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THE AGENDA Books Ex Libris


An authoritative assessment of the private equity world deſtly exposes its shortcomings By Christopher Silvester


than leveraged buyout’. When the stock market fell back after the dotcom boom and bust, institutional investors turned to PE funds as a form of downside protection. There was a 500 per cent increase in deal volume between 2002 and 2007, another fallback during the 2008-09 global financial crisis, and then another long rally despite prominent PE deals ending in bankruptcy. Today there are 700 LBO fund groups, some focused on deal size, some with an industry focus. They control more than 7,000 companies and employ millions of people. The overall amount of equity invested is around $1 trillion. ‘Private equity is a great thing for America,’ said Stephen Pagliuca, co-chairman of LBO group Bain Capital, in January 2020. But what is not understood, says Hooke,


The Myth of


Private Equity An Inside Look at Wall Street’s Transformative Investments JEFFREY C HOOKE (COLUMBIA UNIVERSITY PRESS, £28)


THE CLUE IS in the title. Jeffrey C Hooke, a professor of finance at Johns Hopkins Carey Business School, is an arch-sceptic when it comes to the private equity industry. He believes that 65 per cent of it – the part which funds leveraged buyouts (LBOs) – is one giant racket, and that its claim to produce better returns than the stock market is bogus. ‘Indeed,’ he writes, ‘independent academic studies show that since 2006, private equity funds underperformed relevant public indices, a fact that is easily eclipsed by the Wall Street marketing machine.’ The first LBO to gain the attention of the media was that for greetings card manufacturer Gibson Greetings in 1983. In the next five years, until the infamous LBO of RJR Nabisco by Kohlberg Kravis Roberts & Co, America experienced its first buyout boom, ‘an underpinning for the 1980s culture of greed’.


Given that most private equity (PE) funds were LBO blind pools, they were inherently risky, in addition to which they were loaded with debt. They also required investors to commit funds for ten years as part of a no-cut contract and pay vast fees regardless of the outcome. But the rise of modern portfolio theory (MPT) meant institutional investors were encouraged to hold a ‘core’ portfolio of traditional assets, such as publicly traded stocks and bonds, and ‘satellite’ portfolios of alternative assets, such as PE and hedge funds. The LBO boom stalled in the early 1990s after some notable failures but returned with a vengeance in the mid-1990s, with Wall Street having rebranded ‘debt-laden takeover into private equity, a term that conveys a softer image and a more constructive tone


is ‘the chasm between the vast wealth accrued by PE managers (sometimes called general partners) through management fees and moderate returns provided to LBO fund investors (called limited partners)’. This subject is ‘considered off- limits in the industry and one that outside critics have an uphill battle in publicizing’. A crucial myth is that of top-quartile


performance being repeated in a company’s subsequent funds. Also, fund managers claim to be aligned with investors because they commit 5 per cent of the total of a fund from their own capital, but then they receive 15 per cent in guaranteed management fees, monitoring fees and transaction fees over a ten-year period regardless of how the fund performs. Hooke cites several studies which


have shown that only in the 1990s, ‘the industry’s golden years’, did PE outperform the stock market. ‘In other words, depending on the years chosen, the foundation for a trillion-dollar industry’s marketing fanfare rests on the narrow shoulders of a ten- to 12-year


Fund managers claim to be aligned with investors because they commit 5 per cent of the total of a fund from their own capital, but then they receive 15 per cent in guaranteed fees


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