Private Equity, Like Hedge Funds, Is Better For Managers Than For Investors

Regardless of its macroeconomic consequences, the private equity industry is clearly lucrative. But lucrative for whom? Hedge funds, for example, are a great way of enriching hedge fund managers but don’t seem to actually make money for investors. Private equity is perhaps not so different:

Private equity has proved better at enriching its own managers than producing investment profits for US pension funds over the past decade, according to a study prepared for the Financial Times by academics at Yale and Maastricht University. […] From 2001 to 2010, US pension plans on average made 4.5 per cent a year, after fees, from their investments in private equity. In that period, the pension funds paid an average 4 per cent of invested capital each year in management fees. On top of those, private equity often collects a variety of other fees and a fifth of investment profits.

That’s the FT citing Yale’s Martijn Cremers. The industry trade association defends private equity’s fee structure as industry standard, but nobody is disputing that it’s standard. The question is whether there’s any reason to believe the private equity game, or any other sub-set of investing, can reap returns large enough to justify such large management fees. You can easily imagine telling a story in the 1980s about how the brand-new innovation of leveraged buyouts is able to exploit long-simmering market inefficiencies and reap gigantic returns. But once the asset class becomes mature, all the low-hanging fruit has already been picked and you’re left with the same basic problem as in any effort to beat the market.