Lead Article in the Money Section of the Tulsa Business Journal - Guest Commentary

Private Equity or Public Equity?

The traditional model of investing in the stock market may no longer be the most rewarding asset class.

Over the last ten years, the leaders of our public companies have been increasingly rewarded for short-term performance, which comes at the expense of long-term gains. Public companies are also under increasingly tight regulations and restrictions. In addition, golden parachutes mitigate the compensation risk for executives, even if they don’t perform well. Put this all together, and it is becoming increasingly difficult for public companies to perform well against alternative investments.

Arguably the most successful new asset class has been Private Equity. Private Equity managers use inefficient information flow in private markets to gain an advantage and enjoy proprietary deal flow, which helps them to outperform other asset classes. Looking at the raw data, the U.S. Private Equity Index posted a 25.8 percent gain in 2006 and a 20.4 percent gain in 2007, according to a study by Cambridge Associates. These percentage gains are net of fees, expenses and interest. Now compare this to the stock market, where the Dow Jones Industrials returned 19 percent and 9 percent during the same period, while the S&P 500 only returned 16 percent and 5.5 percent before trading costs.

When you compound this performance over two years and compare the two asset classes, $100,000 in the S&P 500 would have returned $22,000 in two years vs. $51,000 for Private Equity.

If you take the year ended June 30, 2008, a period where the public markets have been declining, the Dow and S&P both lost 13 percent, but the Private Equity Index still posted a small gain of 3.3 percent. So, for $100,000 in the stock market, you would have lost $13,000 before costs versus a $3,300 netprofit from Private Equity.

Private Equity has enjoyed staggering growth in invested funds in the last five years. According to Dow Jones Private Equity Analyst, Private Equity Groups (PEGs) raised $50 billion in 2003, $102 billion in 2004, $171 billion in 2005, $253 billion in 2006 and $266 billion in 2007. That is a 630 percent increase in newly invested funds in five years. This has been good news for owners of mid-size privately-held companies who have sold their companies to PEGs for record prices.

As with any investment, however, there are risks. Due to the lack of regulation and the lack of disclosure that PEGs enjoy, it can be difficult to identify the better PEGs to invest in. You need to carefully research and analyze the past performance, how it was achieved, as well as the managers, investment strategies and leverage ratios of the PEG you are considering funding.

Private Equity is an increasingly attractive vehicle for institutional investors and wealthy individuals who want to diversify beyond traditional investments, but is not immune from the economic crisis. The latest data shows newly raised funds for the third quarter of 2008 are down to levels not seen since 2005, with only $118 billion in new money for the first nine months of 2008. «

Matthew J. Bristow is managing director of ClearRidge Capital LLC, 427 S. Boston Ave., Ste. 702.
ClearRidge provides merger and acquisition, corporate finance, restructuring and turnaround advisory services for midsize companies.

All rights reserved.  Copyright ClearRidge Capital, LLC, 2008.