Guy Hands, the founder and chief executive officer of buyout firm Terrra Firma, today cautioned investors to be more discerning lest they become “third class passengers” on the private equity bandwagon.
He said: “They pay high fees for bad deals and get no access to good deals.”
By contrast he said those sitting in first class get co-investment rights in good deals and pay no fees, while business class get access to good deals and co-investment rights but pay high deal fees.
This situation had come about Hands said because demand for the asset class had hit unprecedented heights, allowing managers to skew terms in their favour.
He warned investors to expect this to continue: “Expect not just two-tier structures, but three or four with different returns for each and expect structures where GPs will become incredibly wealthy for being only half right. Expect funds without hurdles or lower hurdles and higher fees.”
He said investors should expect more managers to go public and “to earn more through selling their company than through investing your money.”
Hands likened the current popularity of private equity to the boom that led to the stock market crash of 1929 when “demand was out of control” and leveraged investment trusts proliferated and invested in their leveraged rivals.
Quoting the economist JK Galbraith, Hands said: “It was a time when ‘Investors would supply capital with enthusiasm and without tedious questions’.”
He said private equity managers are enjoying a similarly golden age that might not last, especially in structures that piled leverage on leverage, where hedge funds invest in publicly quoted private equity funds.