Private Equity And Hedge Funds Are Bad Investments

An Oxford-Said Business School study this week demonstrated that private equity returns have not been higher than public equity returns over the lengthy period since 2006. Similar studies have shown that hedge fund returns, theoretically not correlated to equity returns, have also grown increasingly inferior. Since both types of investment have created new billionaires from nowhere, we are forced to ask: what in heavens name do pension funds and other investors think they are doing investing in them?

The study: “An inconvenient Fact: Private Equity Returns and the Billionaire Factory” by Ludovic Phalippou, looks at a large dataset of private equity funds established between 2006 and 2015, and shows that their return was 11% per annum, equivalent to that of the Standard and Poor’s 500 Index over the period. However, the private equity funds during that period generated $230 billion in “carry” fees for their sponsors, making them far more expensive than any conventional equity investment. Furthermore, they were generally far more leveraged than ordinary public equity funds, so in an era when interest rates were low and generally declining, their return on equity was further artificially inflated by their cheap debt.

That information does not stop institutions investing in the sector. In an interview published several days after the Oxford-Said study, Ben Meng, chief executive of the gigantic California public pension fund Calpers, explained that he intended to meet Calpers’ aggressive return targets (necessary for the fund to be able to pay the bloated pensions promised to the California public sector) by buying private equity positions and leveraging them, thus adding a third layer of debt to those of the private equity funds themselves and the companies in which they invest.

This strategy has been tried before. The Goldman Sachs Trading Corporation, a $100 million fund formed in December 1928 to invest in other companies using Goldman Sachs insights, merged with the Financial and Securities Corporation, then launched the Shenandoah Corporation and the Blue Ridge Corporation, all of these entities being cheerfully leveraged and heavily invested in each other’s shares. By February 1929, aided by some stock purchases of itself (this being permissible before the SEC was formed and again after 1982) GSTC had turned $100 into $222.50. Alas, by 1932 it had turned that $222 into around $1. GSTC had the best names on its board, including John Foster Dulles, and was the subject of a famous witty book by J.K. Galbraith in 1954. Were Galbraith alive today, he would have fun with private equity – or would he? – as a well-connected liberal Democrat he would be good friends with most of its titans and would approve of today’s monetary policy, which is the principal cause of their wealth.

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(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of "sell" recommendations put ...

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Martin Hutchinson 1 year ago Author's comment

Hedge funds would be good investments in a time of tight money, such as we have not had for 20 plus years. Today the Fed spraying money about means there is more money than good deals.

John Doe 1 year ago Member's comment

Very interesting article. Do you think there are exceptions to your article? (A particular time where you would advise investing in a hedge fund.)

Wendell Brown 1 year ago Member's comment

I'd like to know this as well.