Private Equity
In 2002 Tobias J. Moskowitz developed a study named “The Private Equity Premium Puzzle” Moskowitz argues that private equity returns, on average, are no greater than market returns and despite the dramatic lack of diversification, the annual average return on private equity is considerably unimpressive. In his research he also found that the majority of households investing in a private company hold an active management role within the company. He also points out some factors that could possibly skew the returns in private equity which tend to be overlooked by the investor which, we will review these factors later. Moskowitz’s study however failed to present solutions between investing in private or public equity, he simply suggests why one shouldn’t invest all of their money into public equity. The purpose of this article is to unravel some of the discrepancies between investing in public and non-public (private) equity and help create solutions when deciding where to invest.
The US by far has the most mature market in private equities followed by Europe then Asia. If one were to invest in the US private equity market, the premium is going to be much higher than in Europe and so on. Patrick Hosking describes more mature markets to be like antique dealers, selling the same dining table to one another because there are no end users. How many times could the same asset have more valued squeezed from it? Moskowitz’s article shows statistics from private equity investments in the US in which none beat the market by over 10 percent in any given year starting from 1953. In this chart you can see that the average of private equity returns in the last 50 years are considerably equal to the market returns. This leads us to the conclusion that investing in US public equities may be optimal compared to private equities based on risk factors. However when we look at the second most mature private equity market, Europe, we see that in the last ten years alone private equity out pacing the FTSE All-Share by 80 percent and the FTSE World indices by an impressive 100 percent. It’s easy to see from those examples alone that even a maturing market such as Europe can still produce outsized gains in the private equity sector. The reason for losing an investment relates to having too much value squeezed out of a company. Therefore if we use only the first two rules outlined by Hosking (1: buy undervalued, cash generative companies from the share market or from larger more neglectful groups. 2: use cheap, plentiful debt to gear up returns) and invest in a market that hasn’t reached maturity such as Asia or South America, the returns should be healthy with very little risk (considering the lack of diversification.) After discovering this information, it would definitely be a good idea for entrepreneurs to acknowledge these numbers. If so they would be more likely to invest overseas (outside of US) and see much higher return on their money.