Quelle Surprise! It’s Better to Run a Private Equity Fund than Invest in One

It’s perverse that it takes a Mitt Romney presidential bid to shed some long-overdue harsh light on the private equity industry.

It was not as hard as you might think to do well in the private equity business in the 1990s. Rising equity markets lift all boats, and PE is levered equity. A better test of the ability to deliver value is how they did in more difficult times.

The Financial Times reports on a wee study it commissioned to look into who reaped the fruits of private equity performance. Its findings:

From 2001 to 2010, US pension plans on average made 4.5 per cent a year, after fees, from their investments in private equity. In that period, the pension funds paid an average 4 per cent of invested capital each year in management fees. On top of those, private equity often collects a variety of other fees and a fifth of investment profits
“Assuming a normal 20 per cent performance fee, this would amount to about 70 per cent of gross investment performance being paid in fees over the past 10 years,” said Professor Martijn Cremers of Yale.

Now some readers might argue that even with fund managers feeding at the trough, 4.5% per annum returns were still better than the S&P 500, which delivered 1.7% compounded annual returns over the decade. But they are missing several things. First is that the S&P is extremely liquid and tolerates trades in size. By contrast, when you hand your money over to a PE fund, it is an expected 5 to 7 year commitment, and if the fund does badly, they will hold on to your money longer hoping a rally will allow them to unload some garbage barges at a decent price. I have no idea what rules of thumb are used to adjust returns to allow for extreme illiquidity and a lack of any control over exit timing, but in the stone ages when Goldman would value illiquid securities for estate purposes (a task that fell to junior investment bankers), we’d apply a 20% to 40% haircut.

A lot of investors, notably university endowments, took big hits when they put too much in private equity and found they were stuck in the crisis during 2007 to 2009. Some actually tried selling PE stakes in a pretty much non-existant secondary market and took huge haircuts. In addition, there were widespread complaints of the PE funds publishing phony valuations of their portfolios during that period. Bigger swings in value mean more risk, which mean worse Sharpe ratio, which is one of the benchmarks used by the pension fund soothsayers consultants.

So where are the customers’ yachts? The release of Mitt Romney’s tax returns, which show $21.7 million of income in 2010 and $20.9 million for 2011, demonstrate he could buy a fleet of yachts. Wonder how often he takes his clients for a ride, in both senses of the word.

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  1. ScottS

    Love the stats at Bloomberg!

    13.9% tax in 2010! Less than capital gains!

    And this lovely nugget:

    Romney’s income puts him near the very top of U.S. taxpayers. In 2008, according to the IRS, the median adjusted gross income was $33,048, which Romney made in less than a day. Reaching the top 1 percent of taxpayers required $380,354 in adjusted gross income, about Romney’s earnings in a week.


  2. MyLessThanPrimeBeef

    I don’t know about you, but my amygdala is starting to work over time after reading this, just when I need to go to bed.

  3. Lafayette

    Good post, YS.

    It’s about time Americans woke up to the fact that adulating the riches made by VCs, actors and sports-people is not all-goodness.

    Hallucinatory earnings on the part of these super-rich, many of whom have had great good-luck in winning a lottery or becoming a “star” or a “personality” – just because they have accumulated riches – is a plague upon our nation.

    Our culture therefore devolves to one unique attribute: “How much are you worth?” Which becomes the sole yardstick in our ragbag of cultural values. And, of course, we think that Venture Capitalists are the motors of our Schumpeterian process of Creative Destruction – by which we destroy the old in order to build the new. With an eye on the bottom line, of course.

    Is money “everything”? Yes, in this materialistic world of ours it does become superbly important. Particularly to the downtrodden poorer class who see great-riches as the ONLY light at the end of the tunnel. And leads many to take short-cuts to get there.

    Money, however, can’t buy you egalitarianism. (That’s supposed to be a pun on words. ;^) The key challenge in America is its exceedingly high level of Income Disparity.

    Why? Because such disparity is intrinsically unfair and immoral in a country that has the means to generate so much wealth.

