Avoid private equity investments

Investment Analysis Clubs Macro Economic Trends and Risks
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https://www.wsj.com/finance/investing/private-alternative-assets-etfs-cf987342?mod=wsjhp_columnists_pos_1

You’re Invited to Wall Street’s Private Party. Say You’re Busy.

Small-time investors may soon gain easier access to so-called private markets. That usually means higher fees, greater risk, more conflicts of interest and a harder time selling.

By Jason Zweig, The Wall Street Journal, Dec. 20, 2024

Hold on to your wallet. Wall Street is gearing up for a sales push that could enrich the middlemen and impoverish you.

I’m talking about private or alternative assets—investments outside the public stock and bond markets. In the right hands, these assets work wonders. In the wrong hands, they wreak havoc…

Hedge funds, venture capital, private-equity funds, nontraded real estate, private credit and other alternatives hold out the hope of better diversification and higher returns. All too often, those potential virtues come at the cost of higher fees, greater risk, more conflicts of interest and less disclosure. And you can generally sell only at certain times, not whenever you feel like it…

Because the underlying holdings don’t trade publicly, valuing them is a mix of art and sorcery…

… expenses on alternative funds, often 2% annually, can range up to 6% or more. Commissions, often 2% to 5%, can sometimes even exceed 10%…[end quote]

The article has a long list of risky alternative assets and ends with the advice, “No thanks.”

It is much less risky to invest in the public stock and bond markets which have plenty of regulation, transparent price-setting and the ability to trade anytime.

Wendy (as if there wasn’t enough to worry about)

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The Private Equity “skim” rate alone disqualifies these products as an investment.

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Or maybe a Ponzi, where the early entrants are richly rewarded, before the search for bagholders starts?

Steve

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It’s not really a Ponzi. The outrageous Private Equity fees are disclosed in the prospectus, but investors apparently don’t do the arithmetic.

A while back the WSJ had an article where the reporter asked a couple of finance professors to calculate how much money BRK investors would have made over the past 60 years if it was run as a hedge fund instead of the low-fee vehicle BRK is.

{{ If you’d invested $1,000 in the S&P 500 in early 1965 when Buffett took over at Berkshire, you’d have a bit over $300,000 today. If you’d bought Berkshire instead, you’d have more than $42.5 million—a big reason why tens of thousands of adoring shareholders will gather in Omaha this weekend to hear Buffett hold court.

If, on the other hand, Buffett had charged hedge-fund fees, you’d have under $5 million—still far more than the market, but about 90% less than Berkshire’s actual results. }}

https://www.wsj.com/finance/investing/theres-more-to-warren-buffetts-game-than-just-picking-great-stocks-7b58fe86

Minimizing the “Skim” – the Key to Wealth.

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Low fee or no fee? Isn’t it essentially no fee as you can own shares of it directly, it isn’t structured as an ETF, and doesn’t distribute excessive salaries (cash) or stock options (dilution).

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Buffet has said that the 80 people he has at headquarters in Omaha is costing the company 2 basis points on assets per year. I consider that to be the “expense ratio”.

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Typical hedge funds fees are ‘2 and 20’ – 2% plus 20% of the profits above a certain level. It is that 20% that would have greatly shrunk the returns of early investors.

DB2

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The BERKSHIRE HATHAWAY Official Home Page

https://www.berkshirehathaway.com/

“If you have any comments about our WEB page, you can write us at the address shown above. However, due to the limited number of personnel in our corporate office, we are unable to provide a direct response.”

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There is much wisdom there, including the part of the il-liquidity of private ownership shares. (We have some of those.)

But contrary to the negativity of the piece I would just add that there is the possibility of amazing gains, should you be so lucky as to attach to a rocket ship. (Of course that is also true in the public market, but the chances are equally slim.)

Getting into private equity gives you a chance to “get in on the ground floor”, as the saying goes, and your gains can be exceptional - you get there before the company is even open to the public markets, meaning you are in an even more advantaged position if/when the company goes public. And even if it doesn’t, you have the chance for paydays over-and-above what might be otherwise available to you elsewhere.

Yes, I had a friend who left our employ to become President of a small privately owned broadcast chain, and while they did well he did not simply because the investment was “stranded” and the longer he waited for the big payday the less likely it seemed, thanks to the ownership which manipulated things so as to never be “ready” for the next step. In our case, our private issue shares, which were supposedly to be IPOed within a few years never got that far. We did, however, enjoy extraordinary dividend returns for a few years, and while the company is now in trouble, we have been handsomely paid for our trouble and maybe they’ll be worth something again. Or not. Dunno. Doesn’t matter, really.

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I don’t know when he said that, but I wonder if those 80 people really cost $200+M a year? Maybe.

And that brings up another question. A fund with 100M or 500M, with an expense ratio of 0.07%, will only bring in $70,000 to $350,000 a year from the expense ratio. How do they manage a fund with that small amount? There are accountants, lawyers, rent, salaries, etc to be paid. I suspect that I (we?) don’t really understand the fund business, and don’t really understand their numbers.

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When it comes to lifestyle, Ms. Wolf and I have different approaches. She is very definitely a notorious tightwad. I, on the other hand, have a slightly more carefree approach. I don’t like wasting money and I like having a large cushion, but I don’t mind spending money on something enjoyable. After all, you only get 1 ticket on the life ride.

So, like most couples, we’ve negotiated with each other and reached a compromise. We live like notorious tightwads.

However, when it comes to investing, I’m a notorious tightwad. 200 basis points freaks me out. The ‘plus’ something else sends me into cardiac arrest. In addition, when I hear “private equity” I’m reminded of Brooks Hatlen’s quote to Andy Dufresne:

“Son, six wardens have been through here in my tenure, and I’ve learned one immutable, universal truth: Not one of them born whose [deleted] wouldn’t pucker up tighter than a snare drum when you ask them for funds.”

Private equity has a well-earned reputation for making a lot of money. For themselves, not for anyone else.

But that’s just me.

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It was in one of the BRK Chairman’s Letters, maybe 20 years ago, so the market cap was much less than it is today.

I understand that there are only about 25 people in the headquarters office today, so Buffett has been trying to reduce the expense.

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That’s true. And it’s why no investor who understands the arithmetic would ever invest in a new mutual.

Vanguard’s S&P 500 index fund now has $1.4 trillion in assets and one guy can run it with an Excel spreadsheet as a part-time job. (Brokerage commissions and trading costs (i.e., bid/asked spread) aren’t included in the expense ratio.)

Even a 1 basis point expense ratio would collect $140 million in fees per year.

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