Private Equity in your 401k? Be Afraid, be very afraid!

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Private Equity in your 401k? Be Afraid, be very afraid!

Postby grok87 » Wed Mar 13, 2013 8:37 am

...
http://online.wsj.com/article/SB1000142 ... 78018.html
...
In the latest effort by private-equity firms to broaden their customer base, Carlyle Group LP is letting some people invest in its buyout funds with as little as $50,000.
...
Historically, access to these funds has been limited to pension funds, endowments and individuals wealthy enough to commit millions of dollars for years at a time.
...
Private-equity firms are seeking to tap into the collective wealth of individual investors as pension funds—the cash cow that for decades has filled their coffers—face an uncertain future.
...
Some private-equity executives long to offer their funds to typical workers through 401(k) savings plans, calling access to that pool of money their "holy grail."
...
Carlyle's standard fees of 1.5% for managing money and 20% of profits will apply to the fund, as will a fee of about 1.8% that will pay Central Park Group to manage the fund and brokers to sell it to investors.

3.3% annual fee and 20% of profits. Yuk! Coming soon to your 401k plan. Yikes!

Be Afraid! Be very afraid.
Cheers,
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Valuethinker » Wed Mar 13, 2013 8:47 am

grok87 wrote:...
http://online.wsj.com/article/SB1000142 ... 78018.html
...
In the latest effort by private-equity firms to broaden their customer base, Carlyle Group LP is letting some people invest in its buyout funds with as little as $50,000.
...
Historically, access to these funds has been limited to pension funds, endowments and individuals wealthy enough to commit millions of dollars for years at a time.
...
Private-equity firms are seeking to tap into the collective wealth of individual investors as pension funds—the cash cow that for decades has filled their coffers—face an uncertain future.
...
Some private-equity executives long to offer their funds to typical workers through 401(k) savings plans, calling access to that pool of money their "holy grail."
...
Carlyle's standard fees of 1.5% for managing money and 20% of profits will apply to the fund, as will a fee of about 1.8% that will pay Central Park Group to manage the fund and brokers to sell it to investors.

3.3% annual fee and 20% of profits. Yuk! Coming soon to your 401k plan. Yikes!

Be Afraid! Be very afraid.
Cheers,


Just to reiterate.

Standard industry terms are '2 and 20' (2% + 20% carried interest usually above a threshold of 8% pa returns on the carry).

Larger funds 1.5%.

So as an individual investor if you are doing measurably worse than that you'd have to be very lucky on the fund and manager selection to outperform.

Note there *is* manager persistence in PE-- past funds that have been top quartile, new funds from that manager tend to stay top quartile (funds are raised every 2-3 years with a lifetime of 10 years).

A la REITs vs RE LLPs, there is a way around this-- buy listed PE funds. There are a number listed in London (google Private Equity Investment Trusts) and some are 'fund of funds' (eg Standard Life PE). Also there are now a couple listed in the US I think.

With institutional LPs you are 'drawn' as to your commitments when the fund makes significant purchases of target LBOs. You commit $10m up front, you probably make that investment in $500k-1m chunks every 6-12 months over the 5 year investment period of the fund. Distributions are then made when the fund sells an investment-- proceeds less carry are paid back to the Limited Partners. Fund life is usually 10 years (extendable to 12 by a vote of the LPs).

If you default on a drawdown then you lose all rights to your existing money (or at best case, you can only get your money back).

The high IRRs PE funds achieve for investors are critically dependent on that-- if you invested all your money up front, then you'd get a lot lower IRR.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby grok87 » Wed Mar 13, 2013 12:06 pm

Valuethinker wrote:With institutional LPs you are 'drawn' as to your commitments when the fund makes significant purchases of target LBOs. You commit $10m up front, you probably make that investment in $500k-1m chunks every 6-12 months over the 5 year investment period of the fund. Distributions are then made when the fund sells an investment-- proceeds less carry are paid back to the Limited Partners. Fund life is usually 10 years (extendable to 12 by a vote of the LPs).