    So, what has become our sense of morality, if we continue to think that only the wealthy can lead us into the paradise of Unlimited Riches? I will remind you that most, if not all, of the Replicant candidates are members of the One Percent Crowd. They are the Plutocrat Class that gamed the Free Market System with only one objective – to enrich themselves. (And, frankly, most did not even earn that money, but simply inherited it. But they sill still fund elections in order to maintain the status quo.)

    And the rest of humanity be damned … they could care less. We are just road-kill on the High-way of Life. Some may even think is is God’s will …

    If I keep harping about Social Justice of the European type, it’s because I live here and have seen the good it can do to enhance the well-being of a people. Yes, it is sad to say, but I think Europeans live far better lives than Americans nowadays.

    Due basically to the fact that exaggeratedly high incomes in Europe are taxed to be spent on two key Public Services:
    * a World Class National Health-care System that is universal, and
    * the right to an Education nearly cost-free that will give individuals the skills/competencies necessary to earn a decent living for themselves and their families.

    Are we, the sheeple, asking too much for those two societal attributes? Then why can’t we have them?

    1. vlade

      If you, by saying “National Health-care System” mean UK ones, I have to disappoint you – it’s not “World Class”. In fact, it’s worse than in some developing countries (if nothing else, the consistency of care is a cr*pshot).

      To you previous comments – humans seek status. Mone is the easiest way to get status, thus will be the preferred way for a large number of people.

      I’m sure that when Romney wakes up, he’s still dumbfounded that he’s not worth what Buffet/Gates is (or even some hedgies), so he sees his 20m as a pittance. Not because it would be, but because humans are relativists, and compare to the closest ones (in status, which now often translates to income).

      IIRC it was actually Bill Gates (whose status is pretty secure, so he cares less atm) who said that 1M (still a nifty sum) is enough for anyone to have a very comfortable life – any money above that is “just” keeping score (I’d say building status instead).

      1. oliverks

        I think we need to form some rules on this blog about debating health care systems, because frankly all this squabbling is getting us nowhere. I would propose the following metrics get used:

        1) The number of years of living healthily
        2) The cost to achieve item 1
        3) Metrics should come from a well established international source (such as OECD).

        For folks not accustomed to metric 1, here is a quickie overview. There is much more data in medical journals of course.


        1. Unsympathetic

          Note to the anti-health-care trolls: It must really suck when data doesn’t agree with the view you insist must be true.

          1) Obamacare decreases costs. Deal with it.
          2) TriCare, the system for veterans, is a completely socialist health care system within the US. And it works. Deal with it.
          3) Healthcare in the UK is better now than it was 5 and 10 years ago. Deal with it.

          One reason US healthcare is so expensive is that there’s a hospital on seemingly every other street – thus, access to care is not an issue. But the question we have NOT asked as a nation is: Precisely how much money are we, in fact, prepared to pay for having far-and-away the best access to care the world has ever seen?

          UK healthcare isn’t expensive when compared to the US or the rest of Europe, so I’m not sure how to specify the issue the previous commenter had – rather than to observe that clearly he was dissatisfied with something.

          It should not be surprising that HCA, the hospital system run by “private equity” for the purpose of extracting rents, is significantly in the red – to the tune of the dollars extracted by KKR and Bain.. aka, Romney.

          Note that there is an amusing side story to Romney’s health care tales as governor: He makes profits from his share of the IPO of HCA, which Bain once owned. Where do those profits come from? Taxpayers.

          1. JamesW

            Unsympathetic, you make a skewed and incorrect point, but then inadvertently strike a home run with another point!

            Your comment:

            “It should not be surprising that HCA, the hospital system run by “private equity” for the purpose of extracting rents, is significantly in the red…”

            is in the right and brilliant direction.

            The two premier cost drivers over the past 12 years or more in American healthcare have been hedge fund speculation across the entire healthcare spector, and private equity leveraged buyouts across the entire healthcare sector.

