Mark Hulbert was busy elbowing his way onto the anti-private equity bandwagon on July 5th with his confusing dispatch “Real Returns: Are Private-Equity Gains Built to Last?” Mr. Hulbert heroically ignores a large body of readily accessible research and data to precariously perch his pejorative premises on quite arguable findings from a single, tax-return driven study [the study, itself, to be a topic of a separate analysis]. As Mr. Hulbert argues against himself across the article, it is difficult to say that he answered the question he originally posed. Unfortunately, it is clear that Mr. Hulbert has added little to the actual discussion on private equity, descriptive or normative.
Hold your hat as we try to keep up with the whipsaw narrative. On one hand, Hulbert notes that “[t]o be sure, many private-equity buyout funds have in the past produced superior returns.” But he then claims that these returns are due more to market timing as “many of their [private equity] advantages are either ephemeral or can be replicated at a much lower cost.” Thrashing on, the argument goes back to “[t]hese findings don’t mean that the average buyout fund can’t produce impressive returns” but Hulbert follows with “it is relatively rare for a successful buyout firm to repeat its success in a subsequent period.” As icing on the cake, Hulbert also tells us that “[b]uyout firms often pick opportune times to take companies private and then sell them.” Perversely, if you buy low/sell high with public equities – with holding periods measured in fractions of a minute – you are a fêted star bouncing around morning business talk shows; but the private equity industry, with an average holding period of north of 5 years, continues to be vilified en masse as asset flippers. Odd that.
I have trouble connecting commentaries such as Mr. Hulbert’s with the real world of private equity investing. First, the study on which he bases his conclusions continues the worn-out use of a small, non-random, non-representative sample of take-privates to paint an entire industry with a crude, broad brush. I am not sure how Hulbert managed to look past the findings from studies of consulting firms (Bain & Company, McKinsey, Boston Consulting Group), from accounting firms (Ernst & Young, KPMG, McGladrey, Grant Thornton, Deloitte, etc.), from academics (Kaplan, Stromberg, Paglia, Lerner, Gottschalg, etc.), from industry (see Association for Corporate Growth, www.growtheconomy.org, etc.), and readily available from data and analytics firms (PitchBook, etc.). While findings are neither one-sided nor linearly consistent, there is plenty of data contrary to Hulbert’s solo source – and this allows fertile ground for more constructive debate.
Second, I note that pundits who broadly condemn the private equity industry never seem to explain why sophisticated institutional investors would bother with the asset class at all – much less clamor for access to top performing funds – if their experience did not justify it. Are we to believe these investors – many of which have posted very attractive returns from their PE investment portfolios over decades – are foolish and ignorant? Are realized returns over 10+ years ephemeral? A search of the PitchBook database shows over 104 limited partners with more than 100 investments in private equity funds – many of these are investors in multiple fund vintages dating back to 1990s and 1980s. I would argue it is a severe stretch of the imagination to believe whole swaths of the institutional investor universe – public pension funds, endowments, insurance companies, funds of funds – are chasing ‘ephemeral’ private equity returns across decades. Indeed, perusal of publicly available returns data suggests many of these sophisticated investors (which have access to a broad universe of investment strategies) incorporate alternative assets, including private equity, as a key part of their investment programs. From the Iowa Public Employee Retirement System (with a 12% allocation to private equity/debt), to Los Angeles City Employees Retirement System (12% allocation to alternative assets, including private equity), to the Ohio Police & Fire Pension Fund, to the Oregon Public Employees Retirement Fund, to University of Texas Investment Management Company (UT professors would note performance of the latter body), et al., we see LPs with real, long-term investing history and success in this asset class.
Without going into an exhaustive list of academic and industry research findings over decades, the absolute and relative performance of private equity as an asset class is well established, if not conclusive. But the market speaks: the investors seem to understand the benefits of private equity investing when done correctly. Moreover, there has been solid research into the persistence of performance of general partners across funds. If one cares to delve into the information, there is an interesting, on-going debate on results, methodology, etc. – but it’s hard to argue that it’s “relatively rare” for a PE firm to have repeated success.
Hulbert’s article posits that “[c]onsistently being able to time the market is notoriously difficult.” How then, does he explain the persistence of many top-performing funds that we see published by research firms each year (examples: PitchBook and Preqin)? Are these “relatively rare” funds able to do the “notoriously difficult” within each fund that may contain of 8-15+ investments (platforms and add-ons)? And then replicate that across funds of different vintages? Or does the answer lie in the combination effects of financial engineering, multiple expansion, and the operational improvement so often cited in academic and practitioner research? I would argue that the replication of success is, indeed, difficult and the heterogeneity of return performance across vintages speaks to that. But it is not hard to find GPs that can show success across industries, across time, and across economic cycles – if you make the effort.
Is private equity perfect? No. Across thousands of transactions, are there private equivalents of a Facebook IPO? Yes. This non-monolithic industry has strengths, weaknesses, challenges and opportunities – but I will submit the evidence shows Hulbert’s descriptor of “ephemeral” doesn’t make the grade.