First Person: Private Equity: Another Bubble in the Making?
The new investing mode seems to go from bubble to bubble, so is private equity the next one?
I am beginning to see signs.
When a new investment makes money for investors, it is usually behind the scenes and for a small group of sharp wealthy investors. By the time the crowd gets involved, the secret is out and the rules of the game have changed. There is still money to be made, but off the crowd, not the investment.
Real estate did well in the 1980s as interest rates fell. Some sharp real estate investors made a killing. The crowd eventually decided it wanted a piece of the action, albeit belatedly and on a budget. Some enterprising promoters obliged by packaging and selling real estate limited partnerships. For $5,000 apiece you could have a piece of the action previously available only to the select few. The problem was that the money was no longer in real estate, which by then was overpriced, but in selling partnership units. Promoters collected huge fees; brokers got paid juicy commissions - all out of investor money, the rest of which went to buy overpriced real estate with huge leverage to boost returns. The end result was disastrous: real estate prices tumbled, wiping out investors' paltry equity in highly leveraged partnerships.
In 2003 - 2008, commodity trading became very lucrative and hedge funds were the sexiest investments around thanks to their oversized returns. After the 2007 - 2009 stock market meltdown and the complete fiasco of asset allocation theories, advisers began to tout alternative assets: futures, wine and private equity.
Private equity seems to be gaining momentum. The original idea was to raise money from a group of wealthy investors, buy a good but mismanaged company on the cheap, turn it around, and resell it a few years later at a profit. Now almost every day I hear of a publicly traded company being bought out by private equity. Are there still that many lucrative deals around? Or turnaround specialists to be employed? I don't think so. I think private equity is simply buying whatever it can with all the cash investors are pouring in. Who would turn away all this free cash?
The rules of the game must have changed once again: the money is no longer in turning companies around: it's in raising/managing funds for private equity and in fat management fees out of the investor capital locked in for years.
The results of this wave won't be known for several more years - that's how long the money is typically locked in in private equity deals. Until then, what will happen is anybody's guess - private equity is as illiquid as real estate limited partnerships were. My bet is on history repeating itself.
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Published by Slav Fedorov
Full-time stock trader and founder and managing member of TradingZoom, LLC, a provider of timely stock picks to part-time traders. Former banker, stockbroker, financial planner, with over 20 years market ex... View profile
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- Private equity may be the next investment bubble in the making.
- There is probably more money in managing private equity than in the actual deals.