Jeff is a former investment banking, private debt, and private equity executive in both New York and Washington, DC. Subsequent to his finance career, he was a senior lecturer at Johns Hopkins University. He is the author of five books and the co-author of multiple academic papers. His latest book is "The Myth of Private Equity" and his latest academic paper covers the performance shortfalls of private credit. The media quotes him regularly, and he talks frequently before industry groups
In this episode, we are joined by Jeff Hooke, former investment banking, private equity, and private debt executive turned academic critic of alternative investments, for a rigorous and provocative examination of private equity, private credit, and institutional investing. Jeff draws on decades of experience in finance and years of academic research to challenge many of the assumptions driving institutional and retail allocations to private markets. We discuss why pension plans and endowments continue pouring capital into alternatives despite evidence of underperformance, how private market valuations can obscure true risk, and why the fee structures embedded in private funds create enormous hurdles for investors. Jeff explains the methodological challenges of benchmarking private investments, the role of investment consultants and industry incentives, and why illiquidity and opaque reporting make private assets especially difficult for retail investors to evaluate. Along the way, we explore survivorship bias, public market equivalents, unrealized valuations, and the growing push to bring private assets into retirement portfolios. This conversation is an in-depth look at the incentives, risks, and realities shaping the modern alternatives industry.
Key Points From This Episode:
(0:00:18) Introduction to Jeff Hooke and the focus on private equity, private credit, and alternative investments.
(0:04:21) Why institutions and retail investors continue allocating heavily to alternatives.
(0:04:33) What institutional investors are and how pension plans and endowments operate.
(0:05:52) Why institutional staff may prefer complexity over simple index investing.
(0:07:55) How early private equity outperformance fueled lasting enthusiasm for alternatives.
(0:08:47) Why trustees often rely heavily on staff and consultants for investment decisions.
(0:09:29) The social and psychological appeal of “exotic” investments.
(0:10:28) Why institutional investors often resist criticism of private markets.
(0:11:56) The CalPERS example: underperforming a simple 60/40 index despite complexity.
(0:13:28) The role investment consultants play as institutional “gatekeepers.”
(0:15:42) Why many pension plans and endowments may have underperformed due to alternatives.
(0:17:26) Findings from The Grand Experiment and research on private equity fund performance.
(0:18:30) Why institutions struggled to replicate Yale’s endowment success under David Swensen.
(0:20:57) Gross versus net performance in private equity—and the impact of fees.
(0:21:30) The extreme dispersion between top- and bottom-performing private equity funds.
(0:23:26) The weak persistence of private equity manager outperformance.
(0:25:27) Why private investments expanded rapidly after the Global Financial Crisis.
(0:25:54) The illusion of smoother returns in private markets due to subjective valuations.
(0:28:13) Why benchmarking private equity performance is methodologically difficult.
(0:31:13) How private market data can support conflicting performance narratives.
(0:33:41) Why public market equivalent (PME) is one of the best benchmarking approaches.
(0:36:59) Survivorship bias and non-reporting funds in private market databases.
(0:40:09) The rise of private credit and its role in financing leveraged buyouts.
(0:42:29) Findings from Jeff’s private credit research: no evidence of outperformance versus public ETFs.
(0:45:15) Jeff’s response to Cliffwater’s critique of his private credit paper.
(0:47:15) Why retail investors may underestimate the risks and costs of private alternatives.
(0:49:14) Conflicts of interest and fee incentives in wealth management distribution.
(0:51:03) The impact of unrealized valuations and unsold holdings on reported returns.
(0:53:15) Why many private equity funds still hold large unrealized positions after a decade.
(0:56:05) Whether private equity ownership actually improves company operations.
(0:57:42) The major liquidity risks facing retail investors in private funds.
(0:59:20) Canadian private real estate funds, gating, and redemption problems.
(1:02:01) Comparing private market fees to ultra-low-cost public index funds.
(1:06:46) The long-term impact of bringing private assets into retail retirement accounts.
(1:08:17) How much “play money” investors should allocate to speculative alternatives.
