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The transcript below has been edited to improve readability.
Introduction
While the broader private equity industry is seemingly united in its continuing push around ‘democratization’ and ‘evergreen’ funds, we believe the real story about the best way for individuals to access the Private Markets has yet to be written. In this dynamic discussion, William Kelly, CAIA (CEO, CAIA Association), Andrew Akers, CFA (Senior Quantitative Research Analyst, PitchBook Data, Inc.), and Dan Harms (CEO, Third Wire Asset Management) challenge the industry’s conventional thinking and explore the future of private equity.
From the complexities of transparency and fee structures to the critical task of finding a meaningful performance benchmark, this conversation gives listeners a fly-on-wall view into a conversation about an analyst note written by Andrew and published by PitchBook Data, Inc. earlier this year. While the title caught our attention—Taking the Private Out of Private Equity—it seems to have gone largely unnoticed by the usual industry pundits.
Thankfully, Bill, Andrew, and Dan took some time before Thanksgiving to bring us all up to speed on the current influences driving the industry while also providing some innovative ideas to help shape its future. Here’s our chance to catch up on their latest thinking!
Daniel Harms
Hi there! I’m Dan Harms CEO of Third Wire Asset Management, and I’m here with William Kelly CEO of CAIA and Andrew Akers, Senior Quantitative Research Analyst at PitchBook.
We’re here to talk about private equity in general and we will ultimately drill down to some research that Andrew produced earlier this year that is noteworthy and potentially very impactful to the industry.
So let’s start with sort of a lay of the land where private equity is, the current states as it affects financial advisors, family offices, and institutional investors alike.
I guess from an educational perspective it would be best to start with Bill. We don’t need to get into the basic 101’s of private equity but, I guess, what’s the allure—or what is being pushed as the allure of private equity—and then we can talk about what it is and what it isn’t.
Back when PE was an awesome asset class.
Topic: Current State of Private Equity.
William Kelly
Yeah, no, it’s great and thanks for having me, Dan and Andrew. Look forward to learning more about some of the research you’ve done. I find it very interesting and fascinating and maybe a good way forward.
So I don’t think we have to go back very far to the origins of the endowment model. When I began my career, there were 24 private equity general partners in the entire world.
So back then, private equity was an asset class—and an awesome asset class. Any one of those 24 GPs probably had nobody bidding against them, asymmetric information, and the big endowments and foundations of the world would be able to look at the liability side of the balance sheet, recognize that the capital call in any one year might be 5% and why not match to the duration of what’s being called with what is out in the marketplace. And you can think about the sourcing of alpha. It’s found in pockets of inefficiency, pockets of illiquidity, and off we went.
The private equity industry now is really only a couple of decades old, but most of that growth happened post the GFC. And if you look at private capital in total, by most estimates, $15 to $20 trillion, PE is probably $10 of that and Buyout is probably the biggest piece.
But we have a bit of a plumbing problem. We’ve got a lot of assets in there, a lot of portfolio companies—by Bain’s estimation, $3 trillion across 28,000 companies—that is stuck in this plumbing.
Future asset allocation is all of us as individuals—collectively as a group—driving asset flows and every GP out there is winding up to service this sector. I think on the one hand this is good, but on the other hand, are they getting quality product and true diversification at a reasonable price?
It’ll eventually come out. I don’t think we’ll come out at NAV. But this is being married up against this phenomena of ‘democratization’. And I think every GP out there, rightfully in reality, recognizes that Fund X+1 is going to have more and more individual investors. And how do they go and tap them? And I think that value proposition is very easy to understand in that we’re not minting any new DB plans in the future. Future asset allocation is all of us as individuals—collectively as a group—driving asset flows and every GP out there is winding up to service this sector. I think on the one hand this is good, but on the other hand, are they getting quality product and true diversification at a reasonable price?
I think that’s a lot of what we’re going to cover here today.
The whole hog passing through the snake.
Topic: Private Equity’s focus on fundraising from Private Wealth.
Daniel Harms
I forget what the exact analogy was but it was when you said the problem with the plumbing—it reminded me of when the CEO of Apollo was like, the whole hog passing through the snake.
…at its core private equity is a phenomenal investment strategy and it’s necessary for the overall health and growth of the economy. How you approach it, on the other hand, is where things start to break down…
We’re just going to have to wait for it to work its way through. I mean, what is— at least from my perspective—the conversations that I’ve had and the reading I’ve done is that at its core private equity is a phenomenal investment strategy and it’s necessary for the overall health and growth of the economy. How you approach it, on the other hand, is where things start to break down because conflicts of interest are raging, private funds, the private markets in general are the wild west compared to public equities and debt.
And you don’t always know because of the opacity, what the real score is. Unless you’re digging into the offering documents and reading through with a fine tooth comb, which you’re being sold or told or educated—sales through education is predominantly the approach by everybody—whether that aligns and matches up.
So, in my mind, it’s institutional investors, pensions, endowments, the ultra high net worth are more or less, I don’t want to say tapped out, but there’s no appetite. A recent article I saw explained how private investment allocations or alternative investment allocations are being decreased by these investors.
…what does that mean? So you have these mega managers that are looking to increase growth—either because they have shareholders to answer to or partners that are looking for another zero in their net worth—and the biggest untapped source of dry powder is the private wealth space. It very much seems to me like the horde is coming with pitch forks and torches for that capital.
And well, what does that mean? So you have these mega managers that are looking to increase growth—either because they have shareholders to answer to or partners that are looking for another zero in their net worth—and the biggest untapped source of dry powder is the private wealth space. It very much seems to me like the horde is coming with pitch forks and torches for that capital.
It’s reminiscent of the early 2000s before the tech wreck—when every other house on your street was running a hedge fund. And, well, that didn’t turn out so well.
And so you fast forward to today, and now there are private equity shops, and new funds and managers across the private market space that are popping up. I think, at best, disingenuously claiming to be operating a certain way, when the hierarchy sort of operates a different way.
I mean, at the very bottom of the private equity hierarchy, you start with venture and financing rounds. These companies are built out, and then smaller boutique PE shops step in, spotting opportunities to buy them. They might add some operational alpha, increasing efficiency or profitability, which raises valuations. These companies are then acquired by the next tier of PE shops. Valuations continue to grow, and eventually, they end up with the mega fund managers.
Once valuations align with fund managers’ expectations, we could see a wave of IPOs, turning distributions into a fire hose of cash flow back to investors.
For these mega funds, the traditional way to monetize investments for their LPs was year-over-year through clean, immediate cash distributions. But now, since these mega funds don’t have anyone above them to sell to, they’re holding these assets. With the privately market being four to five times larger than the public market, the pendulum may soon swing the other direction. Once valuations align with fund managers’ expectations, we could see a wave of IPOs, turning distributions into a fire hose of cash flow back to investors.