            During 2007, there were an estimated 90 dedicated healthcare hedge funds (and more general hedge funds which speculated also) and the top ten banks made structured finance loans (between 2005 to 2007) to private equity firms to the tune of $680 billion — thatsa lotta leverage!

            Too many ignore all the peripheral firms which make up the healthcare sector — healthcare IT firms, diagnostic equipment and medical equipment firms, etc., etc., etc. — not simply private clinics, private hospitals and medical services firms.

            So many of these have been overloaded with debt during those PE leveraged buyouts, which drastically increased their pricing structure.

            Much hedge fund directed speculation in stocks pertaining to the healthcare sector, the pharmaceutical industry and health insurance industry, likewise drove up their pricing structure.

            Clearly, you understand what’s taking place intuitively, but are missing the proverbial forest for the tress (routinely cited costs, etc.).

            If it was just those equipment costs, then when the Japanese pay only $90 for a routine MRI — because digital electronics and equipment costs have been traditionally falling, then the typical MRI cost in America shouldn’t be $1500 ! ! !

      2. liberal

        If you, by saying “National Health-care System” mean UK ones, I have to disappoint you – it’s not “World Class”. In fact, it’s worse than in some developing countries (if nothing else, the consistency of care is a cr*pshot).

        Please supply nation-level aggregating data on health outcome measures in support of this strong claim.

      3. Lafayette

        I am basing this remark on comparative studies made by the WHO, which can be found extracted in concise form here.

        The UK is amongst the top 30 in a survey of over 190 countries. And one will find a great many European countries also at the top of the list.

        Yes, the study results were highly contested in the US, which sparked the debate about the nature of American healtcare system – which is unique in that it is privatized, whereas elsewhere it is nationalized?

        And it is well worth considering why it has been nationalized. HealthCare in most advanced nations is a matter of very sizable Demand running after a constrained Supply of HC professionals and technology. This results in an oligopolistic situation whereby Supply-siders (the HC-providers and insurance companies) set the prices.

        Which is one significant reason for which American HC total costs (including pharmaceuticals) cost as much as three-times that of, say, France.

        Note also that part of the cost of corporate provided HC policies is subsidized by the Treasury in the US. Which means that those who work for a company that does not provide HC-insurance, by means of their taxes, are subsidizing the HC-insurance of those that do provide it.

        If that is not Corporate Welfare, what is?

        1. vlade

          Lafayette et al.

          I’m talking as a user of the system (NHS), and I had used a number of different taxpayer funded ones (continental europe, New Zealand, Australia to name a few) before, so have something to compare.

          NHS is by FAR the worst for them in my experience for basic care. This opinion is shared by a number of people who have been exposed to other public health systems.

          When (and if) you get to specialists, situation tends to change – there are undoubtedly some world class specialists in NHS. Hell, I even happen to know some of them.

          But the basic level – GP and hospital – care is extremely variable in quality, with the biggest problem being chasing targets as opposed to caring about patients (what else do you call a GP whose first sentence to you is “don’t waste my time!”).

          Personally, I don’t give a toss about metrics – indeed, I believe that following metrics are one of the reasons why NHS is the way it is now (it’s the incentives silly! Metrics aren’t patients).

          But if you do want metrics, I’ll give you one. On cancer survival rates UK is right at the bottom of Europe (the bottom seven countries are UK countries, Ireland, Poland and CZ for female, it’s slightly better for male). Even US with its private health system has better survival rates. Given that cancer is just about THE illness of the century, I’d say that’s not a good sign.

          For those who see any attack on public health system as “trolling” – you know, there are services and there are services. Even public services can be cr*p. The fact that they are public is absolutely no guarantee of quality. I was more than happy with public health system in France, or New Zealand (to give just two entirely different examples).

          Just because you believe that “European” style healthcare is better than US, it doesn’t mean that ESH is the same. In fact, there are VAST differences. Please talk back when you, personally, have experience of a few of them.

          1. Lafayette

            Please talk back when you, personally, have experience of a few of them.

