can this performance continue?

It seems to me that private equity allocators at this point are blindly chasing performance.

I loved Roger Lowenstein's article in the December 15th edition of Fortune entitled "Private Equity Paper Tigers". I highly recommend the complete article. Some of the key take-aways I will list here:

- The industry was once denoted as "leveraged buyouts", which is a more accurate description.

- Private Equity performance in 2006-2010 vintages tracked through mid-2014, has been running on par with the S&P.

- US Buyout funds underperformed a public market equivalent over one and three years, and merely matched it over five. The chart below is from the article:

- As of 2014, PE funds manage $2.6 trillion and are sitting on another $1.2 trillion in commitments

- Capital commitments to PE funds has lately been at its highest level ever relative to stock market capitalization, save for the pre-crash year 2007

- LBO prices in 2015 were almost six times cash flow, close to the peak reached in 2007

I loved the article because it talks about what no one seems to be talking about: Do PE funds create value and do they compensate you for the risks you are taking and paying 2 & 20 for?

In my view, PE investors are blindly chasing performance and will be disappointed. PE investor beware and please read the full article @ fortune.com/private-equity-investors-eff...

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.