(1:10:49) Why leverage layered on top of private funds creates additional risk.
Read The Transcript:
Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision making from two Canadians. We're hosted by me, Benjamin Felix, Chief Investment Officer and Dan Borotolotti, Portfolio Manager at PWL Capital.
Dan Borotolotti: Good to be back with another guest.
Ben Felix: Yeah. Episode 409 and today we're joined by Jeff Hooke, who is a former investment banking, private debt and private equity executive in both New York and Washington DC. He's been a senior lecturer at Johns Hopkins University and he's also written five books and a bunch of academic papers.
His academic papers are largely on the topics that we talk about today, which is private markets, private equity and private debt. He's also got a book, his latest book, I believe it's a 2021 book, The Myth of Private Equity. You can start to get a feel for the direction we're taking this conversation.
His latest published academic paper talks about the performance shortfalls in private credit, which is something that I think was a very important paper because private credit has been being pushed to the industry and more recently to retail investors very, very hard based on its superior performance and a particular superior risk adjusted returns. But in Jeff's research on this, he finds something quite different. It's also interesting, this was discussed in the Rational Reminder community, which is why I bring it up.
His paper did have a rebuttal from Cliffwater, which is one of the large private credit managers. Our friend, Larry Swedroe referenced that rebuttal when we were talking about Jeff's paper. Jeff has some comments about their comments, I guess, and about their critique in general.
This conversation is about private markets, private equity, private credit, private real estate, how they've performed, why people invest in them and Jeff's thoughts as a seasoned professional and researcher in this space on how they fit into portfolios.
Dan Borotolotti: Yeah, I think what really jumped out in the conversation is as we talk about sometimes it's difficult to measure the performance of these investments because someone is used to dealing with public equities. Measuring the returns on US stocks, Canadian stocks, it's all very straightforward because there may be different index methodologies, but they're all very, very highly correlated and this stuff is easy to evaluate. It's a lot different when you're talking about how does private equity compare with public?
Well, which private equity? How do you measure it? How reliable are those metrics?
Obviously, his research is very rigorous, he goes into the methodology about how to do it. I think the other thing that really jumps out is just how much the psychology plays into this and we talk about it a bit in the interview, which is I think we've all encountered it as people who try to manage investments in a very straightforward, transparent way. It's not sexy, it's nothing really to brag about.
People are often looking for something just a little spicier, a little bit more exotic and I think this plays into those impulses.
Ben Felix: I love how Jeff is able to speak to this. He was hired as a consultant to do a report for the state of Maryland and their pension system. That's how he got into this space of researching private market returns.
I had read that report many years ago and it's one of the things that helped me start thinking about private markets. He just continued doing research in this space after that initial paper got some traction. I've got them all here, three published I think, papers in journals and then a few other papers that I believe are unpublished research reports that he's done either pro bono or as a consultant.
He approaches this topic as someone who has extensive practical experience and has also done research in this space. He brings a lot of just nice perspectives and he really doesn't mince his words. It's fun to talk to him.
Dan Borotolotti: Yeah, and yet he's very fair minded. I think people will find when they listen, he's certainly not out to do a hatchet job on anything, but it's quite a methodical approach and a very fair one I think and people can make their own conclusions.
Ben Felix: All right, should we go to our episode with Jeff Hooke?
Dan Borotolotti: Let's get to it.
Ben Felix: Jeff Hooke, welcome to the Rational Reminder Podcast.
Jeff Hooke: Pleasure to be here. Thanks for inviting me.
Ben Felix: Very excited to be talking to you. Why do you think institutions for a while now and more recently retail investors have been so willing to allocate to alternative investments like private equity and private credit?
Jeff Hooke: First, let's tell your listeners exactly what an institutional investor is. It's a giant pool of money that's supposedly managed in a professional way with very educated people, finance experts, investment experts running the pool of capital and selecting investments to buy and sell. A couple of examples of that would be the Canadian Pension Plan, Harvard University, the New York State Pension Plan.
