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To me, the most striking thing in this article ISN'T that there's a vast, opaque, multi-trillion dollar shadow stock market for institutional investors and elit

• CPLX 7y ago
  > I wouldn't get involved with private equity firms The website you posted this sentence on is owned by a private equity firm.
  • C1sc0cat 7y ago
    Y combinator is more the VC model that the PE one.
    • elliekelly 7y ago
      VC is Private Equity. All thumbs are fingers but not all fingers are thumbs.
      • mcv 7y ago
        My son has lately been claiming that the thumb is not a finger, and he can explain why. I'm not sure who to believe anymore.
        • severine 7y ago
          https://www.lexico.com/en/explore/is-a-thumb-a-finger https://www.lexico.com/en/explore/is-a-thumb-a-finger
      • C1sc0cat 7y ago
        Not in the way intended y combinator doesn't do MBO's or dodgy debt loading as far as I know
        • elliekelly 7y ago
          It sounds like you're conflating asset class (PE) with capital structure (how asset ownership is financed). Private equity is just an investment of capital in a non-public company in exchange for equity. YC makes capital investments in non-public companies in exchange for equity. The structure of PE deals can vary from the simple cash investment in exchange for company stock all the way up to incredibly complex leveraged buyouts and everything you could imagine in between.
  • StevePerkins 7y ago
    As an investor, paying them to manage my money, silly.
  • barry-cotter 7y ago
    The venture capital economic model is very different from that of private equity. VC makes relatively small investments in many extremely risky firms, hoping for a few massive blowout hits which return the entire fund by themselves. PE buys firms with proven economic models, cuts costs and tries to improve management in some form, whether by bringing in real estate expertise for franchises (think Starbucks or McDonald’s) or doing bog standard MBA stuff like KPIs and improving staffing, hiring or internal IT. At the high end of VC you get some overlap with PE, like SoftBank investing $X00 million in hot “startups” but PE does not chase 100x returns on investment. They’re in the business of taking a company worth $100 million and turning it into one worth $500 million.
    • rmah 7y ago
      Venture Capital is a strict subset of the Private Equity industry. They are not outside it, they are deep within it. PE firms do exactly what VC firms do (though often with different sorts of businesses), plus a lot more.
      • notfromhere 7y ago
        VCs don't do the same kinds of questionable financial engineering that PEs do.
        • formercoder 7y ago
          Only because they can't. Leverage requires steady cash flows, fixed assets, etc. If VCs could increase their potential return while also increasing financial risk to their portfolio, they absolutely would. Across private equity there is a spectrum from small cap to large cap with increasing leverage. The small cap funds do a combination of the leverage tricks available to PE investors as well as the deal structure tricks available to VCs (preferred, etc).
          • notfromhere 7y ago
            They can't so they don't. That's why its irrelevant.
  • theobeers 7y ago
    This is about LBO, not VC. It’s mentioned in the subtitle of the article and in the first paragraph.
• cmdkeen 7y ago
  It's more complicated than that - as the article says PE can be used to diversify an investments. If you have a few extra billion you might not want to tie it all to the performance of the US equity market. So PE doesn't have to beat the S&P to be attractive if the ups and downs happen at different times to the S&P. Then there is also the question of fees, if the fund is beating the S&P by 1-2% after fees, and their fees are 2 and 20 then the strategy is significantly beating the market. The problem is that there is so much money chasing PE, and that leverage means they don't need that much in client funds, that there isn't a push to lower fees that you see in the equity market.
  • StevePerkins 7y ago
    > "If you have a few extra billion you might not want to tie it all to the performance of the US equity market." Yes, but... Vanguard's S&P 500 fund isn't the only index fund on the planet, either. You can include a broad international fund, a region or country-specific fund, or any other number of factors. Diversification and passivity are orthogonal. > "if the fund is beating the S&P by 1-2% after fees" Yes, but: 1. You're taking on a higher degree of risk, because the information available to you is much more opaque and unregulated (e.g. EBITA as a valuation metric, when it's so easy manipulated). Bubbles are hard to time, even when you do have decent data available. But investors in that world are just completely flying blind. And historically received only a small net premium for that additional risk. 2. Even that historical premium seems to be gone now. As I pointed out from the article, that "1-2%" is looking back over a quarter-century timeframe. Over the past 10 years, half of PE has UNDERPERFORMED the market. The direction of the trend does not look favorable.
