Private equity shills are readying the Blame Cannon for the industry’s widely forecast fall in returns.
Who are the allies of the private equity firms attempting to villianize as the cause of deteriorating performance? Not the 0.1% Masters of the Universe, who are always and every the sole cause of Good Things but never never to be found when Bad Things occur. No, it’s those evil “populists” interfering with the proper operation of the world according to private equity that is messing up returns.
We’re not making this up. From the Wall Street Journal:
The rise of “populist” politicians in western nations could challenge the ability of private-equity firms to do business and make money, according to a report from Hamilton Lane, one of the largest advisers to investors in the industry.
The backlash against globalization may cause higher taxes on private-equity firms, create more regulation, drive more volatility and restrict economic growth, Hamilton Lane’s annual review said.
This is utterly ludicrous if you’ve been paying attention.
From the first half of 2015, the average EBITDA multiple for PE purchases was over 10X, higher than the peak of the last cycle, in 2007. Even limited partners who are leery of saying a bad word about private equity, like CIO Chris Ailman of CalSTRS, described PE acquisitions as “priced to perfection”. The trading prices of the private equity firms that are public shows that equity market investors believe that private equity firms will not earn any carry fees over the next couple of years.
And as we’ve pointed out repeatedly, since the second half of 2015, senior officers of prominent private equity firms have increasingly been warning that private equity returns going forward will be lower than levels of the past. And none of them used Putin, um, Trump, um populism as the excuse for why returns were going to decline.
Hamilton Lane has more reason than most to blame private equity’s declining fortunes on external forces rather than the obvious factors of too much money chasing too many deals, and if the Fed ever pulls it off, rising interest rates being particularly punitive to high risk strategies like private equity, which is fundamentally levered equity. As we’ve pointed out, private equity has doubled its share of global equity from 2005 to 2014.
Hamilton Lane is not just a consultant to private equity; it is deeply conflicted by virtue of being a private equity fund of fund manager, which means it needs to play nice with the general partners in order to maintain access to funds. And the limited partners it has advised on private equity need excuses they can take to their boards and broader constituencies when private equity returns fizzle. So it’s easy to blame those nasty anti-capitalists rather than admit that private equity has always been a cyclical play and the end of a cycle is nigh. In fact, it should have occurred after the 2007 deal frenzy, but private equity was an accidental beneficiary of central banks’ “rescue the financial system” emergency operations, and got a stay of execution.
In a sign that the public is getting smarter about private equity, 80% of the comments on the Wall Street Journal story were not buying what Hamilton Lane was selling. The other 20% were general criticism of populism rather than votes of support for private equity.
This skew should not be surprising given some of the strained claims Hamilton Lane made. Notice in the quote above that the first, and presumably therefore the most important problem for private equity was “higher taxes on private-equity firms,” which almost certainly refers to closing the carried interest loophole. But readers are supposed to believe that that would dent their ability to make money for investors, when those investors are almost without exception exempt from US taxes.
Now some private equity industry members have stomped their feet and said they’d quit if they had to pay more taxes. It’s hard to take this hissy fit seriously since there are not other lines of work in which they’d earn remotely comparable pay even with a bigger tax bill. At the largest firms, the typical annual pay is eight figures, and for the top dogs at big and some medium-large funds, nine figures.
And it’s not as if “talent” makes as much of a difference as the general partners would have you believe. Industry data shows that no one has a secret sauce. Top quartile funds are less likely to perform well in the next period then by chance. An investor in private equity should stop wasting time picking winners. They should try to avoid crooks and otherwise attempt to index.
So who might leave the industry if anyone? The departures are more likely to take place at the smallest funds or ones with mediocre performance, since the difference in tax treatment would have a bigger impact on the ability of the principals to maintain what is perceived to be an adequate lifestyle.
Ironically, thinning out the marginal players is if anything likely to be salutary for industry performance. With too much competition for deals, the winning bid is often made by someone who is desperate to win a deal (as in their investors perceive them to be too slow at putting money to work) or not well informed.
But the Hamilton Lane whinge is a harbinger of the sort of excuses you can expect to hear from both general partners and limited partners over the coming years, the tired old “whocoulddanode?” in new garb.