Equity is equity and ‘Longtermism’ matters, public or private.
Topic: Private Equity, efficient markets, and long-term investing.
William Kelly
And one important point I want to underscore, what you just said, Dan, is that equity is a risk exposure that every investor can make and the word private or public before it are just qualifiers or adjectives to describe equity.
Equity doesn’t have a conscience, or a heart, mind, and soul, and it doesn’t know if it’s private or public. And historically, the reason why investors thought about private equity versus public is that private was much less efficient and that is ‘code’ for alpha.
Equity doesn’t have a conscience, or a heart, mind, and soul, and it doesn’t know if it’s private or public. And historically, the reason why investors thought about private equity versus public is private was much less efficient and that is ‘code’ for alpha.
Now you’ve got a trillion dollars coming in and instead of 24 managers you have over 10,000 funds. Do you have more or less efficiency? Right? It’s hard to argue. It’s more. And if that is the case, less alpha, and much, much wider performance dispersion.
So I think investors have to say, if I want growth in my portfolio, I need equity exposure. And on a risk-adjusted basis, where can I find that in the most efficient way possible? And historically, it’s been in the equity markets. And going forward, the Cliff Asnesses of the world that argue that the public equity markets have gotten less efficient, not more, and there’s a lot of behavioral biases driving it. But I think everybody’s got to understand there’s no silver bullet just because you put the word private in front of it. It’s still equity risk premia.
And “longtermism” matters, public or private. Maybe we’re getting ahead of the narrative, but we’re going to start to create leaky windows every quarter through an interval fund or through some other phenomena, where we’re taking what is largely a long-term hold in private equity and allowing money to come out every single quarter.
The moment it comes out of the ground, you’re leaking alpha out of the window as opposed to allowing liquidity. So more education is a key component, but also giving the investor what they need versus what they want. I think a lot of these vehicles are playing into investors’ worst tendencies.
Everything isn’t always champagne and rainbows.
Topic: The fallacies of liquidity and low volatility for PE funds.
Daniel Harms
Going backwards through a few points you made, those open end funds with —as I call it—the fallacy of liquidity, they’re not selling any portfolio companies to raise cash to make these redemption distributions. They’re manipulating the numbers—and I don’t mean that in a negative context—but it is what’s happening. They’re cross-matching new capital coming in with redemption requests, and if there isn’t enough cash to make redemptions, the gates go up.
And usually, unless it’s a unique reason that you are personally wanting to redeem out of one of these funds, you’re not going to be alone when trying to redeem. Like, it’s usually a run for the door. And those fund managers, if you read through those offering documents, the board has the discretion to slam the door in your face and say, nah, you’re not coming out. Get comfortable.
And usually, unless it’s a unique reason that you are personally wanting to redeem out of one of these funds, you’re not going to be alone when trying to redeem. Like, it’s usually a run for the door. And those fund managers, if you read through those offering documents, the board has the discretion to slam the door in your face and say, nah, you’re not coming out. Get comfortable.
To your point before that, where you’re talking about the Cliff Asness, saying the public markets are actually getting more inefficient. I mean, to me, that sounds like an opportunity for astute stock jockeys, and either hedge funds or long only funds to actually provide some alpha to public benchmarks. Whether that actually ends up being a thing or not, I have no idea because over the long term, it’s a coin flip, whether you beat the benchmark or not.
I would need to see a lot of data points before that changed my mind.
And then to the inference or common misconception that the addition of private equity improves your risk-adjusted returns. I mean, you look at the Sharpe ratio, for example, and how it’s calculated, volatility is a component of that through the standard deviation.
And I’m lumping those together, I know they’re two very separate things, but it’s based on an imaginary standard deviation or volatility level, like 8%.
That is not even sort of true. So you add this private equity fund in some meaningful allocation to an overall portfolio, yeah, it’s going to reduce your volatility, but it’s a BS number.
And I think that’s where I won’t go so far as to say it’s snake oil. But there are misconceptions and misdirection on what private equity is, will do, and can accomplish. And it very much could be a necessary and suitable component to a particular investor’s portfolio, but you need to do it in the correct sizing, given all the accurate information. Not just, you need to put 20% into these four funds and everything will be champagne and rainbows.
And I think that’s where I won’t go so far as to say it’s snake oil. But there are misconceptions and misdirection on what private equity is, will do, and accomplish. And it very much could be a necessary and suitable component to a particular investor’s portfolio, but you need to do it in the correct sizing, given all the accurate information. Not just, you need to put 20% into these four funds and everything will be champagne and rainbows.
Private equity has become a manager selection game.
Topic: Where‘s the alpha? Are you actually getting what modern PE funds are selling?
William Kelly
Yeah.
And in observation, and this could be a segue to some of the work Andrew and PitchBook have done, if you knew just a little bit about private equity and you understood a concentrated shareholder base, maybe a five to seven year hold, and the GP coming in there and providing more efficiency and innovation and that’s creating value and you come out the other side with a much better company…
Daniel Harms
The private equity of yore.
William Kelly
But I saw a recent note. I think it was Bain. They looked for the last 10 years as to where value was created and what I just described about margin expansion, 0% of the value was coming through margin expansion.
It’s on the median, 53% on revenue growth and 47% on just increasing the multiple, multiple expansion. And that is not bringing any efficiency or innovation into the picture.
And if you think about the good old-fashioned public equity markets and being a fundamental analyst and a catalyst for change, and I’m a value investor. I can’t help myself. I grew up in that space. But if you found beaten down companies that were on sale and there was a catalyst for change, you were on to something if you held it for the long term.
But the value in the private equity markets really is not showing that. As you get to the top quartile you’re seeing more of it, and this gets down to the fact that private equity has very much become a manager selection game. It’s not even the right GP, it’s the right manager inside of that GP.
But the value in the private equity markets really is not showing that. As you get to the top quartile you’re seeing more of it, and this gets down to the fact that private equity has very much become a manager selection game. It’s not even the right GP, it’s the right manager inside of that GP. And the ability to replicate that skill set in the next fund, and the next fund, is a very high correlation. But I don’t know the average retail investor or high net worth individual through an RIA is going to find that manager. Oftentimes they’re closed, there’s a big network effect. The big managers have access to them but are we gonna get that as first-time investors? Most likely not.
So I think there’s a lot of reasons to say, “Before I dive into the deep end of the pool, does this make sense to me? In terms of getting something I can’t get for a handful of basis points through some kind of index fund in the public equity space.
Future performance is not forecasted by past results. Period. Full Stop.
Topic: The likely reality of PE performance in the future.