            I have lived in six EU countries, including the UK. The UK universal NHS reimburses 100% of HC-costs to the patient and is one of the few to do so. I had no problem whatsoever with the service whilst there.

            Tit-for-tat is no real debate. I trust the objective opinions of numerous studies that have been made in the matter. Debate those findings by professionals, if you wish, since hearsay is poor rebuttal.

          2. vlade

            Objective studies still show that NHS scores worse than a number of continental europe ones. The results are even worse when you look at costs/results.

            For example there’s a recent (last Nov) OECD study showing that UK spends on average more on healtcare, and while in some measures (life expectancy) it gets results, there are still countries that spend less and get better results (say Spain, Italy. French have higher LE as well but the spend slightly more). But on the other side of the spectrum, infant mortality is above average for OECD, which I have to say doesn’t surprise me at all.

            If you want a different cancer survival study than the european one I wrote about, there’s one in The Lancet, which shows pretty much the same results – UK at the bottom (compared to among others Australia, Nordics, Canada). Cancer Research (UK charity) has similar studies.

            NHS trusts have very high failure rate to meet their own standards (say around 25% of them was failing to meet basic hygiene standards. That was after 70 patients died in 2009 in Basildon hospital entirely due to appaling hygiene conditions). The latest problem is care for elderly, again, mostly involving basic stuff. Indeed to quote the ombudsman “NHS is failing to meet even the most basic standards of care for older people”.

            Those are they own data, not something invented by lobbying group or me.

            Lack of bang for the buck in NHS is actually quite well recognised, especially after Mr. Brown’s solution to any problem was to throw more money at it (which is a great way to waste lots of money, but terrible for solving problems that are not one-off).
            Even the specialists I know (who are world class) recognise that there’s a problem with the current NHS point/targets system, which serves lots of people but patients the least.

            If you personaly had a good experience with NHS, good on you.

            I’ve had some excellent experience – but much more often, I and my family had a terrible one.

            Including for example going to A&E with a serious infection, and despite expresly stating being alergic – both on a form and while talking to the on-duty doctor – to an antibiotics class, ending up with being prescribed the said – highly alergic to – antibiotics. Without even an apology when we found out in the pharmacy and had to go back. This is not hearsay for me, this is a personal experience (and unfortunately not the only one).

            A very large numbe of people I know have similar stories (and, funnily enough, sometimes they have also stories how the behaviour of the same doctor dramatically changes when you are a private patient not an NHS one).

          3. vlade

            And, for avoidance of doubt. I like public health system. I’m not against a socialised one.

            But I believe that it does not automatically follow that every public health system is a good one. On that front, there are much better examples to emulate (I like the French one, personally) than NHS.

            Oh,and I even have a study to support it – this time from Commonwealth Fund, which can be hardly looked at as a bastion of Right Wing “we don’t want socialised health care”. In their “mortality amenable to health care” studies, UK finished second to last in 1998, and only 2 places better in the last one (US claiming the last place in the last one).

    2. Susan the other

      I agree with you Lafayette. The Europeans take the time to do it right. Health care, education, transportation, etc. The European motto surely is: anything worth doing is worth doing well. Our motto? IBG YBG.

      1. Lafayette

        Quite right.

        And the debate about US HealthCare became very pointed within this article (2010) of the New England Journal of Medicine here.

        Excerpted from that article:

        Despite the claim by many in the U.S. health policy community that international comparison is not useful because of the uniqueness of the United States, the rankings have figured prominently in many arenas. It is hard to ignore that in 2006, the United States was number 1 in terms of health care spending per capita but ranked 39th for infant mortality, 43rd for adult female mortality, 42nd for adult male mortality, and 36th for life expectancy.

        These facts have fueled a question now being discussed in academic circles, as well as by government and the public: Why do we spend so much to get so little?

        1. Lafayette

          And I will remind readers that obesity has been declared a public pandemic. Not an epidemic, but a pandemic.