These are huge pools of capital representing hundreds of billions of dollars and they're designed essentially in the case of pension plans to provide annual payments to people that retire from the government. University endowments, on the other hand, the money is often used to subsidize the university's operations. To answer your question, after we just kind of get through that intro, the retail investors, of course, are average people like myself that are saving money for retirement or to buy a house or what have you, and they would be generally less sophisticated than some Harvard MBA or Toronto Business School MBA that studied finance and worked on Wall Street type jobs for years.
So institutionally, these investors like alternatives such as private equity or hedge funds or private real estate, not really because they provide higher returns than their public counterparts. Each of these special investments have a publicly traded counterpart. It's not hard to find.
But from the institutional point of view, the investment staff needs to justify their jobs because if they were to go to the board of trustees of their particular fund and say, look, all we need to do is index the fund and we'll make more money than going into private real estate or private equity, the natural inclination of the trustees would be, well, if we're just going to index all the investments selected by a computer, what do I need you for? Why am I paying you $700,000 a year to pick and choose investments when a computer will make me more money?
So from a career path, they have to invest in these private alternatives because it makes them look smarter. It makes the portfolio look more complex. And therefore, the trustees have to hire a bunch of high salaries to administer everything, even though the evidence shows that these complicated portfolios don't beat a simple index, 60-40 index, which is 60% stocks and 40% bonds, which has been the standard for decades.
They don't beat the index. That's basically career preservation for the investment staff. Now, on the retail level, they're not as sophisticated as the professional staff members, but there's been a lot of hype surrounding the alternative industry for two or three decades.
There's a huge PR promotional program funded by millions of dollars. Retail just wants to get in on the hype.
Ben Felix: That makes sense. The institutional story about the trustees and the staff needing to justify their salaries, that makes sense. But even volunteer investment committees who maybe don't have the same conflicts of interest, why do you think they're particularly susceptible to the alternative story of, hey, we can get you higher returns with less risk?
Jeff Hooke: Well, you got to remember that alternatives did beat the average, the public comparables by a few percentage points in the first 20 years of their existence. That's an indisputable fact. In the last 15 or 20 years, the competition has been so intense for deals that the returns naturally are going to fall because people are paying higher prices for the real estate or the companies that are going into these private funds.
The hangover from the good returns has sort of been still there after 10 or 15 years. I'm a little perplexed why that is. There's only a few of us that really are contrarian in this regard, and a few professors here and there, and a couple of people in the industry.
From the trustees' point of view, part of it's just plain ignorance. A lot of them don't have a lot of financial sophistication, so they're relying on the staff for almost all the information. Secondly, and this has been postulated by people I know in the media who are reluctant to criticize this, but they say, if you're a trustee at one of these big university endowments or some state pension plan, you go to your golf club, what do you want to say?
The computer just did this today. It shifted from 60% stocks to 58% stocks. You want to say that?
That sounds boring. Do you want to say, guess what? We went out to lunch with Goldman Sachs today, about a $200 million fund.
That makes you sound like a big shot. It's kind of ego and ignorance on the trustees' part. As I said, for the staff, it's more career preservation.
Dan Borotolotti: It's interesting because I've had the same kinds of experiences. You'll meet somebody on vacation or at a party or something. They ask what you do for a living.
You say, I'm an investment advisor, and they start asking you, what are you buying these days? What are these stories? I say, index ETFs, maybe some GICs. Boy, that shuts the conversation down pretty quickly.
Jeff Hooke: They don't want to hear it. People want to hear about these huge successes. Yeah, there are some huge successes in these various alternatives, but there's also a lot of failure.
If you spread out all the successes against all the failures and do all the math, which I've done on multiple occasions, you'll find out that the alternatives generally underperform their public benchmarks. There are a few that are home runs, as we say here in America, home runs, and those are the ones that everybody wants to talk about. When you read, pick up the Wall Street Journal or Financial Times, there's a lot less discussion of the many bankruptcies.
Dan Borotolotti: You are speaking to an investment committee. How do you communicate the downsides of these alternatives? What resonates with them?