Daniel Harms
And one last point on it and then as you said, I think this would be a good pivot to seeing what increased transparency may exist. If you look at any marketing collateral from any investment public or private in existence, or at least going back 40, 50 years at a minimum, at the bottom of it, you’ll see past performance is not indicative of future results.
Everybody’s pointing to the private equity returns the past 10, 15, 20 years, and are heavily relying on that going forward.
If you look at these funds and the massive inflows of investor cash, now from the private wealth space, and given the opened end structures that they have the ability and opportunity to raise AUM, the skies the limit.
But they’re going to have to put that to work. And, on average, historically, private equity funds were holding 10 to 20 portfolio companies. They’re going to need a 10x multiple of that, least. And you’re ultimately going to be getting a private equity index-like return.
But they’re going to have to put that to work. And, on average, historically, private equity funds were holding 10 to 20 portfolio companies. They’re going to need a 10x multiple of that, least. And you’re ultimately going to be getting a private equity index-like return.
Because you have to take the good with the bad, you have to put it to work. You don’t have the ability to cherry pick and wait for your ideal target company to come along, and then you issue a capital call, and the whole traditional closed-end fund process takes effect.
The returns going forward are not going to be what they were. They’re going to be more muted. They’re probably going to be more in line with just the S&P—at worst—given the inherent leverage on multiple levels that is utilized by private equity.
It’s probably going to be worse and more volatile. And, I’m done…
Andrew? Thank you for being patient.
Can PE buyout be replicated?
Topic: PitchBook research into replication of Buyout.
Andrew Akers
Yeah, absolutely. I think the conversation that you and Bill just had is a great set up to the way we started thinking about the problem and just going back to one of the first things Bill said, right, is equity is equity.
It doesn’t matter if it’s public or private. And so that means a few things for how we think about potentially replicating private equity. It’s ownership in an underlying company, which is bases its value off of the cash flows that that business will generate.
When you’re an active manager, regardless of whether you’re in the public markets or the private markets, there are a few ways you can generate alpha. And I think there’s a lot of overlap in those processes between public and private.
There’s sector selection. You can choose to invest in sectors that outperform some benchmark or the total market overall. There’s, of course, the security selection. If you pick good companies that outperform the market that leads to to positive alpha as well. And then, leverage is kind of that third component. It isn’t really alpha. It’s a it’s a magnifier and we see that leverage is used in a lot of ways in private equity and over the last decade plus following the GFC, when interest rates were basically 0%, that was a huge tailwind to private equity.
Now there’s some things that public equity cannot replicate. I think, Bill, you mentioned that first and foremost, if you talk to the private equity manager, they’re going to say it’s operational alpha.
Now there’s some things that public equity cannot replicate. I think, Bill, you mentioned that first and foremost, if you talk to the private equity manager, they’re going to say it’s operational alpha. They’re taking a controlling interest in the company. They’re employing people on the board of that company. They’re making improvements. And, theoretically, they want to drive margin expansion. They want to see revenue and earnings growth above their peer group of companies.
But as Bill mentioned, the research that we’ve seen on that recently is that that hasn’t necessarily been realized. Especially for your, say, median deal. There’s always going to be those deals and managers that outperform, but not all managers and not all deals are going to do that.
And so, if you take all of that, the question is, how much of that process can we replicate in the public markets?
Can we systematically build something that kind of looks like a Buyout portfolio in terms of the sectors we’re investing in, the securities we’re selecting, and the leverage we’re applying to that?
So, the first thing that we looked at is, is there any repeatable tendencies in security selection for Buyout managers? Is there a common play book that could be replicated from a factor perspective or from a holding space perspective on an objective systematic level?
And what we found is that the answer to this question is, yes. They do have repeatable tendencies that you can systematically replicate.
And what we found is that the answer to this question is, yes. They do have repeatable tendencies that you can systematically replicate. Which makes sense because the core Buyout playbook is by a cheap company that has cash flows to service an increased debt load. You lever that company up. Like I said, you may or may not make some operational improvements, but if that company over a long term holding period returns to fair value, and you’ve levered them up, that’s an easy way to make a nice 20 to 25% IRR. Which is the core Buyout pitch the you hear.
And what we found is that when we looked at take privates—so companies that were trading on the New York Stock Exchange or NASDAQ and were taken private by one of the big Buyout shops—there were tendencies that essentially allowed us to predict those to a certain degree from their financial statement data and from their stock price.
So really what we found is that buyout managers tend to exhibit a value bias, which isn’t surprising. And we tended to see that that was most notable in terms of free cash flow. So they really focus on companies means that we’re trading cheap relative cash flows. We noted that there were some underperformance in terms of stock price relative to peers, as well as efficiency in terms of employee counts and revenue generated by those employees, and all that also led into a quality bias as well.
And so we did find that if we can repeat those—or find and those tendencies—that we can select companies systematically from the public universe that match those tendencies and work on a holdings-based replication strategy.
And so we did find that if we can repeat those—or find and those tendencies—that we can select companies systematically from the public universe that match those tendencies and work on a holdings-based replication strategy.
And then, I’ve said lot with just two more points and then I’ll kind of take a breath. But the sector exposures, what’s really interesting what we’ve found is that if you compare the sector exposures—and in the Buyout space PitchBook tracks all the Buyout deals—we can see differences. We see that Buyout’s been very heavily overweight tech compared to a standard public benchmark such as the Russell 2000 and underweight financials.
Almost 20% of the Russell 2000 is going to be in smaller commercial banks and Buyout managers really don’t touch those. And that’s led to some performance as well over the last 15 years or so as tech has performed well and financials have underperformed.
And finally, as I mentioned, the leverage component. The traditional kind of standard public small cap company we’ve seen has financial leverage of about 1.3 to 1.5 and when you look at Buyout deal data over the past 10 years, the leverage they’ve been employing is more like 2 to 2.5. So that’s another tailwind we can can replicate. Those three things combined is our approach to the replication strategy.
What about the size of the investable market, and your use of machine learning?
Topic: Investable universe for replication strategies and use of machine learning.
William Kelly
So Andrew, two things that I found interesting and I’m probably the least knowledgeable on this, I know you and Dan have talked about it a bit but maybe you describe a little bit more about how big the investable universe potential is in the public markets and then the machine learning that you’re using that sits on top of this, I found very very interesting too.
Andrew Akers
Yes so the the universe is smaller on a company basis compared to the private markets. That’s a good point. That’s another thing that you might not be able to replicate, the breadth of available companies. After we’ve run through some some filters for mid- and small-market caps and things like that, the selection universe is about 2,300 publicly traded companies in the small cap space.
Market caps roughly in the middle of that distribution are going be three to five billion in market cap. So it still is a pretty large space. As you mentioned earlier in the discussion, companies are staying private longer, so the general trend is actually that university is getting smaller. That is a potential concern, but again, you’re still selecting out of a pretty wide array of companies.
