News, Private Equity

Private Equity Funds Will Start Earning 30% IRRs For Teachers’ Pensions Again Just As Soon As You All Elect Mitt Romney

If you work in private equity the last few months have not been kind to you. Man, dog, and Newt have all been ganging up on the industry, and it has not been helped by faux pas from its most famous alumnus, publicity around job losses and dividend-recaps-into-bankruptcy, or a renewed carried-interest debate.

Not to fear, though: coming to the rescue today are a rag-tag bunch of saviors including a cheesy website, a serial private equity CEO who’s pretty sure he was never instructed to torch the place for insurance money, aaaaaaand Blackstone’s Tony James:

“It is distressing to all of us here who strive everyday to do the best we can for both our investors and for the economy overall, to witness the vicious politically motivated attacks on the P.E. business that are inaccurate and unfair,” Mr. James said. “We provide critical capital for start-ups, growing companies and struggling business on a scale and in times of turmoil that cannot be replicated elsewhere.” …

He noted on Thursday that when Blackstone earns returns, that money goes “predominantly to pension plans and charitable organizations” that are the firm’s limited partners. Those pension funds have struggled to grow amid a volatile investing climate, and many have turned to private equity as a way to bolster returns.

“If they can’t earn back this deficit, retirement benefits will be in jeopardy,” he said.

“When” Blackstone earns returns is carefully chosen. Can you guess when it is? Hint: not 2011. From their earnings announcement released today:

Elsewhere BX mentions weighted average fee-earning assets under management in its private equity business at $36bn (vs. $45.9bn total AUM at the end of 2011), and $16.3bn of dry powder. That gets me about $23bn of LP money actually invested and earning performance fees in 2011.* Blackstone took home $509mm of that money in various fees, or about 2.2% of the actually invested cash; only $70mm of 31bps was performance fees. Assuming 2-ish-and-20ish, that means investors got about 1.5% returns before fees, or $354mm. Before fees. Which were $509mm. $354 minus $509 is …

Well, that math no doubt exaggerates the situation – I don’t know what the fee structures actually look like and am sure I’m getting something wrong – but, y’know. Pension funds are not going to earn back their deficits on that. Blackstone will survive though:

Blackstone’s total assets under management jumped 30 percent, to $166.2 billion, in 2011, and its annual profit fell slightly, to $1.39 billion, from $1.42 billion in 2010. On a generally accepted accounting basis, the firm reported a loss of $269 million on the year.

“Despite volatile markets and struggling economies, Blackstone had strong performance in 2011,” Mr. Schwarzman said in a statement. “Our investors view us as a critical partner, helping them protect and grow their capital.”

Those are across-fund numbers; Blackstone is diversified outside of PE and doing well in e.g. real estate. And obviously no one would criticize the industry just because one firm earned big fees on teeny returns in one bad year. That would be unfair.

Still it’s interesting that the private equity PR push starts today, with Blackstone’s earnings. That private equity CEO talks the usual good game about incentives:

The power of the private-equity model is that, unlike in the traditional corporate model, the interests of investors, management and employees are aligned. Managers like me are required to put our own capital into the company. Some call this “skin in the game”—I call it being an owner. And we all know that ownership is a powerful motivator to care and succeed.

But whatever you call it it’s difficult to pick it out in Blackstone’s 2011 results, where investing performance was meh but revenues were buoyed by asset inflows and management fees. Here is a man quoting David Swensen, who I guess knows from private equity, as “arguing that acting as a fiduciary for other people’s money and maximizing profits are incompatible activities.” I think that’s right, and don’t care very much, and am okay with people managing money for profit, because why else would they manage money? But from a PR perspective it sure looks better when both the managers and the, um, managees get some of that profit.

Private Equity’s Defenders Emerge From Shadows [DealBook]

Private Equity At Work

My Experience as a Private-Equity CEO [WSJ]

* Give or take. Assuming that $3bn of the dry powder is non-fee-earning, to be roughly proportional to total amounts.

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11 Responses to “Private Equity Funds Will Start Earning 30% IRRs For Teachers’ Pensions Again Just As Soon As You All Elect Mitt Romney”

  1. possibly true says:

    Mr. James said “We provide critical capital for stone crab vendors, wineries and pimps on a scale and in times of turmoil that cannot be replicated elsewhere.”

    He noted on Thursday that when Blackstone earns returns, that money goes “predominantly to pension plans and charitable organizations” that are the firm’s limited partners, "but also to ski chalets in St. Moritz and Courchevel" where the firms general partners go to relax and smoke cigars rolled with Eur 500 bills

  2. Hey Mr. Wannabe,

    You sound like some pathetic loser from a bulge-bracket bank who is about to get his bonus cut 60%. Or get laid off. Or both, perhaps.

    People like me have made it. Made the switch from sell-side to buy-side, whereas you just dream of grandeur.

    Don't cry for me.

    And no doubt I am proud of working at the premier PE firm of Warburg Pincus, but that is not to disparage my other buy-siders at Blackstone, a completely respectable institution, just that it is not upto Warburg (or my) caliber.

    -Warburg Pincus Baller
    (ex Morgan Stanley)

  3. secretariat says:

    matt – two quick points from a fan:

    first, we're talking about private equity funds, not hedge funds. PE funds earn incentive fees after a preferred return hurdle. typical structure is 2-and-20 with an 8% or so pref. so if the incentive revenue recognized (more on this in point 2) implies they're getting fees on 1.5% returns, to extend the simplified model a bit, that means they actually generated 9.5% returns, so about 7.5% excess returns over the S&P. that would be the part of the fee structure you're getting wrong.

    second, both (a) the recognition of incentive fee revenue and (b) the concept of counting interim returns on a fund or series of funds that are largely in the middle of their lives are gimmicky accounting concepts stemming from (probably reasonable) concerns about the contents of public investment banks' balance sheets. it's kind of silly for a private equity fund capitalized ENTIRELY WITH NON-REDEEMABLE EQUITY to go through and mark its investments to "market" (whatever that means for private investments) before they are realized, but for consistency's sake, that's what the FASB now requires. having seen both the valuations and the actual results of a number of liquidity events, I would say the best, good-faith efforts of the solid, professional firms that do this valuation work are a weak indicator at best, and probably better described as (unintentionally) misleading.

    so as we peer over the shoulders of giants and conjecture about the meaning of private equity's quarterly financial statements, let's remember that the cards are still on the table. there'll be time enough for counting when the dealing's done.

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