Private Equity: A Government Sponsored Enterprise

By Nanea, a private equity insider, and Yves Smith


This is the first in a series of postings on the private equity industry (“PE”) and will serve as an introduction to private equity investing.

Private equity practitioners, including most famously Mitt Romney, often depict their sector as the epitome of private enterprise. These claims are false. Private equity firms not only depend directly and substantially on government support, they have also actively cultivated links to the state.

Some readers may know that private equity relies heavily on tax subsidies. Private equity firms engage in debt-leveraged buyouts of public and private companies, and the interest charges on this debt are tax deductible. But most members of the public do not know that close to half the investment capital in private equity funds is contributed directly by government entities. In this respect, private equity is little different than companies like Fannie, Freddie, and Solyndra that are regularly criticized in the media as recipients of government subsidies.

Their decisions to invest government funds in private equity reflect assumptions by government officials that have gone unchallenged and, we contend, are quite likely incorrect. Moreover, virtually all of the important details of the private equity investments made by these state investors are kept secret at the insistence of PE firms, in striking contrast to every other type of government contract.


Our discussion and analysis will range across the full spectrum of private equity but will mostly focus on the activity that was formerly called “leveraged buyouts” and is now generally called “buyouts.” This investment approach involves buying generally mature and usually profitable businesses, typically with the acquirer borrowing about half the money used for the acquisition. A broad definition of private equity refers to investing in non-publicly-traded equity securities (the “private” in “private equity” means “not publicly-traded”). So, when a small businessperson buys a restaurant from someone else, he or she is engaged in a “private equity” transaction. Practically speaking, the private equity “industry” excludes all these mom-and-pop transactions and, instead, refers only to the investments in private equity securities made by capital that is organized into “private equity funds”.

Some writers distinguish “venture capital funds” from other types of private equity funds (“buyout funds”). Venture funds make small, non-controlling and unlevered investments in relatively new, unprofitable or barely profitable companies. Despite these differences in the types of investments they target, buyout and venture funds are both private equity because they both have a long time horizon, make illiquid investments and have similar fee arrangements and fund structures.

Private Equity Investments: Numbers and Examples

The private equity industry has over $2 trillion in funds under management. A conservative assumption of $1 of fund equity for every $1 of borrowings translates this figure into over $4 trillion of buying power. By way of comparison, the subprime market reached roughly $1.3 trillion at its peak, the municipal bond market is approximately $3.0 trillion, and the total market capitalization of the US stock market was $15.6 trillion at year end 2011.

The single largest source of capital to the private equity industry is governmental pension funds. According to Preqin, a commercial database that tracks investment in private equity, approximately 30 percent of capital in U.S. private equity funds was contributed by governmental pension funds. Governmental pension funds are more often referred to as “public” pension funds, but this can be confusing because it doesn’t make clear the basic reality that, in the U.S., the funds are essentially always administered by government employees and governed by officials who are directly elected by the public or appointed by elected officials. For example, the New York State Common Retirement System is administered by employees of the New York State Comptroller’s Office, and the Comptroller is the sole trustee for the fund and is elected state-wide by the people of New York. In these posts, we will refer to public pension funds as governmental pension funds.

A second major type of government investor in private equity funds is sovereign wealth funds, such as the Abu Dhabi Investment Authority, the Australian Future Fund, and Singapore’s Temasek. Preqin estimates that sovereign wealth funds comprise approximately 10 percent of the capital in private equity funds.

Public university endowments play a smaller role as sources for private equity investments, probably no more than a couple of percent. They are typically not run directly by elected officials and are not as directly a part of the state govenments that sponsor the universities, thus they can seem more “quasi-public” in character.

Preqin provides a wealth of information about governmental investors in private equity funds. For Bain X (Bain “Ten”), Bain’s most recently established fund, Prequin produces the following list of governmental investors:

Alaska Permanent Fund Corporation
California State Teachers’ Retirement System (CalSTRS)
Employees’ Retirement System of Rhode Island
Illinois Municipal Retirement Fund
Indiana Public Retirement System
Iowa Public Employees’ Retirement System
Maryland State Retirement and Pension System
Massachusetts Pension Reserves Investment Management Board
Michigan State University Endowment
Pennsylvania Public School Employees’ Retirement System
Pennsylvania State Employees’ Retirement System
Purdue University Endowment
Regents of the University of California
San Diego County Employees Retirement Association
State Teachers’ Retirement System of Ohio
University of Michigan Endowment
University of Oklahoma Foundation
University of Washington Endowment

Although this list may seem long, readers should bear in mind that Bain’s level of government investment has historically been below industry averages due to the fact that Bain charges much higher fees than is typical (in particular, Bain charges a 30% upside fee while the industry norm is 20%).

In any case, this list is likely to be incomplete Throughout the world, the PE industry has been amazingly successful at shielding information on PE funds from disclosure by governmental investors. In the U.S., governmental investors are normally required to divulge in which funds they have made investments; in other countries, even this information may not be consistently available. It’s also worth noting, and we will examine this in great detail in later posts, even U.S. governmental investors have been exempted from almost all of the general requirements of state Freedom of Information laws, which means that one typically can’t learn much beyond the names of the funds and a few other somewhat useless facts about the funds that governmental investors commit to.

The Structure of Private Equity Investments

Readers might wonder why private equity relies so heavily upon the deep pockets of state entities for its funding. The reason is basic: governments are among the very few investors that can accept the uncertainty about both when a fu nd may demand capital contributions or when they will give back the money.

Private equity funds are highly distinctive in their design. First, they are almost always “blind pools”, which means that at the time when you commit as an investor, you have no idea what the fund will end up owning.

Second, when a given round of fund raising has been completed (in industry parlance, at the “closing”), you generally do not hand over the full amount of money that was agreed upon. Instead, you make a contractual “commitment” to send in portions of that amount whenever the PE fund “calls” for it.

Third, the investment manager will give your money back (together with your share of the profits, if any) when it suits him – there is no specified schedule. While the PE investors typically start to receive meaningful “distributions” of capital starting around year four or five, and most of the money will typically be given back within eight or nine years after the investor commitment was made, it’s not at all uncommon for some distributions to be made a dozen years or more after the closing.

Because of all this uncertainty about cash flows, private equity has much less appeal to wealthy individuals than hedge funds do. For the most part, only the mega-wealthy (people like Bill Gates or the Walton siblings) can accept the uncertainty of either having to pony up large portions of their fund commitments on short notice or waiting indeterminate amounts of time to get their money back.

In addition, the PE funds need to be sure that investors will be good for the money when they call for it. That restricts which investors the funds will welcome. For the fund, the best possible investors are extremely credit-worthy, supremely liquid institutions – and so governments often fit the bill.

Why It Matters

While some might be opposed to the status of private equity as a government-sponsored enterprise for philosophical reasons, others would be less concerned as long as they were convinced that PE firms produce real benefits for the public. PE industry organizations and various of its defenders do, in fact, claim that private equity yields considerable social benefits.

First and foremost, industry advocates frequently assert that private equity produces impressive returns; some even claim that governmental investors will be unable to meet their commitments without the boost to their returns that PE can deliver.

Private equity supporters also contend that by improving the management of companies they control, PE firms make the economy more efficient, lowering the prices of goods and services and creating jobs.

Unfortunately, there is ample reason to doubt these claims.

