Posts tagged ‘pension funds’

Private Equity: Parasite or Pollinator?

In the wild, there exist both parasitic and symbiotic relationships. In the case of blood thirsty ticks that feed off deer, this parasitic relationship differs from the symbiotic association of nectar-sucking bees and pollen-hungry flowers. These are merely a few examples, but suffice it to say, these same intricate interactions occur in the business world as well.

Our economy is a complex jungle of relationships, spanning governments, businesses, consumers, investors, and many intermediaries, including private equity (PE) firms. With the November election rapidly approaching, more attention is being placed on how private equity firms fit into the economic food chain. Figuring out whether PE firms are more like profit-sucking parasites or constructive job creating mechanisms has moved to the forefront, especially given presidential candidate Mitt Romney’s past ties to Bain Capital, a successful private equity firm he founded in 1984.

Currently it is politically advantageous to portray PE professionals as greedy, job-cutting outsourcers – I’m still waiting for the political ad showing a PE worker clubbing a baby seal or plucking the legs off of a Daddy Long Legs spider. While I’d freely admit a PE pro can be just as gluttonous as an investment banker, hedge fund manager, or venture capitalist, simplistic characterizations like these miss the beneficial effects these firms provide to the overall economy. Capitalism is the spine that holds our economy together and has allowed us to grow into the greatest superpower on the planet. Private equity is but a small part of our capitalistic ecosystem, but plays a valuable role nonetheless.

While there are many perspectives on the role of private equity in our economy, here are my views on a few of the hot button issues:

Job Creation: Although I believe PE firms are valuable to our economy, I think it is a little disingenuous of Romney and his supporters to say Bain was a net “job creator” to the tune of 100,000+ jobs during his tenure. The fact of the matter is PE firms’ priority is to create profitable returns for its investors, and if that requires axing heads, then so be it – most PE firms have no qualms doing precisely that. Romney et al point to successes like Staples Inc. (SPLS), Dominos Pizza Inc. (DPZ) and Sports Authority, Inc., where profitability and success ultimately led to job expansion. From my viewpoint, I believe these examples are more the exception than the rule. Not surprisingly, any job losses executed in the early years of a PE deal will eventually require job additions if the company survives and thrives. Let’s face it, no company can cut its way to prosperity in perpetuity.

Competitveness: Weak, deteriorating, or bankrupt companies cannot and will not hire. Frail or mismanaged companies will sooner or later be forced to cut jobs on their own –the same protocol applied by opportunistic PE vultures swarming around. While PE firms typically focus on bloated or ineffective companies, I think the media outlets overemphasize the cost-cutting aspects of these deals. Sure, PE companies cut jobs, outsource functions, and cut benefits in the name of profits, but that alone is not a sustainable strategy. Trimming fat, by replacing complacent management teams, investing in modern software/equipment, expanding markets, and implementing accountability are all paramount factors in making these target companies more efficient and competitive in the long-run.

Financial Markets-Arbiter: At the end of the day, I think the IPO/financial markets are the final arbiters of how much value PE firms create, not only for investors, but also for the economy overall. If greedy PE firms’ sole functions were to saddle companies with massive debts, cut heads off, and then pay themselves enormous dividends, then there would never be a credible exit strategy for investors to cash out. If PE firms are correctly performing their jobs, then they will profitably create leaner more efficient durable companies that will be able to grow earnings and create jobs over the long-term. If they are unsuccessful in this broad goal, then the PE firm will never be able to profitably exit their investment via a corporate sale or public offering.

Bain Banter: Whether you agree with PE business practices or not, it is difficult to argue with the financial success of Bain Capital. According to a Wall Street Journal article, Bain Capital deals between 1984 – 1999 produced the following results: 

“Bain produced about $2.5 billion in gains for its investors in the 77 deals, on about $1.1 billion invested. Overall, Bain recorded roughly 50% to 80% annual gains in this period, which experts said was among the best track records for buyout firms in that era.”

 

Critics are quick to point out the profits sucked up by PE firms, but they neglect to acknowledge the financial benefits that accrue to the large number of pension fund, charity, and university investors. Millions of middle-class American workers, retirees, community members, teachers, and students are participating in those same blood sucking profits that PE executives are slurping down.

Even though I believe private equity is a net-positive contributor to competiveness and economic growth in recent decades, there is no question in my mind that these firms participated in a massive bubble in the 2005-2007 timeframe. Capital was so cheap and abundant, prices on these deals escalated through the roof. What’s more, the excessive amounts of leverage used in those transactions set these deals up for imminent failure. PE firms and their investors have lost their shirts on many of those deals, and the typical 20%+ historical returns earned by this asset class have become long lost memories. Attractive returns do not come without risk.

