The role of Private Equity

[Dona Ferentes]

some see it as a way to boost returns, while others think PE is toxic. I'm in the latter camp, because many a sin can be hidden.

I'll start with a view from a U.S. newsletter from Jarad Dillian

August 22, 2024​

Everything Is Worse Because of Private Equity​ Have you noticed that across businesses in a range of industries, prices are higher and the customer experience is worse? It’s because a huge swath of the economy is now private equity owned. Dental practices, car washes, laundromats, veterinarians, smoothie joints, restaurants, self-storage units, funeral homes—practically no business has avoided ruination by private equity. To wit, private equity-owned nursing homes have a much higher mortality rate. There is a lot to say here. The main reason this is happening is because the founder of a business has a different time horizon than a temporary owner of a business. The founder of a business is long-term greedy (making sure customers are satisfied so they keep coming back again and again). The temporary owner of a business has one objective: squeeze as much profit out of the business as possible before selling it to someone else at a higher valuation. This means two things: cutting jobs and raising prices, which the private equity people refer to as “efficiency gains.” Who knows better how to run a restaurant chain? A 62-year-old founder who has been in the business his entire career or a 33-year-old, fleece-vest-wearing Ivy League graduate to whom the business is just an abstraction, numbers in a spreadsheet? There are real, intangible reasons why founders don’t jack up prices and fire a bunch of people—they care about the customer. PE guys don’t. In fact, they’re not particularly upset if the business fails as long as they get their money out. Private equity used to be a smart way to take advantage of low interest rates to buy undervalued businesses with stable, predictable cash flows. Now, the cancer has metastasized, and PE has invaded industries with highly cyclical cash flows, or businesses with real-life consequences if things go wrong, like medical care for people and pets. And don’t get me wrong—I am not one of these “people before profits” progressives. I’d bet that I’m more of a capitalist than you are. But private equity is a perversion of capitalism—treating living, breathing businesses like trading cards. I suppose this will all be over when a private equity firm rolls up a bunch of private equity firms. It's a Bubble​ We are in the midst of a massive investment bubble, but you wouldn’t know it from looking at the stock market. I believe it’s a bubble on par with the financial crisis. Private equity poses real, systemic risks to the economy, and this is primarily because of the use of leverage. Debt on top of debt on top of debt, used to amplify returns. To err is equities, but to really screw things up takes fixed income. And now, we are in a position where we depend upon it. Your pension depends upon it. Your university depends upon it. Pension funds and endowments have been gobbling up private equity for years. It’s illiquid, and if there is a real downturn, there is nothing they can do about it. Endowments have been copycatting David Swensen for years, and now it has reached the point of absurdity. And why not? Why not get returns equal to or greater than the stock market with zero volatility? Aha! It is the illusion of zero volatility. When the stock market was down 4% two Mondays ago, for sure, private equity was also down 4%. But did PE firms mark down their holdings? Of course not. Another thing I thought of recently: A private equity fund is not too different from a plain-vanilla stock mutual fund. They are both long-only. In fact, the private equity fund has leverage. And people are paying 2 and 20 for long-only funds with zero liquidity and no way to get out? Madness. People have gone barking mad. And arguably, these are worse businesses than the S&P 500. You’re going to pay 2 and 20 for someone to buy Quick Quack car wash? I want to repeat myself here: In the old days, a good candidate for a private equity target would be a business with stable, predictable cash flows. There is nothing more cyclical than a car wash. All It Takes​ All it takes is a catalyst. I can imagine a scenario where public markets go down 20% and private equity firms don’t mark down their holdings at all, and then people start asking hard questions. Then the redemption orders start coming in, and if the PE firms honor them, they will be selling businesses at distressed levels, creating realized losses and actual marks on their portfolios. Or maybe none of this happens. Maybe we get a mild recession, and the companies in the portfolio just earn their way out of it. Liquidity always finds a way. Leverage is always unwound. I am very, very bearish.

 

[qldfrog]

You see a parallel slightly mitigated form with REIT funds.
Nearly 20 y ago, i got into an REIT.
Is not redeemable, its unit price is .well what i am told it is ! but what is the real value of something you can not get?
Imho not far from $0
But at least there are some assets, some leverage,occupancy figures on the public domain.
Private equity is worse.

 

[Garpal Gumnut]

some see it as a way to boost returns, while others think PE is toxic. I'm in the latter camp, because many a sin can be hidden.