Then on the the machine learning side, what we’re leveraging is not some shiny new AI model. It’s actually a model that was first released in academia in the 1990s. It’s called a long short-term memory (LSTM) neural network.
Then on the the machine learning side, what we’re leveraging is not some shiny new AI model. It’s actually a model that was first released in academia in the 1990s. It’s called a long short-term memory (LSTM) neural network.
What that actually does is it takes in naturally sequences, so it’s built for time series data. We will basically feed in the quarterly financial statement and stock price data, and it’s able to understand not just levels and interactions and ratios, but how these variables have been changing over time, which is the important component of that.
A lot of other research that we’ve seen has been trying to calculate ratios themselves, different types of value ratios, different types of growth rates, and that becomes a challenge and becomes somewhat subjective.
We’re basically just giving it information that you would expect a junior analysts at a Buyout shop to be looking at as well, right?
Here are the financial statement data from the past 10 years. Here’s how their stock prices moved. You know, is this a candidate for a Buyout?
It’s kind of how we do it.
How do you compare private equity with what is readily available in the public markets?
Topic: The challenges of finding a proper benchmark for PE.
William Kelly
And then maybe my last point to me in this particular subject, maybe for both of you—and probably Dan, one of your maybe pet peeves in the space—mine as well is, the yardstick to measure performance, public versus private.
I just looked—and I won’t name the name of the company because I see this pretty consistently—but I saw a chart that was showing performance dispersion, but also showed the median returns of various quote unquote asset classes from public equity, public debt, VC, buyout, real estate, etc.
If I focus on it, I think it was the All-Country World Index, which was the proxy for public equity over 10 years. If I look at that little diamond on the chart, it was hard to tell exactly where it is because performance was so tight. It was about seven and a half-ish as a median return. If I look at private equity, I think this is in the buyout space, it looked like it was about 15 percent—twice as much.
But then I go down and look at the little fine print. And the seven and a half is a time weighted return. The 15 is IRR. They’re not even in the same food group. And sometimes I see this and they’ll use a PME.
But then I go down and look at the little fine print. And the seven and a half is a time weighted return. The 15 is IRR. They’re not even in the same food group. And sometimes I see this and they’ll use a PME (Private Market Equivalent), and the PME has a short coming as well. But I think some of the challenges for the end investor, particularly the less sophisticated, is to understand how to compare this to what is readily available in the public markets, i.e. all-country world index, which I can look at. It’s investable. I control the cash flows. Versus an IRR, where there are capital calls and money coming back to me.And if I see a public market equivalent, it has its challenges as well. So maybe, Dan, I don’t know how big of a presentation issue this is?
And then maybe for for both of you. What do you think about PME, and then some of the work that you’re doing with PitchBook, how it’s the same, different, or better perhaps than in the public market equivalent?
Daniel Harms
I think benchmarking PE in general has been a struggle.
I was going back and forth with some internal partners of mine three years ago, and we were discussing regression models and trying to come up with a better way than the Cambridge Associates U.S. Private Equity Index or something more arbitrary like the the S&P or the Russell 2000 plus four or five hundred bips (basis points).
All of them aren’t great. The Cambridge index, there’s selection bias, like are they getting data points from the total available universe?
I actually think—and this is not to toot PitchBook’s horn—but they may be the largest repository of data points, of fund data points. And they might be able to see the biggest slice of the forest for the trees of the total private equity space and make an assessment.
The more arbitrary, just slapping 4 or 5% on top of a public equity benchmark is weak. It’s the easy way out.
And so there needs to be a better way to properly compare, assess, and judge, whether or not I am I getting what I was told. And net of fees.
And is it appropriate that I add more to it?
International developed and emerging markets, like it’s a throwaway. It’s one, two percent. It’s nothing meaningful. It’s not going to move the needle. International is probably the biggest of it, but still, it is the U.S. economy and markets that are the engine for most of not all private portfolios. Using the all-cap world index, what the hell?
I mean, you look at any private wealth asset allocation and it’s not usually a substantial number that is allocated to the equity-style box that is not U.S. domestic large value, or small growth. It’s those nine boxes: value, core, growth, large, mid, small. International developed and emerging markets, like it’s a throwaway. It’s one, two percent. It’s nothing meaningful. It’s not going to move the needle. International is probably the biggest of it, but still, it is the U.S. economy and markets that are the engine for most of not all private portfolios. Using the all-cap world index, what the hell?
It’s hugely weighted to foreign markets that nobody’s invested in anyway, so it’s more, apples to oranges. And the IRR versus time-weight, is just, wow, that is is some nefarious activity.
You’re not even comparing fruit at that point.
Topic: Benchmark selection and Private Market Equivalents.
William Kelly
Well, on that point, I’ll just posit it here.
I found this for a blog post I did in the last year or so, it’s somewhat of an age, but it aged very well, piece that the Common Fund put out is October of 2017, and they looked at a comparison where beginning cash, interim cash, and ending cash were exactly the same in two scenarios.
One was through a time-weighted return where those flows are controlled by the investor, so you ignore them. And in this case, at the end of those four periods, the time-weighted return was 15%. And then the identical cash flows, but here, the GP is controlling them, so they factor in, and you put it through an IRR calculation. Same beginning point, same ending point, same interim cash flows. 15% time-weighted? 34% IRR!
So if you present that to a less than sophisticated investor or maybe somebody wholesaling this product, even if you’re 50% wrong, it’s still substantially better. And it’s exactly the same and it’s probably less tax-efficient. It’s probably not doing anything except hurting your risk adjusted returns.
So if you present that to a less than sophisticated investor or maybe somebody wholesaling this product, even if you’re 50% wrong, it’s still substantially better. And it’s exactly the same and it’s probably less tax-efficient. It’s probably not doing anything except hurting your risk adjusted returns.
So, I don’t know if, Andrew, maybe this is sort of the ball back in your court in terms of thinking about how we should be benchmarking private equity.
Andrew Akers
Yeah, we spend so much time at PitchBook talking about this exact thing. And really what we see is our clients making two comparisons, like you mentioned. They’ll take a fund level IRR and they will apply it to a benchmark. The benchmark selection is also not good because a lot of times what they’ll ask for is, show us what the S&P did. Like the the comparison of the Apples and the NVIDIA’s of the world to most companies in the Buyout space are just are not good.
It’s interesting now is that we’ve seen more managers switch to the Russell 2000. I think is an improvement. But I also think the skeptic would say well the Russell 2000 has started to to underperform and that might be driving that benchmark switch. But even the Russell 2000—as we kind of go through in this paper—as I talked about the overweight tech versus underweight to Financials, is really not a good comparison just on a sector and security basis. And then it’s not even getting into the risk components of that. Buyout managers are typically employing 2x to 2.5x leverage.
