Bloomberg Businessweek - USA (2019-10-07)

◼ FINANCE Bloomberg Businessweek October 7, 2019

26

●TheReturnsAreSpectacular.

ButThereAreCatches

Forinvestorsthedrawofprivateequityissimple:

Overthe 25 yearsendedinMarch,PEfundsreturned

morethan13%annualized,comparedwithabout

9%foranequivalentinvestmentintheS&P500,

accordingtoanindexcreatedbyinvestment firm

CambridgeAssociatesLLC.Privateequityfans say

thefundscanfindvalueyoucan’tgetinpublic mar-

kets,inpartbecauseprivatemanagershave more

leewaytooverhaulundervaluedcompanies. “You

cannotmaketransformationalchangesina public

companytoday,”saidNeubergerBermanGroup LLC

managingdirectorTonyTutroneina recent inter-

viewonBloombergTV.Biginstitutionalinvestors

suchaspensionsanduniversityendowments also

seea diversificationbenefit:PEfundsdon’tmove in

lockstepwithbroadermarkets.

Butsomesayinvestorsneedtobemoreskeptical.

“Wehaveseena numberofproposalsfrom private

equityfundswherethereturnsarereallynot calcu-

latedina mannerthatI wouldregardashonest,”

saidbillionaireinvestorWarrenBuffettatBerkshire

HathawayInc.’sannualmeetingearlierthis year.

Therearethreemainconcerns.

○THEVALUEOFPRIVATEINVESTMENTS

ISHARDTOMEASURE

Because private companyshares aren’tbeing

constantlyboughtandsold,youcan’tlookup their

pricebytypingina stockticker.Soprivate funds

Thebasicideais a littlelike

houseflipping:Takeovera

companythat’srelativelycheap

andspruceit uptomakeit more

attractivetootherbuyersso

youcansellit ata profitin a few

years.Thetargetmightbea

strugglingpubliccompanyora

smallprivatebusinessthatcan

becombined—or“rolledup”—

withothersin thesameindustry.

①A fewthingsmakePE

differentfromotherkindsof

investing.Firstis theleverage.

Acquisitionsaretypically

financedwitha lotofdebtthat

endsupbeingowedbythe

acquiredcompany.Thatmeans

thePEfirmanditsinvestors

canputin a comparativelysmall

amountofcash,magnifying

gainsif theysellata profit.

②Second,it’sa hands-on

investment.PEfirmsoverhaul

howa businessis managed.

Overtheyears,firmssay

they’veshiftedfrombrute-

forcecost-cuttingandlayoffs

toMcKinsey-styleoperational

consultingandreorganization,

withtheaimofleaving

companiesbetteroffthanthey

foundthem.“Whenyougrow

businesses,youtypicallyneed

morepeople,”saidBlackstone

GroupInc.’sStephen

SchwarzmanattheBloomberg

GlobalBusinessForumin

September.Still,thebusiness

modelhasputPEatthe

forefrontofthefinancialization

oftheeconomy—anybusiness

it touchesis underpressure

torealizevalueforfar-flung

investors.Quickly.

③Finally,thefeesare huge.

Conventionalmoneymanagers

areluckyif theycanget

investorstopaythem1%oftheir

assetsa year.Thetraditional

PEstructureis “2and20”—a

2%annualfee,plus20% of

profitsabovea certain level.

The 20 part,knownas carried

interest,is especiallylucrative

becauseit getsfavorable tax

treatment.—J.K.

Wait, Remind Me How Private Equity Works?

PE invests in a range of different assets, but the core of the business is the leveraged buyout

KKR, and Carlyle now dwarf regional banks such

as Fifth Third Bank and Citizens Financial Group

Inc. Yet “private equity is subject to almost no direct

regulation beyond some very basic transparency,”

says Jonah Crane, a senior official at the Treasury

Department during the Obama administration.

Among the few windows the government has

intoprivateequityfirmsandtheriskstheytakeis

a documentfiledwiththeSecuritiesandExchange

CommissionknownasFormPF.ItsSection4 can

reveal the amount of debt a PE firm is piling onto

the companies it’s buying, as well as where in the

world firms are investing. But the industry has suc-

cessfullylobbiedtolimitaccesstothatinformation,

sayingit’sproprietary.Onlyabouta dozenofthe

SEC’s4,500employees can easily see it.

Even so, advocates for private equity have been

pushing back against the disclosure requirements.

The industry argues that so few people have access

to the information that it can’t be of much use

anyway and that it may present data-security risks.

Natalie Strom, a spokeswoman for SEC Chairman Jay

Clayton, says the regulator takes “data protection

veryseriously.”Clayton’sofficesaidina statement

thatofficialshadmetwithindustryandinvestor

groupsaboutFormPF and that it wasn’t considering

scrapping entire sections of the document.

The PE industry would also like to be able to

reach everyday investors who’ve long been barred

from investing in their funds—and, of course, to col-

lect fees from them. And it’s gotten a sympathetic

hearing from Clayton. Although it’s unclear how far

the SEC might go, Strom says “we should explore

whether it is possible to reduce cost and complex-

ity and increase opportunities.”

In an April interview on Bloomberg TV’s The

David Rubenstein Show, Clayton told Rubenstein,

co-founder of Carlyle, that many people might ben-

efit from having a slice of their retirement money in

private equity. The host agreed. “Probably wouldn’t

be that damaging if 5% of it was lost or didn’t do as

well,” Rubenstein said, speaking of retiree nest eggs.

“So some percentage maybe should be allowed.”

�Heather Perlberg and Ben Bain

● Familiar companies

that went private in the

buyout wave