Memo to the Private Equity Growth Capital Council: No One Outside Your Echo Chamber Believes Your Big Lies Any More

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.

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  1. participant-observer-observed

    Great work-definitely a public service….let’s NOT see how far pensioners would get on hot air returns!

    1. participant-observer-observed

      This one from January 8-14 issue of China Daily/Asia Weekly:

      Banks top share buyback on SGX
      Companies listed on the Singapore Exchange (SGX) bought back S$2 billion ($1.4 billion) of their own shares in 2015, according to a SGX report released on Jan 4. In December alone, 66.6 million shares were repurchased by 38 stocks for a total consideration of S$63.1 million, the report said.

      Banks were among the biggest buyers of their own shares, according to the bourse. The top five buyers of their own stock in December were United Overseas Bank, PEC, DBS Group, OCBC Bank and Pacific Century Regional Developments.

  2. Clive

    Even their name is a tell. “The Private Equity Growth Capital Council” shares the same oxymoronic quality as “The Democratic People’s Republic of Korea”. Neither of them actually lives up to the claims which they make in their titles. In reality, they are the exact opposite of what they say they are.

    1. flora

      “The Private Equity Growth Capital Council”
      Did they get the name from a Bird and Fortune skit?

      Paar: We invested because they’ve got a very good name.
      Interviewer: You mean they have a good reputation?
      Paar: No. The name itself is very good. ‘Equity’, that’s a good word. And ‘growth’. That’s a very good word.

  3. Ishmael

    Since most PE investments are LBO’s and thus by definition leveraged to their ears, just imagine what those PE returns would have been if Bernanke and Yellen had not destroyed the private saver to refloat the leveraged world. I will tell you — zero!

  4. Assolonius

    Let’s ease up on the Calpers remarks, that whole subject has grown very long in the tooth and despite the headlines, videos, press they are well intentioned.

    I’m sure there are other subjects worth opinining on at this point-

    1. Sluggeaux

      Given that the recent former CEO of CalPERS is currently pending sentencing for conspiracy to defraud the fund, while “cooperating” with the Feds, I think that there is still quite a bit of doubt about CalPERS being “well intentioned” when staff and the oversight board have not had significant turnover since his departure.

      Rhode Island is not an outlier. The intentions of CalPERS top staff appear to be aligned with the PE industry’s “divine right to investor money” that seems to be driving a willingness to blindly abandon oversight of billions of dollars in deferred public employee compensation, the loss of which will have to be back-stopped by the taxpayers if the hidden investments turn out to be dreck.

    2. Yves Smith Post author

      1. CalPERS is widely seen as the model for other public pension funds and investors generally. They get media attention way out of proportion to their size as a result. And they are also way better staffed in private equity than anyone else. So it is entirely fair to use them as an example, as in “it does not get any better than CalPERS among public pension funds.” And I am not kidding when I say that public pension funds should not be accredited investors. They don’t have the expertise needed to invest in products like hedge funds and private equity funds. That trustee letter to the SEC was proof.

      2. It is hardly unreasonable to refer to prior work when it supports a point we are making.

      3. I assume you were not around in 2010. We were also posting very regularly on mortgage issues, much more so than on PE. This is what it takes if a site like this is going to puncture the mainstream narrative: relentless, well documented and argued coverage.

      4. I don’t care about intentions. I care about actions. “Well intentioned” is too often an excuse for cowardice, inertia, intellectual laziness, or worse. Does anyone doubt that Ben Bernanke and Janet Yellen are well intentioned? You could similarly argue that even Greenspan was well intentioned, since he sincerely and devoutly believes in Ayn Rand and has applied her principles religiously. By your logic, we should also give them a free pass. Per a terrific article by JW Mason on the Fed, Bernanke and Yellen have managed to convince themselves that keeping workers fearful about their job prospects is good for them:

  5. nat scientist

    Thanks to the internet and the memory hole sites, lots more secrets of great fortunes without apparent cause, are exposed rather than forgotten, however expertly-done. (h/t the digitally-enhanced Honoré Balzac)
    Huuuuge profits; noooo widgets anywhere but cash withdrawn from the scrum in the fog of perpetual wars; the greatest laundry for cash done the private way, done over there. A casino that needs send out no public winners is a private scam, blessed by the well-dressed regulators. Following the narratives of justification enters the labyrinth controlled by the minotaurs of sponsored-media on the largest screens, disturbs the toddlers of all ages crawling in ignorance of the real rapacious game. The dinosaurs outside the cave are scary indeed until one develops self-content and silences the messages of far-away dreams and fake retail fears of imagined crimes and unnecessary approvals.