If you default on a drawdown then you lose all rights to your existing money (or at best case, you can only get your money back).

The high IRRs PE funds achieve for investors are critically dependent on that-- if you invested all your money up front, then you'd get a lot lower IRR.

The drawdown point is an important one. That is discussed in the article as it is problematical for a retail investor. The way they plan to address it is to take all the money up front from the retail investor (standard mutual fund approach) and then buy secondary private equity. Looked at with a cold cynical eye, one might say that existing private equity investors are salivating at the chance to dump their poorly peforming private equity investments at opaque prices on naive retail investors...
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Grt2bOutdoors » Wed Mar 13, 2013 12:12 pm

Precisely, Grok - they will sell the scraps to the "holy grail" of investment pools (aka retail investors) and keep the golden dubloons for themselves. Why would I pay 2 and 20 plus IDR's to the private equity manager for accepting the lowest return portion of the investment? :oops:
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby grok87 » Wed Mar 13, 2013 4:27 pm

Grt2bOutdoors wrote:Precisely, Grok - they will sell the scraps to the "holy grail" of investment pools (aka retail investors) and keep the golden dubloons for themselves. Why would I pay 2 and 20 plus IDR's to the private equity manager for accepting the lowest return portion of the investment? :oops:

Exactly.
My hunch is that they are going to be sneaky about it and try to get in through the back door. Look for these things to start showing up in target date funds, target-risk funds, balanced funds etc.
The pitch will be that these sort of funds need to diversify away from stocks and bonds and include these ALTERNATIVES. Unsuspecting 401k plan committees may not even know what is going on if they are not vigilant (few are!)
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Iorek » Wed Mar 13, 2013 8:47 pm

If I was a 401k fiduciary you couldn't pay me enough to put that in my plan. Even with all the disclosure in the world, seems like a recipe for problems.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby LadyGeek » Wed Mar 13, 2013 9:00 pm

For those without a WSJ subscription, you can view the article via a reference link from google: carlyle group lowers velvet rope site:wsj.com - Google Search It's currently the first search result.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby grok87 » Wed Mar 13, 2013 10:44 pm

Iorek wrote:If I was a 401k fiduciary you couldn't pay me enough to put that in my plan. Even with all the disclosure in the world, seems like a recipe for problems.

I agree. This article (see last paragraph) supports the idea that these sort of private equity funds will probably not be added to 401k plans as stand-alone investments but will be snuck in via target date funds.
http://www.pionline.com/article/2013020 ... /302049994

cheers,
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby grabiner » Wed Mar 13, 2013 11:21 pm

grok87 wrote:
Iorek wrote:If I was a 401k fiduciary you couldn't pay me enough to put that in my plan. Even with all the disclosure in the world, seems like a recipe for problems.

I agree. This article (see last paragraph) supports the idea that these sort of private equity funds will probably not be added to 401k plans as stand-alone investments but will be snuck in via target date funds.
http://www.pionline.com/article/2013020 ... /302049994


And that looks like a recipe for lawsuits for breach of fiduciary duty when something blows up. I don't know what the standard is, but making the default option include an investment which is not suitable for the average investor would be difficult to defend, and target-date funds are the default in a lot of 401(k) plans.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Valuethinker » Thu Mar 14, 2013 8:01 am

grabiner wrote:
grok87 wrote:
Iorek wrote:If I was a 401k fiduciary you couldn't pay me enough to put that in my plan. Even with all the disclosure in the world, seems like a recipe for problems.

I agree. This article (see last paragraph) supports the idea that these sort of private equity funds will probably not be added to 401k plans as stand-alone investments but will be snuck in via target date funds.
http://www.pionline.com/article/2013020 ... /302049994


And that looks like a recipe for lawsuits for breach of fiduciary duty when something blows up. I don't know what the standard is, but making the default option include an investment which is not suitable for the average investor would be difficult to defend, and target-date funds are the default in a lot of 401(k) plans.


