The Financial Times recently published an opinion piece by Hunter Lewis, a co-founder and former chief executive of Cambridge Associates, with the headline “Why I am not investing in a buyout for a long time to come”. His credentials underscore why this should be of interest to any investor in private equity.
Lewis co-founded Cambridge Associates 50 years ago and is now chief executive of the eponymous Hunter Lewis LLC. “For most of my career, I have been a strong proponent of both venture and buyouts, not a critic. I was present at the creation of today’s private equity industry,” he writes in the article.
You could not look for a higher, more credible, more perceptive commentator on the state of private equity. And yet here he is, saying…exactly what’s in the headline.
His arguments are that private equity in its current bloated form owes much of its recent growth and popularity to the cheap money era that followed the global financial crisis. He endorses the conclusion, substantiated by many academic studies, that private equity as an asset class has not outperformed public markets since at least 2006, despite the industry’s repeated claims to the contrary.
He dismisses other claims made for private equity as “fantasy thinking”.
“Inflated returns, denial of volatility, high prices and fees, excessive leverage, absence of covenants on buyout debt - all this together represents fantasy thinking. It is what happens when a successful investment model becomes too popular”.
Lewis bemoans the absence of external, objective assessment of private equity performance. “Who exactly can be expected to provide an objective appraisal or question reported fund returns?” He cautions that an institution’s own personnel, let alone its advisers and consultants, may be too closely implicated with the private equity proposition to question its value.
Lewis is in the unfortunate position of a doting guardian witnessing the vigorous youth he helped to nurture grow into an obese, immobile glutton, fattened and weighed down by pure greed.
This is not to dissuade institutions from investing in private equity per se. There are many reasons for doing so besides diversification, and many opportunities for outperformance. However, such investments should be very carefully watched and managed, very modestly allocated versus overall assets, and very coldly and objectively evaluated, especially when faced with blizzards of private equity fund sales rhetoric.
And remember that you are looking at an asset class that is probably overinflated, and hostage to the law of diminishing returns. Don’t take my word for it - take Hunter Lewis’s.