The principle difference from one age to the next is the line of flimflam each falls for.
Remember that gobbledygook by George Gilder in Wired Magazine, during the last big delirium? Towards the end of the ’90s, it felt as if the moment of Rapture had arrived. Who could doubt that electronic communications, fed through the Internet like a belt of ammunition through a machine gun, were annihilating space, time and ignorance?
At last, everyone with a Yahoo account had infinite access to information. Even the lowliest assembly line worker in Guangzhou could read Shakespeare…even the humblest bellhop at the Ritz could solve Poincare’s last theorem…and even the dustiest goat-herd in the Hindu Kush could learn to make a car bomb. We were all supposed to become geniuses.
Now, a decade later, what happened to all those geniuses? One humbug gives way to another. The flimflam of this New Bubble is that only some people are super-smart…and everyone else is a moron. These new Werner von Brauns work for hedge funds, investment banks, and private equity firms. Like old Werner, their funds aim for the stars…and are likely to blow up in London.
So smart is this new brood of geniuses that they are able to spot overlooked values – right in plain view of the rest of us in the public markets. Somehow, we missed them! Private equity mavens can even pay a premium for these stocks, and still add so much value that everyone comes out ahead. At least, that is the theory. And just to show how smart they are, they’re able to do what million-dollar managers can’t – buffing up their acquisitions to such a shine that… Lo! The whole world looks upon their beauty like Antony on Cleopatra. And with similar consequences.
In America, no further proof of genius is needed than the evidence that comes with dollar signs in front of it. While the average person earns no more per hour than he did in the Carter Administration, the two Blackstone ( founders, Stephen Schwarzman and Pete Peterson, took home more than half of the US$4.8 billion from the recent Blackstone IPO – the biggest payday in history. Overall, no group is better paid that hedge fund managers and private equity entrepreneurs…no art auction is complete without their professional buyers…and no luxury private aircraft manufacturer could stay in business without at least a few of them.
Alas, now theory is giving way to fact, and the pretensions of the Smart Set are getting marked down faster than subprime-backed CDOs.
If you went back and looked at all the leveraged buyouts over between 1981 and 2003, according to researchers from Harvard and Stanford, you’d find that the buying firms were almost always harmed by the transaction. Last year, KKR raised US$5.1 billion from the public for a company that invests (funds) KKR deals. Despite the biggest bubble in private equity ever, the shares now sell for about 10% less than the IPO price. And over the long sweep, KKR’s track record is no better than an index-following mutual fund; it is just more highly leveraged.
A conceit of the private equity industry is that taking companies out of the public markets allows managers to focus on longer-term strategies. But on Tuesday, a Moody’s report contradicted that claim too. Private equity “does not really invest over a longer term horizon than public companies…” said the report. “They’re taking capital out over a short period of time, providing themselves with a dividend in the first three years…”
Meanwhile, according to figures from Credit Suisse Tremont, the data provider, the average hedge fund across all strategies has returned 7.86% over the year to date – almost exactly the same as the performance of the S&P 500 index.
And a recent S&P study of Absolute Return Funds – funds designed to outperform the benchmarks – showed that none of them hit their targets, after fees. The worst in the group, Baring’s Directional Global Bond fund, hoped to produce 4% over the London Inter-Bank Lending Rate, net of charges, thanks to elaborate use of derivatives. So complex were the funds’ formulae, Heisenberg himself probably would have been proud to call them his own. But despite the highest rates in the business, what the fund delivered over the last 12 months was a net loss of almost 6%. Of the 21 funds tracked by S&P, only four beat the rate of return an investor could have gotten from cash – without paying any fees at all.
Both in theory and in practice, an investor would have to be a moron to want to pay a hedge fund “2 and 20” for the privilege of getting ordinary returns (actually, many funds charge an additional 1% management fee…plus an additional 10% of performance as a commission…bringing the total to ‘3 and 30’). But a man who was looking for idiots in the investment markets of 2007 is spoiled for choice. He might as well be trying to identify the dumbest member of the British parliament or the fattest American tourist.
But the financial world, circa 2007, is full of wonders. Who could have imagined that professional investors would buy leveraged packages of mortgages made to people who lied about their incomes and were unlikely to be able to pay the money back? Or that shareholders would allow their companies to be loaded up with debt, stripped of assets, and used to pay huge “dividends” to the private equity marauders?
And now, who would have imagined that those same public shareholders would buy shares from Henry Kravis, Stephen Schwarzman, and other private equity hustlers? What do they think, that they are going to put one over on the very geniuses who made such suckers of them?
Markets and Money