Don’t rush to judge private-equity firms
KAI RYSSDAL: Even though the economy’s slowing… And no less an economist than the chairman of the Federal Reserve says even he doesn’t know where it’s going to end up, there is plenty of money sloshing around out there. On Wall Street especially. Goldman Sachs CEO Lloyd Blankfein said yesterday the world’s biggest investment bank plans to raise about $20 billion for a new private equity fund. Maybe a little more, maybe a little less.
The announcement comes on the heels of the Blackstone IPO. That private equity group has about $18 billion$ to play with. And it’s going to be getting another 4 billion from investors. Some analysts are criticizing the recent boom in private equity transactions as unsustainable. Economist and commentator Glenn Hubbard wonders about that.
GLENN HUBBARD: The Blackstone IPO has generated substantial controversy — and not a little jealousy over what the principles at Blackstone stand to earn. As well as a few misunderstandings about private equity.
In private equity’s defense, insiders don’t earn too darn much money. They’re getting it fairly from fees earned for management responsibilities and for performance.
But that performance only pays when these people deliver big increases in shareholder value. And the current high returns are in large part due to the skill of those private equity managers — the people who re-engineer operations and suggest new strategies for growth.
It’s also true, of course, that today’s low-borrowing costs have put strong winds in the sales of big, private transactions. Those interest rates have more to do with saving decisions in China and the Middle East than with financial machinations at home.
We won’t necessarily see very high returns in private equity as far as the eye can see. From one thing, a rising risk premium — higher interest rates in debt markets — will make highly-leveraged transactions more costly and less attractive.
And traditionally, very successful private equity deals have focused on funding lesser-known, high-value opportunities or promising turnarounds.
Today’s size of funds puts us in uncharted, but not necessarily unpromising waters. Giant funds will have to pursue acquisitions of much greater size and prominence, and the competition among private equity firms is likely to reduce returns.
But private equity remains important. The best private equity firms will still improve management and returns. And private equity will remain a source of capital patiently awaiting results. It also remains a key investment for our own portfolios through our pensions and other investments. Stay tuned.
RYSSDAL: Glenn Hubbard used to run the Council of Economic Advisors for President Bush. He is now the Dean of Columbia University’s Graduate School of Business.
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