Well, right away your your beta is probably 1.5 to 1.8. And so you’re not using a benchmark that’s even comparable on a risk perspective. You combine that with comparing IRRs to time-weighted, inappropriate benchmarks… I mean you’re not even comparing fruit at that point. You’re… it’s just you’re doing more harm than good.
Well, right away your your beta is probably 1.5 to 1.8. And so you’re not using a benchmark that’s even comparable on a risk perspective. You combine that with comparing IRRs to time-weighted, inappropriate benchmarks… I mean you’re not even comparing fruit at that point. You’re… it’s just you’re doing more harm than good. And a lot of times what we hear is that, “Well, I have to benchmark it right? I have to do something?”
What we’d often see is that probably those practices are more harmful than beneficial in actually understanding the performance. Our preferred approach is the PME, which has its own issues but essentially—just the quick overview of that for those familiar—is a PME is a relative return of investing in a private fund, if you had matched the cash flows of the private fund into a public index that controls for cash flow timing, and it gets rid of some of the assumptions baked into the IRR, namely the reinvestment assumption.
And what we like to do is if we can get a benchmark that’s appropriate on the risk and allocation perspectives, then the PME becomes a better performance metric.
But one of the main things baked into the PME that we don’t like is that it just seems essentially a beta of 1 to the index. So if we make some adjustments to the index itself, that gives us a much better, better place to start.
And so that’s the original application that we had for this research was just, can we build a better benchmark in terms of the, what’s actually in the benchmark, the risk of that benchmark, that better matches the Buyout funds.
And what we found in the paper is that if you use the Russell 2000, you would walk away saying Buyout funds have really outperformed in the past 10, 15 years.
When you start making some of the adjustments, what you get is Buyout funds may be outperformed a little bit. And I think that matches a lot of what we’re seeing in the academic literature.
There’s now, I think, a very good amount of peer-reviewed literature. PMEs came out in 2004. There’s been a lot of work done in the space and the overwhelming consensus is that once you control for risk, there is not much outperformance in private equity and Buyout in particular.
There’s now, I think, a very good amount of peer-reviewed literature. PMEs came out in 2004. There’s been a lot of work done in the space and the overwhelming consensus is that once you control for risk, there is not much outperformance in private equity and Buyout in particular.
And what that really means is that 100% of the alpha share is essentially going to the Buyout managers, because they are probably charging you—depending on the carry fees—roughly 5%, right? So they are generating alpha, but they’re actually just taking that in fees.
And so that is another segue into looking at what should you be looking for in the private funds is understanding the fee structure.
I think we had our second Cliff Asness reference today.
There is not an investment profit so good that there is not a fee that can make it bad to the client.
So I think that’s something really to be on the lookout for.
Fear is the mind-killer… err, uh, we mean, fees are the return killer.
Topic: Fees are the #1 killer of performance. And don’t forget to read the fine print around catch-up provisions and hurdles.
Daniel Harms
Well, fees are a return killer. We did a fee analysis—again, not naming names—but it was a private fund with three different share classes; the broker share class where the sales guys and the wholesalers, they’re just slinging funds, then the middle was for negotiated terms, and then there was the institutional rate—which no individual investors are going to get access to unless they are a client of one of the big shops that negotiated that.
On the left end—the more transactional share class—if you assumed a 10% annual rate of return, that investor was only taking home just over 4%. It’s disgusting. Absolutely not. Put your money is cash. You’re better off.
On the far end, it was still 7% versus 10% and this was substantially less management fee, plus carry, than the 2% and 20%. I think it was 1.25% and 12.5%
Another fine detail that needs to be understood—and I think it’s becoming a bigger problem because there’s a raging misconception of what it is and how it operates—is the catchup provision with a hurdle.
Another fine detail that needs to be understood—and I think it’s becoming a bigger problem because there’s a raging misconception of what it is and how it operates—is the catchup provision with a hurdle.
People think the first 5% goes straight to the investor. The investor’s like, oh, first 5%, I don’t pay any performance on that.
Well, it’s what happens after the 5%. A manager is incented to maybe swing for the fences more so than they normally would, because they’re not getting their big slice of the fees until they clear that five percent. Every dollar over the 5% hurdle—100% of it—goes to the manager until they get the equivalent of what the performance fee would have been on the first 5%.
…but wealth managers, financial advisors, and individual investors don’t understand it. They see a hurdle, they think, up to that hurdle, it’s all mine, and the fund doesn’t get paid the performance fee until after that. And that’s not true, not even sort of, the fund is not going to give up their fees. They will get it one way or another.
There is no free lunch. And this is going to be a gross generalization—but this is not how most wealth managers, financial advisors, and individual investors understand it. They see a hurdle, they think, up to that hurdle, it’s all mine, and the fund doesn’t get paid the performance fee until after that. And that’s not true, not even sort of, the fund is not going to give up their fees. They will get it one way or another.
And that’s basically the scenic route to saying the complexity of fees are egregious and will deteriorate and degrade any fluffy return numbers that they’re saying these funds are going to return.
Slight detour into secondaries.
Topic: Growth of the secondaries markets?
William Kelly
I agree. It may be slightly off topic but related to this and maybe an observation for Andrew and maybe for you, Dan, as well.
If I think about entry points into this market now, and I think about alpha coming in these pockets of inefficiency, the secondary space is still small and still pretty inefficient, more efficient now than it was back at the GFC, but you get the other side of the J curve, more discovery—and if you think about size of it—if it’s about $100 billion on a denominator of 15 to 20, it’s not even 1% of the action.
And I would think that if I had a crystal ball that was very on point, if I look out five years from now, I would have to think that the secondary market is going to get bigger.
Because who ordained that value is created over 3 to 5 or 7 year window inside of that fund?
And part of what we’re talking about today is that LPs have different needs, different times. The pesky thing about beneficiaries is they want to check in the mailbox every two weeks and they don’t want it in kind, they want it in cash.
And part of what we’re talking about today is that LPs have different needs, different times. The pesky thing about beneficiaries is they want to check in the mailbox every two weeks and they don’t want it in kind, they want it in cash.
And then maybe the LP wants to get into the next vintage year and can keep going. So there’s reasons why we’ve seen the liquidity is going to be more, I think, part of the offering.
I wonder as that area starts to grow, maybe both of your views on that as maybe an asset class within an asset class. And then Andrew, don’t know if it’s ever possible to create an index to track the secondary space.
Daniel Harms
Go ahead.
Andrew Akers
Yeah, I would agree with the general statement of the potential growth of the secondary market. We are working on tracking those better.
