Distant gratification

It has become almost cliché to say that private equity has a hard time telling its story to the outside world. But it is worth repeating this fact as each new regulatory and PR challenge besets the industry.

I used to think that the widespread bewilderment about private equity was squarely the fault of reticent GPs, many of whom cling to an old-school “one-mustn’t-appear-in-vulgar-newspapers” code of silence. But now I think the asset class’s historic aversion to press is just the first of two major challenges.

General partners are today embracing transparency, and this is a good thing. But private equity remains an inherently difficult activity to explain because of its long-term, illiquid organising principles. The asset class may be more communicative , but it has not yet discovered the right way to communicate its benefits. In a marketplace of ideas used to instant gratification, you might say private capital offers incompatibly distant gratifications.

The challenges of fitting distant gratification into standard PR plotlines can be seen across a number of fron

The asset class may be more communicative, but it has not yet discovered the right way to communicate its benefits

ts where private equity often fails to explain itself fully:

Performance: It cannot be overstated how incompatible the true shape of private equity performance is with the quarterly reporting required of public equities and other liquid strategies. And yet the quarterly update is so important and so ingrained in fiduciary systems that private fund managers must play along. It is amusing to see the leaders of KKR and Blackstone, both now publicly traded, discuss the ’results‘ of their operations on a quarter-to-quarter basis – as if Stephen Schwarzman actually believes the mark-ups of a three-month period offer deep insight into Blackstone’s private equity or real estate investments. Likewise, the annual public-pension performance news coverage always focuses on the extent to which private equity “held back” or “propped up” the overall performance of the individual year in question. Private equity’s inclusion in broader performance conversations is unavoidable, and in most cases welcome, but industry participants need to be broken records in stressing that this asset class must be viewed in decade-by-decade snapshots in order to be properly understood.

Employment: With a US presidential election looming, and Bain Capital founder Mitt Romney again in the race for the White House, expect private equity’s effect on employment to become a political football again. It will be interesting to see not only whether the private equity industry enters this fray with facts to counter the job-killer accusations, but whether it will have the wherewithal to frame the jobs debate in a longer-term context. It is a fact that LBO firms often kill jobs; layoffs are unavoidable when a struggling company is purchased, or a healthy company is purchased that then hits a rough patch. What Romney and the rest of private equity need to prove is that over the long term, as portfolio company values grow, so too do the employment rolls, and that this growth more than makes up for the job-shedding earlier in the life of the investment. It’s a nuanced case to prove, which means it will require more energy and good data than soundbites typically convey.

Expect private equity's effect on employment to become a political football again

Compensation: An interesting proposal has come out of Europe that US managers should pay attention to, given that carry is in the cross-hairs of lawmakers everywhere. Among other things, the latest consultation paper of the Alternative Investment Fund Managers Directive calls for a three-to-five year deferral of between 40 percent to 60 percent of a manager’s variable pay. Clearly this proposal has in mind hedge funds, which tend to pay themselves carry each year and have been accused of reaping huge rewards for huge risks and then walking away from the subsequent wreckage. This isn’t how private equity carry works, of course, but the AIFM proposal seems not to recognize this. Private equity’s task will be to spread awareness of the way that GPs put their money into deals and then, following a multi-year “deferral,” get paid a reward (if all goes well) – but usually only part of the reward, as the fund’s waterfall formula divides up the spoils over several more years.
Framed the right way, the long-term story is a pretty good one to tell. It portrays an industry that is manacled to its financial obligations and doesn’t get paid the big bucks until many successful years later. The hymn sheets have been distributed. Now it’s time to sing.