  6. rich

    Fortress Investment Group’s Ghoul-like Returns

    32 Advisors website shamelessly reveals the ways politicians and public servants cash in after leaving government. They profile how the big money boys hire political insiders, who subtly direct them to industries experiencing major disruption. In this case 32 Advisors highlights Austan Goolsbee’s turn at the till.

    Through a contract with New York City-based consultancy 32 Advisors, Austan Goolsbee has held conference calls most Fridays since February 2013 with employees of large hedge fund firms Fortress Investment Group, York Capital Management, Perella Weinberg Partners, SkyBridge Capital and others.

    Fortress Investment Group is the only publicly traded company in the group. How has Fortress’ stock performed since Goolsbee began advising them? Fortress (symbol FIG) closed Friday at $4.65 per share. The size of the loss depends on which Friday Austan started.

    February 1 – Close on 2-4 of $5.53, loss of 88 cents per share or a 16% decline

    February 8 – Close on 2-11 of $6.32, loss of $1.67 or a 26% drop

    February 15 -Close on 2-18 of $6.15, loss of $1.50 per share or 24% loss

    February 22 – Close on 2-25 of $6.39, loss of $1.74 per share or 27% decline

    Austan Goolsbee helped Fortress achieve ghoulish returns.

    The big money boys are happy to pay retired political ghouls for insider connections, because that’s the way work gets done in Washington. Note that Goolsbee is advising Perella Weinberg, once cited by President Obama as speculators holding up efforts to save Chrysler. Yet Obama reformed the healthcare landscape for those very same speculators.

  7. west

    Does anyone know how many companies these companies own or what their revenues are? Do they even share this basic info with the pension funds?

    1. Jim Haygood

      Shhhh! Just between us:

      Disclosure of detailed portfolio company information as best practice is based on the assumption that this information will be kept confidential.

      Often, public investors and others subject to Freedom of Information Act (FOIA) laws may not receive as much detailed company information as other investors since they may not be able to guarantee its confidentiality.

      [quoted from page 62 of the chapter “Limited partner financial reporting” beginning on page 59]

      So it’s quite possible that public limited partners are receiving “dumbed down” quarterly reports, compared to private LPs.

      How would they even know? They don’t!

      1. west

        Thanks. That is what I thought. GTCR which was Rauners( now gov disaster capitalism of Illinois) does list their companies on their website. I have never heard of any of them ,nothing financial . To be honest they all say they provide solutions to things. From what I have seen here they might be a collection of thin air. Like you said Jim..How would the investors know?

  8. susan the other

    end of road rationalizing. Private Equity Stealth Bail-in Council. Private equity puts on the masquerade of restructuring a business when its hopeless – just to skim some big fees – and they are enabled by the whole finance “structure” – it’s finance, as we all know, that needs a little restructuring. A blurb on ZH today to do with the contradictions in the EU – they are all for “protecting tax payers” from bailing out the banksters so they are making shareholders and depositors do the bailing but it has begun to dawn on them that this will not cure the problem because the banks just keep going along their merry way and soon will find themselves in need of moar. I wonder how long PE will continue with their business model? Do they have PE enterprises in China? Is that why their debt levels have gone to the moon?

  9. flora

    Great post. Thank you.
    More newspaper magazine articles are debunking the PE claim to greater returns. When compared to the risk adjusted returns they ought to generate it’s clear they fall short. Now the PE world is pushing back. “First they ignore you, then they laugh at you….”

    Thanks very much for your continued PE reporting.

    1. Jim Haygood

      I love that “5-Year Risk-Return” chart on page 25 of the Rhode Island report.

      Volatility of public equity (stocks) is shown as 12%, a bit below the long-term average of 15%.

