The Investment Scientist

What Oxford Taught Me About Private Equity

Posted on: July 14, 2021

Today I finally finished the Oxford class on Private Equity, and I’d like to share with you, my readers, some of my takeaways.

Long-time readers of my newsletter should know that I have long advised against investing in private investments unless 1) you know the business and 2) you have a measure of control. The reason for this is that private investments are not under the purview of the SEC, and thus provide a fertile ground for conflict of interest. After the Oxford course on private equity, I feel completely vindicated.

Some of my readers, if you are wealthy enough, will be approached with private equity investment opportunities. You will be presented with mouth-watering return numbers. My professor called these numbers complete “garbage,” they can be manufactured (but not fabricated.) Fabricating numbers is against the law, but manufacturing numbers is not, and there is only a hair’s breadth separating them. Next time you see a number like 36.8% annual return, think “manufacturing” and don’t waste your time! I will show you how they manufacture numbers in the next article. 

On top of that, fees are exorbitant, arbitrary and hidden. It is quite common for private equity to charge 2% management fees and 20% carry. 20% carry means that whatever profits the fund makes, the managers get 20%. This is supposed to align the interest of the managers with that of the investors.

The 2% fees are supposed to cover the day-to-day business expenses of private equity. Oh boy, don’t the managers find ways to skin the investors? It has been the trend for the last ten years that private equity funds are charging more and more of the expenses of running the funds to the investors, including consulting fees, attorney fees, and interest expenses. In fact, the 2% so-called management fees are not used for any management, instead they go directly into the managers’ pocket. Investors actually pay all the expenses associated with managing the funds. Of course, these are usually not clearly disclosed in the investment agreement. 

Private equity can go by many different names. If they invest in startups, they are called venture capital; if they invest in growth companies, they are called growth capital; in matured companies, they are usually called LBO (leveraged buy-out.) They may also go by a mundane name like real estate investment,  oil and gas investment, etc. The common feature of any type of private equity is that they are private investments unregulated by the SEC. David Swensen, the CIO of Yale Endowment, once said that private equity is for very sophisticated institutional investors. Most other investors should avoid it.

Schedule a 2nd opinion financial review, buy my wealth mgmt books on Amazon.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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