Couple of weeks ago, I posted, as a reply, a link to an article in the Financial Times that basically explains why hedge funds suck no matter how you slice the performance numbers. The author of that article posted another great article, this time on IRR calculations used by PE funds.
The gist of it is that IRR calculations are heavily manipulated by PE funds to artificially inflate their performance and take more incentive bonuses. Even Yale had to retract their statement that their annual return from PE funds exceed 93% per annum because it is just not true. Obviously, the manupulation of IRR calculations are pretty robust and well hidden and complicated enough that most investors just say mmmm kay good enough.
So, I went to our controller and asked about this whole thing…He looked at me blankly and said yeah so what do you want to know…Now I am not saying or implying that my fund utilizes such IRR calculation methods…just saying don’t trust those numbers you see on online or even investor briefings…
By the way the author is not some English literature major or psychology major but a practitioner. He works in the research dept at nareit and holds a phd and is a charterholder.
Return calculations are always interesting. But yes, I’d assume most PE funds that are incentivized on those numbers game the numbers. The company I work with looks at a very simple free cash flow return. But given the dollars flowing into PE, I have to assume its destined for bad returns for the next few years.
Did you see the article earlier this year that 100% of unicorns were overvalued by venture capital? It is funny when people pull back the curtains.
How does one conclude that 100% of all unicorns are overvalued?
What is the benchmark to value these unicorns
These companies are illiquid and private companies so how do you put a value on it
100% of all unicorns…so the author of the article took a look at all unicorns? Did he have access to financials and capital inflows?
What is overvalued?
What is intrinsic value? Intrinsic value is not some number you get out by putting together DCF and discount rate…in real world “value” is whatever the investor is willing to pay…So with that in mind, again, what is the meaning of overvalued?
10 years ago, for 10 years, people have called Amazon an overvalued company…Facebook and Microsoft and Google and YouTube…All were hailed by some and hated by some…So what is the value?
Yeah, I do these calcs, and they are all BS. We flat out lie and make up new rules of math.
It’s complicated enough that micro-thinker Americans can’t figure out the scam. But when presenting to East Asia people see thru the lies, they see the whole picture and are like “yeah, this stinks, we do not believe.” Then the arguments start “but that’s crazy, look at our made up numbers, see the fictitious returns, you would be stupid not to invest!”
This is part of what Eric Weinstein has pointed out, that ALL the numbers in America are lies, it’s a giant Ponzi, and the moment they stop lying, the whole thing collapses.
its quite funny but aswath damodaran of nyu actually tries to value these unicorns on a per user basis and does an npv on them. they use an extremely high discount rate relative risk free rate.
some people place a value based on their most recent capital raise. 100k capital raise for 10% is a 1m valuation. then they used that number until the next capital raise. im sure they use 1 or compare it to a publicly traded co for multiples if they hav rev or profits.
if we are looking at it from a profitability multiple standpoint, then unicorns are all prolly overvalued. the best investments in terms of highest returns are typically the most overvalued and are either unprofitable or at pre rev.
to me its anything that isnt in a reasonable multiple based on profitability and its level of growth.
i think from a traditional perspective, value is dcf, when you pay for an investment, there are 3 things you worry about, the price you pay today, the amount and timing of the cash it will generate, and the rate at which you can reinvest those cash flows when you receive them. value is subjective to story that you believe is applied to the company, aka growth rate, revenue per user, discount rate, etc. price, on the other hand, is what you can get someone else to pay for it aka supply and demand. hence ibankers typically determine price by creating demand and calling people and asking them if you would pay at this price.
value is the story you believe in. personally for me, i own fb, sold out of google (their recent earnings last 2 quarters sucked, but willing to buy if prices crash or earnigns improve, im a big fan of waymo and youtube, as well as their trad bizness), never owned msft or amazon. but i would prefer msft over amazon. to me their best upside is the cloud and the expanding margins and organic growth.
Outright fraud is very rare (as in deliberately misstating figures). But IRR can be manipulated for sure.
Early gains flow through to a high IRR in perpetuity. So quick exits are a key goal for all PE managers. But that generally aligns with the interest of LPs so no-one really cares.
Another way to game the process is with credit facilities. This is more controversial. Some PE funds now don’t call capital for up to a year after an investment is made. The plus is that it increases the IRR from successful investments, but the trade off is that LPs have their money on the sidelines for longer than expected. Lots of push back on this recently from investors.
Here’s a good explainer from Bison (sadly departed).
This surprised me. I thought you were a woke realist?
Back in subprime 2002 I went to mgmt, as a naive noob…“look at this trend, seems like this could get out of control fairly easily.” Was told to never answer the phone when the credit risk dept called, and never to share any of our risk analytics without mgmt approval. So yeah, they know they are lying. Never did that again.
yea thats why asia is investing so heavily into fund of funds… because they can see through the cloak of masking crappy returns…
agreed as well… see tons of deals where the IRR’s are essentially backed into by virtue of the structure of financing and building in when you want to pay for fees associated with the deals. then seeing as how your exit is the bulk of the IRR anyway you justify a way not to take a hit on revaluation & hold onto it until the fund is winding down & the cash flows mean less anyway so your fund IRR is fine.
This is pretty outlandish even for you PA. Asia cannot get enough of US PE so I don’t know what you are going on about. If you think US PE returns are manipulated (which I don’t disagree with), I can’t even imagine how bad they are for countries that lack serious controls (hint: China).
lol so only East Asian people see through this lie eh? Are they the ones who went to US based universities and speak English fluently and wear Boss suits and checks his Facebook on his iPhone while listening to Guns N Roses on their Bose headphones while working on their models on Excel on Dell desktop while dreaming about visiting Miami Beach in the near future?
Asian made and American trained and American washed. We did good extending our tentacles.
Interesting that you “do these calc” Maybe the structure is different over there because these kind of calculations are done in the back office aka accounting team
You see with stats on a page, I see with being there in Asia in the room doing deals. Also, they can disbelieve and still take a position.
There is a cultural aspect of Asian thinking which “sees the whole,” while the micro American mind is down in the numbers believing the lie. The guys I’ve worked with are Western MBA/etc, but maintain the Asian perspective, if they did not they would be too Americanized for corps like Samsumg/Tencent to hire (they hate 100% US-brainwashed, as those people are lazy and rude).
Ludovic Phalippou wrote a book called Private Equity Laid Bare which is worth reading if you are interested in learning more about this topic and PE in general.
oh wow. lol subscription credit line. well you can fix this by setting the start date to when they can first call it. but i guess you’d only do that when the fund’s performance is bad. haha