Carlyle Group: Be Wary of Public Investments in Private Equity
For good reason, too.
Private equity firms raise money for a series of funds with a specified duration, usually around five years. They invest those funds through a variety of methods, such as buyouts, venture investments, or distressed investments.
The practice has created billions in wealth for those lucky enough to take part. While the average private equity fund stays pretty close to the market, the best can return north of 20% per year. For decades.
Unfortunately, only “accredited investors” – or institutions and wealthy individuals – can take part directly.
Everyday investors are left to buy shares of publicly traded private equity firms, like newly public Carlyle.
If you’re considering it, though, let me tell you why I’m convinced that Carlyle (and other public companies like it) should stay off of your “Buy” list.
Investors vs. Shareholders
From this point forward, I’ll use “investors” to refer to those who can give funds directly to Carlyle to invest. And I’ll use “shareholders” for those who buy shares of Group on the stock market.
It’s an important distinction, as the results for the two groups couldn’t be more off balance.
You see, for investors, Carlyle is very good at turning money into more money. It has returned about 27% per year for investors. That’s helped drive its assets under management to roughly $164 billion.
With numbers like that, it’s easy to see why private equity investments are so desirable. So when a firm like Carlyle has an initial public offering – thereby allowing the public to invest – it seems like a no-brainer.
Of course, it’s not that easy. Buying stock in Carlyle makes you a shareholder in the investment management firm, not an investor in its high-performance funds.
And while the fees these investment firms generate have made people into billionaires, that doesn’t seem to be the case for shareholders.
Now, the trend of private equity firms offering public shares is relatively new. But so far, the returns for public shareholders have been abysmal across the board.
One problem is that earnings for these firms will be volatile and difficult to predict. That’s because the bulk of a private equity firm’s fees come from a bonus based on performance. Not the easiest thing to foresee.
On top of that, trying to understand a firm’s exposure to various markets (through the small amount of information released in the public disclosures) is a monumental task. In general, this uncertainty leads to lower stock valuations.
But the biggest problem with public investments in private equity funds is the inherent conflict of interest that the managers face.
Executives of traditional publicly traded companies have a fiduciary duty to make decisions in the best interest of their shareholders. But private equity managers have spent their whole careers striving for high returns for investors, not shareholders. So when the funds perform well and generate higher fees, managers will pay themselves and their teams higher bonuses.
Case in point, just before it began the IPO process, Carlyle paid a special one-time dividend to its partners totaling $398.5 million. The source? A $400 million loan from Abu Dhabi’s sovereign wealth fund. That debt is being paid for by shareholders in the form of lower earnings.
The fact that Carlyle was a massively profitable company with no need for public funds makes it more likely that the IPO was just a way for early investors to cash out. Those who become shareholders now are simply too late.
If you’re one of the lucky few who can invest in a Carlyle fund, you should consider it, because Carlyle is the best in private equity. But for most, buying shares of private equity investment firms simply won’t pay off in the end.
Ahead of the tape,