Far from being a sort of steroids for weakened investment portfolios there is substantial academic evidence that private equity net returns consistently underperform lower risk public market alternatives. As we will discuss at some length, the industry uses methodologies for calculating their returns that result in much higher reported returns than studies that are based on actual cash flows. There are many important implications of this finding, one of which is that private equity managers may receive as compensation more than 100 percent of any net returns they generate relative to lower risk alternatives.

Ultimately, these findings raise hugely important questions about whether the result may be extractive and socially destructive. Potentially overstated private equity returns are used to justify enormous state commitments to private equity investments. PE firms engage in large scale cost cutting, including many examples where they have reduced private sector worker pay, pensions, and health care benefits, all in the name of “productivity increases.” Their power to exert these changes depends on the government, not only for capital, but also because interest on acquisition debt remains tax deductible, although the intent of those sections of the tax code was of course to facilitate borrowing for investment, and almost certainly did not anticipate its use for financial engineering, liquidation via underinvestment, or rent extraction.

Unlike America’s high growth, low unemployment period of the 1950 and 1960s, the benefits of these sorts of “productivity increases” appear not to have been shared with workers, despite the claims of some private equity managers that the public benefits via their pension fund investments. Rather, it appears that they accrue mainly to the buyout fund managers. If the claim doesn’t hold up of high returns for governmental investors, there appears to be no justification at all for the collateral damage of job losses, underinvestment in portfolio companies, and economy-wide distortions, not only of capital allocation but even of policy priorities as a result of the industry’s attempts to justify itself.

The public should be concerned about so much capital winding up in the hands of so few players, particularly when they have gone to extreme lengths to bar public inspection and oversight. And, as we peel the layers back over the course of this series, we will show how many other widespread industry practices, like “transaction fees” do not stand up to scrutiny.

Next Up: An Introduction to Private Equity Fund Terms

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    I’ll begin discussing my harsh critique of Private Equity by directing the kind reader to a Comment I made earlier today, here at NakedCapitalism:

    “Was once a quaint time, not so long ago (chronicled by Michael Thomas from Lehman) that the banks simply fed from the public troth. A little ‘taste with the snout’ as the Sicilian Mafia say. Now, the entire purpose of US Government is to put out the troth, fill it with public EARNINGS and, once filled, deliver it to the Banks. I have, until this very moment been thinking if the US Government as the ‘muscle’ for the banks, but now have a clear insight into their role as ‘bag man’ too. I guess the Government has extended it’s role in our society.”

    Now, to support and expand upon our erudite authors’ Post (I need to add very few words, as their argument stands on its own):

    “waiting indeterminate amounts of time to get their money back.”
    This, my dear reader is the true sign of a scam. ‘Two hamburgers, for one given today’.

    “claim that governmental investors will be unable to meet their commitments without the boost to their returns that PE can deliver.”
    Here we see the telling sighns of a real mark. These Comptrollers can’t make their bills, so figure they’ll ‘double-up’ for the Big Hit, which, when combined with the Big Lie #1 above, means IT LOOKS LIKE THEY’VE GOT THOSE PENSIONS FUNDED, but in 10 years…oops!

    Boychik, you been had!

    1. Doug Terpstra

      I’ll gladly pay you [next] Tuesday…

      Great comment. It’s now clear that the best way to rob a government is to own it. Captured “public servants” are the fattest dumb-money Muppets ever, probably the last source of tax-deductible loot, and they’re certainly good for the money . . . so far. What an exceptional ROI on bribe money.

      Hey, let’s start a lamppost equity fund. When TSHTF and pensions evaporate, there won’t be enough to go around. We’ll make a killing.

      1. DANNYBOY

        The Public Servant has been CAPTURED by the Controller/ Investment Manager, who get his dough. Not-so-much-dough left for the pensioner, who doesn’t even know what hit him.

    2. LucyLulu

      “claim that governmental investors will be unable to meet their commitments without the boost to their returns that PE can deliver.”

      Sounds eerily similar to the worker who is putting $20 on the maiden filly to win, or buying fistfuls of lottery tickets at 7-11, because his paycheck won’t cover the rent.

      1. DANNYBOY

        Except the worker is only fooling himself. Here, these A-hole Comptrollers are putting down their bet and saying it’s a sure thing. They get to keep their a-hole job and all those bribes, and the horse-race results and lottery announcement isn’t made for another 10 years, on another guy’s watch. And around and around it goes…

    3. citalopram

      I don’t know if it’s rage fatigue, or just the pragmatic realization that nothing will be done about this anytime soon, but I’m starting to care about it less and less.

      It doesn’t seem worth agonizing over when nobody (the American people) give a damn.

      The other day on Youtube, the very top video had 2.5 million views accusing Obama of being a traitor. It was yellow journalism in the finest, and I’m guessing it was favorited by a military audience. The stuff they were accusing him of being a traitor for completely missed the point as documented by Yves for years.

      Your average grunt or Marine doesn’t realize they’re being used in the name of corporatism. Neither does the Fox News watching public.

      Another group in this country supports Obama, and are either completely ignorant of his warcrimes and failures, or paper them up and make excuses for him. All the while they are as guilty as he is for the evil that he hath wrought.

      And then there’s the vast majority: they’re too busy with their iPhones and Starbucks to give a shit about what’s going on. Sure, they lost the house, but at least they can afford the latest app. Oh, and they have an the latest iPhone. And their cousin’ getting married next year. And the banks really aren’t all that bad, but if they are there’s nothing that can be done about it anyway.

      1. DANNYBOY

        But citalopram,

        You don’t need a majority to effect change. Give me some Men, who are stouthearted men…

          1. Gundar

            People fear change more than death, so abiding by the current structure of society is the path of least resistance. Others are determined to be happy and if it means ignoring the tsunami of corruption, arrogance and theivery that is manifest on every level of public life every day then so be it. That attitude could almost be deemed a form of protest, only it has absolutely no effect on the machinations of power and is selfish in nature.

          2. Waking Up


            What is sad is that most people will not realize they have lost everything…civil rights, finances, homes, their moral centers, until well…until they HAVE lost it all. Many will try to pretend everything is “just fine, thank you” when it absolutely isn’t. Even sadder, there will be people around them who will blame THEM for not “working hard enough”.

          3. Maximilien

            “Others are determined to be happy and if it means ignoring the tsunami of corruption, arrogance and theivery that is manifest on every level of public life every day then so be it.”

            But Gundar…..people don’t have to be ignorant in order to be happy. I read about the tsunami every day on NC, yet I don’t consider myself unhappy. Ignorance is NOT strength; neither is it necessarily a guarantee of happiness. KNOWLEDGE is strength, and can be a source of enduring happiness.

            For with knowledge, the individual cannot be duped by business or government. With knowledge, he or she can educate others and join with them. And with knowledge, he or she is armed, and prepared to fight the good fight if necessary.

            In a thousand tiny ways the informed can fight back (something the ignorant cannot do)—and find pleasure in doing so. Until, come the inevitable day, when that thousand is multiplied by a hundred million and justice and righteousness finally win out.

          4. DANNYBOY

            Waking Up,

            You sure have…woken up.

            One thing is always clear: If you allow a man to deceive you today, then he will cheat you tomorrow, then he will then steal from you…

            I will not allow any man to deceive me.

        1. Smellslikechapter11

          A few highly focused and patient people with the willingness to risk their lives for their cause is proven way to effect change.
          However the change we get can look like Lenin, Hitler, Mao or bin Laden.
          While I sympathize with notion of a few stout hearted men to be the agents of real change, i am scared of them too

      2. Waking Up


        Never give up. Instead, remember these words: “When good men do nothing, they get nothing good done. To be good, one must do good.”

