When I talk with Stupid German Money, what I often hear is that stocks are too risky -- just look at all that volatility! -- so real estate is the place to be. I counter that real estate would demonstrate similar volatility if it were liquid, which it unfortunately ain't, so where's the actual advantage?
Well, there's the artificial or perceived scarcity of RE; in light of the three >$1 trillion IPOs planned for this year, nobody's describing the stock market in those terms.
My layman's view of Private Equity would be that it shares RE's advantages of perceived scarcity and hidden volatility. (With stress on "perceived" and "hidden").
The hilarious thing, of course, is that RE traditionally has even lower returns than equity when you look at all RE in all areas and take in to account the costs of upkeep. And of course, the terrible demographics of Germany should not argue for RE inflation. But RE can go on crazy decades/half-century long bubbles, and at least in the US, it's MUCH easier for retail/common people to lever to the hilt with noncallable loans on RE (with mortgages) than with equity, so there's that argument.
Well, I concede the Mag 7 point about US equities, but I don't like the straw man of top quartile PE funds as a benchmark. It's like saying active management works as long as you invest in the top 10% of funds by performance. The reality is that investors do not experience top quartile performance but the whole range from top quartile down to bottom quartile, so the only fair comparison, in my view, is a value weighted PE index, which is roughly what this study does.
Good point. Russell 2000 or another small-cap index would be better. But then, as I mentioned in a comment above, PE uses leverage so that the correct comp would be leveraged small-cap stocks. That’s what we used two decades ago at a previous employer, and we found it perfectly matched PE for portfolio construction purposes (and that alone is a pretty concerning statement).
When i worked at a major pension fund in the 1980's, a partner from a long established Private Equity house came in to present to us.
He gave performance figures and obviously they were very favourable.
I asked him what would be the return if he bought an S&P future with gearing that matched that of his Fund.
He didn't know but promised to get back to me. Which being a gentleman (as existed in investment in those long gone times), he did.
The answer was that the returns were identical.
So even one of the most experienced, long established equity houses, at a time of far less competition, didn't add any value other than their ability to access debt.
Since then, about 1988, i have ignored the siren calls of PE.
When I talk with Stupid German Money, what I often hear is that stocks are too risky -- just look at all that volatility! -- so real estate is the place to be. I counter that real estate would demonstrate similar volatility if it were liquid, which it unfortunately ain't, so where's the actual advantage?
Well, there's the artificial or perceived scarcity of RE; in light of the three >$1 trillion IPOs planned for this year, nobody's describing the stock market in those terms.
My layman's view of Private Equity would be that it shares RE's advantages of perceived scarcity and hidden volatility. (With stress on "perceived" and "hidden").
The hilarious thing, of course, is that RE traditionally has even lower returns than equity when you look at all RE in all areas and take in to account the costs of upkeep. And of course, the terrible demographics of Germany should not argue for RE inflation. But RE can go on crazy decades/half-century long bubbles, and at least in the US, it's MUCH easier for retail/common people to lever to the hilt with noncallable loans on RE (with mortgages) than with equity, so there's that argument.
This paper is literally the only thing you ever need to remember when dealing with pension funds and the like: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1687660
It's the reason why I am glad I don't have to deal with them anymore.
That was good!
I’m not sure it is fair comparison period with the mag 7 returns, and their growth being driven in part by acquiring private equity firms.
Is this also top quartile returns?
A fairer comparison would be against an apples for apples benchmark.
Well, I concede the Mag 7 point about US equities, but I don't like the straw man of top quartile PE funds as a benchmark. It's like saying active management works as long as you invest in the top 10% of funds by performance. The reality is that investors do not experience top quartile performance but the whole range from top quartile down to bottom quartile, so the only fair comparison, in my view, is a value weighted PE index, which is roughly what this study does.
Noted! Is the market cap fitting? Would a Russell 2000 be more appropriate?
Good point. Russell 2000 or another small-cap index would be better. But then, as I mentioned in a comment above, PE uses leverage so that the correct comp would be leveraged small-cap stocks. That’s what we used two decades ago at a previous employer, and we found it perfectly matched PE for portfolio construction purposes (and that alone is a pretty concerning statement).
When i worked at a major pension fund in the 1980's, a partner from a long established Private Equity house came in to present to us.
He gave performance figures and obviously they were very favourable.
I asked him what would be the return if he bought an S&P future with gearing that matched that of his Fund.
He didn't know but promised to get back to me. Which being a gentleman (as existed in investment in those long gone times), he did.
The answer was that the returns were identical.
So even one of the most experienced, long established equity houses, at a time of far less competition, didn't add any value other than their ability to access debt.
Since then, about 1988, i have ignored the siren calls of PE.
Back when I started my career at a major Swiss Private Bank, we used to model PE as US Small Cap value with 10% leverage. Worked like a charm.
Add in the portfolio management costs of a private equity program and you're negative. These portfolio's aren't built for free.