Is the End Coming for Private Equity?

Private Jets vs. Pension Funds.

By Matt Stoller and cross-posted from his substack blog.

It’s rare that a finance professor causes a public stir, but when it happens, it’s worth paying attention to, because it means that trillions of dollars may eventually start to change direction. A few weeks ago, Oxford professor Ludovic Phalippou published a paper striking at the heart of the modern private equity industry, and in particular, large buyout shops that borrow money to buy companies to flip them a few years later. His paper got coverage in the Financial TimesBloombergForbes, and Institutional Investor, and will in the long-term make it harder for pension funds to put money into private equity.

Most people interested in criticizing private equity discuss how leveraged buyouts (“LBOs”) are bad for society. For instance, one manufacturer I talked to a few years ago for a piece on how finance ruined our defense industrial base told me angrily about how the “LBO boys” destroyed our ability to make things. Phalippou, however, asked a different, and much more simple question than that of whether LBOs are good for America. He asked, are investors getting a good return? And his answer is, since 2006, no.

Phalippou’s paper is titled “An Inconvenient Fact: Private Equity Returns & The Billionaire Factory.” To paraphrase his argument, he basically described the private equity industry business model by saying 40 years ago there were a lot of people with pensions and very with few private jets, whereas today there are very few people with pensions and a lot more billionaires with private jets. In other words, buyout shops don’t offer good investment returns, but siphon off cash from pension funds and turn that into luxury goods and political power for a narrow group of billionaires.

Now to clarify, what Phalippou, and most of us, mean when we say “private equity” are buyout funds that use debt to buy companies like Toys R Us with borrowed money, and then find various ways of looting them. These are funds like KKR, Carlyle, Blackstone, etc. So when I write private equity, I mean those kinds of funds, the billionaire factories, not smaller funds with expertise in a specific style of growth investing. (Indeed, what I’m finding as I hear from many of you is that there is actually a great deal of frustration within the finance industry towards the private equity barons, because their giant financial engineering strategies are an unfair extractive game based on who has political connections.)

What intrigued me about Phalippou’s paper was not the observation that mega-cap private equity funds aren’t good investments, but that there was a shift in investment returns around 2006. Prior to that year, LBOs did generate returns for investors better than you could find on the public markets, but afterwards, those excess returns disappeared. Why?

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