Private Equity Customers Can't Win

A blog about business and economics.
Feb. 9 2013 3:56 PM

Why Customers Can't Win With Private Equity

A man looks out the window of Fidelity Investments in New York's financial district on September 17, 2001.

Photo By Darren McCollester/Getty Images

Matthew Klein quotes some interesting data that gets at the real reason why you can't make money investing in private equity funds, even though it's not quite true that nobody can "beat the market":

It so happens that Fidelity, the mutual-fund company, offers something that sounds quite similar to PE (buy smaller companies with lots of debt), but without the 2% management and 20% performance fees. The best part is that the 10-year returns of this product (15.8% annualised), which I am not endorsing in any way shape or form, are significantly higher than the 10-year returns generated by the PE industry on behalf of their limited partners after fees (13.7% annualised), according to Cambridge Associates. Intriguingly, the differential in performance is extremely close to what you would get if you took the numbers from Fidelity and subtracted out private equity fees.

The general issue here is that to make money as an investor in any kind of managed investment vehicle, you have to run the "efficient" markets hypothesis gauntlet twice. First, your investment manager needs to be able to systematically identify underpriced financial assets. That's hard. But the really bad problem for you is that the market for investment managers services needs to be systematically mispricing the value of the manager's skill! Otherwise, all the positive returns the manager generates are going to go into his pocket as fees. As long as investment management firms have some non-zero level of skill at sales and marketing, then returns after fees are going to be negative.

The old question, Where Are The Customers' Yachts? remains a good one, in other words.

I don't think we should ever rule out the possibility that there are some clever people out there devising investment strategies that are so daring and weird that their services actually do end up being underpriced. But once something becomes so well known as to be written into pension fund and endowment investment guidelines, those days are almost certainly over.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.


Sports Nut

Grandmaster Clash

One of the most amazing feats in chess history just happened, and no one noticed.

The Extraordinary Amicus Brief That Attempts to Explain the Wu-Tang Clan to the Supreme Court Justices

Amazon Is Officially a Gadget Company. Here Are Its Six New Devices.

How Much Should You Loathe NFL Commissioner Roger Goodell?

Here are the facts.

Amazon Is Officially a Gadget Company


The Human Need to Find Connections in Everything

It’s the source of creativity and delusions. It can harm us more than it helps us.


How to Order Chinese Food

First, stop thinking of it as “Chinese food.”

Scotland Is Inspiring Secessionists Across America

You Shouldn’t Spank Anyone but Your Consensual Sex Partner

Sept. 17 2014 5:10 PM The Most Awkward Scenario in Which a Man Can Hold a Door for a Woman
  News & Politics
Sept. 18 2014 10:42 AM Scalia’s Liberal Streak The conservative justice’s most brilliant—and surprisingly progressive—moments on the bench.
Business Insider
Sept. 17 2014 1:36 PM Nate Silver Versus Princeton Professor: Who Has the Right Models?
Sept. 18 2014 11:25 AM Gays on TV: From National Freakout to Modern Family Fun
  Double X
The XX Factor
Sept. 18 2014 12:03 PM The NFL Opines on “the Role of the Female”
  Slate Plus
Slate Fare
Sept. 17 2014 9:37 AM Is Slate Too Liberal?  A members-only open thread.
Brow Beat
Sept. 18 2014 11:48 AM Watch the Hilarious First Sketch From Season 4 of Key & Peele
Future Tense
Sept. 18 2014 10:07 AM “The Day It All Ended” A short story from Hieroglyph, a new science fiction anthology.
  Health & Science
Bad Astronomy
Sept. 18 2014 7:30 AM Red and Green Ghosts Haunt the Stormy Night
Sports Nut
Sept. 18 2014 11:42 AM Grandmaster Clash One of the most amazing feats in chess history just happened, and no one noticed.