While the deal creates the world’s second-largest theme park group behind Walt Disney, one is tempted to ask, are buy-out firms making dummies of the rest of us?
Many people seem to think so. Trade unions have denounced private equity firms as “asset-strippers” intent on slashing costs and axing jobs. German politicians have labeled them “locusts” and British Labour party members and some asset managers have expressed their concerns. Even Paul Myners, the former Marks and Spencer chairman and City of London luminary, who six years ago advised UK pension schemes to invest in a wide range of asset classes including private equity, has criticised the lack of job security and loss of benefits suffered by those who work for companies owned by private equity firms. He also asked whether pension funds were closely comparing the costs of investing in private equity versus public stocks and urged the UK government to examine a tax regime which benefited private equity groups with heavy borrowings.
At a recent private equity industry conference in Frankfurt, Guy Fraser-Sampson, a 20-year veteran practitioner and author of a book entitled Private Equity as an Asset Class told investors to “wake up and face the truth about private equity returns”. He said historic figures showed a clear and direct relationship between rising fund size and falling returns. Given the rapidly rising size of large buy-out funds (average fund size has increased more then tenfold since 1995) he contended a significant and prolonged decline in the returns of such funds was inevitable. Mr Fraser-Sampson sees these returns falling to just one or two per cent over the returns available from quoted equities.
He added that a similar picture emerges from the fund-raising figures of US venture funds. Fund commitments have already returned to 1998 levels. He said this might be as much as three times more capital than the US venture industry can accommodate for optimal returns.
“Illogically”, he said, many investors continue to pour money into mega-funds even when they must realise this can only possibly drive returns lower still, and that much better returns are available elsewhere within the private equity spectrum. Since the beginning of 2001, funds in excess of $1bn (€761.4m) have comprised only about 6 per cent by number of all private equity funds worldwide, yet they have attracted well over 50 per cent of the available capital.
Since the millennium, buy-out funds have garnered returns ranging from the low 30s to the low teens, while venture capital funds have languished in or close to negative territory.
Private Equity Intelligence, a research and advisory firm, reveals that the money-weighted average internal rate of return (IRR) to date of buy-out funds formed in 2001 is 30.1 per cent compared with a weighted average IRR of just 1 per cent for venture capital funds launched globally in the same year. On the other hand, investors who went into venture funds before the technology bubble burst in 2000 have been handsomely rewarded. Such funds started in 1995 and 1997 have racked up returns of 53.4 per cent and 39.6 per cent respectively to date. US venture funds launched in 1995 have reaped a return of 64.3 per cent.
Mr Fraser-Sampson said that European pension funds have made very low allocations to private equity (in some cases as low as 2 per cent to 3 per cent compared with 15 per cent to 25 per cent in the US ). He maintained that an allocation of less than 15 per cent to any asset class “cannot possibly” have any significant effect on overall returns. European institutions had also failed to hire specialist in-house professionals to manage their private equity investments. He believes this will lead to a “pernicious cycle” whereby they put the money to work in a sub-optimal fashion, experience poor results, and are then reinforced in their prejudices against the asset class.
Mr Fraser-Sampson’s comments resonate in the hedge fund industry where an abiding herd mentality continues to drive institutional investors into funds of hedge funds and popular single strategies such as European long-short equity and market-neutral equity to the detriment of performance.
It is about time that mega-rich, mega buy-out firms and their well-endowed hedge fund counterparts came clean on the future performance prospects of the vehicles they are promoting to unsuspecting institutional investors. The heavyweights of the private equity world might be making a killing as the size of their buy-out deals climbs towards the stratosphere, but that does not necessarily mean that everyone else is enjoying the fun (see article on p22).
Henry Smith, editor
henry.smith@ft.com
CLARIFICATION An article in February’s FT Mandate entitled "Partnerships sought in more dynamic hedge fund market", stated that JPMorgan provides administration for over $300bn of assets. This figure relates to assets under administration in traditional funds and not hedge funds. JPMorgan Hedge Fund Services provides administration for $56bn of hedge fund assets.
