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boom generation prepared for retirement .
Pension funds have long term obligations and had to deal with pensioners living longer and investing more . Interest rates in the US ( the rest of the world was similar ) fell from a high of 20 % in 1980 to around 1 % after the 2008 financial crisis . Pension funds and mutual funds ( unit trusts ) could no longer get decent returns by just putting their money into the bank or government gilts .
This issue of “ surplus cash ” won ’ t stop any time soon . The world is ageing fast . No Western country has a replacement birth rate of more than 2.1 . By 2050 more than 45 % of the UK ’ s population will be over 50 – and these ageing groups will all be saving for their retirement .
Add to this the sovereign wealth funds – the amounts of money accumulated by many states , often from oil sales . Take one small state , Norway , a country of 5,379,000 people . It has a fund of $ 1.3 trillion . That is the equivalent of $ 242,000 for every Norwegian . And everyone with any cash to invest faced the same problem .
So a group of what we might call “ investment managers ” ( IM ) began to offer solutions . They go by various names . Venture capital will invest funds in new ideas – most famously in Silicon Valley . Hedge funds offered high-tech software driven investments geared to exploiting small ( or sometimes large ) differences in financial situations . PE acquires existing companies , borrowing most of the cost as interest rates fell in the
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2000-2020 period , and seeks to improve those businesses either by cutting costs , making more acquisitions or installing new management to improve the companies .
The US Securities and Exchange Commission reports on what they call private funds every quarter and groups venture capital , hedge funds and PE together . The term ‘ public funds ’ is also one you will increasingly hear – it covers all of these businesses which invest in all sorts of assets without the heavy oversight of quoted stock markets .
A very superficial guide to how it works PE started small in the 1990s , with tiny amounts raised ( typically say $ 10m from a few friendly pension funds or banks ). But little by little they showed that they could get far higher returns than a bank account or the stock market . IMs do not seek to buy and hold a business for ever . Typically they might raise funds from investors for a five year period . They buy businesses in that period but promise to sell those businesses and return the money ( plus any profit ) to their investors at the end of the five year period .
Although there are a large number of different analyses , the most comprehensive estimate of PE returns which I know is the US Private Equity Index provided by Cambridge Associates . It shows that private equity produced average annual returns of 10.48 % over the 20-year period ending on June 30 , 2020 . During that same
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time frame , the Russell 2000 Index , a performance tracking metric for smaller companies , averaged 6.69 % per year , while the S & P 500 ( the 500 biggest companies in the USA ) returned 5.91 %.
While the difference between 10.48 % and 6.69 % may not seem too large , if you had invested £ 1,000 in Private Equity on 1 January 2000 , by 31 December 2020 you would have £ 7,326 as opposed to exactly half - £ 3,625 – in the stock market .
Buy your daughter a place at Harvard – and help fund private equity Given that banks were paying very little interest on deposits , and the number of companies which you could invest in on the stock market were disappearing fast , PE and the big holders of cash were made for each other .
It wasn ’ t just pension funds . Universities and local authorities commonly sit on large amounts of cash . The Harvard University endowment fund ( principally gifts from alumni and the rich trying to smuggle their offspring into the university ) currently has $ 53bn in assets , Yale $ 42bn . That money has to go somewhere . ( The largest in the UK is the Cambridge Colleges with £ 7bn – a typical university like Southampton has £ 13m ).
If you have a pension , you are probably already an investor in private equity I apologise for such a brief summary of a complex world . But the truth is that if you want to invest serious money today you go to PE
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or venture capital . If you are selling a business , then it is most likely PE will buy it . This affects everyone . Most people reading this paragraph will have a pension fund managed by someone like Aviva or Standard Life . They will be putting some of your pension into PE . So you are very much part of this investment world .
In a particularly comical development , many PE firms are now seeking to be quoted on the public stock exchanges in London and New York . They are inviting investors to take a slice of their business via the public markets ( and by doing so are , of course , making it possible for the managers of the PE companies to sell their own shares in the open market ). The irony , of course , is that PE has succeeded by offering a more successful alternative to traditional stock markets and is now going back to those very markets to cash in .
How private equity now borrows money even more cleverly Things are getting even more complicated . Many PE companies and public funds are now quoted on stock exchanges and borrow money from banks directly . What ’ s new ? You might ask . Well , this is very new . The historical ( and very profitable model ) has been typically the following :
PE company buys an asset ( maybe a trade show company ). To do so it puts up perhaps 30 % of the money from its own cash and the other 70 % it borrows from specialist banks . It the past decade those borrowings have generally been at an interest
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