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"Private Equity: Overvalued and Overrated?"


Liberty
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He is a smart kid (like really, really smart, summa at Harvard, with his thesis published as a book), but he is talking his own "book" here.  He has a fund that seeks to replicate PE funds by buying levered, but cheap, small caps.

 

Further, rhetorically he posits institutional investors as experts.  Sorry, but the treasurer of Idaho ain't no expert.

 

That said one insight, however obvious, found young, can lead to great success in life--his is: with PE deals returns are tightly correlated to low purchase price, the rest is hooey.

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I think he's got a point here, even if it's somewhat promotional for his fun; an LBO is really just financial engineering and low volatility is merely a mirage because assets aren't being marked-to-market every minute.. It seems pretty obvious, since the underlying asset, a business/corporation/company, is the same for a stock fund vs a PE fund, but many institutional investors think PE is somehow better.  ::)

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I think his point is similar to the wave of hedge funds that came out after hedge funds had great success, and then after that wave, on average they didn't have much success.

 

In the case of PE, it was less competition leading to lower prices paid. In the case of hedge funds, it was... less competition leading to lower prices paid (or more esoteric inefficiencies left to discover and exploit, whatever they do).

 

One good insight is enough, because it's too easy to extrapolate past results in the future. Most market participants do it. If you're not a PE expert - like I'm not - it's easy to look at historical data and think that the performance is inherent to the model rather than based on a context that has been changing.

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An interesting aspect of private equity is that its relative opacity can be a source of stability as mark-to-market fluctuations can be attenuated, at least for some time.

 

"...it's easy to look at historical data and think that the performance is inherent to the model rather than based on a context that has been changing."

 

Great insight, I agree. In a way, private equity can be seen as an asset class which has been recently characterized, using historical standards, by high multiples and high debt ratios, which makes the author suggest: "In our view, the 2015, 2016, and 2017 vintage years are likely to return close to zero percent per year if history is a good guide."

 

At a time when PE firms are flooded by capital (as per the linked article and many other sources) and have accumulated a record amount of "dry powder".

 

The author calls the situation "bizarre".

"Facts sometimes have a strange and bizarre power that makes their inherent truth seem unbelievable."

Werner Herzog

 

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I think I read a white paper or something by him like a year ago via Meb Faber or Alpha Architect.  Just saying, like I got the gist right?  True volatility is masked by lack of quotation, no real special operation expertise for most shops/deals, fat wallet, what smart man does in the beginning. 

 

I don't love the Japan thesis because after all, is it a real market system where you can bank on property rights and rule of law and rationality to get your anticipated ROIC?  I'm not so sure.  Several activists have found it hard to get exercise shareholder/ownership rights.  Can't exactly sell to a PE shop to take it private and whack some plants.  May be more like quasi-state/executive/worker benevolent trusts. 

 

Ideally, I would prefer to limit investments to countries with a longer history and solid grounding in property rights and capitalism (basically Netherlands, UK, Ireland, Nordics, Switzerland and North America) but I suppose that is discounted to a large extent.

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Additional data related to the private equity value proposition going in 2018.

http://go.bain.com/rs/545-OFW-044/images/BAIN_REPORT_2018_Private_Equity_Report.pdf?aliId=12399378

 

"The challenge is to create more winning deals" at a time when a well known CEO reports, reflecting on 2017 potential opportunities: "...price seemed almost irrelevant to an army of optimistic purchasers."

 

"Spreadsheets never disappoint".

 

Interesting times.

 

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  • 3 weeks later...

https://overcast.fm/+HOFhYToVA

 

New  podcast with the author.

 

Definitely worth the listen.  I previously caught him on Meb Faber's podcast, so I had the intro to his thoughts on PE, but Patrick is just very different as an interviewer so he brought out a lot of "deeper cuts."  They talked about behavioral psychology, Kahneman and Tetlock and why detailed projections and analysis just make you more likely to be more confident in your wrong conclusions.  I've not read much Tetlock stuff at this point (although I follow him on twitter...the man is a saint to put up with Taleb).  I will have to put him in my to read shelf.

 

Listening to them both in the order I did was actually pretty good.  Meb's podcast episode was back in January, I think.

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