I don’t think PE overall actually generates alpha (of course some will), but how that is the definition of alpha: excess returns above a benchmark. What would you call alpha?

quote:
Why sacrifice liquidity and less risk for what amounts to be similar to inferior returns?

Agreed here. I’ve gone down the rabbit hole, and it looks worse and worse as I learn more about it. My newest discovery is that PE forms will take out subscription lines of credit, not to maximize real returns, but instead to delay deploying capital so they can show a higher IRR (6.1% on average), but with lower real returns because of interest financing.

This is the most absurd thing I’ve seen. They take on more risk with leverage, to get worse returns for their investors, solely to give a distortedly higher IRR, to make it seem like a better investment.

I’m usually anti-regulation, but I think there at least needs to be some regulations that require more transparency. This just flat out dishonest nonsense that misleads investors. I’m ok if they do it, but I think they should be required to let investors know what they are doing and how this distorts their IRRs. I bet they would suddenly change their mind.

And note, not all firms do this though but inflation-adjusted debt financing for PE firms, went from $86 million in 2014 to $5 billion in 2018, a huge increase, so obviously it’s pretty pervasive. And obviously there are plenty of other valid reasons to take on leverage, but this is not one of them.

So it’s no wonder PE has gotten so big, when they can mislead investors and rip them off. And a lot of them probably don’t have any idea (studies show this), but they see that really high IRR and probably think “that was a good investment,” failing to realize that the real returns are mediocre and those funds are locked in and illiquid for upwards of a decade.

This post was edited on 10/9/21 at 12:03 am

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Posted by RedStickBR

Member since Sep 2009

14577 posts

Posted on 10/9/21 at 1:22 am to buckeye_vol

PE is another victim of low rates. As investors search for yield in a low yield world, they go further and further out the risk curve. Generally speaking, the lower the risk of an investment, the larger the market, such that the bond market > the equity market > the PE market > the VC market.

As more capital is allocated to riskier investments, the pig moves through the python, deal competition increases, and yields get compressed. In my experience, it’s hard to find alpha unless you’re in a market that is too small to attract much interest from institutional players (which is why I struggle with why ordinary people want to do things like get into the storage unit business after that industry has already been flooded with REIT money).

There are no doubt PE firms out there who generate alpha based on their industry expertise or because they’ve carved out a niche. But those managers are few and far between, and the better they do, the more inaccessible they become for smaller investors.

LINK

This post was edited on 10/9/21 at 1:24 am

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Posted by wutangfinancial

Treasure Valley

Member since Sep 2015

11195 posts

Posted on 10/10/21 at 1:04 pm to buckeye_vol

If I'm analyzing a fund managers alpha I'm comparing returns of PE over other PE managers. Cross-asset comparisons aren't very useful. Hedge Fund vs. Hedge Fund, PE vs PE, VC vs VC etc...Saying that you earned excess returns in this perma-low rate environment (where valuations are infinity) over the S&P is just an admission that you took on an insane amount of risk and you happened to time it right because of luck and perverted incentive structures setup in this system. Greater fools theory.

But ya about everything else you commented on - the PE business is frothy for the underwriters, not the idiots with too much dry powder to know what to do with it.

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