thomast2

Private Equity Returns: You May Do Better With Treasuries

Thank you very much for your comments, I agree with most of your points.

Besides energy stocks, I also feel that precious metals and mining companies will also provide hedge against inflation, probably even better hedge and less overvalued than energy stocks. The upside of this sector is far superior to energy stocks, IMHO. Also I think the consolidation of the mining majors acquiring minors has a long way to go to reach its pinnacle, while the oil sector has been.

Private Equity's Boom Now Busting?

Thank you so much for your comments, Fang Hsieh. It is a very thoughtful and objective one.

I agree that the risk is more spread now than 80s, this is probably the reason that we see a good and extended equity bull market in both developed and emerging markets for so long without a decent correction, because they are helping and shoring up each other. But at the same time they are also contagious, one bad market could bring down others, as in 1998 the default of Russian bonds brought a huge crisis to Wall Street with the failure of LTCM due to its huge leverage.

Capital market is also a speculative market. It all depends on people's perception on future economic situation. I agree for short term turnover of buying and selling companies, borrowing cost is not the key due to its short time frame, but timing is. You need the timing for leverage or ability to sell those loans to fund your purchase thus institutions are willing to buy those bonds from you. Then you need subsequent timing to do IPO when equity market is still intact thus individuals are willing to own and hold stocks so PE firms can sell and cash out.

Another problem I have is leverage. With leverage, the return is larged explained by the leverage factor. Just use your example above, without leverage, the talent PE managers will only have 25% return (the real alpha). So leverage explains 50% of the return without brining the talents into the picture. Then if the deal takes longer, say 5 years instead of 2 years, the borrowing cost will become a factor. Then don't forget each year PE firms are charging 2% on the asset, 5 year is 10% on $2B. After successful IPO with $1B net profit, don't forget again PE firms will take 20% cut on $1B. After all these, what do you think the real return for PE clients?

I think it is probably around zero or merely $0.1B ($1B profit - $0.2B fee - $0.2B PE profit cut - $2B*5%*5yr interest), thus at best 5% in 5 years. Would you think 5% US treasury per year is a better return (if you don't factor in the fall of US$)?