        Simple, but effective. Yves is certainly doing a great deal of good in this world by educating and keeping so many people informed on financial institutions and how they effect our lives.

      3. LucyLulu

        I don’t know if it’s rage fatigue, or just the pragmatic realization that nothing will be done about this anytime soon, but I’m starting to care about it less and less.

        Oh dear. Sounds like your ad isn’t working anymore. ;)

        Seriously though, I get it and can relate to what you’re saying.

        “So I say, “Live and let live.” That’s my motto. “Live and let live.” Anyone who can’t go along with that, take him outside and shoot the motherfu**er. It’s a simple philosophy, but it’s always worked in our family.”
        George Carlin

      4. The Pale Scot

        As H.L. Mencken said,

        “Democracy is the idea that the people know what they want, and deserve to get good and hard.”

      5. Elizabeth

        Even if I’m not about to go under the bus, I get this. You’re right . . . Look at what they talk about, like, “freedom” and “free enterprise” and the American spirit or some such stuff. And there’s “hope” and “change” (remember them?) and how great we are for wearing Birkenstocks and being nice to gay people. Just as boring.

        Everybody’s talking about Clint Eastwood talking to that damn chair, but what I want to know is why they think that’s funny, when Obama IS an empty chair. Nobody said anything about the image of a cowboy with a gun behind Eastwood. As if that’s real.

        The real Romney speech, if it were honest: “If I’m elected, I’ll put an end to this pussy-footing around about helping homeowners and just give it to you straight that you’re about to be screwed big time. But it’s only because you deserve to be screwed and my friends deserve to be rich. That’s the American way. And stop whining about private equity. Your money is my money, is what I always say. Just keep paying it in, and I’ll make sure it gets spent wisely on sending your jobs overseas, you blithering idiots. It’s enough to stand here and not laugh out loud at you boobs.”

    4. LeonovaBalletRusse

      DB, These are RACKETS, by any name. Bring RICO.

      The “free trade-government-in-a-bathtub” MYTH of “Private Equity” is now “BUSTED,” thanks to the ever-vigilant Yves Smith and her performing troupe at NC. I wonder what Jill Stein can make out of this manna from heaven.

      1. DANNYBOY

        Today I received this lovely post card in the mail, whose contents I’d like to share with you for your amusement.

        The front of the postcard seemed normal enough, nothing that I haven’t seen countless times in the last 30 years (it is good to keep the same address, if only for the consistence of mail received). The front read: Fine Art & Estate Auction. So far, nothing out of the ordinary. But……when I turn it over it reads: “Liquidation Auction Mandated Due to the HEDGE FUND & PONZI DISASTER VICTIMS PERSONAL ASSETS, Contents of Home and Other Consignments for Immediate Cash Realization” and I think, there for the grace of my relentless vengeance, that could have been me.

        So, it does appear, fellow posters that the game has come to its predetermined ends. The rich are now eating each other, with the scraps sold to the highest bidder.

        1. skippy

          Yes DannyBoy…

          I too have such memorabilia in my man shop down stairs. It reads…


          ***** FUNDED BY ******

          The Gambling Community Benefit Committee

          State Government logo in the bottom left corner…. snort!

          Skippy… Sign is about 1m x 600mm and was hung in window front of a shop located on the edge of the CBD.

          PS. You asked in another thread how things were down here in Straya… see: Resistance is futile, Seeney tells unions:

          UNIONS can beat their drums as much as they like, but it won’t stop public service cuts, Queensland’s deputy premier says.

          Thousands of screaming firefighters and ambulance workers rallied outside Parliament House today against the government’s latest offer on pay and conditions.

          Firefighters took off their boots and hurled them over a fence and into Parliament House’s courtyard.

          Others brandished placards with the slogan: “My boots stand on the frontline.”

          Premier Campbell Newman and Deputy Premier Jeff Seeney did not front the angry workers.

          But Mr Seeney told reporters the protests were pointless.

          “Protesting is not going to help,” he said.

          “The tough decisions we’re going to have to make are not going to be influenced by a group of people making noise outside the gates (of parliament).

          1. DANNYBOY

            Those firefighters are HEROES, they are the CHAMPIONS OF OUR SOCIETY. I say this before I saw, firsthand these men COURAGEOUSLY rush in to the burning WTC on sept 11, while my only instinct was to run to safety. They are too brave of character to have to deal with Premiers and Deputy Premiers. These politicians cannot face strong men like these. Now I offer my opinion (everything written so far is plain fact):
            These politicians couldn’t SHINE THE SHOES of firefighters and ambulance workers, who do more good IN ANY SINGLE DAY than that whole political lot. These men deserve comfort for what the face daily and these f-n politcos give them grief. THERE WILL BE JUSTICE.

    1. LucyLulu

      Very informative article, esp. about historical backdrop for rise in LBO’s and how they benefit investors. Thanks, Nicholas.

  2. Susan the other

    What could go wrong… Just invest government pension funds in a hostile takeover of an asset-heavy corporation, label it as an inefficient business in order to justify liquidating the treasury; destroy its labor force and slash all future pension fund contributions – in fact liquidate its old pension fund altogether; take on crushing debt to make your destroyed corporation look like it is still functioning; write up books to show it as a profit; pay out your investors; skim a huge and obscene fee for your services; and leave the corporation and its surviving employees to pay back the debt? Oh beautiful, for spacious skies…

    Thank you for this series. It is going to make us all too sick to even look at Mitt Romney.

  3. ep3

    “almost certainly did not anticipate its use for financial engineering, liquidation via underinvestment, or rent extraction.”
    I would disagree Yves. I think the objective of public policy is to pass “rules & Regs” that look like they are to benefit the public and show toughness but really it’s to benefit the few elites. So in this example, make interest tax deductible because “it encourages investment”. When actually it’s to deflect interest costs to a tax advantageous position.

  4. fuzed

    I’m new to this, so forgive, but I don’t understand exacly how you determine this implied calculation:
    “The private equity industry has over $2 trillion in funds under management. A conservative assumption of $1 of fund equity for every $1 of borrowings translates this figure into over $4 trillion of buying power.”

    $1 -> $4?

    1. DP

      She’s saying $1 of equity supports $1 of debt (to be conservative, actual is probably higher), so over $2 trillion of equity supports another $2 trillion plus of borrowed money to go with the equity and give private equity over $4 trillion in capital to buy things with.

      1. LeonovaBalletRusse

        DP – “in capital” – rather, “in DIGITS,” leading to massive “debt money” (asset) inflation, massive inflation of the “Finance Economy” – made more massive yet through “digital derivative” permutations unto infinite expansion of “debt” which is “externalized” to the 99%. What a corporation+government (Fascist) RACKET.

        1. LucyLulu

          and debt also results in the financial destabilization of the company taking on the debt and taking excess risks by the PE investors who win no matter the outcome.

  5. Always Lurking

    Thank you very much for this series, Yves. I am anxious to learn much, and to provide fuel for further personal research.

  6. Solyndra?

    I agree that the decision to invest government funds in private equity reflects unchallenged assumptions. And, given the ineptness of many government officials charged with making these decisions, that is worth revisiting. But, comparing the investment by public pensions in private equity to Solyndra goes beyond hyperbole into outright dishonesty. Solyndra was a group of politically-connected people who borrowed money they couldn’t repay for a product that didn’t work (and was uneconomic even if it did work). Outside of the occasional case of a corrupt official receiving kickbacks, public pensions are at least investing in private equity in pursuit of profit (and therefore the ability to provide for the retirement of their beneficiaries – which there’s no way they can do realistically, but that’s another argument). Subsidizing pipe dreams of alternative energy is in no way related to that.