I'll start with a view from a U.S. newsletter from Jarad Dillian

​ August 22, 2024​

​ Everything Is Worse Because of Private Equity​ Have you noticed that across businesses in a range of industries, prices are higher and the customer experience is worse? It’s because a huge swath of the economy is now private equity owned. Dental practices, car washes, laundromats, veterinarians, smoothie joints, restaurants, self-storage units, funeral homes—practically no business has avoided ruination by private equity. To wit, private equity-owned nursing homes have a much higher mortality rate. There is a lot to say here. The main reason this is happening is because the founder of a business has a different time horizon than a temporary owner of a business. The founder of a business is long-term greedy (making sure customers are satisfied so they keep coming back again and again). The temporary owner of a business has one objective: squeeze as much profit out of the business as possible before selling it to someone else at a higher valuation. This means two things: cutting jobs and raising prices, which the private equity people refer to as “efficiency gains.” Who knows better how to run a restaurant chain? A 62-year-old founder who has been in the business his entire career or a 33-year-old, fleece-vest-wearing Ivy League graduate to whom the business is just an abstraction, numbers in a spreadsheet? There are real, intangible reasons why founders don’t jack up prices and fire a bunch of people—they care about the customer. PE guys don’t. In fact, they’re not particularly upset if the business fails as long as they get their money out. Private equity used to be a smart way to take advantage of low interest rates to buy undervalued businesses with stable, predictable cash flows. Now, the cancer has metastasized, and PE has invaded industries with highly cyclical cash flows, or businesses with real-life consequences if things go wrong, like medical care for people and pets. And don’t get me wrong—I am not one of these “people before profits” progressives. I’d bet that I’m more of a capitalist than you are. But private equity is a perversion of capitalism—treating living, breathing businesses like trading cards. I suppose this will all be over when a private equity firm rolls up a bunch of private equity firms. It's a Bubble​ We are in the midst of a massive investment bubble, but you wouldn’t know it from looking at the stock market. I believe it’s a bubble on par with the financial crisis. Private equity poses real, systemic risks to the economy, and this is primarily because of the use of leverage. Debt on top of debt on top of debt, used to amplify returns. To err is equities, but to really screw things up takes fixed income. And now, we are in a position where we depend upon it. Your pension depends upon it. Your university depends upon it. Pension funds and endowments have been gobbling up private equity for years. It’s illiquid, and if there is a real downturn, there is nothing they can do about it. Endowments have been copycatting David Swensen for years, and now it has reached the point of absurdity. And why not? Why not get returns equal to or greater than the stock market with zero volatility? Aha! It is the illusion of zero volatility. When the stock market was down 4% two Mondays ago, for sure, private equity was also down 4%. But did PE firms mark down their holdings? Of course not. Another thing I thought of recently: A private equity fund is not too different from a plain-vanilla stock mutual fund. They are both long-only. In fact, the private equity fund has leverage. And people are paying 2 and 20 for long-only funds with zero liquidity and no way to get out? Madness. People have gone barking mad. And arguably, these are worse businesses than the S&P 500. You’re going to pay 2 and 20 for someone to buy Quick Quack car wash? I want to repeat myself here: In the old days, a good candidate for a private equity target would be a business with stable, predictable cash flows. There is nothing more cyclical than a car wash. All It Takes​ All it takes is a catalyst. I can imagine a scenario where public markets go down 20% and private equity firms don’t mark down their holdings at all, and then people start asking hard questions. Then the redemption orders start coming in, and if the PE firms honor them, they will be selling businesses at distressed levels, creating realized losses and actual marks on their portfolios. Or maybe none of this happens. Maybe we get a mild recession, and the companies in the portfolio just earn their way out of it. Liquidity always finds a way. Leverage is always unwound. I am very, very bearish.

Thanks @Dona Ferentes , a great thread and a great post. For the unfamiliar I'm posting an explanation of " Two and Twenty" which is intrinsic to the risk with mutual funds.





gg

 

[Dona Ferentes]

a view on ascendant themes, to whit, passive ETFs and Private Equity.

Is the passive investing dream waning?

There are signs that passive investing is struggling to keep up in a world that's rapidly passing it by. To understand why, we need to talk about how private equity has revolutionised the investment landscape.

www.firstlinks.com.au

 

[qldfrog]

Relevant today's AFR

 

[Dona Ferentes]

a brace of LIT listings
.
MA Financial will launch a traditional private equity offering, giving investors access to its $3.7 billion portfolio of private credit strategies.

The Dominion Income Trust (DN1) from Realm Investment House is more diversified across government banks,  hybrids and structured credit and structured as a single debt note housed within a listed vehicle.

Both MA and Realm are seeking to raise $300 million. MA is looking at an 04 March listing date, two business days after Realm.
.
As they are Listed Investment Trusts, there is the discount to NTA issue. Realm’s pitch to investors claims its innovative structure would limit big discounts between the units’ trading price and their net asset value, thanks to greater certainty around when the capital is due to be returned. MA Financial is attempting to limit discounts by committing to quarterly off-market buybacks at NAV for up to 5 per cent of the issued capital, a mechanism also seen in a credit fund listed by Pengana last year.

 

[Dona Ferentes]

The Australian Securities and Investments Commission’s chairman, Joe Longo, said it was time for a national discussion on the rise of the so-called private capital market, which the regulator estimates has swelled to some $150 billion in assets. Public markets are worth more than $5 trillion.

Private assets can include anything from a loan for a commercial property development to an ownership stake in Sydney Airport. The investors do not trade on an open exchange like a share or a bond, cannot be easily bought or sold by smaller investors and their price is less transparent.

ASIC is concerned that these investments often lack the same disclosures as publicly listed assets. That could mean investors are left in the dark about how a business is performing, how fees in the fund are accrued, and even if the value placed on an asset is in line with publicly traded equivalents.

“Private markets pose particular challenges for market confidence. For instance, a lack of transparency can lead to mistrust about the valuations of private assets,” ASIC’s report reads. “Given the complexity of the dynamics driving the apparent shift from public to private markets, we need to understand whether regulatory considerations are having an undue impact on driving investors’ and companies’ decisions.”

"Opacity, conflicts, valuation uncertainty, illiquidity and leverage in private markets are the key risks. “Data is essential. International peers are increasing access to reliable data on private markets. ASIC needs better recurrent data to more accurately assess risk.”

“It’s not the role of the regulator to tell investors where to put their money or where to raise finance,” said Longo. “It is the role of the regulator to know what is going on in the markets maintaining high standards of disclosure and conduct, and for all of us to have integrity.”

 

[Dona Ferentes]

a drift


.
minor quibble, valuation rather than value?

 

[Dona Ferentes]

interesting that private equity houses are listed

Of the big players in the United States,

• KKR has fallen 32 per cent from its recent all-time high at the end of January,
• Blackstone is down 30 per cent from its recent peak,
• Ares Management has dropped 27 per cent,
• Apollo Global Management is down 25 per cent,
• Carlyle is down 26 per cent, and
• Brookfield has fallen 18 per cent