I write to try to help out Michael Gordon in his attempt to understand the success of private equity funds.
Let us remember that these funds buy (overpay?) companies, often against companies in the same sector and, after a couple years or less of private equity magic, they sell them back, either to the very same companies originally outbid or, through an IPO, to the shareholders of these very same companies, to investors similar to Fidelity, all at much higher prices!
Private equity funds have attracted attention because, by following this strategy, they have generated returns significantly above market returns for many years. Agreed that they invest in the same business and so do not diversify and agreed that they use much more debt (why not?). Also, investors need to be careful with the new entrants, including those new hedge funds that now want to play in this market, who lack the track record and particularly the experience in down markets.
Nevertheless, the private equity way of doing it is clearly superior as compared to the leisurely way company managements have historically acted to give investors market returns, at best.
Onésimo Alvarez-Moro
See article:
From Mr Tim Price.
Sir, I was intrigued to read of Michael Gordon's scepticism at the rise of private equity. Have private equity groups really persuaded investors that their funds comprise a distinct asset class? Even if they have, investors should be aware that, as with hedge funds (most definitely not a distinct asset class), the dispersion of returns between top decile and bottom decile private equity funds can be huge - potentially invalidating the decision to enter the sector in the first place. Private equity is a skills-based business and like all investment it requires appropriate due diligence.
Mr Gordon suggests that the only real difference between public and private equity performance is leverage. Arguably, the difference is in the discipline imposed on management by leverage - together with successful resolution of the owner-manager conflict (see, for example, the recent price that the publicly listed Home Depot put on executive failure).
See full Letter (paid subscription required)..
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