      Leave out the “alternate energy” and it’s the same bidness model. There are no misspellings in the last sentence.

    2. Nanea

      It is a very strong goal of mine to avoid hyperbole in this series and let the facts speak for themselves.

      You think that invoking Solyndra is, at a minimum, hyperbolic because you assume that the company was criminal and its product a fraud. I don’t see the evidence supporting those conclusions. To my knowledge, nobody associated with the company has been indicted. As for the assertion that the product didn’t work, a whole bunch of PE firms apparently thought it did work. Wikipedia says the company was backed by U.S. Venture Partners, CMEA, Redpoint, Virgin Green Fund, Madrone, Rockport, Argonaut, and others.

      1. DANNYBOY


        Solyndra, shmolyndra…doesn’t matter.

        But….what does matter is that you get past this myth that these boys are not criminals because theres been no indictments. Pl….ease!

        I know this type of thug. Not as honest as you’d like.

      2. darms

        Solyndra‘s process for making Copper indium gallium selenide (CIGS) thin-film solar cells worked just fine, their process was less expensive than other makers at the time. Problem was, once they began to ramp up production, the market was flooded by Chinese government-backed firms who had found a less-expensive process so the startup went belly-up…

        1. The Pale Scot

          “Chinese government-backed firms who had found a less-expensive process”

          I don’t believe this to be true, I have never found any description of a change in technology or manufacturing processes by the Chinese companies, only vague descriptions of “efficiencies”. I have read of the USA and the EU implementing anti-dumping tariffs after finding manufacturers received massive amounts of help from the Chinese government and dumped large quantities of cheap panels on US markets.

          Chinese government officials have been quoted saying China’s strategy is to capture the solar cell market and have “the rest of the world buying them from us”

          Why the hell are trying have “free trade” with a communist regime? It’s an oxymoron.

    3. reslez

      This is a pathetic red herring. Nanea is indicting an entire industry sloshing with trillions of funds for corrupt, society destroying behavior. You are calling out a single company with annual revenue a miniscule percentage of that as though it is somehow worse. As Wolfgang Paul would say, you’re not even wrong.

  7. anonymous

    At some point, I hope, someone will write a book that details the massive tranfer of wealth from the American taxpayer to hedge fund and private equity owners. If governments had simply made realistic assumptions about pension performance and funded the pensions appropriately, they would not have had to pay the billions they are paying to fund managers to goose their investments.

    And one major contributing factor to this is that Americans don’t understand that the millions of dollars out of each pension fund going to fund managers is actually a cost. While Americans raise hell over $400 toilets, they don’t care about multi-million dollar payouts to fund managers.

    1. LucyLulu

      You didn’t mention that during the time the funds WERE paying high returns, the employers looted the ‘excess’ to pay themselves large bonuses.

  8. alex

    “Far from being a sort of steroids for weakened investment portfolios there is substantial academic evidence that private equity net returns consistently underperform lower risk public market alternatives.”

    So why do people, pension funds, etc. invest in them? That’s a straight question, not snark or skepticism. While I’m far from a “markets über alles” type, I’d hope markets would work in a situation like this. Why don’t they?

    1. Bubba

      Typically, the studies mentioned by the author report “average” returns of the private equity industry. Pension funds, and just about anyone investing in private equity for that matter, have convinced themselves they can pick “better than average” (aka “top quartile”) private equity managers/investments. Otherwise, why would you ever invest in higher risk private equity when there is ostensibly a lower risk/better returning alternative in the stock market? Oh, and it’s no coincidence that 100% of private equity managers claim they are in the top 25%.

    2. charles sereno

      @alex Yours is an important question crying out for an answer. Even if PE funds did “outperform,” there may be good reasons for public investors to shun them. However, if “lower risk public market alternatives” are available, the social damage is then only multiplied.


      The MANAGERS of pension funds invest in Private Equity and make shitloads of money. The INVESTMENTS in Private Equity do poorly. The PENSIONER has now been f-d by both the PE Fund and his own Investment Manager.

      And it goes around,and around, and around, in the circle game.

      1. LeonovaBalletRusse

        DB: see it on film, in metaphors of the same “revolving door” in the era of economic/social disintegration recognized by Arthur Schnitzler; for whose story Stanley Kubrick straddles times.

        “LA RONDE” (1950) – Directed by Max Ophuls. Arthur Schnitzler’s turn-of-the-century play “Reigen,” adapted for film by Jacques Natanson and Max Ophuls. Cast: Anton Walbrook, Simone Signoret, Serge Reggiani, Simone Simon, Daniel Gelin, Danielle Darrieux, Fernand Gravey, Odette Joyeux, Jean-Louis Barrault, Isa Miranda, Gerard Philipe.

        (DVD box features Essay,”VICIOUS CIRCLE,” by film critic Terrence Rafferty; other special features. Under exclusive license from Euro-London Films, © 1950 Cofradis. All rights reserved. © 2008 by Criterion Collection. All rights reserved. Cat. no. CC1765D. ISBN 978-1-60465059-4.);

        “EYES WIDE SHUT” (© 1999) – Produced and Directed by Stanley Kubrick. Inspired by “Traumnovelle” by Arthur Schnitzler. Screenplay by Stanley Kubrick and Frederic Raphael. Cast: Tom Cruise, Nicole Kidman, Sydney Pollack, Marie Richardson, Rade Sherbedgia.

        (DVD box with special features, including documentary film: “The Last Movie: Stanley Kubrick and Eyes Wide Shut” © 1999 Channel Four Television Corporation. Package Design & Supplementary Material Compilation © 2007 Warner Bros. Entertainment. Distributed by Warner Home Video. All rights reserved.)

        Detect the RESONANCE.

        1. LeonovaBalletRusse

          FRAME of history: “History is not dead. It’s not even past.” (Wm. Faulkner):

          “1815-1915: From the Congress of Vienna to the War of 1914” by Ch. Seignobos, Translated by P.E. Matheson; A brochure from the “STUDIES AND DOCUMENTS ON THE WAR Publishing Committee (Paris, Librairie Armand Colin, 1915);

          “A NERVOUS SPLENDOR: Vienna 1888/1889” by Frederic Morton (Boston/Toronto; An Atlantic Monthly Press Book; Little, Brown and Company; 1979);

          “THE END OF ORDER: Versailles 1919” by Charles L. Mee, Jr. (New York, E.P. Dutton, 1980);

          “THE FALL OF DYNASTIES: The Collapse of the Old Order, 1905-1922” by Edmond Taylor (Garden City, New York; Doubleday & Company, Inc.; 1963);

          “THE COURSE OF EMPIRE” by Bernard DeVoto, with maps by Erwin Raisz (Boston, Houghton Mifflin Company, 1952)–which offers this quotation from Abraham Lincoln, in advance of the text proper:

          “A nation may be said to consist of its territory, its people, and its laws. The territory is the only part which is of certain durability. ‘One generation passeth away and another generation cometh, but the earth abideth forever.’ It is of the first importance to duly consider and estimate this ever-enduring part. That portion of the earth’s surface which is owned and inhabited by the people of the United States is well adapted to be the home of one national family, and it is not well adapted for two or more. Its vast extent and variety of climate and productions are of advantage in this age for ONE PEOPLE, whatever they might have been in former ages. Steam, telegraphs, and intelligence have brought these to be an advantageous combination for ONE UNITED PEOPLE.” (CAPS mine)

          What happened? See Coleman’s YouTube speeches on “The Committe of 300,” and weep.