Ahhh...

if it is say 2-3% of total invested (not more than 5%) then 'prudent man rule' might protect the fiduciaries.

It is diversifying (whether it is diversifying adjusted for leverage is less likely. The academic research seems to show the average LBO fund underforms an S&P500 investment with the same leverage. HOWEVER there is manager persistence. If you can, like Yale, pick the *right* funds, then you can do a lot better than the average, and sustainably so).

This is better than it looks, by putting it in the Target Date we can reduce the liquidity problem massively.

The dangers are:

- PE is looking to this source of funding because of lack of institutional funding (partly, the decline of the DB pension scheme ie structural change). To the extent that there is a mug in the poker game, the individual investor could be the mug (ie late to the game)

-this is idiosyncratic risk-- it's not an asset class, so much as a manager class. And so if they pick the wrong managers then they'll have egg on their faces. A lot of university endowments went 'me too' after Yale, and got badly burned.

My guess is the Target Date funds don't have the manager selection skills. They'll buy blue chip funds that will underperform.

But it's not a stupid idea, if structured as implied by above. It's probably better in theory than in practice, though.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby grok87 » Thu Mar 14, 2013 11:27 am

Valuethinker wrote:
grabiner wrote:
grok87 wrote:
Iorek wrote:If I was a 401k fiduciary you couldn't pay me enough to put that in my plan. Even with all the disclosure in the world, seems like a recipe for problems.

I agree. This article (see last paragraph) supports the idea that these sort of private equity funds will probably not be added to 401k plans as stand-alone investments but will be snuck in via target date funds.
http://www.pionline.com/article/2013020 ... /302049994


And that looks like a recipe for lawsuits for breach of fiduciary duty when something blows up. I don't know what the standard is, but making the default option include an investment which is not suitable for the average investor would be difficult to defend, and target-date funds are the default in a lot of 401(k) plans.


Ahhh...

if it is say 2-3% of total invested (not more than 5%) then 'prudent man rule' might protect the fiduciaries.

It is diversifying (whether it is diversifying adjusted for leverage is less likely. The academic research seems to show the average LBO fund underforms an S&P500 investment with the same leverage. HOWEVER there is manager persistence. If you can, like Yale, pick the *right* funds, then you can do a lot better than the average, and sustainably so).

This is better than it looks, by putting it in the Target Date we can reduce the liquidity problem massively.

The dangers are:

- PE is looking to this source of funding because of lack of institutional funding (partly, the decline of the DB pension scheme ie structural change). To the extent that there is a mug in the poker game, the individual investor could be the mug (ie late to the game)

-this is idiosyncratic risk-- it's not an asset class, so much as a manager class. And so if they pick the wrong managers then they'll have egg on their faces. A lot of university endowments went 'me too' after Yale, and got badly burned.

My guess is the Target Date funds don't have the manager selection skills. They'll buy blue chip funds that will underperform.

But it's not a stupid idea, if structured as implied by above. It's probably better in theory than in practice, though.

Thanks.
Do you think the manager persistence is simply a function of stale pricing for illiquid assets? i.e. if these things were fully market to market then the manager persistence would disappear?
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The Carlyle Group?

Postby Taylor Larimore » Thu Mar 14, 2013 11:51 am

Grok:

In my opinion, a hedge fund does not belong in a 401K designed for retirement. Read this:
Carlyle Capital Corporation (CCC), a unit of the private equity firm Carlyle Group, has said it will not be able to meet lenders' demands for money.

The Carlyle Group

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Re: The Carlyle Group?

Postby grok87 » Thu Mar 14, 2013 3:57 pm

Taylor Larimore wrote:Grok:

In my opinion, a hedge fund does not belong in a 401K designed for retirement. Read this:
Carlyle Capital Corporation (CCC), a unit of the private equity firm Carlyle Group, has said it will not be able to meet lenders' demands for money.

