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PE Panorama: The bells are tolling

By Paul Mackintosh  
December 9, 2019

I hate to say I told you so. But I did. Repeatedly. With many variations. And data points. And warning signs. Now Bloomberg has released a report warning that “peak private equity fears are spreading across the pension world”. It looks like the institutional investor base has finally managed to kill the goose that laid the golden eggs, by piling onto it until it suffocated beneath them.

The report cites the California Public Employees’ Retirement System (CalPERS) as one representative example. The US$354 billion bellwether investor in the asset class has said that as of end-March 2019, the net internal rate of return of its private equity programme since inception was 10.8%. But the Bloomberg report notes that CalPERS’s private equity portfolio returned 7.7% in its last financial year ended June 30, 2019, down from 16.1% in the preceding 12-month period. And that’s one of the world’s most widely recognised experts in investment in private equity. If this is the best that the best can do, what about the rest?

In the report, Lisa Shalett, Morgan Stanley Wealth Management’s chief investment officer, is quoted saying that investors who are “tempted to chase the double-digit returns that many earned in private investment vehicles this past decade need to downgrade their expectations”, warning of annual returns of less than 10%.

If you’re looking at returns that dip into single digits, in a notoriously illiquid and expensive asset class, you have to wonder why you’d even bother investing in it. And this comes as a report in The Wall Street Journal notes that buyout activity in the US is sharply lower even as firms’ unspent cash allocated for North American deals hits a record $771.5 billion. “US private equity firms, armed with a record amount of cash, are struggling to find ways to spend it,” WSJ says.

I’m not sure if that record amount has created record highs in deal multiples; I do fear that it may be driving private equity return averages down to record lows.

The kind of herd mentality that has led institutional investors to plough money into the asset class far beyond its capacity to deliver outperformance makes you worry about their fiduciary obligations. It’s been obvious for the longest time where this is going.

I don’t know whether those pension fund investment committees and other fiduciaries really thought they were getting into something as easy to get out of as real estate investment trusts or exchange-traded funds, or whether they just closed their eyes because the other options were worse. And unless you have a cynical view of pension funds as piggy banks for corruption and rake-offs, you probably have a right to expect better.

Christmas is a good time for parables of greed and its consequences. A shame, though, that the Christmas uncheer will be shared out among so many pensioners and their families.