Real Returns
Our CEO Brent sent out his annual letter earlier this month, which included musings on AI, the role of a CEO, board members, selling, and more. One of the most interesting sections, however, was his discussion of fees and performance in private equity. He cites several studies to conclude that “in traditional private equity structures, the GP is both taking a significant portion of the total return and doing so independent of performance.”
When performance is good, this maybe isn’t a big deal. After all, no one is really going to grouse about the difference between a 30% gross and 25% net return. But if 13% gross becomes 8% net because of fixed fee drag, well, your investors will probably let you know that they would have been better off buying an index fund.
So how good are private equity returns really? Historically, they’ve been good. But historically money was cheap and there wasn’t as much competition. So it’s a good question if private equity returns going forward – with more expensive capital and more people bidding for deals – will enable the industry to continue to justify its high fees.
Two things are happening right now that suggest they may not. First, midlevel employees are reportedly leaving large private equity firms “due to uncertainty about receiving carried interest.” Second, large private equity firms are selling assets to themselves via continuation vehicles at record rates.
Taken together, those two phenomena suggest something subtle but important: recent real returns are likely materially lower than what’s being reported in spreadsheets. Further, they’re not likely to improve, at least in the near term. After all, if the people who would know don’t think there are performance fees to be had, and the firms themselves are reluctant to put verifiable numbers on the scoreboard, that probably tells you all you need to know.
– Tim
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