Overall private equity returns over the past
30 years have been disappointing and raises questions about
investor’s sophistication when choosing to invest in leveraged
buy-outs, according to a report published by London economic
think-tank Centre for the Study of Financial Innovation.

The report, Private Equity, Public
Loss, by former Morgan Stanley managing director Peter Morris,
called into question whether private equity firms deserve to charge
high fees and urged more transparency around private equity
performance.

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The report quoted the University of Chicago’s
Steven Kaplan and Massachusetts Institute of Technology’s
Antoinette Schoar who found the average buy-out fund, net of fees,
underperformed the S&P 500 between 1980 and 2001. The median
buyout fund delivered 83% of the S&P 500 return; the mean
93%.

 

Private equity alternatives

Writing in PBI in March, Jeffrey
Hooke, managing director of valuation firm Hooke Associates,
referred to the Kaplan/Schoar research and said synthetic public
stock portfolios may be a reasonable alternative.

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“Even PE executives admit that anyone applying
50% margin to the S&P 500 index can beat buyout returns.
However, many institutions can’t buy stocks on margin, or they are
reluctant to purchase leveraged exchange-traded funds,” Hooke
said.

“It may be up to private bankers (and those
managing publicly-traded equities) to develop tools for clients to
mirror PE investment attributes without the high fees,” Hooke
added.

The report comes at a time when private equity
is a “hot topic” for family offices, according to Scorpio
Partnership.

Scorpio said 57% of family offices surveyed
are considering boosting their exposure to private equity this year
with most offices seeing private equity as a major investment
opportunity in the next 2-3 years.

 

Other Private Equity, Public Loss findings
included:

  • Realised returns are lower than advertised, even for
    top-quartile managers.
  • The quality is also lower: excluding high debt levels and
    general stock market performance, managerial skill accounts for
    only a fraction of the total return.
  • This calls into question fee structures, which may remove all
    the gains attributable to skill.
  • Investors’ apparent failure to question the level and make-up
    of returns, and fees, raises questions about their collective
    status as “sophisticated investors”.

The British Private Equity and Venture Capital
Association was unavailable for comment.

 

Related private equity
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Private equity underperforms S&P 500