Tuesday, October 05, 2010

When exuberance fades

Two recent articles attracted my attention. Will the current low interest rate environment lead investors to vehicles that take new types of implicit risk to generate returns in a yield-hungry marketplace?

The first was in Bloomberg Businessweek and was about university endowment funds that had been put in high-risk, high-return portfolios. Some of those schools have had to issue large amounts of taxable debt to fund their working capital (i.e., to meet payrolls). An excerpt:

The loans and interest are the continuing price the colleges are paying for embracing the endowment investing model pioneered by Yale’s David Swensen. The approach produced market-beating profits by loading up on real estate, private equity and hedge funds. During the worst collapse of credit since the Great Depression, the reliance on hard-to-sell assets left them short on cash both to meet investment commitments and run their campuses.

“They thought they were terribly clever and they took those risks and now they are paying for them,” said Andrew Hacker, professor emeritus of political science at the City University of New York’s Queens College.

The second was a New York Times article about the techniques used by private equity firms under certain market conditions. Some excerpts:

As deal activity has picked up, some private equity firms are turning to transactions whose merits have come under some criticism from their investor base.

Among them are so-called secondary buyouts, which involves passing a company from one private equity firm to another. There have been a flurry of these transactions this year, amounting to a record 25 percent of the value of all private equity deals....

These deals hold great appeal in the private equity ecosystem, allowing sellers to book profits and buyers to deploy their billions of dollars of unused capital.

Investment banks, meanwhile, earn big fees on these deals by advising and lending money to finance the transactions.

Secondary buyouts also tend to be more expedient than the traditional route of an initial public offering, with its regulatory hassles and the vagaries of the market, or selling to a publicly traded company whose shareholders may object.

But secondary buyouts have a mixed reputation among private equity investors. The world’s largest private equity firms share the same investor base: American public pension funds and foreign countries’ investment vehicles, or sovereign wealth funds. In some instances, these investors are selling a company through one private equity firm and buying it — at a higher price — through another firm.

...Mr. Dear, Calpers’s chief investment officer, said he had mixed emotions about the Vertafore deal and other similar ones in his portfolio.

“We still have exposure to the company but at a higher valuation,” Mr. Dear said. “To me this isn’t a sign of strength in the private equity business, but more a sign that firms must commit their capital before their investment period runs out.”

1 comment:

Anonymous said...

No doubt the secondary buyout market is the attraction for Cerberus and a reason to seek only a 3 year holding period for the Caritas assets. I also notice 2 of the cited secondary buyouts in the NYT involved other health care companies; I believe this is now seen as a "rich" market in potential. Are we looking at a private health care bubble?

Quote from the article:

“Where we tend to scratch our heads is where a company is passed between two large firms with similar characteristics and skill sets,” she said. “You have to ask, what performance improvements will the new owners be able to make to the company that the previous owners already haven’t made?”