Let’s take an investment proposition whose model is to pay a significant premium to current market rates for acquisitions, throw in lots of leverage, charge enormous fees, and which allows the investment manager to value a company using basically any measure that they choose.  Are you as an investor ready to take the plunge and commit your savings?

Well what I have just described is Private Equity (PE), formerly known as the LBO business .1  Those that currently are invested in PE, as well as those who work in PE, point to the superior returns of this sub-asset class2 in the past.  Yet in aggregate, what have those returns really been?  Of equal importance, what do investors really think their returns will be going forward based on the dynamics I outlined in the first sentence?

My skepticism over historical returns in PE, is derived from a number of factors.  One of the most significant is that unlike the stock market and hedge funds, there is no easily definable and frequently cited index.  Equity markets have the most ubiquitous ones, such as the S&P 500 and Russell 2000, which are quoted daily in newspapers, radio, and TV, and can be brought up in real time on any financial website: Yahoo, Bloomberg, WSJ, etc.  Hedge funds also have easily obtainable indexes that are updated monthly soon after the funds report returns.  Here are two that are quickly googleable: HFRX and Barclay’s HFI.  While I would be the first to admit that these indexes are imperfect as they lump together a lot of completely different types of investment strategies under the vague moniker of “Hedge Funds”3, and may have many other imperfections4, at least third-party organizations have taken the time to painstakingly quantify a general number on a regular basis.  Furthermore, these indexes have increasingly been cited in the financial press, mainly to note how poorly hedge funds have been performing recently relative to other investments, and to question the large fees being paid out for this under-performance.  While PE supposedly also has third-party organizations compiling returns, just try and actually see them – it’s absolutely not going to happen on Google.  Worse, Continue reading

  1. Sure, I know that PE encompasses so much more than LBO’s these days, but whether a PE firm is buying a whole company in the public markets or a private company or a division of either public/private, it still usually entails a bidding process w/ the winner paying the highest price.  Leverage/fees/valuation methodology all still apply.  This goes for real estate, distressed situations, credit, and all the other assets lumped into PE []
  2. Alternative Investments is the usual moniker given to the full asset class, though really when you break it down PE is simply leveraged equity.  Furthermore, I fully concur with the sentiment that Alternatives are a compensation scheme, masquerading as an asset class []
  3. Where do I even start w/ this term: first off, some completely hedge, and some very transparently do not at all, and some do so to varying degrees.   Some use leverage, some do not, and then some use massive amounts.  About the only similarities that most hedge funds do share is that they charge much higher fees than conventional money managers, and are predominantly invested in publicly traded securities []
  4. are they weighted by AuM or not? Survivorship bias? []


It started with CALPERS, then a year and a half later came NYCERS, weeks after it was Buffett’s turn, climaxing 48 hours hence with Stevie Cohen (of all people!).1  As the crescendo of hedge fund bashing reaches it’s peak, I’ll seize the moment to make three observations that differ from everyone else who’s piling on the financial topic du jour.

Before I do, let me say that I’m in no way a cynic of the criticisms that are currently being leveled at hedge funds overall.  Extremely high fees combined with a very crowded arena have more than eliminated any possibility of taking advantage of inefficiencies.2  Nevertheless, this was also the case 3, 6, and even 9 years ago3  to anyone immersed in Wall Street who made an objective back-of-the-envelope analysis (Warren Buffett wasn’t the only one).  Yet institutional investors, who’s objectivity may very well have been hindered by the extreme shortfalls in their projected pension funding, continued to pile into “alternatives” from what in many cases was a very small or non-existent base.

With that as a background, my first thought in reading the excoriating hedge fund headlines and quotes, is that after the effects of this verbiage leads to the inevitable exodus from hedge funds – in about 6-9 months4markets themselves will have reached a crescendo, and fall.  Wait, make that crash!  Of course they will, this always happens immediately following the removal of all hedges, doesn’t it?  In all seriousness, equity markets are currently at all-time highs, and bond yields are anemic.  As monies get taken out of hedge funds and redeployed into long-only markets, pension fund investors will inevitably have zigged, when they should have zagged.  They always seem to feel the need to “put-it-to-work”, and can’t -or don’t have the luxury to just let it lay fallow like Warren.

Of course they can, and probably will, reallocate some of this money into Private Equity (PE), in the hopes of garnering expected returns not tethered too closely to zero.  Thus my second thought in reading the hedge fund bashing headlines is “Isn’t Private Equity also due for similar scrutiny?”  So far investment in it has completely escaped opprobrium and continues to see big inflows.  In fact, just today – in the midst of all this HF bashing, comes an article saying the PE firms are regaining the upper hand on institutional investors.  Taking fees to all time highs and “eliminating terms from their current funds that are designed to protect limited partners, such as preferred returns, also called hurdle rates, and clawbacks.”

Personally, I think the lack of criticism towards PE has to do with the difficulty attaining real annual performance numbers5 and zero accounting for volatility; the lack of a suitable, or any, benchmark; and the opacity of their fees.  I have a lot more skepticism about investing in PE in the 21st century, but lack the time to script all my thoughts at this moment6, and don’t want to get too off topic.  Underlying this skepticism is many of the same critiques leveled at hedge funds, including crowding – whether one calls them trades or acquisitions, and Warren’s lament about “Wall Street salesmanship” trumping performance.

Finally, the third and most important thought I have in reading the latest financial brouhaha, is that both institutional managers and Warren Buffett are ignoring the biggest curse facing investors today: Continue reading

  1. This hf manager rarely, if ever, talks about the markets or to the press/public directly, and most news about him focuses on his art collection, home sales, personal wealth, and travails w/ the SEC.  Though long before he was famous, he did go on the Dating Game! []
  2. Ironically, Steve Cohen’s comments this week lamented the lack of talent in the hf industry today.  Personally I think it’s the exact opposite.  Largely due to his and others tremendous growth and financial success managing hedge funds, they have spawned a whole slew of Stevie Cohens.  Thus it’s a v crowded market and there is way too much brain power analyzing securities in 2016 []
  3. Huge tip of the hat to Buffett, who not only saw this but put money and his reputation on it in his $1 million bet w/ Ted Seides of Protege Partners []
  4. institutional investors are slow to act []
  5. instead of mark to market like in the hf world, it’s mark to whatever the PE manager thinks a company’s value is []
  6. though I will someday soon, so stay tuned []