stock market bubble, private equity, hedge fund performance, Bill Bonner

When genius fails...and fails...and fails…

13.07.2007

by Bill Bonner

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This genius investor does dizzying levels of research to uncover...Half Price Shares!

The key difference between one age and the next is the line of flimflam each falls for. Remember the incomprehensible essays by George Gilder in Wired magazine, during the last big delirium? Towards the end of the 1990s, it felt as if the moment of Rapture had arrived. At last, everyone with a Yahoo account had infinite access to information. The lowliest assembly line worker in Guangzhou could read Shakespeare. The humblest bellhop at the Ritz could solve Poincaré’s last theorem. Even the dustiest goatherd in the Hindu Kush could learn to make a car bomb.

We were all supposed to become geniuses. A decade later, what happened to those geniuses? 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.

These new geniuses can spot overlooked values – in plain view of the rest of us in the public markets. Somehow, we missed them! Private-equity experts can even pay a premium for these stocks, and still add so much value that everyone comes out ahead. At least, that’s the theory.

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 $4.8bn from their recent initial public offering (IPO) – the biggest payday in history. No group is better paid than hedge-fund managers and private-equity entrepreneurs. 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 looked at all the leveraged buyouts between 1981 and 2003, according to researchers from Harvard and Stanford, you’d find the buyers were almost always harmed by the deal. Last year, KKR raised $5.1bn from the public for a firm that funds KKR deals. Despite the biggest bubble in private-equity ever, the shares now sell for about 10% less than the IPO price. Long term, 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 public markets allows managers to focus on longer-term strategies. But on Tuesday, a Moody’s report contradicted this 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, figures from Credit Suisse Tremont, the data provider, show the average hedge fund across all strategies has returned 7.86% over the year to date – almost the same as the S&P 500 index.

And a recent S&P study of Absolute Return Funds – funds designed to outperform the benchmarks – showed that none had hit their targets, after fees. The worst in the group, Baring’s Directional Global Bond fund, hoped to produce 4% over Libor, net of charges, thanks to elaborate use of derivatives. But despite the highest rates in the business, what the fund delivered over the last year was a net loss of almost 6%. Of the 21 funds tracked by S&P, only four beat the return an investor could have got 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 extra 1% management fee, plus an additional 10% of performance as a commission, bringing the total to ‘3 and 30’). But a man looking for idiots in the investment markets of 2007 is spoiled for choice. He may as well be trying to identify the dumbest member of Britain’s 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?

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