    4. Dikaios Logos

      My somewhat patchy list of reasons why public pensions invest in LBO funds:

      The LBO firms often have a first fund that posts returns that are impressive in absolute terms, in risk-adjusted terms they are of course less impressive. Once a firm has had a moderately successful first fund (usually with money from family offices and wealthy individuals) they can then raise money for the later funds from various pensions, usually enormously larger quantities of money than the first fund had. Almost always, the later funds have lower returns.

      As the money committed to LBO funds increased, a support system of consultants and placement agents grew. They promote these investments to LPs (pensions and other investors). So there is another group with an interest in pushing pro-LBO firm propaganda.

      Investors seldom are good at understanding the returns. A lot of numbers get thrown around to sell certain types of investments. Many of these numbers are either bad or outright deceptive. Bad firms tend to not be included in ‘representative’ data sets. And investors seldom get or understand the details of where the returns come from for a ‘successful’ fund. Often, it is just a few investments in a portfolio of ~10-15 investments. Those low numbers should tell you that it might be good to not count on getting the same results again.

      If a firm has been deemed ‘successful’, it then means that investment staff and investment committees at pensions and other investors see investing in its subsequent funds as ‘safe’ from a career perspective: few will blame you for a poor choice if the big name investment goes bad. Think of how when hiring, someone who has Harvard, Goldman Sachs, or McKinsey on their resume (sorry, Yves!) gets treated with more deference than other job candidates, mostly because no one will blame you for hiring someone with a ‘good pedigree’, even if it later becomes apparent that they suck.

      There is also an a naive belief in ‘diversification’ in much of the investment community, this makes investments marketed as ‘different’ a lot more attractive than they should be. Pension staff and management often combine that with a belief that LBO firms, like them, have a ‘long-term’ view and so that they feel they are getting something that offers them diversification that only they can really appreciate.

      Finally, pensions are subject to all kinds of political pressures that make them slow ships to change course. And LBO firms are full of psychopaths who know how to exploit pension funds’ inertia.

  9. alex

    One suggestion I’ve always liked is to limit the tax deductibility of corporate debt. I don’t know exactly how that should be structured (perhaps by only allowing deductibility on debt up to a certain percentage of a company’s value) but it’s a good idea.

    Allowing 2:1 or greater leverage on an investment is no different from allowing a person to take out a tax deductible loan for an investment. It’s a tax shelter at best.



      Ever question the limitations that have been put on the tax-deductibility of individual debt?

      Is there equity in this?

      Do I need to get my own private lobbyist?

      Please advise.

    2. Yves Smith Post author

      In 1987, Treasury leaked the idea of limiting the tax deductibility of debt used for “highly leveraged transactions.” That was it was concerned about stock prices (a Goldman report attributed 75% of the rise in the stock market to LBOs: an LBO company would do a deal, and all the other companies in that industry would go up on the assumption that other buyout firms would comb that industry for other candidates and find one. And then even the ones that weren’t acquisition targets would rise in price because they’d look “cheap” on some metric relative to the others). But the market crashed shortly thereafter, so that took care of that problem (in fact, some people at the time saw the Treasury proposal as one of two triggers of the crash, my dim recollection is the other was bond market related, I’d guess an increase in yields of longer-dated Treasuries).

      1. F. Beard

        But the market crashed shortly thereafter, Yves Smith

        The boom-bust cycle, created by money that is lent into existence and which requires accelerating debt, according to Steve Keen, to avoid collapsing?

        But it is exciting. Only last century and within the living memory of some is GD I and its child, WWII – both products of the existing money system.

      2. Phichibe

        IIRC, it was when James Baker, at the time Secretary o/t Treasury, got in a spat with the West German finance minister over exchange rates and threatened to scuttle the Treasury’s stabilizing efforts (think it called the Plaza Accord, from the Plaza Hotel). Anyway, the market panicked and tanked.

        What’s funny is that I was at the GSB at Stanford at the time, and I remember my professor of economics coming into a micronomics class (that he’d scheduled horrendously early as an exercise in 1st Phd sadism)with an enormous smile on his face as he recounted the failure of the Markowitz-inspired portfolio insurance funds on Wall Street. The irony is that this professor (Kreps) was one of two (the other Harrison) whose papers are foundational in martingale calculus for the high finance that help to cause the meltdown in 2008-2009. I wish I’d shot him when I had a chance, maybe I wouldn’t have been crushed by margin calls after Lehman tanked. Sigh.


  10. Warren Celli

    “Private Equity: A Government Sponsored Enterprise”

    I think you give ‘government’ a bad rap with the title. We don’t have ‘government’, we have Xtrevilist corporate gangster co-opted human resource departments.

    How about…

    “Private Equity: A Sociopathic Gangster Enterprise”

    Are we ready for the election boycotts yet?

    Deception is the strongest political force on the planet.

        1. DANNYBOY

          Terrific Insights, especially Old Fashioned Vanilla Greed expanding to Pernicious Greed. I agree, as you have probably surmised from the description I previously offered of the ‘snout in the trough expanding to eating the entire thing.

          The fire has been lit and cannot be extinguished, as we pass on these truths to our children. We Will Not Be Stopped. As I said to a couple of them boyz the other day…”Only the two of you, better go back for a few more…and bring your guns.”

  11. Dikaios Logos

    The government sponsorship interestingly comes AFTER many of these managers have had their best returns, which are almost always in their first funds. Many of the early LBO deals and funds were relatively small and so had a relatively higher chance of making eye-popping (though highly levered) returns. Most of these public sector LPs (the pension funds) are typically required to invest in second or later funds. These funds have many more dollars under management and almost always have substantially worse returns than first funds. Why the LPs don’t wise up to the fact that the subsequent explosion of assets after a first fund almost guarantees lower returns is beyond me. But the large quantity of assets means that the management fees alone make the business attractive to fund managers, regardless of whether they produce high returns.

    Another pernicious aspect of the private equity business relation to government is that a few notable fund managers, have come from powerful positions in government. This means a) they have contacts and the imprimatur that comes from using a position that was supposed to be public service and b) they have uncommonly good access to the various palace eunuchs in government that will gladly the grease rails for their activities when need be. Consider that a number of U.S. Treasury Secretaries have become wildly wealthy from private equity and that one of the largest private equity firms, The Carlyle Group, has top executives and board members that can fix parking tickets and much, much more in many nations.

    1. LeonovaBalletRusse

      DL, don’t forget: Michael Milken was hailed as a “genius” and “great leader” in his hey day. Yes, he showed everybody how to game “Capitalism-Democracy” and P.E. still follows his lead and greed. Michael Milken & DBL – S&L Scandal – Enron – Carlyle et al. (P.E. “legal” looting and war profiteering w/ leverage of inside information/strategic contacts), leading to TARP 2008, to Obama “Health Care,” and Anti-Justice; and now we are bent over to receive “Bain’s Mitt” for Prez.

      All crime, all the time. All treason, all the time.

  12. Doug Terpstra

    Bravo, Nanea and Yves! Sunlight is the best disinfectant — lethal to vampire squids, and it’s not surprising that Mitt wants to keep his tax returns away from UV light.

    “‘… men loved darkness instead of light because their deeds were evil. Everyone who does evil hates the light, and will not come into the light for fear that his deeds will be exposed.'” – JC (John 3: 19-20)

      1. Doug Terpstra

        I though you’d appreciate that. JC sure swung a sharp one, always aimed squarely at hypocritical high priests, Pharisee politicians, and moneychangers. He probably skinny-dipped in the Sea of Galilee too, with his beloved disciples. Just sayin’.

