Tuesday, June 2, 2015

An Industry Doesn’t Like My Work: PE Responds to my Column in the N&O

An Industry Doesn’t Like My Work:  PE Responds to an N&O Column/1

Two weeks ago I wrote my Sunday column about the unconscionable wealth accumulated by a small group of private equity and hedge fund managers (see, “Rising Wealth of Money Managers has a Downside”)./2   I’ve been busy with a variety of non-financial matters and missed a letter to the editor from Steven Judge, President of the Private Equity Growth Capital Council disputing part of my column and defending the honor of private equity.  To be blunt, I could do a better job of refuting my column.


Here’s his argument and my refutation:

1. private equity invested nearly $11 billion in North Carolina’s economy, strengthening companies and securing good-paying job.

Although $11 billion sounds like a lot of money, it isn’t so much money in an economy of nearly $500 billion.  Moreover, much of those funds didn’t go into new investment, but were used to retire debt and cash out previous owners of those companies.  While some of that investment certainly found its way into creating some “good-paying” jobs, it also resulted in lay-offs.  I’m not critical of private equity for firing people; that is part of their mandate.  Investors expect them to fire people.  In capitalist economies companies, both public and private, downsize all the time.

2. In 2014, this asset class also returned over 18 percent, net of fees, to North Carolina’s public pension, benefiting hardworking teachers, firefighters, public servants and police officers.

For the fiscal year ended in June 30, 2014, the state’s pension plan reported an 18% return.  However, Mr. Judge doesn’t mention that PE only returned 5.5% over the last 15 years, or that plain old stocks returned nearly 25% during the same one-year period.

3. The fees paid to private equity were less than 1% of the gains in pensions portfolios in fiscal 2014

I’ll give Mr. Judge credit for creativity, but this statistic is meaningless.  Most of the gains in the pension were due to a sharply higher stock market, not anything private equity had a hand in creating.  Private equity charged the pension plan 1.8% in fees and carry for the nearly $4 billion in assets it managed for North Carolina, and PE underperformed North Carolina’s benchmark by 1.9%.

4. Private equity managers aren’t money managers because they add much more value to companies than conventional stock or bond managers.

Mr. Judge is correct when he says that private equity managers are much more involved in their companies than conventional money managers.  That doesn’t mean that they aren’t still money managers.  In fact, public pensions, endowments and foundations would be aghast if private equity managers weren’t money managers.  After all, North Carolina and every other institutional investor has hired every one of its PE managers to act as fiduciaries in investing a portion of the pension fund’s assets.    From the pension plan’s perspective, PE’s job is to generate returns, and that is called money management.

What should concern North Carolina and other investors is that all of private equity’s hands-on involvement in hiring executives, sitting on boards, and continually refinancing portfolio investments results in hidden fees that aren’t part of the management fee or carried interest.  While some private equity funds produce stellar returns, it isn’t clear that the entire PE industry is capable of adding value to investor portfolios.  Moreover, only a tiny number of managers are able to generate value over a sustainable period.

In the end, the only ones making out well are a small group of incredibly wealthy PE executives who pay Mr. Judge to lobby to protect their interests and wind up on the Forbes 400 list.

[1] http://www.newsobserver.com/opinion/letters-to-the-editor/article21709716.html
[1] http://www.newsobserver.com/news/business/article20986962.html)

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