The unpleasant task of telling a propaganda outfit, um, think tank, that it needs to up its game has fallen to your humble blogger. Specifically, the private equity industry’s official mouthpiece, the Private Equity Growth Capital Council, has taken to issuing such howlers that it is rapidly losing credibility. A think tank with no credibility is of no use to its backers.
The Private Equity Growth Capital Council’s one and only one public relations strategy is The Big Lie. When confronted with a well-documented case against its sponsors’ interest, it responds with the loudest and most brazen statement of the opposite viewpoint. We have an object lesson that we’ll turn to shortly, its laughable response to an International Business Times story on the Rhode Island pension fund.
This “bluster it out” strategy is popular in private equity. The few times professionals working for private equity firms have deigned to deal with me, they have, without exception, said things that are demonstrably untrue, as if the fact that someone from private equity was speaking meant of course the remark would be accepted as gospel. For instance, I had a Bain flack assert something that was flatly contradicted by Bain’s SEC filings.
But what the Private Equity Growth Capital Council fails to appreciate is that Reich Minister of Propaganda Joseph Gobbels could use the Big Lie quite effectively because the German government controlled communications within Germany. Big Lies work only if you have a large share of voice (as they now call it in the trade) and weak enough opposition that you can drown out competing views. But in the world of messaging, the Private Equity Growth Capital Council is a pipsqueak. And thanks to the SEC exposing private equity misconduct and journalists getting further down the curve about how private equity really works, unsupported and worse, patently false assertions not only don’t cut it any more, they diminish whatever credibility the messenger had.
If you’ve read mainstream media stories on private equity over the last year, you can infer that the Private Equity Growth Capital Council is the go-to when the journalist needs some sort of remark from the other side and the private equity firms are being close-mouthed, as they are generally wont to do. But their comments all seem to come from such a short list of prescribed themes, and are so firm in their refusal to acknowledge all the dirty laundry about private equity that is in the public domain that it comes off like a time warp, as if one of the prelates who’d tried Galileo for his heresy of saying the earth revolved around the sun was still confidently expounding his case 100 years later.
The latest miscue comes in the apparently-obligatory attack on David Sirota for daring to question Rhode Island’s investments in private equity. The Private Equity Growth Capital Council managed the impressive feat of having each of the four key sentences of its rejoinder, featured at close to the end of a Politco newswrap, be flat out falsehoods or so misleading as to be the functional equivalent. From Politico:
PEGCC RESPONDS TO IBT — Via the Private Equity Growth Capital Council: “David Sirota’s story on Rhode Island’s pension misses the mark on several key fronts. Pensions, just like all other private equity limited partners, are sophisticated investors which negotiate their limited partnership agreements line-by-line. This transparent arrangement creates an alignment of interests which leads to strong returns.
“In fact, The Rhode Island Statement Investment Commission’s report shows private equity outperformed the total portfolio on a 1-year, 3-year, and 5-year basis, net of fees. Further, private equity is the top performing asset class for large public pensions, net of fees, over the long-term.”
The first claim, starting with “Pensions,” is ludicrous. First, public pension funds aren’t sophisticated. We’ve seen that with CalPERS, the best of the breed. Senior staff have demonstrated that they don’t understand basic features of private equity agreements, like the economics of management fee waivers and whether the general partners really have incentives that are aligned with those of the limited partners.
The fact that trustees of many of the biggest public pension funds in the US wrote the SEC asking for the agency to intervene on behalf of their funds in private equity says that they recognize that the public pension funds are badly overmatched. Moreover, as we pointed out in a Bloomberg op-ed, this call for SEC oversight was an admission that these funds are not skilled enough to be treated like accredited investors, which are presumed to be rich enough or savvy enough to take a walk on the wild side as far as risk is concerned.
It’s also flat out untrue that the limited partnership agreements are negotiated “line by line.” It appears that the staff of the Private Equity Growth Capital Council have never read through any, much the less many, limited partnership agreements, unlike Oxford professor Ludovic Phalippou, who has examined over 300. His conclusion? They are “take it or leave it” agreements. It’s well known that to the extent negotiations take place, it’s on a few headline items, like the management fee offset percentage, and most certainly not on the dense language where the real artwork lies. On top of that, as CalPERS pointed out in its private equity workshop last November, the GPs take the position that they will not retreat on language that has been in previous agreements; they present a black-lined version and argue that since the LPs accepted certain language in the past, they can and should expect to continue to live with it. As CalPERS summarized the issue: “Very difficult to change terms LPs agreed to in previous LPAs that are pro-GP.”
