Saturday, September 22, 2012

The "Juice"

The “Juice”

After several days of critical comments about private equity, you’re probably thinking that the business is pure evil.  Not so.  Private equity is actually no different than any other form of business-ownership.  If there’s an opportunity to make money by building, hiring or expanding, public and private companies alike will invest.  If there’s a way to make money by dismantling, firing or contracting, public and private companies alike will have at it.  Plenty of publicly owned textile and furniture companies here in North Carolina shuttered their plants and fired their workers (and those plants and workers were the progeny of plants closed and workers axed in the northeast).

Oh No, My Portfolio (1995)

The big firms in private equity are like homerun hitters on steroids.  Remember when Mark McGuire and Sammy Sosa dueled to break Roger Maris’s homerun record and then Barry Bonds shattered it?  The large private equity firms, and particularly the folks who own these companies have played the game of capitalism on steroids.  Playing baseball on steroids undermines the integrity of the national pastime, just as playing capitalism on steroids ruins the integrity of our economy and pollutes our political discourse.  Unfortunately most of the elite players in the world of hedge funds, mutual funds and institutional money management employ the “magic juice” to varying degree.  We’ll stick to private equity for now.

How do you mix up a batch of financial steroids?   You’re probably thinking the biggest ingredient is money.  You are almost right.  Financial steroids are two parts money along with one part each of influence and story-telling.  Deploy this mixture for about 10 to 20 years, and you’ll seldom strikeout, and if you do, it won’t matter because all your other hits are homeruns.

We’ve already seen the political part of the influence at work in the campaign fund raising process.  However influence is also at work at university endowments, and pension plans where the investment gurus use their contacts on Wall Street and Capital Hill, and status as alumnae at elite universities to get in front of the people who ladle out the money.  Your run-of-the-mill money manager doesn’t have the opportunity to dine with a Governor, University President or Chief Investment Officer of a Foundation. 

Let’s sprinkle some story telling into the brew.  The best of the best at this game will tout some extraordinary investment returns (and indeed there will always be some truth to these numbers).  However, if you were to examine the numbers closely you’ll probably find they were accomplished on a relatively small scale, or in a different environment, or were the by-product of plain old luck.  Nonetheless, the story surrounding these number is compelling whether its packaged in a multi-media presentation or spun over a fine bottle of Merlot.  The story is going to convince the listener that the offering is “proprietary”, capable of solving the university’s (or pension plan’s) problems and worthy of a premium fee.

Money is the binding agent that gives the influence potency and story-telling credibility.  The private equity guru will undoubtedly pledge millions to his alma mater or favorite foundation.  He will spearhead the addition to the hospital or the opera house.  As I’ve noted before, he will be active in campaign finance, and not just the measly amounts given to Governors, Treasurers and Comptrollers (that doesn’t really buy much), but the big sums to the parties, congressional PACs and Super PACs. 

Where does this money come from?  Teacher pensions, university endowments and charitable foundations.  As we’ve seen the fees paid by these investors are so large that it isn’t difficuly for the large private equity firms and hedge funds to take a small amount, say $100 million or $200 million, and look like one of the world’s great philanthropists.  In reality, the patrons of the arts should be thanking the trustees of pension plans and endowments for agreeing to pay 2% to 3% fees plus 20% of the profits: it’s there money that made it all possible.  In any event, political and charitable giving provides the mavens with even more influence and more credibility for their stories, so that the steroids will be even more potent the next time.

The private equity folks are happy for you to attack their capitalist tactics.  They can defend those because that’s how capitalism works.  More importantly if you’re attacking their investment model, you’re distracted enough not to mess with their steroids.v

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