Private equity (PE), whether in or out of market favor, perennially remains a magnet for advocates and critics ranging from investment professionals to economic, political, and policy analysts. In Private Equity Unchained: Strategy Insights for the Institutional Investor, Thomas Meyer does not enter this fray, instead focusing on PE’s investment merits. He aims to develop a strategy for institutional investors, primarily from the perspective of the limited partner, which is the principal entry point into private equity for most institutions. Meyer concedes that he does not develop a complete strategy. But he presents a wide-ranging survey of private equity investing—including academic and nonacademic research and data—and, in the process, provides useful insights and guidelines for institutional investors.
The title of the book refers to chains that in Meyer’s view hold back PE from achieving its full potential. He argues that they arise from misguided efforts by institutional investors to adapt public market investment strategies and tactics, derived from modern portfolio theory, to private equity. In arguing against this approach, he makes the following key points.
- Historical context shows that private equity has been an effective investment format over a much longer period than most public market counterparts have. Private equity sponsors and advocates often highlight the disruptive and innovative role of private equity in current markets. But its roots and key structures—in Meyer’s view, its “DNA”—go back at least to the late Middle Ages and the Renaissance. Some of the most effective features of private equity, such as the division of labor between general and limited partners and the allocation of risk and return between them, trace back to the history of traveling and silent trading partners, long before the current version of private equity.
- In its key investment characteristics, private equity differs sharply from many investments that institutions typically consider. For one thing, it has substantial uncertainties as well as risks because it has a long investment horizon—well beyond that of many institutional investors. In addition, PE is highly illiquid, especially in periods of stress, and has no widely accepted market basis for valuation. During some periods, PE has produced higher returns than other market segments have, but these returns have often disappeared as more investors have moved into the field.
These features of private equity make it appropriate only for a limited range of institutional investors. Successful institutional investors generally have been those that are able to accept long periods of illiquidity and to tolerate wide swings in risk and uncertainty in exchange for potentially outsize returns at the end of the investment period. Generally, such investors have been university endowments, foundations, family private offices, and pension and life insurance portfolios funding long-dated liabilities (with limited or no mark-to-market requirements).
For these investors, Meyer stresses some guiding principles:
- Maintain flexibility as the economic environment and financial performance of investments change—even radically. This can best be done by phasing in investments over time, including co-investments with the general partners (GPs) and, where possible, real options (if limited partnership arrangements permit).
- Cultivate relationships with the general partners. For many institutional investors, GPs are the most valuable source of data and information on current and potential future investments. The GP relationship must be supplemented by the institutional investor’s own analysis, but Meyer argues that for many institutional investors, relationships with GPs may be more valuable than GP performance records because GP outperformance often has a limited life.
- Recognize the limits to upscaling institutional investments in private equity. By the time new investment formats are developed to facilitate increased investment in private equity—for example, funds of funds—attractive investment opportunities have often disappeared because new inflows bid down investment returns.
Meyer’s book is not without some weaknesses. In terms of its organization, it is at times scattered, with some topics repeated and overlapping and some chapter heads and subheads giving only a limited sense of the material they introduce. Occasionally, Meyer limits his discussion of private equity’s shortcomings. For example, he appropriately argues that public market transparency standards are inappropriate for private equity and can be counterproductive, but he devotes limited space to areas in which private equity disclosure has needed improvement. Examples of such areas include the specifics of management and other fees.
These shortcomings aside, Meyer argues effectively that private equity can be an attractive alternative for some, though by no means all, institutional investors. This book is a useful guide for institutional investors considering private equity—in both good times and bad.
—W.C.