Hirsch: LPs want to see GPs get rich on carry

The CIO of Hamilton Lane recently appeared on CNBC and offered a wide-ranging defense of the industry, including the idea that public pension systems are main beneficiaries of the asset class.

The largest funds in the private equity industry are having a tougher time raising capital from limited partners in part because of an LP “backlash” over high fees, according to Erik Hirsch, chief investment officer with Hamilton Lane.

“What people want to see on the LP side, they want to see managers who are going to get rich if they’re successful and good at what they do through carried interest,” Hirsch said. “They want to see them get paid on the profits, they don’t want to see them get paid on a fixed income stream where if they’re unsuccessful or mediocre, they continue to” amass wealth.

Hirsch appeared on CNBC’s “Squawk Box” earlier this month and talked about some of the big issues in the industry, including the political negativity surrounding the asset class and the returns private equity has delivered to public pension systems. GPs have in recent interviews been touting Hirsch’s appearance as an example of the kind of message that needs to come across to counter the headline negativity related to the US presidential election this year, and the candidacy of former Bain Capital chief Mitt Romney.

What people want to see on the LP side, they want to see managers who are going to get rich if they're successful and good at what they do through carried interest.

Erik Hirsch

Despite the political negativity related to Romney’s presidential run, the asset class remains an essential part of LPs’ portfolios, Hirsch said. “Private equity has been powering most of the pension funds’ performance,” he said.

Also, private equity is not simply about piling leverage on an investment to juice returns and stripping assets, he said. Successful private equity managers focus more on improving operations in businesses they buy.

“That’s not about cutting jobs, that’s about helping these companies grow,” he said. “The leverage impact if you look across private equity is de minimis; most of the gain is actually coming from earnings growth.”

While some GPs have touted Hirsch’s words, the CIO has long been outspoken about issues in the industry. At an industry conference earlier this year, he said the lack of universal benchmarks with which to measure fund performance makes it tough for LPs to accurately gauge the best managers.

“We’re in an industry where the benchmarks suck. LPs can’t distill the information uniformly or consistently to tell who is best of breed, it’s almost impossible. Every firm is top quartile,” Hirsch said, repeating a complaint other LPs have long voiced. GPs need to offer more than simply strong performance to set themselves apart from other GPs, all of whom are probably touting strong performance, he said.

President Barack Obama’s campaign, in its attacks on Romney, has managed to vilify the industry, despite its assurances that it is not attacking private equity in general, but only the way Bain Capital did business under Romney’s leadership.

However, some high placed Obama allies have come out in defense of private equity, including former Pennsylvania governor Ed Rendell, and Newark, New Jersey Mayor Cory Booker, who said the Obama attacks on the industry were “nauseating”.

“I’m not about to sit here and indict private equity,” Booker said. “I live in a state where pension funds, unions and other people are investing in companies like Bain Capital. If you look at the totality of Bain Capital’s record, they’ve done a lot of stuff to support businesses to grow businesses … This kind of stuff is nauseating to me on both sides. It’s nauseating to the American public. Enough is enough. Stop attacking private equity.”