They’re difficult to track, especially if it’s just going from a GP to another vehicle of that same GP, right?
You don’t necessarily get the event—like an M&A or an IPO—that you can tag. So one of our big data goals in the next few years is to better track that space.
I think where you’re going to run into challenges here—and we’ve already seen some LPs pushback on this—is the conflict of interest on the valuation side between the LPs cashing out and the LPs rolling over. Those are obviously at odds.
I think where you’re going to run into challenges here—and we’ve already seen some LPs pushback on this—is the conflict of interest on the valuation side between the LPs cashing out and the LPs rolling over. Those are obviously at odds. I think that’s where you’re going to start to seeing more and more battles between LPs and GPs. But the idea of GPs not having to sell the asset based on the structural limitations of the fund is very attractive to them. And the potential for that illiquidity to be a little less dramatic, I think, is beneficial on the LPs side. So there’s probably a balance there.
As I was thinking about this earlier in the conversation—and this is a good segue probably—as liquidity changes, I’d be curious, Bill, to get your thoughts on the illiquidity premium as a component of private returns. How do you see that changing as we talk about secondaries? Not just GP led secondaries, but LP led secondaries, as that market grows, not necessarily a transfer of assets, but LPs can’t get liquidity from that.
And if you see that changing at all.
Is the illiquidity premium still a thing?
Topic: Illiquidity premiums, industry jargon, misconceptions about the ‘magic’ of PE, and the importance of longtermism.
William Kelly
Well, I think if you went back to the good old days of the David Swensons and the 24 GPs, you could probably calculate an illiquidity premium and a complexity premium down to a handful of basis points and maybe be pretty much spot on.
But when you’ve got this plumbing problem, I alluded to before and still probably in the trillions of dollars of liquidity sitting on the sideline, I would argue it’s less—and maybe almost borderline nonexistent—because there is so much liquidity sloshing around. And when it comes to the private wealth client, I think we’ve converted an illiquidity premium into a liquidity discount and nobody wants to measure that because it’s negative.
But when you’ve got this plumbing problem, I alluded to before and still probably in the trillions of dollars of liquidity sitting on the sideline, I would argue it’s less—and maybe almost borderline nonexistent—because there is so much liquidity sloshing around. And when it comes to the private wealth client, I think we’ve converted an illiquidity premium into a liquidity discount and nobody wants to measure that because it’s negative.
But we’ve got to recognize that every one of these these valves we open up has a leak attached to it. It’s interesting we try to talk the media on a regular basis and when it comes to the interest of the investor, they oftentimes get it wrong. When you’ve got a fund—and there’s been some well tested cases of recent vintage—where it’s set up as an interval fund, the commitment is 5% redemptions quarterly, 20% a year of liquidity but if everybody’s showing up at the window at the same time, the fund has got a gate.
But then the storyline is, look at these poor investors, they can’t get out. And I feel, what about the poor investor that understood what they were buying into and assumed the person on their left and right had the same commitment. The liquidity window was a place you would go to very sporadically for unusual reasons, not a place to go when Jim Kramer on CNBC says the world’s coming to an end.
But then the storyline is, look at these poor investors, they can’t get out. And I feel, what about the poor investor that understood what they were buying into and assumed the person on their left and right had the same commitment. The liquidity window was a place you would go to very sporadically for unusual reasons, not a place to go when Jim Kramer on CNBC says the world’s coming to an end.
Daniel Harms
I’m thinking of BREIT a couple of years ago when everybody went for the door at the same time. And it wasn’t until, who was it, Calpers stepped in and wrote them a big check.
William Kelly
And it was funny because that was meant to be a ‘democratized’ solution, but a big institution came in there with great, great transparency and was able to lock in an awesome return going forward.
So I think there’s still a lot of misconceptions around the magic of what PE can do. And the jargon we’d throw around as industry practitioners around illiquidity premium, MOIC, IRR. Do people really understand what these mean? Most likely not.
And I think if we could get one thing right to the end investor, the concept of longtermism. Warren Buffett, my favorite holding period is forever.
And I think we’ve got to get investors to be thinking about that in a tradable ETF, all the way up to exposure in private real estate and private equity.
And if we can’t get that right and instead we’re creating these leaky valves, you’re better off giving them the exposure very inexpensively in some kind of an index replication where maybe they’ll hold on for a bit longer if they have to get out, they’ll get out, but they’re not getting out at after they paid 2 and 20 with a big value leak.
The average holding period when I was born in 1960, for an equity, was eight or nine years. Today is less than six months. So we’re going the other way. And then platforms like Robinhood are selling options on the outcome of the U.S. election but they tell everybody they’re an investor platform. Really?
The average holding period when I was born in 1960, for an equity, was eight or nine years. Today is less than six months. So we’re going the other way. And then platforms like Robinhood are selling options on the outcome of the U.S. election but they tell everybody they’re an investor platform. Really?
Daniel Harms
I’ve got a handful of hand gestures I want to make right now, but I won’t. I mean, the Buffett investment philosophy is much like what you were describing Bill of the couple dozen GPs way back when with the lag in information dissemination and you could actually get there first and there was enough inefficiency.
But much like Buffett has said, you couldn’t build Berkshire again and get the returns that I have attained, today.
Same thing for PE. The same layers of information technology and the increased number of participants are occurring, and the spreads on those companies, regardless of valuation, are going to tighten. You’re not going to get the outsized positive P&L that transactions used to garner, and you’re just not going to get the returns that PE had previously put up. And there’s not enough, if any, light being shown on that.
William Kelly
Yeah, and I think the other thing about Buffett since we’re on that topic is how did he make most of his money for shareholders?
He was a provider of liquidity when nobody else could offer it. And back to this $3 trillion of value stuck in there, I think Berkshire probably as close to a trillion dollars of cash in their balance sheet.
If they levered that up just one time, and they went to the industry and said, you know what? I don’t even have to look at the merchandise. I’ll take it all for $0.60 in the dollar. Who’s a taker? I guarantee you, that’s a bite he could handle, and yeah, yeah, exactly.
Daniel Harms
I’m seeing Eddie Murphy and Dan Aykroyd in the pit, like, now, not yet, now, not yet, now, all right, now. Sell em!
Conclusions on PitchBook’s research.
Topic: Is buyout replication possible and likely to be more common?
Daniel Harms
So Andrew, given your, your endeavor to replicate the Buyout space, using the qualitative and quantitative data of data successful and even failed deals to build out this long short-term memory neural network and put a small army of PE analysts potentially out of the job—what conclusions—and more importantly—observations did you arrive at?
The biggest conclusion is that there is indeed a lot of what private buyout funds are doing that isn’t necessarily inherent to the ‘private’ aspect of that. Which means, to a certain degree, replication in the public markets is a viable strategy.