      Meanwhile, leveraged private equity is indicated as having half the volatility of public equity, at an absurdly low 6%.

      Can you say “valuation smoothing”?

      This particular Big Lie is gonna blow up in their fool faces, sooner rather than later. Leveraged equity does not trade at 6% volatility — not in this solar system.

      1. Yves Smith Post author

        Oh, I know, and thanks for bringing that up. I didn’t get to that here, and I can only address the issue of PE phony valuations occasionally because the posts on PE tend to get long due to how much space is needed to debunk the party line. PE is levered equity. It should therefore fall more in a bad stock market than stock indexes. Yet mirable dictu, PE defies financial gravity! It never falls as much as stocks, or so the GPs that supply the valuations say.

        And the worst is that most PE investors are not SO dumb that they don’t get what is going on, that they are using fake accounting that does not represent the actual economics. Go look at the clip from Bob Maynard in this post, where he makes clear that the phony reporting is a feature, not a bug, from the LPs’ perspective:

        1. Jim Haygood

          Public equity returns with half the volatility. It’s like … financial alchemy!

          Meanwhile, as markets melt down, the IPO window (the only exit from the crowded private equity ballroom, where the fading holiday decorations just caught fire) has slammed shut. It started back on October 15th:

          Albertsons’ initial public offering has been delayed indefinitely.

          Goldman Sachs, which was the lead underwriter on the IPO, declined to comment for this story. Albertsons’ private-equity owners, Cerberus Capital, also declined to comment.

          Troubling. We may have to mark down the 1Q 2016 valuation by 2 percent or so, just to acknowledge that we’re mindful of correlations and such.

        2. Ishmael

          Talking to a PE and valuation firm about one of their client companies which had a track record of practically zero EBITDA I asked, and “how did you come up with that valuation.” They almost did not say because they were afraid I would burst out laughing!

          1. west

            Valuation of any privte company is tricky. Forbes compares to similar public . Most small business seem to be not much more than the owners salary. I looked at sub s tax return data. I averaged officer wages divided by 3 for a conservative average . 3 was the ave shareholder number. I divided by 3 again for the profit. Between both I found a decent wage but not a lot of business value. Seaz valued sub s corps at 2 trillion. Prive business is about half of business revenue and unlike public companies mosltly US. Maybe Yves might want to have a topic on this someday. Is half of American business worth a lot or a little?

  10. Oregoncharles

    ” the most basic principle of finance, that rewards from investing should be commensurate with risk.”
    And there, I suspect, lies the rub. Has ZIRP made it impossible to follow that principle? Remember, their fixed-income yields in low-risk bonds must be very low. I know that the Oregon pension fund, some years ago, had made return commitments they could not keep. Even without that, their pension commitments depend, to some degree, on the returns they can get.

    So it seems to me they’re ignoring that basic principle because they have to; they have to find higher returns somehow, and private equity may be only investment that even pretends to provide them. Of course, they wouldn’t want to admit that, so they’re lying about it.

    But it’s Yves that’s been doing the research; does this theory make sense?

  11. John Wright

    I suggest that if PE could have a higher rate of return because it is effectively taking advantage of the US Government’s tax system.

    As I remember the story, a young Michael Milken was at Penn undergrad and a professor mentioned in class that many corporations could service a lot more debt, but no one could borrow enough money to buy their equity.

    Milken was inspired and the LBO was born afterwards. Eventually LBO was euphemized into “Private Equity”.

    Conceivably, PE could have higher returns, due to pretax deductions for interest on new debt if PE shareholders are convinced their investments’ higher returns compensate well for the higher risk.

    In a sense, corporate America’s balance sheets have been “mined” for LBO opportunities since MIlken’s time.

    One would expect the good PE opportunities to eventually go away as corporations all lever up.

    This has happened in many companies, I worked for Hewlett-Packard for 20+ years and when “Bill and Dave” were alive it was communicated to the troops that H-P had enough business risk that they didn’t want financial risk as well, so H-P had very little debt and self-financed growth.

    And, contrary to current practice, H-P did not exactly rush to have an IPO. The company was founded in 1939 and the IPO occurred in 1957.

    One can now observe HP as it follows a death by acquisition/divestiture future.

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