The Carlyle Group

Best wishes.
Taylor

Taylor,
I agree.
Thanks for the article you posted from 2008.
The hedge fund did in fact collapse
http://en.wikipedia.org/wiki/Carlyle_Gr ... orporation
most hedge funds in fact don't survive very long. As this paper points out hedge fund mortality is about 9% per year

https://docs.google.com/viewer?a=v&q=ca ... _5xHv_9DhA

That means that the half life of the average hedge fund is about 7 years (since (1-9%)^7 is about 50%)

And As Valuethinker points out, the average private equity fund underperforms the S&P 500, after adjusting for leverage.
So clearly hedge funds and private equity are bad investments in general and particularly bad for retail retirement investing.

Nonetheless I predict that the wall street machine will continue to push to include these products in target date funds etc. The reason is that their traditional customers, defined benefit pension plans, are drying up.

So we must be vigilant!
cheers,
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby swaption » Thu Mar 14, 2013 4:27 pm

grok87 wrote:
Taylor Larimore wrote:Grok:

In my opinion, a hedge fund does not belong in a 401K designed for retirement. Read this:
Carlyle Capital Corporation (CCC), a unit of the private equity firm Carlyle Group, has said it will not be able to meet lenders' demands for money.

The Carlyle Group

Best wishes.
Taylor

Taylor,
I agree.
Thanks for the article you posted from 2008.
The hedge fund did in fact collapse
http://en.wikipedia.org/wiki/Carlyle_Gr ... orporation
most hedge funds in fact don't survive very long. As this paper points out hedge fund mortality is about 9% per year

https://docs.google.com/viewer?a=v&q=ca ... _5xHv_9DhA

That means that the half life of the average hedge fund is about 7 years (since (1-9%)^7 is about 50%)

And As Valuethinker points out, the average private equity fund underperforms the S&P 500, after adjusting for leverage.
So clearly hedge funds and private equity are bad investments in general and particularly bad for retail retirement investing.

Nonetheless I predict that the wall street machine will continue to push to include these products in target date funds etc. The reason is that their traditional customers, defined benefit pension plans, are drying up.

So we must be vigilant!
cheers,


Have to be careful not to mix apples and oranges here. The referenced CCC was a hedge fund with capital provided by the Carlyle Group. I do know a little bit about that fund. It was minimally capitalized and invested in mortgage backed securites heavily levered through repo facilities with banks. Carlyle's response to the margin call was not unlike that of the underwater California home owner, here take the keys. The way it reads, it would seem that the Carlyle Group was the investor, and the indication is that losses were minimal. This is very different than your typical private equity fund that they manage.

But all of the above does nothing to contradict the very valid comments regarding the prudence of such investments.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Valuethinker » Thu Mar 14, 2013 5:50 pm

grok87 wrote:Thanks.
Do you think the manager persistence is simply a function of stale pricing for illiquid assets? i.e. if these things were fully market to market then the manager persistence would disappear?


In the sense that the returns and IRRs are measured cash to cash, I don't *think* stale pricing is a big issue?

I think that there is genuine skill in buying and managing illiquid private companies-- informational arbitrage.

However there's a raft of literature whether that is *really* persistent, when you dig into the data.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby larryswedroe » Thu Mar 14, 2013 7:15 pm

Few thoughts

First on my blog there are many posts on history of PE and the evidence. Here are links to a few

http://www.cbsnews.com/8301-505123_162-57571821/does-private-equity-beat-the-market/


http://www.cbsnews.com/8301-505123_162-37841355/private-equity-creates-public-headaches/


http://www.cbsnews.com/8301-505123_162-37841359/why-private-equity-may-not-be-a-good-investment/

http://www.cbsnews.com/8301-505123_162-57365836/private-equity-gives-poor-results-for-high-fees/

http://www.cbsnews.com/8301-505123_162-57328657/harvard-selling-$1.5-billion-in-private-equity-investments/

Second while value thinker is correct that PE is the one place we do see persistence of performance beyond the randomly expected that MAY not be skilled based, but simply because the winners (like Kleiner Perkins) have higher costs of capital (they can charge more for their money). This was the finding of a study on the subject. Problem is that unless your Yale Endowment you're not going to get access to these winners.