Jeff Hooke: Nothing really. I mean, they don't want to hear it. I've testified in a couple investment committees because I've been invited as a contrarian.
There's a couple of people on the trustee committee that think I should be heard, but most of the time, I'm not invited to any of these things. I'm not invited to any investment conferences or any of that because I would be against these huge fees that are being paid to Wall Street type firms. I just think it's a waste of money.
So in the one or two instances where I've gotten up there, I've sat in front of a legislative committee or the pension fund trustees. I give them my spiel. I tell them, look, you're wasting a lot of money and returns aren't so good.
You ought to just index the whole thing and tell the staff to take an extended paid vacation. They just don't believe me. So they kind of look at you blank because they don't have much sophistication to begin with, most of them.
Then immediately, the staff gets up there and testifies and just calls you a liar, totally contradicts you. So the staffs of these institutions, they're in touch with the trustees on a weekly or monthly basis, pushing their propaganda. I might show up once every two or three years, they might see a quote by me in the newspapers or something.
Ben Felix: So you don't get an audience, but if you did have an audience and for the benefit of our audience, how do you communicate the downsides of alternative investments?
Jeff Hooke: Well, I mean, look, I just did this letter for the Department of Labor comment, and it's just, let's take the biggest pension plan in the United States, okay? For all your listeners, the biggest pension plan in the United States is the California State Pension Plan and the nickname for it is CalPERS. CalPERS is the bellcow, it's like Harvard.
Everybody follows what CalPERS does, no one really wants to be original, they just follow what CalPERS does. CalPERS is knee deep in these alternatives, it's got about 30 or 35% of its portfolio in private equity, hedge funds, real estate, et cetera. If you look at their performance over the last 10 years, it's 8.3% over 10 years. That sounds pretty good, 8.3% a year. But if you look at the largest blended Vanguard fund, which is what you guys invest in, index funds, it's a 60, 40 index fund, which is a popular gold standard. It beats California 9.5% to 8.3%. So that's a 1.2% difference over 10 years. And you might say, big deal, it's only 1.2%. But when you compound that over 10 years, you've got 15% more money by investing an index fund than CalPERS ever does. The trustees totally ignore these facts, assuming they know them at all.
Ben Felix: What role do you think investment consultants play in the proliferation of these investments?
Jeff Hooke: Investment consultants, for your listeners, are these mega firms that might have hundreds of employees and their main job is to supposedly give totally objective, independent investment advice to these big state pension plans, and sometimes to the endowments. Now, as I've said earlier, these plans and endowments, they have their own professional staff, but particularly on the state pension side, and probably in Canada as well, they're a little stretched. So they use these investment consultants to help them pick and choose private equity funds, or hedge funds, or real estate funds.
Supposedly, the investment consultants are kicking the tires of all these funds, making sure that they're good investments, and then they're studying the asset allocation of the portfolio, how much stocks or bonds they should buy. And so they get paid millions of dollars by these various funds that do this kind of work. So that's their official job, if you read an annual report.
Their unofficial job is to provide air cover for the staff. So if the staff screws up, it's like California, where you're 1.3% below a simple index fund that pays virtually no fees at all. You can say, well, it's not my fault.
Cambridge or Callan Associates recommended that fund or bunch of funds and the asset allocation. So they can kind of walk away and say they're blameless. So the institutional consultants for these big funds are called gatekeepers.
So they have the keys to the kingdom. And so all the investment funds walk into their door and prostrate themselves and say, please recommend us to CalPERS or the Canadian Pension Board. We want to get in there and get the fees.
Now, on the retail level, which is something your firm probably does quite a bit of, your representatives, the clients would look to your advisors as sort of the investment consultant and you would help them pick and choose funds or I guess in your case, ETFs, since that's a lot of what you buy, which have a lot lower fees, but they would look to that kind of guidance on a retail level.
Dan Borotolotti: So Jeff, you spoke specifically about CalPERS as an example, but more generally, how would you assess how allocations to alternative investments have generally worked out for institutions? Is it an overall negative picture?
