The short-termism of ‘private equity’ has a growing cost

The operations of private equity they’re getting too incestuous. The volatility of the market and the sheer size of the sector means that Blackstone, KKR and others have to sell more and more assets to each other, and even to themselves. This merry-go-round can generate governance problems and extra costs.

The way they structure their funds encourages them to start dumping companies in about five years. Two of his favorite exit routes – sales to large companies and IPOs – are difficult due to weak markets.

It’s one of the reasons groups are selling more and more assets to each other. According to PitchBook, these operations were 64% of exits from private equity in the US in the first quarter, compared to 40% in the previous decade. And in a new twist, managers are also holding on to companies, selling them to a new vehicle controlled by them, sometimes backed by the same investors. The so-called continuation funds doubled in 2021 to $52 billion, according to Lazard.

Neither of these options is ideal for investors such as pension funds. They can own stakes in both the buying and selling funds, so they end up with the same asset, minus transaction costs, which are estimated to be as much as 3% of the company’s value.

There is another problem with continuation funds: there are fewer controls on price fairness. It’s hard to tell if the company is doubling down on a winning bet or avoiding a loss on a bad one. They can also allow return fees to be increased, for example by removing a good asset from a fund that is unlikely to meet its return targets.

There is a simple solution. So-called long-lived funds, which hold assets for a decade or more, give you the flexibility to sell when the time is right. According to Bain & Company, its lower transaction costs can double returns over time. This gives investors private equity One more reason to push for change.