Best wishes
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby grok87 » Thu Mar 14, 2013 11:58 pm

Valuethinker wrote:
grok87 wrote:Thanks.
Do you think the manager persistence is simply a function of stale pricing for illiquid assets? i.e. if these things were fully market to market then the manager persistence would disappear?


In the sense that the returns and IRRs are measured cash to cash, I don't *think* stale pricing is a big issue?

thanks. this article suggests that cash IRRs can be misleading
http://hbr.org/2007/12/the-truth-about- ... mance/ar/1
cheers,
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby grok87 » Fri Mar 15, 2013 12:02 am

larryswedroe wrote:This was the finding of a study on the subject. Problem is that unless your Yale Endowment you're not going to get access to these winners.

Best wishes
Larry

thanks. and especially troubling to me is the plan to dump secondary (and presumably poorly peforming private equity investments) into these "retail" private equity investment vehicles.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Valuethinker » Fri Mar 15, 2013 6:46 pm

larryswedroe wrote:Few thoughts

First on my blog there are many posts on history of PE and the evidence. Here are links to a few

http://www.cbsnews.com/8301-505123_162-57571821/does-private-equity-beat-the-market/


http://www.cbsnews.com/8301-505123_162-37841355/private-equity-creates-public-headaches/


http://www.cbsnews.com/8301-505123_162-37841359/why-private-equity-may-not-be-a-good-investment/

http://www.cbsnews.com/8301-505123_162-57365836/private-equity-gives-poor-results-for-high-fees/

http://www.cbsnews.com/8301-505123_162-57328657/harvard-selling-$1.5-billion-in-private-equity-investments/

Second while value thinker is correct that PE is the one place we do see persistence of performance beyond the randomly expected that MAY not be skilled based, but simply because the winners (like Kleiner Perkins) have higher costs of capital (they can charge more for their money). This was the finding of a study on the subject. Problem is that unless your Yale Endowment you're not going to get access to these winners.

Best wishes
Larry


Just to be clear about a distinction-- Swensen takes us through it.

*venture capital partnerships* have highly skewed returns. A small elite (including Kleiner Perkins) of about 12 firms outperforms the NASDAQ handily. The rest not so. And access to that elite is entirely closed-- no way an individual (unless you are in bed with KP via running a portfolio co of theirs etc.) will be in that as an investor.

LBO funds, which are much more common, the question is whether they outperform an equivalently leveraged S&P500. We are talking Blackstone, Carlyle, KKR, Permira, Cinven etc. The Barbarians at the Gate crowd.

Answer is they do not, but the top quartile does fairly handily. As Larry's list points out, that may not be manager skill.

Comparing KP with that lot is apples to organges-- they do very different types of investing:

-the former, frequently minority stakes, equity only, high growth companies

- the latter, acquistion of the target via a new takeover vehicle, majority control, management has limited stakes (typically less than 10%), a big part of returns is the use of debt leverage
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Valuethinker » Fri Mar 15, 2013 6:51 pm

grok87 wrote:
larryswedroe wrote:This was the finding of a study on the subject. Problem is that unless your Yale Endowment you're not going to get access to these winners.

Best wishes
Larry

thanks. and especially troubling to me is the plan to dump secondary (and presumably poorly peforming private equity investments) into these "retail" private equity investment vehicles.


That is a key, if these are not greenfield ie new investments.

The potential for conflicts of interest, and subsequent investor litigation, is huge.

