Experience can be a curse. On the one hand it makes one more cautious – perhaps too cautious. No doubt this is why commentators on business television look like teenyboppers to the likes of myself. The investment industry certainly needs young folk to innovate and take risks. On the other hand, the benefits of hindsight are lost when seasoned professionals retire or are simply too old to compete for jobs.
For example, does anyone under 40 remember when real estate got crushed and bankrupt office towers went ‘no bid?’ And I am not talking about the financial crisis we suffered roughly only a decade ago either. A 30-year old wasn’t even born when the October Crash of ’87 occurred. I could go on, but age is taking its toll on my memory.
Everyone seems to agree the stock market is overbought, but watching CNBC I frequently hear comments like: ‘We aren’t worried, job growth is solid and the economy is in good shape.‘ Another correction doesn’t worry me, but worse is likely coming or might be here already.
Most crises are unexpected. A fuse of some sort creates panic selling, assets decline in value, balance sheets deteriorate and more selling is necessary to generate liquidity needed for solvency. The problem is that nobody wants those assets declining in value. When the last fool buys the asset (thinks he/she is getting a great deal at a discount) liquidity dries up completely (the ‘no bid’ scenario). At this point, the better quality assets are put on the auction block.
The amount of money invested in startups, infrastructure and real estate has ballooned in recent years. Many institutional investors (pension plans, banks & insurance companies, and especially private equity funds) have boasted of outstanding performance thanks to this asset category. The massive dollars governments have spent and are spending to either help fund new ventures or provide subsidized real estate for incubators reminds me of times gone by – when venture capital (now renamed startup or private equity) was in vogue. Their efforts then eventually proved to be a quantum waste of our tax dollars. Governments (and banks) are a great contrarian indicator – sectors to avoid when the public sector scrambles to get on the bandwagon. [PS – I’m sure younger Canadians have no idea where the original PetroCanada came from.]
So what’s the issue? How is private equity ‘performance’ measured? In a few instances, the investment was made privately, and in due course the company or asset bought becomes publicly traded resulting in a big score. Of course, unless the stock was disposed of (hard for a committee to do when its worth lots) it’s just a paper gain. But for investments that remain private, a bit of a pyramid scheme bolsters performance data. New investors (and legacy investors) keep providing funds but a higher valuations. As we know, this works fine until…well we know what happens when there’s no more investors willing to invest.
As of March 31, 2019 the Canada Pension Plan had $302 billion in net assets. Private Equities accounted for 93.1 billion or 23.7% of these assets. Real Assets (real estate, infrastructure etc.) slightly more than this – hardly what I’d consider ‘liquid’ assets but that’s just my opinion.
Infrastructure fundraising grew 17 percent globally and 59 percent in Europe, backed by a long-term secular need for investment.McKinsey Global Private Markets Review 2019
In a recession, infrastructure investment will generate cash flow, but in the event the investor needs hard cash to match lower asset valuations to liabilities these assets will certainly be less liquid that they are at present.
Of the Ontario Teachers Pension Plan’s over $200 billion in assets, 17% are non-publicly traded equities. I’ve seen other huge pension plans in the U.S. that intend to bump their private equity allocations.
It seems there are nearly 12,000 private equity funds out there (that are accounted for). And these funds have raised an awful lot of money. Of course, much of that cash may not be invested yet, but their mandate is to put the $ to work, and I agree with this quote from Bloomberg:
Firms may find it hard to replicate their past gains, however. The tide of new money has pushed up asset prices at the expense of returns — a pattern that’s occurred across all areas of the market, said Jill Shaw, managing director at Cambridge Associates, which manages funds on behalf of wealthy families and pension, endowment and foundation clients.Private Equity Is Starting 2020 With More Cash Than Ever Before
By Melissa Karsh and Benjamin Robertson January 2, 2020
Where I might differ from the above opinion, is that past returns may have to be revised down if it turns out that private businesses and assets that were expected to make money just aren’t going to.
Now that you’ve seen the size of these numbers, consider that the OECD (Financial Market Trends 2008) estimated the size of losses from the Subprime Crisis to be USD 350 – 420 billion. Clearly, the total fallout across the global economy that crisis caused was one heck of a lot bigger. It was, as all crises are, a matter of assets simply turning out to be worth much less than everyone thought they were worth. But the damage to global wealth (financial markets, consumer demand, capital spending and so on) is catastrophic.
So have a look around the office. If you see a plethora of youngsters making strategic decisions perhaps you should practice a different kind of ‘diversity’ – hire someone with a few grey hairs quick. And by the way, I could use a gig.
Welcome back! Missed you!
Sent from my iPhone
Thank-you Brian. Haven’t had much to say for awhile.
Great to see you back Mal. Agree totally with this being an overexploited and dangerous area of investment, with particularly large and unreasonable fees. One aspect that you might have covered is the distortion (or if you prefer BS) of performance that PE managers often use in describing performance in terms of cranking up IRR (internal rate of return).The numbers can be overstated, distorted, and misleading.
Good point Rick. I suspect their misrepresentations will soon become moot.
Mal, I have been waiting for the next article for some time. Keep them coming as I always enjoy them.
Thanks Jeff. Hope to improve the site soon too.