Not everyone liked the suggestion, and Clayton has said it isn’t happening anytime soon. Retired hedge fund manager and philanthropist Stanley Druckenmiller responded that maybe the president should consider tweeting once every six months. Others argued that semiannual reporting gaps would favor large institutional investors with extensive research networks over individuals. But the conversation isn’t going away.
Governance by boards of directors has been less than stellar, according to consulting giant McKinsey. Board members were often appointed as rewards for past service; poor governance, oversight and groupthink played a pivotal role in the accounting scandals at Enron and WorldCom and in the failure of many giant banks to shield themselves from the 2008 financial crisis.
Other studies have concluded that corporate directors as a group lack a clear grasp on what is involved in creating long-term value for shareholders. In one study of 772 directors of public companies, only 22% said their boards had a clear understanding of how their companies created value and a scant 16% indicated their boards were knowledgeable about the industry’s underlying dynamics.
For his part, Veronis told attendees at the Inside Alternatives event that private equity firms have increased their average holding periods: What was three to five years is now five to seven. That’s a major change from the leveraged buyout (LBO) mentality of the 1980s when many operators looked to make quick killings flipping debt-laden concerns. Equity prices in that era were much cheaper, and corporate cost structures often were bloated, making it easy in many cases to slash nonproductive expense centers.
The big advantage of private equity investors and their newfound buy-and-hold religion is that “they won’t panic and sell at the wrong time,” Veronis continued. Even if they wanted to, the way private markets transact—via extended negotiations and legal agreements with potential buyers—prohibits them from panicking and selling at the click of a mouse.
When confronted with problems and economic downturns, private equity managers are forced to think strategically. That means they are likely to be focused on streamlining costs, consolidating smaller competitors, upgrading management talent and expanding into adjacent markets.
Nearly one decade into one of the longest bull markets for public equities in the last century, institutional investors are looking for better places to generate returns. Veronis cited a December 2017 survey by Preqin of 250 institutional investors, of whom 91% expected their private equity investments to beat their public market portfolios.
But the market for thousands of private companies is far more opaque and fragmented than the stock market. About 200,000 middle-market companies account for one-third of private sector GDP (98% of them are private) and employ nearly 48 million people.
This broad level of dispersion carries over into the arena of private equity performance. Like the children of Lake Wobegon, everyone in the PE locker room is “in the top quartile,” Veronis noted. In reality, performance dispersion is vast. But research by Cambridge Associates has found that private equity has outperformed both the S&P 500 and Russell 2000 over 10-, 15- and 20-year periods.
There are three ways to create value, and Veronis observed that not “all internal rates of returns are created equal.” The first strategy is applying leverage, pure and simple, and not losing one’s equity. Next is multiple expansion, or timing the entry and exit points to the investor’s advantage.