        1. F. Beard

          He probably skinny-dipped in the Sea of Galilee too, with his beloved disciples. Just sayin’. Doug Terpstra

          Lucky for you that blasphemy against the Son of Man will be forgiven but I’d tread much more carefully if I were you.

          1. Doug Terpstra

            Ha, I imagine JC would chortle with the tax-collectors on that one! I rather imagine he was a delightful guy to hang with.

            It’s funny how the heinous sins our own Pharisees condemn as blasphemy and abomination are things that Jesus never once mentioned in his entire mission. When he wasn’t denouncing greed, deceit, self-importance, hypocrisy, and violence, he was cuddling kids, healing and feeding people, and speaking about love and honesty. Too busy I suppose, to rail against more important issues like gays, taxes, and abortion. It’s a good thing our own high priests have clarified the gospel of prosperity for us. Otherwise we might presume to question the war economy and free-market orthodoxy, instead of more critical issues like contraception and sex.

          2. F. Beard

            It’s one thing to acknowledge that Jesus associated with sinners (How else to save them? And who isn’t a sinner?) but quite another to insinuate He was a sinner. He wasn’t. He challenged His enemies “Which one of you convicts Me of sin? If I speak truth, why do you not believe Me?” John 8:46

            If Jesus was sinner, you can be sure His enemies would have used that against Him. They couldn’t.

          3. reslez

            quite another to insinuate He was a sinner

            How is skinny dipping in the Sea of Galilee a sin?

            Lucky for you that blasphemy against the Son of Man will be forgiven

            Forgiven by whom, you? Or are you speaking for God? Do you think it’s OK for you to speak for God and say what He will or will not do, and wield this like a club against other people in debates? Is it not a rhetorical weapon you are using to (attempt to) win an argument?

            I suggest to you that speaking for God in this way is a vanity. It is taking His name in vain.

          4. F. Beard

            How is skinny dipping in the Sea of Galilee a sin? Reslez

            It isn’t but here’s the complete quote:

            He probably skinny-dipped in the Sea of Galilee too, with his beloved disciples. Just sayin’. Doug Terpstra

            Or are you speaking for God? Reslez

            “Whoever speaks a word against the Son of Man, it shall be forgiven him; but whoever speaks against the Holy Spirit, it shall not be forgiven him, either in this age or in the age to come. Matthew 12:32 New American Standard Bible (©1995)

          5. Maximilien

            @DT & FB:

            “In many of the complexities and entanglement of affairs it is no easy matter to find an answer off-hand to the question, ‘What is it right to do?’ But put it another way: ‘What would Christ have done?’ and lo! there is light! Doubt spreads her bat-like wings and is away; the sun of truth springs into the sky, splendoring the path of right and marking that of error with a deeper shade. Then if you want a nice cool walk you know which way to go.”

            Guess who wrote this? Surprisingly, the godless—but virtuous— Ambrose Bierce in 1891.

          6. LucyLulu

            Can’t resist a little levity:

            “Religion has convinced people that there’s an invisible man…living in the sky, who watches everything you do every minute of every day. And the invisible man has a list of ten specific things he doesn’t want you to do. And if you do any of these things, he will send you to a special place, of burning and fire and smoke and torture and anguish for you to live forever, and suffer and burn and scream until the end of time. But he loves you. He loves you and he needs money.”
            George Carlin

          7. Doug Terpstra

            Thanks for Carlin’s dark humor, Lucy. He certainly sliced thru the BS. Jehovah was indeed a smiteful, genocidal monster, who prescribed certain rules for slavery, rape and brutal means of capital punishment, stoning, for violations of several commandments. The Judeo-Christian legacy is a decidedly mixed blessing that we still suffer today.

            It’s a bit creepy when people set themselves up as arbiters of SIN, like wannabe inquisitors. Even the word carries such dark foreboding, evoking pangs of horrific guilt and the terror of eternal damnation (well it does if you were raised Calvinist, another JC who saw all newborns as “seething sacks of sin”)—all part of the fear-based control that powermongers and moneychangers wield. Rather over the top when the word for sin from original Greek actually translates as “falling short”, shortcoming, or “missing the mark”. As in try to do better next time and in time you’ll find your bliss and purpose, not “burn in everlasting hell for ever and ever amen”.

            It’s tragic that people focus on the codified trappings of faith, the rules and appearances of righteousness, rather than the spirit. Of course, skinny-dipping alone might be alright, but with the disciples? Oh the horror, the horror, it’s just too wicked to contemplate. Why?

          8. F. Beard

            Oh come on! Your implication was that Jesus was homosexual, wasn’t it?

            Heck, men shower naked together (locker rooms) all the time with not a hint of it being sinful. So why even mention skinny dipping unless you were alluding to something else?

          9. skippy

            Funny that you say that beardo…

            Jesus was a Hebrew rabbi. Unusually, he was unmarried. The idea that he had a romantic relationship with Mary Magdalene is the stuff of fiction, based on no biblical evidence. The evidence, on the other hand, that he may have been what we today call gay is very strong. But even gay rights campaigners in the church have been reluctant to suggest it. A significant exception was Hugh Montefiore, bishop of Birmingham and a convert from a prominent Jewish family. He dared to suggest that possibility and was met with disdain, as though he were simply out to shock.

            After much reflection and with certainly no wish to shock, I felt I was left with no option but to suggest, for the first time in half a century of my Anglican priesthood, that Jesus may well have been homosexual. Had he been devoid of sexuality, he would not have been truly human. To believe that would be heretical.

            Heterosexual, bisexual, homosexual: Jesus could have been any of these. There can be no certainty which. The homosexual option simply seems the most likely. The intimate relationship with the beloved disciple points in that direction. It would be so interpreted in any person today. Although there is no rabbinic tradition of celibacy, Jesus could well have chosen to refrain from sexual activity, whether he was gay or not. Many Christians will wish to assume it, but I see no theological need to. The physical expression of faithful love is godly. To suggest otherwise is to buy into a kind of puritanism that has long tainted the churches.


            The most astounding finding from the newly discovered lead codices is that Jesus Christ was unambiguously and openly gay. He and his disciples formed a same-sex coterie, bound by feelings of love and mutual support. There are recorded instances of same-sex activity – the “beloved disciple” plays a significant role – and there is affirmation of the joys of friendship and of living and loving together.

            A whole new complexion is given to that rather puzzling passage where Jesus exhorts his followers to break family ties: “If any man come to me, and hate not his father, and mother, and wife, and children, and brethren, and sisters, yea, and his own life also, he cannot be my disciple.” (Luke 14, 26). It seems clear now that this is less a negative repudiation of family and more a positive exhortation to join in affirmation of a gay lifestyle and love.


            Skippy This >>>>>>>>>>> to the Gay Bar….

          10. Garrett Pace

            “Jehovah was indeed a smiteful, genocidal monster, who prescribed certain rules for slavery, rape and brutal means of capital punishment, stoning, for violations of several commandments.”

            When it came to the treatment of the poor, and a community’s use of resources, the old Law was light-years ahead of us.

            I believe Israel rejected the higher law, and so they got the best one they would accept. It didn’t have to go the way it did.

            “Wherefore then serveth the law? It was added because of transgression, till the seed should come to whom the promise was made…”
            Galatians 3:19

          11. F. Beard

            You know skippy, one of the backhanded compliments to the veracity of the Bible is the innumerable attempts to discredit it.