The optimal way to give investors access to this asset class is via a closed end fund structure, listed-- like a REIT. However the funds will trade at discounts to NAV, and there may be significant tax issues for individual investors.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Valuethinker » Fri Mar 15, 2013 7:53 pm

grok87 wrote:
Valuethinker wrote:
grok87 wrote:Thanks.
Do you think the manager persistence is simply a function of stale pricing for illiquid assets? i.e. if these things were fully market to market then the manager persistence would disappear?


In the sense that the returns and IRRs are measured cash to cash, I don't *think* stale pricing is a big issue?

thanks. this article suggests that cash IRRs can be misleading
http://hbr.org/2007/12/the-truth-about- ... mance/ar/1
cheers,


thank you for that. Interesting.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby grok87 » Fri Mar 15, 2013 8:36 pm

Valuethinker wrote:
grok87 wrote:
larryswedroe wrote:This was the finding of a study on the subject. Problem is that unless your Yale Endowment you're not going to get access to these winners.

Best wishes
Larry

thanks. and especially troubling to me is the plan to dump secondary (and presumably poorly peforming private equity investments) into these "retail" private equity investment vehicles.


That is a key, if these are not greenfield ie new investments.

The potential for conflicts of interest, and subsequent investor litigation, is huge.

The optimal way to give investors access to this asset class is via a closed end fund structure, listed-- like a REIT. However the funds will trade at discounts to NAV, and there may be significant tax issues for individual investors.

It's not clear what the mix of new and secondary private equity will be. Here's what the wsj says:


The fund will try to avoid the losses that hit most private-equity investors during the early years of their commitments—a period during which they are paying management fees but not yet seeing returns—by buying others' interests in Carlyle's funds on the so-called secondary market, according to the filing.

My guess is that the funds will have broad discretion to invest in both primary and secondary private equity at all times and that theses retail funds will become a significant dumping ground for poorly performing private equity investments
Cheers,
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Valuethinker » Sat Mar 16, 2013 11:21 am

Grok

Fund secondaries is actually an interesting area. A lot of money to be made.

You have Limited Partners who need liquidity. You have portfolio NAVs and underlying valuations which are externally audited (but subject to wide discretion by the fund manager).

In buying secondaries you get mature portfolios much closer to realization- -so significantly lower risk.

I share your concerns about the structure of this thing (2 levels of fees etc.) but, intrinsically, it's not a bad thing.

As an informed investor interested in the asset class, as you are, I would suggest to you the alternative route-- look at the London Stock Exchange listed vehicles, particularly hg Capital, Graphite, Standard Life PE, Pantheon, SVG (permira funds), Electra.

http://www.ipeit.com/Performanceandstatistics.aspx

Some of the fund of funds even have US exposure.

EDIT

even a chapter on it!

http://www.ipeit.com/Portals/0/Assets/P ... pter20.pdf
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby grok87 » Sat Mar 16, 2013 12:02 pm

Valuethinker wrote:Grok

Fund secondaries is actually an interesting area. A lot of money to be made.

You have Limited Partners who need liquidity. You have portfolio NAVs and underlying valuations which are externally audited (but subject to wide discretion by the fund manager).

In buying secondaries you get mature portfolios much closer to realization- -so significantly lower risk.

I share your concerns about the structure of this thing (2 levels of fees etc.) but, intrinsically, it's not a bad thing.

As an informed investor interested in the asset class, as you are, I would suggest to you the alternative route-- look at the London Stock Exchange listed vehicles, particularly hg Capital, Graphite, Standard Life PE, Pantheon, SVG (permira funds), Electra.

http://www.ipeit.com/Performanceandstatistics.aspx

Some of the fund of funds even have US exposure.

EDIT

even a chapter on it!

http://www.ipeit.com/Portals/0/Assets/P ... pter20.pdf

Thanks for the links VT. Will take a look when I get a chance. I guess I'm still skeptical that private equity makes sense even for institutional investors like myself. And I defintely think they should be kept out of 401k plans.

