Newswise — According to Johns Hopkins Carey Business School Senior Lecturer Jeffrey C. Hooke, private equity (PE) “is a current manifestation of the irrationality that grips Wall Street from time to time.” The PE industry maintains a certain mystique, he says, because the lack of public information about it blocks the scrutiny that public equity markets receive. Private equity firms and fund managers claim their investments provide better returns than the stock market. But is this true?
In his latest book, The Myth of Private Equity: An Inside Look at Wall Street’s Transformative Investments, Hooke compares today’s private equity mania to the internet stock boom of the late 1990s and the mortgage-backed securities craze that led to the 2008-2009 financial crisis. He explains the foundation for PE and why, despite the industry’s downward trend of late, a “protective ecosphere” allows it to continue, to the detriment of its investors and their beneficiaries. In the following Q&A, the author explains the book’s central themes and why he felt he had to write it.
What is private equity?
Private equity is an asset class for investing in companies not listed on a stock exchange. PE firms like Blackstone, KKR, and Carlyle-to name a few-obtain capital from large institutions such as public pension funds, university endowments, and charitable foundations. The PE funds, which typically have a 10-year life, are run by investment bankers, with a sprinkling of management consultants. The funds buy privately held companies and then try to improve and sell them, all within the 10-year window. The sequence of events resembles “house flipping.”
How do private equity firms make money?
PE firms make a profit from yearly management fees (paid by their institutional investors). If the firms sell a company that has improved in value, they get a piece of the profit. The fees add up to 3 or 4 percent of annual asset value, which is much more than what you pay for public mutual funds. Most of the fees are paid whether the underlying funds achieve good results, and the PE funds put up very little of their own money to participate in the profits. It does not get any better than that on Wall Street. Many people confuse PE funds with their distant cousin, hedge funds. Hedge funds also pool capital and invest it, but hedge funds trade mostly in publicly traded stocks and bonds, not private companies.
So, what are some of the problems with private equity?
PE paints itself as the greatest thing since sliced bread, but its big marketing claims that its returns crush the public stock market is patently false. In fact, the returns over the …….