Andrew Akers
The biggest conclusion is that there is indeed a lot of what private buyout funds are doing that isn’t necessarily inherent to the ‘private’ aspect of that. Which means, to a certain degree, replication in the public markets is a viable strategy.
That being said, again, we’re talking about replicating the market as a whole. And so there are some benefits to that.
One is that at least in the backtest that we were able to do on this strategy is that you greatly outperform the small cap benchmark.
The sector selection was positive, leverage was mostly positive, and the security selection was positive. So all these things that we were able to essentially systematize from buyout managers led to outperformance, which is good.
And a couple other things on that is, if you to do this in the public markets, there is the liquidity there if you need it.
Although, as we talked about, this should still be meant as a long-term strategy. It shouldn’t be meant to be traded in and out of, but liquidity is there and it’s going to be more robust than open-ended funds which can gate you.
The second big thing is that it has the potential to have much lower fees—as we talked about the importance of fees. So it may not be able to replicate everything, but it’s starting at a head start really in not having complicated fee structures, which is, of course, another benefit.
Then third could be the potential for ease of access for the individual investor—this was mentioned a couple of times earlier. They’re not going to be able to jump into that top performing manager or fund in their kind of legacy products.
Obviously, there’s product proliferation and those are going to be targeted more to individuals. But actually doing the due diligence, selecting those managers, that takes time. That takes energy. And that’s a difficult thing to do.
There are systematic things that we can replicate from buyout in the public markets. We feel that this is a better benchmark for private equity buyout funds that appropriately takes into account the what those funds are buying and the risk that those funds are taking on, so it could help investors just better conceptualize performance.
There are systematic things that we can replicate from Buyout in the public markets. We feel that this is a better benchmark for private equity buyout funds that appropriately takes into account the what those funds are buying and the risk that those funds are taking on, so it could help investors just better conceptualize performance.
Hey, what am I actually getting out of my private equity funds? Are they generating alpha above and beyond systematic risk-type exposures?
Those are the main conclusions. We think this is a burgeoning space. We’re not the first people to have come to this conclusion. There’s academic literature to back this up. There’s various other quantitative groups working on this right now. And so we think that as private markets grow, they’re going to start to look more like public markets as well.
There’s going to be this kind of convergence. So these type of replication strategies will become more common and potentially an option for individual investors.
What does PitchBook’s Buyout Replication Portfolio data say about the true volatility of private equity?
Topic: Overview of PitchBook’s Buyout Replication Portfolio and describing how private equity actually behaves in client portfolios.
Daniel Harms
There’s a handful of numbers and data points—because I feel that they are extremely relevant and super important.
Beyond the outperformance of the model over say the Russell 2000 and I think it was what 8.3%—something like that was the upper boards. Could you speak to the other metrics and conclusions you came to i.e. volatility, sharp ratios, annualized rate of return even with any drawdowns?
Andrew Akers
Definitely, so we talked about the can of worms that is comparing performance of private markets to public markets. On the risk side, it’s even more difficult. What is often known in private markets is this smoothing effect in how the performance is calculated.
For most private funds you’re going to get quarterly net asset values and those are actually provided by the GPs themselves. Post GFC there’s been some more stringent regulation on how those are calculated but there’s still a lot of leeway. And what the research has shown is that there’s a smoothing effect to this.
They anchor on previous quarter evaluations. They’ll make some slight changes to those. So what you’ll see, for example, in the PitchBook benchmarks, we aggregate all these net asset values across funds. In the first quarter of 2020 and second quarter of 2020, they’ve barely moved down, while the public markets were falling 30%.
So if you imagine what that does to your risk metrics, it essentially hides all the risk.
And what we found is that volatility, for example, over the backtest period from the beginning of 2014 through the third quarter of this year was over 30%. And the max drawdown. in 2020 was close to 60%.
By doing this buyout replication, we have this daily marked portfolio, which we can calculate the more traditional risk metrics that we think is a better indication of the actual risk in private equity. And what we found is that volatility, for example, over the backtest period from the beginning of 2014 through the third quarter of this year was over 30%. And the max drawdown in 2020 was close to 60%.
This is maybe surprising to some, but if you actually look at the metrics of the portfolio with it levered up, having the beta of about 1.6x, then this is essentially what you would expect from a levered, small cap portfolio of companies.
And that is consistent, again, with a lot of the academic literature. [PE is] levered all cap equity. It is going to be volatile and there’s risk there. This replication process shines light on that.
Daniel Harms
I’m going to tie that back to something I said earlier, where you’ve got the private equity industry at large, pushing this 8% annualized volatility and it being a BS number.
The work you did provides transparency into what the true volatility of private equity is, and it better arms investment committees, CIOs, financial advisors, everybody—the investment community at large—with how private equity actually acts.
The work you did provides transparency into what the true volatility of private equity is, and it better arms investment committees, CIOs, financial advisors, everybody—the investment community at large—with how private equity actually acts.
If you imagine public equities as the engine that is driving any goal-based planning—whether it’s a retirement, a vacation home, or a 3% cash burn— depending on your net worth or AUM—having that information, when constructing your portfolio, allows you to better incorporate those potential risks and volatility, and you may not be biting off as much as you would with an 8%.
And the only other point I’d hammer is in the model itself, the BRP, annualizing at close to just under under 16%. And that’s with that almost 60% drawdown. So it still works. It’s still successful. It’s in line with what PE as a whole has done over the past 10-15 years—unless you have been fortunate enough to pick one of those top quartile or top decile managers.
Everybody claims to be a top quartile manager, and that’s just not how statistics work. Everybody can’t be a top quartile manager. So in effect this could be a way to gain the PE-like exposure without all of the illiquidity, opacity, and egregious fees.
Thanks for playing along. I wanted to get those points out because the transparency and volatility, I think—even more so than replicating the return side of it is the risk—and it’s beneficial to everybody.
We believe in capital formation, recognize where it’s happening, and believe in the power of it. But how do we get the average investor there, responsibly?
Topic: How do we get investors access to private equity, responsibly?
William Kelly
So the famous or infamous Willy Sutton—a bank robber—was not a complicated person.
When they asked him why he robbed banks, he says, “because that’s where the money is.” And if we had the modern day Willy Sutton today and said, “Why do you invest in private equity?” I would be shocked if he would say, “Because, that’s where the IRR is.”
His answer would be, “That’s where capital formation is.”
I think Andrew alluded to this earlier, that it is a fact that there are—I think I saw the Hamilton Lane put this out—87% of companies in North America with more than $100 million in revenue are private. Full stop.
So if you want to have access to the private markets—and here you’re not necessarily talking about Buyout—where I think we have the greatest efficiency, the greatest cash flow. You’ve got growth, you’ve got value, venture capital, early- and late-stage—and innovation is more and more happening in these private markets.