            And btw, I have loved male friends without ever wanting to have ANY form of sex or even touching.

          12. Garrett Pace


            So Mary Magdalene was just an unconvincing beard? This is a novel idea!

            If the “Black Jesus” movement has taught me anything, it is that people generally have a strong desire to imagine Jesus Christ as just like them, only perfecter. So no big surprise that a pious homosexual might do the same.

            This extends even to my church. Lots of LDS have Nordic blood in them. Look at representations of the Savior in LDS art and sure enough you’ll see a hulking Scandinavian staring back at you.


            At least he’s not blonde.

            I don’t think it’s such a bad thing, though. Even if he didn’t exactly live everyone’s life, someone who died for your sins should be able to relate to you and your experiences, whatever they were.

          13. Garrett Pace


            Here’s the second headline of the “lead codices” article you linked. It qualifies the content a wee bit:

            “What if the newly found codices provided evidence of Jesus’s same-sex activity? Michael Ruse imagines the implications”

          14. skippy

            @”Michael Ruse imagines the implications”

            DUH… that’s what everyone does and has done from the inception of – any – mythology.

            Skippy… anyway no one will ever know, you can’t ask them personally and then they might tell you too… piss off… its personal…. shezzz.

          15. Doug Terpstra

            Thanks, Garrett. That’s exactly the context. I thought the Bearded theologian might have caught that subtlety before launching his homophobic crusade of omniscient righteous judgment.

            That article on the sinny-dipping “scandal” is so Onionesque (how dare he contaminate the holy waters of Galilee) and this thread is a perfect example of how predictably convenient our prurient fixation on sex is for political propaganda; the distraction/diversion button works without fail, as reliably as false-flag war pretexts. It also shows the tragic dissonance trap caused by insistence on the infallibility of scriptures, so inspired yet so rife with contradictions.

          16. F. Beard

            OK Dough,

            I went off 1/2 cocked on the Sea Of Galilee thing. I did see the headline (but didn’t read the story) so I should have caught your nuanced allusion. My apologies.

            It also shows the tragic dissonance trap caused by insistence on the infallibility of scriptures, so inspired yet so rife with contradictions. Dough T

            The more I read the Bible, the more consistent I find it. Example: I read in 1 Samuel (?) that Saul killed himself to avoid capture yet 1 Chronicles 10:14 says the Lord killed him. Contradiction? No, because 1 Chronicles 10:4 ALSO says Saul killed himself. So the Bible can’t keep it’s story straight for 10 verses? Or is the truth that the Lord doomed Saul to death one way or another?

  13. F. Beard

    “If the claim doesn’t hold up of high returns for governmental investors, there appears to be no justification at all for the collateral damage of job losses, underinvestment in portfolio companies, and economy-wide distortions, not only of capital allocation but even of policy priorities as a result of the industry’s attempts to justify itself.” Nanea and Yves Smith

    I notice that the Federal Government is not listed among PE governmental investors. But, of course, the US Federal Government is monetarily sovereign; it has no need for ANY investments except indirect ones in the general welfare of the entire country.

    So why not Federalize all government pensions? Or allow the States to become monetarily sovereign?

  14. F. Beard

    And yes, the tax deductions for debt should go. Usury should certainly NOT be encouraged by government much less, in the case of credit creation, counterfeiting.

  15. Because

    Government sponsers “market economics”. Phfft. Lets get a clue here. It is why Libertarians want to destroy the “government” because it represents the last link to traditional form of social organization. Better having the laws being directly controlled by capital based on market prices. The longer it stays, the more you get risks of another Hitler trying to bring back the pre-christian order. Socialism itself is as much a deevolution as a evolution politically, this fact misses people as well. If you are against capitalism, a good bet you are against Marxism because Capitalism as Marx said, is a critical step to egalitarian utopia’s.

  16. Skeptical

    As Allan Sloan has pointed out, private equity is the new euphemism for what used to be called LBO shops. Most of their business is not spent on seed money for fledging enterprises with growth prospects; it’s to load up an older type of business with the maximum amount of debt.

    Yves, I hope you will have occasion to focus on the overly cozy relationships between the private equity funds and the agent banks in syndicated loans, who are always eager to be awarded the next mandate for the next LBO.

    1. F. Beard

      and the agent banks in syndicated loans, who are always eager to be awarded the next mandate for the next LBO. Skeptical

      Ah yes, the banks who are allowed to use their helpless depositors’ money to destroy their jobs with.

  17. Doug Terpstra

    This post dovetails seamlessly “The Coming Rentcropper Society”, evidence of shock doctrine synchronicity.

  18. Phichibe


    Let me just compliment you on the fact that you start by defining terms. In math, physic, and the hard sciences no discussion of complex ideas begins before a definition of terms. Bravo.

    I have thought for years that much of the “3 card Monty” aspect of modern finance is due to the fact that the hucksters coin a new term as soon as its predecessor gains a (deservedly) bad odor. Private equity, VC, hedge funds, etc, are all just pools of capital aggregated to make wealthy people even wealthier. The sooner we stop accepting their obfuscations, the sooner we can start to reclaim the financial system and put it under control. Yves’ suggestion of the “North Dakota” inspired regulated utility appeals to me, not least because it would cause a NY real estate crash and I’d love to see Mort Zuckerman have to sell his commercial empire for pennies on the dollar.


    1. LucyLulu

      If I understand correctly, tax code reform, with loss of debt interest deductions, would go a long way towards discouraging these type of financial schemes.

  19. Jim Haygood

    ‘There is substantial academic evidence that private equity net returns consistently underperform lower risk public market alternatives.”

    David Swensen, who manages Yale’s endowment, says the same in his book Pioneering Portfolio Management (pp. 224-229):

    Consider two decades of buyout partnership returns. For funds formed beginning in 1985, limited partners received a disappointing 7.3 percent median return. In contrast, the S&P 500 delivered 11.9 percent returns. First quartile buyout results reach double digits with a 16.1 percent per annum result, while third quartile performance falls into negative territory at -1.4 percent per annum. The median buyout result compares unfavorably to the marketable security alternative.

    Steven Kaplan of U. of Chicago and Antoinette Schoar of MIT Sloan School, in an August 2005 study on private equity performance [from 1980 to 2001], conclude that “LBO fund returns net of fees are slightly less than those of the S&P 500.” Because the authors make no adjustment for leverage, the failure of LBO funds to match stock market returns adds the insult of higher risk to the injury of poor performance.

    Investors in buyout partnerships received miserable risk-adjusted returns over the past two decades. On a risk-adjusted basis, marketable equities win in a landslide.

    Buyout managers deserve scant incremental compensation for adding debt to corporate balance sheets. By paying buyout partnership sponsors 20 percent of all gains, fund investors compensate the fund managers with a significant portion of leveraged market gains over which the fund manager exercises no control and for which the fund manager deserves no credit. The large majority of buyout funds fail to add sufficient value to overcome a grossly unreasonable fee structure.

    Investors [such as Yale] justify the inclusion of private equity in portfolios only by selecting top quality managers pursuing value-added strategies with appropriate deal structures.

    What private equity does accomplish for public pension funds prohibited from using leverage themselves is to subcontract the dirty job of levering up, doubling down, and hoping for a big, lucky win.

    The Capital Assets Pricing Model says unequivocally that pension funds would be better off levering up their own efficient portfolio, and avoiding private equity fees. But since that’s legally impossible, they employ marginally respectable workarounds such as private equity, usually to the detriment of beneficiaries.