Here is a link on the secondary market for private equity.
http://m.pionline.com/article/20120806/ ... /308069970
Looks like they typically sell for 70-80% of NAV. So I think your point, that perhaps there is some money to be made might have some validity, again only for institutional investors. The problem is that there is a big informational asymmetry between the sellers and the buyers of secondary PE.
As far as 40lk plans, I think the plan sponsors/boards should he heading off the issue by prohibiting their plans from ever investing in them or having them be a part of the target date funds etc.
grok, CFA | "You can only convince people who think they can benefit from being convinced."- Taleb
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby nedsaid » Sat Mar 16, 2013 11:30 pm

It is the old saying that late adopters to a strategy are the ones left holding the bag. Retail investors should just stay away. I have the same feeling about individual investors getting into hedge funds.

Private equity is actually not a bad idea but pretty hard for the small investor to execute. The biggest investors and the Wall Street houses will keep the best for themselves and give the small guy the dregs.
A fool and his money are good for business.
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby steve roy » Sun Mar 17, 2013 2:00 am

I have a bit of experience as a trustee on a 401(k) Plan. And Trustees will likely shy away from private equity. They know too well that if they offer "exotic" investment choices, and those investments go south, litigation could well follow.

One of 401(k) trustees' top priorities is to avoid lawsuits. They can't get in trouble with vanilla mutual funds (index funds, Pimco Total Return, etc.) but private equity stuff will scare them to death. (The Plan I'm involved with offers Vanguard Target Retirement Funds. Anybody think Vanguard will fold private equity into those anytime soon?)
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Re: Private Equity in your 401k? Be Afraid, be very afraid!

Postby Valuethinker » Sun Mar 17, 2013 4:18 am

steve and ned

I take what you say. In practice this may be undoable.

But in the context of Lifestyle strategy funds I can see how it could work. The risk exposure of any individual is small. What we are really doing is synthesizing what an institutional fund, like a Defined Benefit pension plan, does. Before they closed to new members and switched heavily into bonds, they were leading investors into PE, RE etc.

Although private equity is a mature industry in some markets like the US and UK, that doesn't mean there are not opportunities for returns. Changes in regulation and market practice have made it increasingly unattractive for businesses of say sub $500m market cap to be listed (public). PE has become the alternative capital market for companies below a certain size.

There are a couple (at least 3) of other areas where this might work

- real estate - I am thinking the TIAA RE annuity but without the problem right now that individuals can 'time' the fund NAV, thus transferring performance to the people who get in/ out v. the ones who just stay in. Institutional investors invest in RE via LP structures (which do not have these issues)

- infrastructure - leading edge thinking pension plans like Ontario Teachers (c. $100bn) are big into infrastructure. Long term liabilities to plan members are matched by long term assets, with revenues linked to GDP growth, strong inflation hedging (most revenue contracts have a CPI component)

Again the nature of public markets means companies want to get rid of capital intensive infrastructure (eg electricity distribution networks). The parlous state of public finances mean regional and local governments want infrastructure to be built, owned, operated by private companies.

This is a huge area of assets imperfectly addressed by public markets.

- timber (the third opportunity) - another area where individuals just can't get good access to the asset class

We can both see all the fiduciary issues (managing all this, picking the right managers, excessive fees, what if it goes wrong?) but also the attractions *if* you can limit the individual 401k member's exposure to any one bad fund or asset class.

Perhaps the best way to do this is a la REITs, ie create quoted vehicles in these areas and invest in them.

My own view is that the conventional 401k, with the volatility of equities, is not a good solution for retirement planning. Individuals need greater certainty, along the lines of the Dutch career average salary pension schemes. Transferring 100% of the risk of capital markets onto the individual was not a good solution to the problem of retirement income (neither was making membership and contribution levels voluntary). Derivative strategies (guaranteeing wealth as we taxi towards retirement date-- in the manner of the 'G' Fund of the TSP or Stable Value Funds) may be part of this. But asset class diversification (as above) may also be part of it.
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