Gavin Baker @GavinSBaker Husband, Becky Painter. CIO, Atreides Management. Former PM, Fidelity OTC fund. No investment advice, views all my own. Jan. 19, 2020 3 min read

1) Thoughts after reading Bain Capital’s superb 2019 report on private equity.

TL;DR: Returns vs. SP500 are compressing, there is a greater skill gap in PE vs. public equity which is wild and I suspect allocators stay focused on PE vs. public equities. 

2) Curious to see PE returns going forward. Energy, retail and legacy IT have been large areas of investment over the last 5-7 years. Suspect it will be difficult to outrun those industry headwinds and return differentials were already compressing. Don’t think it will matter.

3) Industry bets will likely dictate returns for individual firms and funds to a much greater degree than they have historically. My thought would be that growth equity PE firms outperform LBO firms for near future vintages (VF wrecked the growth equity mkt for 2016-2018).

4) Illiquidity valuation premium will be an increasing headwind as future exits will involve more valuation compression given that liquid assets broadly trade at a discount to illiquid assets today. Logical result of defining risk as volatility. 

5) Interesting to see Bain Capital discuss the “Illiquidity Valuation Premium” in their 2019 report on the industry. Result is more PE to PE transactions. And to answer their question, yes this is the new normal until risk is no longer defined as volatility.

6) Interesting that return differentials for PE vs. US public equities over the last 5 and 10 years are much lower than the 20 year return differential – even before the impact of all the above factors (terrible industry selection and the illiquidity valuation premium).

7) 5 and 10 year return differentials are likely already negative. i.e. US public equity markets have almost certainly outperformed the average US PE fund as of the end of 2019 over the last 5 and 10 years based on the charts in the Bain report.

8) MOICs have gone from 2.8 to 3.1 for the 2002-2004 vintages to 1.9 to 2.1 for the 2009-2013 vintages. Also how is it possible that 2009 had a lower MOIC than 2001-2005?

9) IRR’s have been more stable than MOICs due to increasingly common practice of delayed capital calls. Also a reason that 1 year IRRs look so good relative to 5 and 10 year IRRs.

10) Fascinating that there is a larger skill gap in private equity vs. public equity. Top quartile PE funds perform 1000 bps per year better than average PE fund, which is a much bigger gap than top quartile mutual funds vs. the average.

11) Found this in McKinsey’s 2019 report on private equity (overall Bain report was better IMO). Does anyone have a good explanation for this?

12) McKinsey data may include venture where best firms have a huge sourcing advantage that isn’t present in traditional private equity where most deals are auctions.

Even so, looks like there is a larger skill gap in private equity vs. public equity. Really surprising.

13) Datascience and digital X-Ray’s in private equity. Having seen similar analyses in venture/growth investing, I can attest that they are amazing. Plugging into a startups AdWords, Facebook and Stripe accounts can be super insightful. Can cut cohorts however one likes, etc.

14) Surveys and satellites!

Reading this and knowing that PE is running reasonably sophisticated data science ops makes the idea that alternative data is a competitive advantage for any hedge fund outside of TwoSigma/Renaissance/Bridgewater even sillier.

15) If only it were so easy!

Identifying disruption is a quintessential right brain activity that defies process. Private equity wouldn't own so much legacy IT and retail if disruption could be systematically identified and dimensionalized.

16) Interesting reading overall. Public equity investors are eager for the demise of PE, but as long as risk equals volatility PE isn’t going anywhere. IMO, public equity returns have to be much better than PE returns to change allocator preferences.

17) That's it! No idea how I spent a beautiful Sunday morning in Boston with bright blue skies after it snowed yesterday rereading the 2019 Bain Capital report on private equity. 🤷‍♂️

You can follow @GavinSBaker.


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