Private equity – does the sausage match the sizzle?


Private markets are being touted as the promised land for retail investors. They off “milk and honey” at a time when the traditional asset classes can barely feed us locusts. At the PLSA conference, some managers I spoke to questioned why DC workplace pensions should restrict themselves to an allocation to private markets of 20% when the returns on offer were so clearly superior to those from quoted assets.

Over the weekend, the FT ran an article by the economist Mohamed El-Erian, entitled “private equity cannot ignore the reckoning in public markets”. 

He lists a number of reasons why the seemingly high performance of private equity funds today cannot be relied on. Most importantly, valuations of the underlying assets lag six to nine months behind quoted valuations, we can all remember how much more optimistic markets were last autumn. Supporters of private equity argue that much of the downturn in quoted stocks is due to panic selling (contagion) and abuse of liquidity by speculators (neither of which is so likely to happen in private markets. But if the mass sell off in bond and equity markets is because of a fundamental shift in markets (as argued by Dame Deanne Julius), then Mohammed El-Erian will be proved right.

El Erian argues that private equity has flourished since the financial crisis because of the availability of “free money” that has financed not just the taking of publicly quoted stocks to private ownership but the refinanci9ng of these deals to give everyone (especially the managers) a realised return. If the cost of re-financing increases , then the magic money-go-round could grind to a halt leaving investors exposed to some nasty write-downs.

Of course this is less likely to happen if a flood of money can be attracted to the private markets not just from DC workplace pensions but from the roaring “wealth management ” sector. But retail investors are entitled to and get better protection from regulators than institutional clients (who are expected to know the risks). So some of the more obscure practices of private equity markets are likely to be exposed through a new transparency. Couple this with the unfortunate tendency of ordinary people to want to exercise rights to switch funds and even ask for their money to be paid out as pensions, and illiquidity could turn from a strength to a weakness.

There were very few dissenting voices to the clamour for investment into illiquids. One , surprisingly was Emma Douglas, the new PLSA Chair who questioned whether the perceived member advantage of owing private assets (in terms of excess return) was a sufficient incentive for the funders of workplace pensions to pay extra for investment. This is realistic -so long as employers choose workplace pensions on price (rather than value), then there is no incentive to offer the attractions of private markets when it makes your product uncompetitive.

But a more interesting conversation is to be had about whether there are more fundamental risks associated with such investments. My worry is that the important questions  about such risks are not being asked. Indeed , a question I put to a panel of “experts” about the risk of our money simply not being invested but sitting as “dry powder” was simply ignored in one session. When I asked it again, I was given a proper answer by Rene Poisson but I could see the majority of the audience and panel had no idea what I was going on about.

And if it is being left to people like me, to articulate the other side of the debate, then there is a very real risk that a lot of the money that is piled into private equity over the next five years will be invested without a real understanding either of the cost of the asset management or of the value being offered. This is why we really need to scrutinise the funds that are being offered to DC investors and why – when private equity is bought into the defaults of workplace pensions, those investments are properly assed for their value and their fees.

I am not sure that there is sufficient expertise to go round for while there are investment consultants who can sort the wheat from the chaff, they tend to be employed by the large institutional DB schemes.

We like the packaging and we’ve smelt the sizzle. But before we bite into the private equity sausage, let’s make sure we know it’s safe for consumption.


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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