    • avn2109 7y ago
      No matter how much you diversify your long-only strategies, you will still not even be close to market neutral, which is probably what you really want at that scale.
    • batmenace 7y ago
      Regarding 1. the risk can also be substantially lower for PE firms, because A. Extensive FVDD (Financial Vendor Due Diligence) and other types of risk assessment are carried out over the negotiation phase, and you are far less susceptible to stock market movements. Also, unlike investing in public companies, the PE fund is almost always the sole investor in the business alongside a small management tie-up, meaning you actually have full control over the business financially and strategically
• C1sc0cat 7y ago
  Not sure how it is in the US but in the UK anyone can buy listed PE Investment trusts. And quite often you can look at the discount and do arbitrage on that I certainly did very well with Electra Private Equity (ELTA)
  • benj111 7y ago
    How do you arbitrage? I assume you can't hand Electra one of their shares and get back its constituents. And I assume because it's private equity, you can't do the obverse either, or do a long/short type trade.
    • C1sc0cat 7y ago
      You buy when the trust is at a larger discount than normal in a bear market or look for trusts where there is corporate action going on and the shares will be rerated or trust will be wound up. You presumably could short a quoted trust or us CFDs or buy warrants but that's a bit rich for me.
      • OldManAndTheCpp 7y ago
        That is not what is traditionally referred to as arbitrage. You are betting on an unknown variable (correct discount), not noticing pricing for the same asset being different in the same moment. Arbitrage is “sugar being sold at $2 at shop A, and bought at $3 at shop B, and the shops are next to one another”
    • OJFord 7y ago
      Investment trusts themselves are publicly traded, they're closed-ended funds with capital raised once on launch - sort of like pooling private equity, but you can then sell your stake. The public listing is of the company, whose business happens to be investing, so though I've never looked I don't see why CFDs & derivatives wouldn't be available. Venture Capital Trusts (VCTs) are similar (perhaps a subset?) but focus on earlier stage companies (clearly) in exchange for a tax advantage for the initial investors - but not for those who subsequently purchase shares in the VCT itself from them.
• nabla9 7y ago
  If you want to get into well managed private equity, buy Berkshire Hathaway. Most private equity companies use substantial debt leverage to acquire companies and flip them as fast as possible. Berkshire is just the opposite. They use mostly their own capital and leverage from insurance float. They buy businesses permanently. They hire good managers, enforce good corporate governance and the business is free from short term performance goals.
  • mcv 7y ago
    Wow. That sounds like a downright responsible way to do business. Hedge funds always love to claim that they fix companies and make them healthier, but most of them have a reputation for looting them, loading them with debt, and then dumping them at a temporary profit. It's good to see that Warren Buffet actually tries to make businesses healthier.
    • abakker 7y ago
      Alternative view (not necessarily my view): Hedge funds are able to buy companies that are already in trouble. They do a lot of up-front financial engineering to free working capital for last-ditch efforts. Frequently, those last-ditch efforts don't work and the companies fail anyway. Obviously, this isn't universally true, but, not all troubled companies can be saved, or really, need to be saved. The standard pivot model just doesn't work on most businesses, while deferred investment and cash flow problems are always fatal.
    • notfromhere 7y ago
      Hedge funds and private equity are slightly different. Private equity is the leveraged buyout business that got rebranded after its callous performance in the 80s. Hedge funds are usually long/short in public equities (stocks, bonds, etc). Those guys haven't been performing well, and they have had a secular decline in their ability to charge high fees to clients. 2/20 doesn't exist for the vast majority of HFs anymore, more like 1/15, etc. There are a small number of funds that do growth equity (where they buy a small business and grow it), but so much of it just depends on financial engineering in the way you mentioned in your comment.
• Spooky23 7y ago
  People investing in things can yield higher effective returns because the private equity funds are also tax shelters. In the most simple scheme, your billion dollars of income in an S&P 500 ETF will generate $20M of taxable dividends. Wrapping it in the fund can be used to make that a long term capital gain, and the partnership structure has other positive taxation features. (Like avoiding gift or estate taxes) In general, if you see some complex/bullshit sounding financial vehicle that doesn't make sense to you, it likely exists to avoid taxation.
  • Blackstone4 7y ago
    Your logic can be reduced to "If I can't understand something then it must be a tax dodge." This is extremely reductionist and too simplistic... The main driving force behind private equiy are the returns where the best funds have out performed the S&P 500...private equity funds are typically limited partnerships where the investors pay tax on income.
