By ROBIN POWELL
A small number of private equity barons have accumulated vast riches from running funds that have performed no better on average than simple index funds, according to new research.
Ludovic Phalippou, Professor of Financial Economics at Oxford University’s Saïd Business School, found that the number of PE managers with personal wealth of more than $2 billion has risen from three to 22 in 15 years.
Over a ten-year period he estimates that investors paid around $230 billion in performance fees for returns that could have been matched by a tracker fund costing just a few basis points.
Professor Phalippou’s analysis suggests that, net of fees, US public pension plans earned about $1.50 for every $1 invested in private equity funds between 2006 and 2015. This translates into annualised returns of about 11 per cent. The US stock market delivered similar returns over the same period.
One of the largest wealth transfers in history
“This wealth transfer from several hundred million pension scheme members to a few thousand people working in private equity might be one of the largest in the history of modern finance,” he says.
“The private equity industry may need to rethink its business model, lowering costs and reconsidering how performance fees are paid in order to remain sustainable. This, however, will probably generate fewer billionaires.”
As you would expect, major players in the private equity industry haven’t taken kindly to this latest research. Blackstone, for instance, said it contains errors and was deliberately intended to reach negative conclusions. Carlyle has accused Professor Phalippou of “selective engagement with the facts”.
Study reinforces earlier findings
But the Oxford study is by no means the first to raise serous questions about the net returns delivered by private equity funds. Earlier this year, for example, a report by the Harvard economist Josh Lerner and Bain and Company showed that, in the ten years to the end of June 2019, PE funds underperformed public equities.
Over that period, private equity investors received an average annual return of 15.3% compared to the 15.5% they would have made by investing in the S&P 500.
“There’s been a huge influx of money into private equity,” said Professor Lerner. “But when you look at the returns numbers for the last decade… it’s hard to feel that there’s really been much alpha at all.”
Is there an illiquidity premium at all?
In a 2017 study, Erik Stafford, also from Harvard, showed that the so-called “illiquidity premium” associated with private equity is actually “zero or even negative”. Investors can achieve similar, and perhaps slightly better results, Stafford said, with a portfolio of publicly traded small-cap value stocks.
In a blog post published in December 2019, Cliff Asness from AQR Capital Management suggested that it’s more appropriate to refer to an illiquidity discount. Yes, PE returns appear to be smoother than for public stocks, because investors aren’t confronted with rising and falling prices every day. But the volatility is actually comparable.
Recent research by Nicolas Rabener from Factor Research produced similar conclusions.
Huge inflows in recent years
Studies such as these are especially relevant at the moment. Private equity funds have attracted huge inflows in recent years from institutional investors including pension schemes, insurers, sovereign wealth funds, endowments and family offices.
The chief investment officer at CalPERS, the largest public pension fund in the United States, is quoted in today’s Financial Times as saying that the fund has decided to bet heavily on private equity.
At the same time, the Trump administration is edging closer toward allowing individual investors access to PE funds through their retirement accounts.
A hero who deserves our thanks
Ludovic Phalippou has produced a wealth of evidence in recent years that there is too much opacity surrounding both costs and performance in private equity. I’m saddened to learn that this latest paper will be his last on the subject.
As with the mutual fund industry, there are powerful vested interests determined to maintain the status quo. Judging by his Professor Phalippou’s comments on LinkedIn, the struggle to raise awareness on these issues has rather worn him down.
In my view, the guy is a hero and deserves the heartfelt thanks and support of investors everywhere.
You can read Professor Phalippou’s report here:
An Inconvenient Fact: Private Equity Returns & The Billionaire Factory
You can read more about Professor Phalippou’s research and his views on private equity on his blog.
You may also be interested in these related articles:
How good an investment is private equity (honestly)?
Is private equity an accident waiting to happen?
Let’s use plain language on private equity performance
Beware private equity funds that muddy the water on performance
Private equity returns are not what they seem
Picture: Danilo Capece via Unsplash