However, the Private Equity Growth Capital Council outdoes itself with its next claim, which is basically a word salad of pet terms that the private equity industry loves to banter about, well save maybe “transparent” which looks to have been shoehorned in out of perceived necessity. We’ve got the hoary chestnuts of “alignment of interest” and the dubious claim that financial results are good asserted as a result of the negotiation process. Since the CalPERS presentation on private equity contracts makes clear that the process is one-sided, that the limited partners are divided to begin with and the general partners are skilled at playing off those divisions, pray tell how can the limited partners expect the agreements not to be anything other than one-sides, which in fact they are? For instance, the limited partners have broadly indemnified the general partners. That means they’ve sloughed off having a fiduciary duty to pension fund beneficiaries when the pension funds themselves have a fiduciary duty to them. That’s one of many examples we’ve cited where limited and general partner interests are clearly not congruent.
And the “transparent” assertion is ludicrous, an insult to the reader’s intelligence. Private equity is the most secretive industry outside the surveillance-industrial complex. Private equity agreements are the only contracts that state and local governments enter into that are shielded from public scrutiny all over the US. And if the Private Equity Growth Capital Council is merely trying to claim that a multi-party contract negotiation has some sort of special status, any corporate lawyer could quickly disabuse you of that notion.
Now we get to the Private Equity Growth Capital Council trying to perpetuate the canard that private equity performance by public pension funds over the last decade has been attractive. Not only does Rhode Island hew to the widespread pattern of private equity not earning enough to compensate for its risks, Rhode Island is a poster child of particularly poor performance relative to its own benchmarks. Private equity fell over 150 basis points below Rhode Island’s private equity benchmarks for the last 10 years, a stunning 500 basis points short for the last 5 and 3 years, and was still below the benchmark even over the last year. And keep in mind that these lackluster results are taking place when private equity deals are being done at peak-of-cycle multiples. There’s nowhere to go but down in light of Fed tightening.
As for the Private Equity Growth Capital Council’s effort to finesse the elephant in the room, by trying to make private equity results look better than they are by comparing them to the much-lower risk overall portfolio results, Elieen Applebaum, co-author of the landmark book Private Equity at Work, decided to offer a wee tutorial, since lobbyist’s staff is obviously in need of one:
Let’s see if we can help the PEGCC understand the most basic principle of finance, that rewards from investing should be commensurate with risk. Perhaps a simple example will help.
Consider an individual whose fixed income portfolio consists of 10-year Treasury bonds, 10-year AAA-rated corporate bonds and a high yield mutual fund (junk bonds). The yield on junk bonds is about 8%, but the individual expects some to default and some to provide a high return. A return of 5 to 6% on the high yield mutual fund will provide a risk premium of 2 to 3% over corporate bonds to compensate for the extra risk. The median annual yield over the last 5 years on high yield funds is 3.84% . Clearly, the high yield mutual fund has the highest yield and enhances the overall performance of the individual’s fixed income portfolio. But a return of about 1% over the return from high-rated corporate bonds is clearly not commensurate with the risk, and few who knew this would be inclined to make this investment. Not many investors would want to take the risk of investing in junk bonds for this meager return.
The situation is much the same for risky private equity investments. Using the superior PME measure preferred by finance professors, the median PE fund yields about 1% above the return from investing in a stock market index, well below the 3% risk premium most pension funds are looking for. Many perform far worse than this.
In fact, Applebaum’s view is so widely shared that even experts hired by limited partners, who have incentives to say what their clients want to hear, will not go near the returns garbage barge that the Private Equity Growth Capital Council is trying to float. For instance, Harvard Business School Professor Josh Lerner said at CalPERS’ workshop that private equity outperformance was so modest that it was not worth investing it unless you could be in top quartile funds (we’ve debunked that idea repeatedly; see here for an example). Similarly, Andrew Junkin of Wilshire Consulting said at CalPERS’ last board meeting that the benchmark for private equity needed to be at least 300 basis points over the relevant stock index; otherwise, “I don’t think private equity is worth it.”
In fact, the mainstream media no longer buys the Private Equity Growth Capital Council’s tired patter. For instance, the Los Angeles Times published a story in November titled, CalPERS fee disclosure raises question of whether private equity returns are worth it. In a sign of how much skepticism of private equity has grown, a heretofore stalwart backer of private equity in academia, Steven Kaplan of the University of Chicago, gave only a very cautious endorsement in this November story.
I know I should be delighted to see the Private Equity Growth Capital Council destroy what little brand equity it has by persisting in an obviously out-of-date and increasingly counterproductive messaging strategy. But I also believe that even having given fair warning, that the private equity industry is so convinced of its divine right to investor money, and that both investors and the public are bedazzled with their star power and easily fooled, that there’s no need to change course. So expect more hefty doses of hollow talking points and bogus factoids.