With the presidential election rhetoric heating up, the media will continue to politicize, demonize and oversimplify the challenges surrounding this asset class. Despite its shortcomings, private equity will continue to have a positive symbiotic relationship with the economy…rather than a parasitic one.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in SPLS, DPZ, Sports authority, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

July 21, 2012 at 6:43 pm Leave a comment

Opal Conference: Hedge Fund Heaven and Regulatory Rules

The recent Alternative Investment Summit held December 5-7 at the Ritz-Carlton in Laguna Niguel, California provided a little bit of everything for attendees – including a slice of hedge fund heaven and a less appetizing dollop of regulatory rules. If you are going to work hard, why not do it in an unrivaled, picturesque setting along the sandy shores of Dana Point? The well-attended conference, which was hosted by Opal Financial Group, was designed to address the interests of a broad set of constituents in the alternative investment food-chain, including representatives of hedge funds, fund of funds, endowments, consulting firms, private equity firms, venture capital firms, commodity trading advisors (CTAs), law firms, family offices, pension funds, along with various other vendors and service providers.

Although the topics and panel experts covered diverse areas, I found some interesting common themes emanating from the conference:

1)      Waterboard Your Manager: In the wake of the Bernie Madoff Ponzi scheme and the recent sweeping insider trading investigations, institutional investors are having recurring nightmares. Consultants and other service-based intermediaries are feeling the heat in a fever-pitched litigation environment that is driving defensive behavior to avoid “headline risk” at any cost. As a result, institutional investors and fund of funds are demanding increased transparency and immediate liquidity in addition to conducting deeper, more thorough due diligence. One consultant jokingly said they will “waterboard” managers to obtain information, if necessary. In the hedge fund world, this risk averse stance is leading to a concentrated migration of funds to large established funds – even if those actions may potentially compromise return opportunities. In response to a question about insider trading investigations as they relate to client fund withdrawals, one nervous panel member advised clients to “shoot first, and ask questions later.”

2)      Lurking Mountain of Maturity: Default rates in the overall bond markets have been fairly tame in the 2.0 – 2.5% range, however a mountain of previously issued debt is expected to mature over the next few years, meaning many of those corporate issuers will need to refinance the existing debt and issues longer term debt. For the most part, capital markets have been accommodating a large percentage of issuers, due to investors’ yield-hungry appetite. If the capital markets seize up and the banks continue lending like the Grinch, then the default rate could certainly creep up.

3)      CLO Market Gaining Steam: The collateralized loan obligation market is still significantly below pre-crisis levels, however an estimated $3.5 billion 2010 new issue market is expected to gain even more momentum into 2011. New issuance levels are expected to register in at a more healthy $5.0 billion level next year.

4)      Less Fruit in Debt Markets: The general sense among fund managers was that previously attractive bond prices have risen and bond yield spreads have narrowed. The low hanging fruit has been picked and earning similarly attractive returns will become even more challenging in the coming year, despite benign default rates. Even though bonds face a tough challenge of potential future interest rate increases, many managers believe selective opportunities can still be found in more illiquid, distressed debt markets.

5)      Fund of Funds vs. Consultants: Playing in the sandbox is getting more crowded as some consultants are developing in-house investment solutions while fund of funds are advancing their own internal capabilities to target institutional investors directly. By doing so, the fund of funds are able to cut out the middle-man/woman consultant and keep more of the profit pie to themselves. From a plan sponsor perspective, institutional investors struggle with the trade-offs of investing in a diversified fund of funds vehicle versus aggregating the unique alpha generating capabilities of individual hedge fund managers.

6)      Emerging Frontier Markets: There was plenty of debate about the dour state of global macroeconomic trends, but a healthy dose of optimism was injected into the discussion about emerging markets and the frontier markets. One panel member referred to the frontier markets as the Rodney Dangerfield (see Doug Kass) of the world (i.e., “get no respect”). The frontier markets are like the immature little brothers of the major emerging markets in China, India, Brazil, and Russia. Examples of frontier markets provided include Vietnam, Nigeria, Bangladesh, and Kenya. In general, these markets are heavily dependent on natural resources and will move in unison with supply-demand adjustments in larger markets like China. Of the approximately 80 frontier markets around the globe, 30 were described as uninvestable, with the remaining majority offering interesting prospects.

All in all the Opal Financial Group Alternative Investment Summit was a huge success. Besides becoming immersed in the many facets of alternative investments, I met leading thought leaders in the field, including an unexpected interaction with a world champion and living legend (read here for a hint). Many conferences are not worth the price of admission, but with global economic forces changing at breakneck speed and regulatory rules continually unfolding in response to the financial crisis, for those involved in the alternative investment field, this is one event you should not miss.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) is the General Partner of the Slome Sidoxia Fund, LP, a long-short hedge fund. SCM and some of its clients also own certain exchange traded funds (including emerging market ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

December 8, 2010 at 12:32 am 3 comments


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