Reply With Quote
Private equity is conducting a reverse bailout from public pension funds and university endowments to millionaires and billionaires.
CalPERS and other public pension funds cling so doggedly to private equity despite ever-increasing evidence that the strategy doesn’t beat simple stock investing, when it needs to do a lot better than that to compensate for its much higher risk that one has to wonder why. As a wag in the Financial Times comment section put it:
There a strange but widely held assumption here that PE is operated to enrich people other than the general partners.Another nail in the private equity hype coffin comes via a new study by CEM Benchmarking, Benchmarking the Performance of Private Equity Portfolios of the World’s Largest Ins utional Investors in The Journal of investing. The article is paywalled but Chris Flood provided a detailed write-up in the Financial Times and supplied more detail about the article in the comments section.
https://www.ft.com/content/0640d664-083e-4439-8fe4-faa06eee6e17#comments-anchorCheap tracker funds trounce private equity
Nevertheless, this salvo by CEM will be hard for limited partners to shrug off. CEM took a simple small cap index and lagged it from three to five months as a basis of comparison.1 CEM then compared that performance to the results achieved by 330 private equity limited partners, including any co-investments, from 1996 to 2018.
The choice of time frame is damning. More and more studies have found poor performance of private equity for the last ten years or so, starting with just before or just after the financial crisis, when investors started reaching for yield. Private equity as a share of global equity more than doubled from 2004 to 2013, for instance.
Thus one explanation for private equity’s flagging performance is too much money chasing too few deals. And that hasn’t gotten any better with pension funds like CalPERS trying to throw even more dollars at private equity, much like a rat desperately hitting the lever of a machine that once dispensed treats but is now empty.
The CEM study demonstrates that private equity underperformance is far more fundamental. 1996 was during the glory years of 1995 to 1999, when private equity was coming out of a period of disfavor and was trying to distance itself from its earlier “leveraged buyout” branding, which produced a lot of terrible end of cycle deals in the late 1980s that blew up in the 1990-1991 recession. The industry story line has been that if you participated in those “vintage years,” you reaped outsized results. CEM has demonstrated you would have done even better in a simple stock index, a full 67 basis points, which over the long investing horizon of pension funds and life insurers, adds up.Keep in mind that there are “public market replication of private equity” strategies that have been modeled, of buying the kind of public companies that private equity firms like, and selling/rebalancing quarterly using pre-set rules. That has produced even better results than a simple small cap index; it would be useful if someone could update those models and see if the outperformance continues to hold.
Doing deals in house is an even better strategy. CEM found those investors beat private equity funds by 1.44% per annum over this timeframe.
From the Financial Times:
Cheap index tracking funds beat the returns of private equity investments over the past two decades, according to a survey of pension schemes…
CEM chose a mix of small-cap indices as a test of skill for private equity managers because it provided a robust benchmark that could be recreated easily by investors.
Alex Beath, a senior analyst at CEM, said the mix of small-cap indices had comparable risk and was highly correlated, but was “hard to beat” for private equity funds.
He added private equity presented a “double edged sword” as a pension fund might earn a 20 per cent outperformance over a public market from a top performing PE portfolio or a 20 per cent loss if its bets soured.a recent study slammed public pension funds’ investments in private equity and real estate as drags on performance. From a July post:
We are embedding an important new study by Richard Ennis, in the authoritative Journal of Portfolio Management,1 on the performance of 46 public pension funds, including CalPERS, as well as of educational endowments.
Ennis’ conclusions are damning. Both the pension funds and the endowments generated negative alpha, meaning their investment programs destroyed value compared to purely passive investing.
Educational endowments did even worse than public pension funds due to their higher commitment level to “alternative” investments like private equity and real estate. Ennis explains that these types of investments merely resulted in “overdiversification.” Since 2009, they have become so highly correlated with stock and bond markets that they have not added value to investment portfolios. From the article:
Alternative investments ceased to be diversifiers in the 2000s and have become a significant drag on ins utional fund performance. Public pension funds underperformed passive investment by 1.0% a year over a recent decade.<.blockquote>
https://www.nakedcapitalism.com/2020...eat-funds.htmlEven as evidence keeps growing that private equity is a poor choice on a risk adjusted and even an absolute basis, investors keep sticking their heads in the sand. As the pink paper concludes:
A survey by the data provider [Preqin] also found investors expected pension plans and other large investors to further increase PE allocations…So the transfers from taxpayers to billionaires are set to increase.
It showed 23 per cent of respondents expected a significant increase in their PE allocations with a further 56 per cent planning a slight expansion. Just 4 per cent of the investors planned to reduce their PE allocation.