  20. ella

    Wonderful in depth analysis. But for those of us who want the points it is far too wordy. I suggest one summary paragraph per section either as the intro paragraph or conclusion paragraph. Those pararaph give the reader the poinst of the sections and then the reader can choose to read the supporting analysis for more in formation.

    Such a structure enocurages those of us with limited time to read the vital information on private equity funds that the articla imparts.

  21. pathrik

    This is great information yves- on an industry few actually take the time to examine. Will look forward to the future posts.

  22. rf

    How the heck are these government funds? We are talking about pension funds investing in PE? The money is not the government’s its the pension fund’s aka the pension fund participants’. There are trustees who decide on how those funds are invested so your complaint is with them if you believe that PE is a bad investment.

    Soveriegn wealth funds are set up to make money so they decide how to allocate their capital to make more money. Same thing…if you think PE is a bad investment then become a pension or sov wealth consultant and tell them why.

    I could care less about PE and maybe it is a bad investment but your logical extension makes no sense to me that PE is a GSE.

    Just say what you mean. Romeney bad, PE bad, made money bad, rent seeker bad, couldn’t do it without government.


      Jim Haygood,

      Don’t give me any of that Capital Assets Pricing Model bunk. More innocent people have been harmed by Efficient Market Theory than with guns.

      Hmmmm! Maybe sponsor me some laws against tawdry economic theories…

      1. rf

        This is not an MPT agruement, I’m not the dumbass paying Bain 2/20 and MPT doesn’t make sense for a pension fund anyway (its a steam of cashflows like a bond) but they are not a GSA by this arguement. Makes no sense.

    2. Yves Smith Post author

      With all due respect, it appears you have a reading comprehension problem. The post was very clear on this point. So called “public” pension funds, those for state and municipal employees, are overseen by state officials. And if the pension returns fall short, the state/municipality has to make up the shortfall.

      1. F. Beard

        So called “public” pension funds, those for state and municipal employees, are overseen by state officials. Yves Smith

        A potential conflict of interest. What if the pension funds activities that are harmful to the state or municipality?

        And if the pension returns fall short, the state/municipality has to make up the shortfall. Yves Smith

        States and municipalities, being non-monetarily sovereign, are in no position to offer defined benefit plans but they could offer a “profit sharing plan” whereby retirees receive a fixed percentage per retiree of tax revenues up to some generous cap, I suppose.

      2. rf

        I see, insult anyone who disagrees. Again, pension money to PE makes no sense because pension benefits are clear cashflows that can be hedged with fixed income. Only in the case of a pension surplus would alternatives make some sense or to hedge the tail end liabilities that would be small as a percentage of the fund assets.

        Even if you don’t believe that and want to buy equity or PE the stretch is that anyone the trustees hire to invest the money is somehow a GSE. They are a vendor and not responsible to the pension’s level of funding unless they represent that and manage the entire pension. Is a construction company hired to build a road a GSE because they take a government contract? Maybe by this logic, but then write about construction companies as well as PE. I suppose you would if Romeney ran a construction company in the past…

        It’s not the fault of PE for pension shortfalls its the fault of trustees and their consultants who suggest asset allocation that fails to keep up with pension liablities. Also, the legal responsiblity was created by politicians who may not have considered what their tax base could afford.

  23. bbb

    There seem to be 2 claims here:

    1. public pensions should not invest in PE on ethical grounds, because they are bad for society.

    This kind argument is very hard to prove in general. Anecdotal evidence is not helpful to support generic statements like this… But let’s see what you have there.

    2. they should not invest in PE because of crappy returns.

    But they do, so why, if the returns are so crappy? If this is such poor investment, then who are the fools investing the other 50% of those trillions? While the industry may use favorable metrics, the fund managers are going by standard performance metrics, so how does that help them?
    I’m looking forward to seeing more evidence in support of this, but let me venture with a very mundane explanation of what you’re describing: in the early days of PE (when was that? – probably junk bond days?) PE offered lucrative returns. As time went by, more and more players jumped in, public pension funds including. As the field got more crowded, returns decreased. This is where we are now. Exit by public pensions en mass will create a slack that somebody else will pick up. This is how markets should function, right?

    1. Waking Up

      See the following comments above by:

      Dikaios Logos, August 21, @ 1:21 p.m.
      Jim Haygood, August 22, @ 8:30 a.m.

    2. Yves Smith Post author

      First, you have the order wrong.

      1. They fail at their entire raison d’etre, which is superior returns.

      2. The second claim is not ethical. It sounds as if you are using the term “ethics” to dismiss the idea that PE fund managers engage in looting and asset stripping. Economists, hardly known for being ethicists, have discussed this problem a LONG time, see in particular the work of George Akerlof and Paul Romer on looting.

      PE produces what economist call an externality, which is a cost imposed on third parties (ie, neither the buyer or seller, which in this case is the PE fund and the fund investors) in the form of higher bankruptcies and unemployment. That results in losses to the community (lower tax revenues, falling property values due to more foreclosures, more costs to bankruptcy courts, losses to lenders to the bankrupt company).

      Google “externalities” and then we might have an intelligent conversation.

      1. bbb

        Um, I don’t understand your beef with the word ethics… or why the order matters. I don’t think you’re saying that if they did have great returns, their existence would have been more justified, looting and all.

        Regardless, I’m looking forward to reading further expose on PE and understanding how the looting comes about, and how a vast majority of PE firms are engaged in it. This post has nothing about it, so no need to get defensive or jump ahead of yourself.


      In short, it is the destruction of wealth of the many for the benefit of the few.

      You good with that?

      1. DANNYBOY

        i need to correct myself here, should read:

        In short, it is the destruction of the well-being of the many for the benefit of the few.
        I mean, who do you know with any Wealth? (I’ve got to stop using those MBA, Finance, Wall Street, Gov’t words, and must, must get them out of my memory.)

        I want my well-being back.
        You good with that?

  24. john

    Thanks for making the point government spending is out of control. Looks like public employee pensions funds are most of this government “funding”. In other words the money comes from taxpayers. Epic failure liberal. go back to Econ 101. your obviously failed

  25. Dude

    I like the attempt to educate people on this market, though I do feel its a little misleading in calling it a gov’t-sponsored, despite understanding the point you are trying to make…

    Pensions CHOOSE to give money to PE, it is not the result of some special excpetion from a law which they lobbied for. Funds come and pitch pensions, they are not required to invest but invest where they (or their consultants) see fit based on…..whatever.

    Please differentiate between mega buyout funds and the rest of the PE space because the two are vastly different and you create a misleading stereotype of all PE when you really mean the handful of mega LBO funds which control a large portion of PE assets.

    Part of the problem is also that these public pensions are so large that they have to make huge commitments and the only funds which can take that much money are the mega funds. Any suggestions Nanea? Forced reduction in PE allocations?

    Local papers love scandals, if you know of a local company owned by PE with job cuts and find your state pension is invested in that fund, tell the paper/local news

  26. Elizabeth

    For more on Mitt Romney’s Mafia-style “bust-out” of American businesses, check out the current Rolling Stone magazine. Matt Taibbi’s latest expose’ of this sociopathic as**hole is one of his best. There’s also an informative side piece about how to blackmail the FDIC for fun and profit, also as demonstrated by Mr. Romney. Imagine running a bankrupt company and threatening to give big bonuses to your executives, blowing up the whole enterprise, if the FDIC doesn’t settle your bank debt for 30-35 cents on the dollar. And it’s all in the contract and perfectly “legal.” As Tony Soprano would say, Bada-bing!

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