• deleted 7y ago
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• throwaway9d0291 7y ago
  > have only managed to beat an S&P 500 index fund by 1-2% after fees "Beating" the S&P500 doesn't necessarily mean earning higher returns. Earning the same returns with lower risk/volatility would also be widely accepted as "beating" it as most people are more afraid of losing their fortune than they're ambitious to increase it. I'm curious whether taking that into account changes how many private equity firms beat the S&P 500.
  • pmart123 7y ago
    Given your money is tied up for 10 plus years and there’s a lot of leverage involved, you need to have a much higher hurdle rate to want to invest. Say 3.50% or more after fees.
• hacknat 7y ago
  Is any hedge-fund trying to index private equity? Some of the unicorns, for example, probably merit(ted) being ranked among the fortune 500, but are not part of the S&P 500 index. It would be interesting to see index investing make it's way into private equity.
  • the_watcher 7y ago
    Honest question - how would you actually go about doing this? The phenomenon you're describing is definitely true to some extent. Look at when in their lifecycle companies went public prior to 2008 compared to now: far more of the value created is now captured by private capital. This is why, ironically, PE is the largest source of alpha to vehicles like pension funds - they can't capture the same kind of yield in public markets anymore and have mandates about the types of investment they can make. Figuring out a better way to democratize access to the potential yield that used to be available in public markets would be excellent, but I'm not sure how to do it without pretty massive side effects.
• esoterica 7y ago
  Why would you expect a magic “beat the S&P” button to exist at all? That would be a gross violation of the EMH. If it has indeed beat an index fund by 1% in a risk adjusted manner that would be a miracle in itself.
  • mruts 7y ago
    He’s not talking about on a risk adjusted basis. Moreover, EMH is a framework for understanding, not some magical law. There are funds who’s returns over time are like a 10 sigma event.
• julienchastang 7y ago
  > only managed to beat an S&P 500 index fund by 1-2% after fees From the article: "Over the 25 years ended in March, PE funds returned more than 13% annualized, compared with about 9% for an equivalent investment in the S&P 500" When you are dealing with exponents small differences become enormous over time. Remember: y = y0*e^kt where y is money later, y0 is money now, e is 2.71, k is the interest rate, and t is time. So assuming 9% annualized return in the SP500, after 10 years, your million dollar PE investment will yield 2.5 million in the stock market, but 3.7 million in PE or a 1.2 million dollar difference. In addition, they maximize y0 by leveraging. Ignoring the terrible social costs (e.g., Shopko from the article) and the fact that their accounting and tax practices are suspect, I'll take the PE any day.
• mruts 7y ago
  The S&P isn’t a reasonable benchmark to PE in the first place. Your argument is like saying: “US Teasuries underperform the S&P by 8% every year, people and countries buying treasuries are stupid and just want to be part of some secret club.” There’s a couple of things wrong with this argument so let’s go over it: 1) Low or uncorrelated return streams are very valuable due to the central limit theorem. As you add these return streams together, they form an increasingly tighter normal distribution. This gives us two advantages: we can convert non-normal distributions into normal ones, and we reduce our standard deviation with every stream we add as long as the correlation is less than one. 2) Returns aren’t the defining factor of whether a strategy is worth it. Instead institutional investors measure investments by their Sharpe ratio: the slope of the line between return and risk (the axis is the risk-free rate). The reason for this is that since these kinds of investors can not just lend, but borrow at the risk-free rate, they can lever up their returns to anything they want. This is called risk-adjusted returns. 4) The biggest risk in investing is exposure to Beta, “the market,” which in the US is usually measured by the S&P 500. Reducing exposure to Beta is often goal #1 of institutional investors. Maybe not a 100%, you should definately not be exposed to a 1.0 Beta coefficient. This is especially important for endowments, pensions, and other funds that have monthly or yearly pay-outs. The auto-workers would be super pissed if the economy tanked and they no longer got their retirement pensions. After all, that’s one of the things that pensions are supposed to hedge against. Before I started working in finance, I definately had the same questions and theories as you. After all, the field is very baroque and complicated and the explanation of the industry being stupid is very simple and straightforward. Chesterson’s Fence is a good way to view a lot of things. Understanding is always a prerquisite for change.