          This very serious problem of American HealthCare leads to a great variety of illnesses that are itemized here.

          Which further means what?

          That our country is heading for a major HealthCare crisis brought about by generalized obesity. One can easily imagine why the Replicants fought dearly to sink Obama’s proposition to have a Public Option in his ObamaCare legislation.

          The business that the Obesity Pandemic will generate for HC-insurance companies will be enormous. Why contain the cost of that care by means of a Federal mandate of HC-services pricing including pharmaceuticals) – as do the European HC systems)?

          Nope, we can’t have that in America. We prefer genuflecting at the altar of BigInsurance rather than provide World Class HealthCare.

          More Corporate Welfare for those who need it least.

  4. vlade

    A few years ago Telegraph run an article calculating how much less investors would have made with Buffet if he charged the usual HF fees (2/20).
    IIRC it showed that if you invested 1k in 1965 with B, it would be either a few mills (under current structure) or a few 100ks with 2/20.

    Not to mention that the “financial advisors” – who are just sales people really – take their percentage cut etc. etc.

    Funds are IMO much bigger rip-off than banks, because with banks people at least know the banks are out there to scr*w them.

    1. Lafayette

      What ever happened to just putting a part of one’s savings into an Index Fund? And the rest in property; which, bad or good times, does not go to hell in a hand-basket.

      The S&P (for which the historical trend-line is here) has risen since 1950 (at 18) to 2012 (at 2260) – which represents a CGR run-rate of 8% per annum over that period.

      No nonsense, generalized market-risk (meaning acceptable given the risk), no wasted time interfacing with a useless Investment Advisor. (All that one need worry about is inflation.)

      And what if a capital gains tax of O% were applied to any fund maintained consecutively for more than 40 years?

      And what if the US government opened up at each Post Office branch in America a Bank Window for commercial operations. (No lending, just check books, debit cards, government bond purchases and the above suggested Index Fund vehicle.)

  5. Lyle

    Just like it is better to be an exec at Citi or BofA than a common stockholder, (down 90 and 80% from the peak).

    1. LeonovaBalletRusse

      Lyle, the really significant *stock* is rigged: Class A has votes (teeth); Class B does not (toothless, along for the ride).

  6. David Fiderer

    Does anyone have an actual copy of the cited study?

    The FT example seems to be an antidote to the “study” on private equity and job creation recently touted in The Wall Street Journal.http://online.wsj.com/article/SB10001424052970204301404577171010352218538.html
    The Journal failed to mention that the authors of the study were employed by the American Enterprise Institute.


    1. JamesW

      Recommended reading, Josh Kosman’s The Buyout of America, and Ellen E. Schultz’s Retirment Heist, I believe these are most pertinent to this discussion.

  7. A Conservative Teacher

    It must be real easy to be a successful investment banker- the kind of skills that just anyone has. I’m surprised that more people haven’t figure out this scam and become highly rich and successful investment bankers? Might it be because there are important and valuable skills there (the kind of skills that could be transferable to the office of the President) that he is being compensated for according to a free market?

    Not that you care, but one of the sins listed in the Bible is coveting a neighbors wealth- maybe you should work harder, better, and brigther rather than looking at what your neighbor has and desiring it.

    1. F. Beard

      Maybe you should read the Bible more – the parts forbidding usury between fellow countrymen, theft by debasement and oppression of the poor.

      “Free market?!” Surely you jest. I see a government enforced/backed banking cartel that generates 97% of the money supply and that most are slaves to.

      As for defending the rich:

      He who oppresses the poor to make more for himself or who gives to the rich, will only come to poverty. Proverbs 22:16

    2. F. Beard

      – maybe you should work harder, better, and brigther A Conservative Teacher

      Ever hear of “3-6-3”?

      Look it up and then tell us how hard bankers work, for example.

    3. babooshka!