Again, Andrew alluded to this, companies are staying private longer and sometimes private forever. Public companies are being taken back private, there’s so much capital there.
We as investors—if I’m thinking about getting the very best exposure to growth—it’s happening in equity.
But if I can find a way—and we’ve got to be able to find a way for investors to participate in where this capital formation is happening—that is a win-win. But if they can’t get there through their advisor or on their own, is there a way of replicating that in a fairly efficient and transparent way?
But if I can find a way—and we’ve got to be able to find a way for investors to participate in where this capital formation is happening—that is a win-win. But if they can’t get there through their advisor or on their own, is there a way of replicating that in a fairly efficient and transparent way?
And I think that’s what we discussed today and how we solve for it. But I don’t want anybody that’s listening to this to believe that we don’t believe in capital formation, don’t recognize where it’s happening, and don’t believe in the power of that. It’s that how do we get the average investor there?
And I think that’s a very, very difficult thing to solve for.
Daniel Harms
I mean, private equity and the function that it serves is necessary and it can be very profitable. But the structures the enormous players, the mega fund managers, are putting out there—in their view, incrementally more tailored to the private wealth space—are not the way to do it.
But the structures the enormous players, the mega fund managers, are putting out there—in their view, incrementally more tailored to the private wealth space—are not the way to do it.
I would actually argue that the closed end private equity funds—with the J-Curve—is better because you have a finite amount of capital that is raised and then deployed and there’s, it used to be 5, 6, maybe 7 years for the entire term of the fund—now it’s a decade plus… But it doesn’t allow for these fund managers to just raise capital for world domination, charge a management fee, worry less about the performance fee, and scale up to all holy health.
You’re not going to get the returns like the last 10, 15, 20 years going back even further from these open end funds.
This ties into what you said, Bill, with the manager selection being key. You need to go to the more boutique and the spectrum, where fund managers and these PMs not only have skin in the game—investing alongside their investors and their clients—but that they are smaller and they can remain nimble and flexible. They’re not just a cog in the machine of building valuation, selling them up the food chain, then going back down to whoever is feeding them, and it’s just a factory. You need managers who have the time and ability to cherry pick or wait for the opportunities to come to them, the potential for outsized returns—and especially if they’re installing their own people on boards or in the C-suite and they’re adding operational efficiencies and there’s operational alpha—doing the work to increase the cash flows of these companies, so that those valuations, or the ask to spin off, or even IPO are more truthful.
That’s where an investor is going to get the most returns, but you also need to be cognizant of the volatility that inherently exists in private equity, but is being hidden through this separate set of accounting rules that private equity gets to play by.
And know that private equity is not a long-term diversifier or volatility dampener. It’s the public equity is the engine that’s driving the goals-based planning and that private equity is the nitrous. Know that, and then plan accordingly. There’s a better way, and it’s it’s not the open-end funds.
And know that private equity is not a long-term diversifier or volatility dampener. It’s the public equity is the engine that’s driving the goals-based planning and that private equity is the nitrous. Know that, and then plan accordingly. There’s a better way, and it’s it’s not the open-end funds.
Don’t send us your hate mail 😉 We’re talking about transparency and accountability.
Topic: Who represents the LPs in all this?
William Kelly
Yeah, and transparency, as you say, I think we’ve got to get that right. I do wonder if I think about Fund X plus, where you’ve got more than 50% of the LPs are individual investors.
What does that LPAC look like? Who’s representing the limited partnership interest? I don’t know. And we struggle when….
Daniel Harms
Are you talking about unionizing LPs?
William Kelly
But how do you do it? Because they don’t know each other. So we’ve got to find ways of protecting that transparency, because the less the GP knows who those LPs are, and the more of them there are, it’s harder for them to say, “Hey, you’ve got to run certain things by me before you do it, or at least take inputs from me.”
But how do you do it? Because they don’t know each other. So we’ve got to find ways of protecting that transparency, because the less the GP knows who those LPs are, and the more of them there are, it’s harder for them to say, “Hey, you’ve got to run certain things by me before you do it, or at least take inputs from me.”
Daniel Harms
It instills a sense of accountability, too. If you’ve got a couple dozen LPs, and you’re say a three billion dollar shop as a whole but you’ve got two or three funds that are like you say equal amounts a billion dollars each like you’re having discussions with each of those LPs as the the PM of the fund. It’s not you’ve got a platoon of wholesalers that are out as mouthpieces for the firm at large. You’re tied to them. There’s a personal relationship, for better or worse, and you’ve got to answer for why you underperformed, or show up and ask for a high five when you outperform. It’s better, and without a more liquid, fully transparent, and easier access point today, that’s where I would go and that’s where we look constantly.
Andrew, anything to add?
Andrew Akers
The common theme here for all three of us is not pushing back its private markets themselves for individual investors, but it’s the treatment of the markets to individual investors in terms of both the investment strategies that they’re getting, fair accessibility—we talked about, you know, BREIT offering preferential treatment to institutional investors—lack of potential representation in the limited partnership agreements, and of course, the fees.
Just because you can invest in open-ended funds doesn’t mean that throwing 20% to 30% of your portfolio blindly at that is a good investment strategy. As people, start to bring more awareness to this, I think that private markets is an incredibly adaptive industry and they will continue to adapt and it’s not necessarily about the democratization but also the fair treatment of individual investors.
Just because you can invest in open-ended funds doesn’t mean that throwing 20% to 30% of your portfolio blindly at that is a good investment strategy. As people, start to bring more awareness to this, I think that private markets is an incredibly adaptive industry and they will continue to adapt and it’s not necessarily about the democratization but also the fair treatment of individual investors.
William Kelly
And I think Andrew to underscore what something you said, I think we could have spent this last hour collectively building a case about why private equity, why does it make sense. But then we would need months and months and months to discuss and maybe not even solve for how, how do we do it.
I think we’ve got to focus on a lot more on the how than the why, because if we focus on the why, you’re just going to have a lot of asset gathering and a lot less value creation. Value creation is what the investor wants. Without that the LPs lose. The investors lose.
I think we’ve got to focus on a lot more on the how than the why, because if we focus on the why, you’re just going to have a lot of asset gathering and a lot less value creation. Value creation is what the investor wants. Without that the LPs lose. The investors lose.
Disclaimer:
This article is for informational and educational purposes only and should not be construed as providing investment, tax, or legal advice. It does not take into account the specific investment objectives, financial situation, or particular needs of any reader. Readers should consult with their own tax, legal, and financial advisors to determine the appropriateness of any investment strategy or approach mentioned herein. Investing involves risk, including the possible loss of principal.
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.