      Obviously there are “valuable” skills at work here, though not necessarily skills transferrable to the job of President. First of all, you need to find someone to lend you $100 million for your harebrained scheme. Best shot would be to see one of your fellow alums at the local megabank who can borrow from the US taxpayer at zero and lend it to you for a couple percent. Then you can pay yourself a special success dividend! And he gets the million dollar commission.

      So who is going to lend our venture capitalist President $100 trillion dollars? Perhaps the Chinese? They might not see the humor in it.

      Aside from that…back to the skill piece.

      So how will the venture capitalist turn around the US? Well, the fastest way would be to split off the performing assets and sell them to foreign investors. Pay this out as a dividend to yourself. Then dump the costly debt service and pension liabilities onto the US taxpayers. Oh wait. That won’t work. Maybe he can dump the liabilities onto those Chinese!

    4. SteveDallas

      Here we have it… a very concise statement expressing the ‘Amerikan mainstream majority’ sentiment:

      “…our wonderful celebrity elites are much more successful than ever… their wealth is going exponential… and they’re protecting us and exterminating evil across the globe like never before… they deserve their success and our faith and loyalty… we need to support them because, after all, look how well they’re doing… we should teach our children to follow them… admire and aspire to be them.”

      Three years ago I was essentially among this majority… then I read Naomi Klein’s The Shock Doctrine at the same time I was discovering that the Wall Street Journal was not helping me understand the economic crisis. I promptly read dozens of books such as Econned, FreeFall, It Takes a Pillage, 13 Bankers, The Dark Side, Invisible Hands, Cornered, False Profits, Confessions of an Economic Hit Man, etc. In the early stages I was tuning in to the traditional media including FoxNews while finding much more information on-line where I quickly discovered NakedCapitalism, GlobalResearch, ZeroHedge, AlterNet, TruthDig, MaxKeiser, TheRealNews, HuffingtonPost (was good before…), DemocracyNow, etc. My Fox News fanatic mother in law brought me her stack of 20 (at least) books and to be ‘balanced’ I read two Glen Beck, two Shean Hannity, one Anne Coulter, one Bill O’Reilly, two Ron Paul, and at least a half dozen other ‘Amerikan mainstream majority’ books.

      My perspective now… three years after the Elite’s Ponzi Schemes should have been exposed and dismantled by the peoples government… nothing has changed because of one main reason… the mainstream majority of Amerikans simply do not understand (i.e. don’t have the slightest clue of) what’s going on. The criminal elite may be despicable and dangerous but, yes, you can respect them for knowing what they’re doing and getting ahead of the rest. But what about ‘the rest’, like this ‘Teacher’? He/She, like all the other ‘mainstream majority Amerikans’, will not expose themselves to alternative, more independent information sources. They will not question their celebrity corporate leadership. They, the mainstream majority Amerikans, will now do exactly what their great leaders are demanding… dismantle the people’s government and handover all public assets to they-who-know-best.

      After years of study and trying to socially function among the mainstream majority Amerikan public with a ‘new/alternative/more-independent/they-call-it-conspiracy-freak perspective’, I am MUCH more alarmed by the general people’s attitude than the elites attitude. Let’s say it this way, if the people weren’t so totally ignorant and incompetent, then the elites would not be able to do what they’re doing. So again… I respect the elite criminals MUCH more the the average Amerikan like this Teacher.

      Also, one of the most difficult things for me to understand, and subsequently grow to appreciate, is how much and how totally the Supra-National Anti-American Mega-Elite Looting Criminal Organized Global Mafia despise and enjoy crushing the The Average Mainstream Majority Totally Ignorant Amerikan like this Teacher.

  8. charles sereno

    “Garbage Barges” — The name of financial boats which will live in infamy. From Yves(Word)Smith.

  9. Tim

    Wasn’t there a Danny DeVito movie called “Other Peoples Money” in the late 80s-early 90’s dealing with private equity? It may be 20 years ago but people that are old enough still have an angry place in their heart for corporate raiders.

  10. LeonovaBalletRusse

    YVES, your headline goes with:
    “The Best Way to Rob a Bank Is To Own One” by William K. Black

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