Jeff Hooke: Yeah, it's negative because like I said, they're all following the example of Harvard and CalPERS. That's the example or the guide for all these funds because again, something screws up with their fund. They could say, well, it's not my fault.
We just copied Harvard and CalPERS. I'm totally blameless. Plus the investment consultant said I should do that. That's kind of the arrangement.
Ben Felix: Do you have a sense of how much public pension plans, for example, have lost due to their alternative investment allocations?
Jeff Hooke: I've been looking at this for free. I don't get paid for doing this. I did it pro bono for a think tank that wanted to look at the Maryland Pension Plan.
I was surprised to learn how it underperformed 60-40 index and was also in the bottom 10% of its peer group. So it was a total disaster. They asked me to take a look at it.
I didn't know a whole lot about investment management, but I picked it up pretty quick. That study got some waves, and then we were asked to look at it on a national basis. We hired a young person to help out.
We looked at all the states. We found out 90% of the state funds underperformed the simple index as well. It was pretty surprising that that happened.
And then when I got into academia after my investment banking career, I was at Johns Hopkins University for six or seven years as an adjunct professor. Me and another professor looked at it in a more scientific manner.
Ben Felix: Is that The Grand Experiment paper? Is that the one you're talking about?
Jeff Hooke: Yes. Yes. We've had a couple of variations on the same theme where we looked at how do big private equity funds, for example, do versus small private equity funds.
It's about the same. Buying a big brand name fund doesn't get you any further than buying a fund you never heard of. I thought that was kind of interesting.
Ben Felix: In those papers, you're finding that these institutions and these funds are underperforming a public equity index?
Jeff Hooke: Yeah. I'm doing a presentation to a big wealth management company in a few weeks. I looked up the State Street, McKinsey, Bain.
These are outside consultants and ones that keep a private equity index. If you look over the last 10 years, private equities underperform the stock market by, I don't know, maybe one or one and a half percent a year. They were doing pretty well the first 15, 20 years of their existence, but now the performance has flattened out. It's not going south in a significant way.
Dan Borotolotti: Jeff, you talked about how many institutional investors look to big plans like CalPERS, Harvard, et cetera, and copy what they do. It's interesting because the late David Swensen, who's sort of known as one of the most popular institutional money managers of the last several decades, wrote a book called Unconventional Success, which was kind of playing on this idea right, in that institutions would rather fail conventionally than succeed unconventionally. They didn't want to be the ones making independent decisions with institutional money.
He gained a lot of popularity and had tremendous success during his career, but it does kind of raise a question. Why have institutions struggled so hard to replicate the success that he had with the Yale endowment?
Jeff Hooke: He was one of the first big institutional investors to get in early. A couple other big institutions that got in early were State of Washington and the State of Portland, but he was one of the ones that got in early. He was near the big media center, New York City.
Much like other early investors in this sector, if there was 15 or 20 years, he was doing better than, say, a Vanguard balanced fund, like I said earlier, that California doesn't beat. But as time went on, his returns started flattening out. The last 10 years of his reign at Yale, he basically matched the Vanguard fund.
I'm not critiquing his investment style or his book or anything. I'm just stating a simple fact. He couldn't overcome, and neither can these funds.
They simply had too much competition after the mid to late 2000s. Everybody's looking for the same kind of deals and the prices go up. The returns falter.
Even the private equity funds and private real estate funds have cut their fees, but simply not enough to make up the difference.
Ben Felix: You could argue that fees go down, allocations just go up to push asset prices up to where they would need to be for the net benefit to be zero.
Jeff Hooke: That's probably true.
Ben Felix: That's what you'd expect in an efficient market for manager skill, I think.
Jeff Hooke: Yeah. Of course, in an efficient market, the private equity industry wouldn't exist in its current form. It would be much, much smaller because so many of the firms are not performing well.
Ben Felix: The crazy part about it though is that they do perform really well gross of fees.
Jeff Hooke: I would agree with that assessment. Net of fees, if you read independent literature, there aren't that much out there. It's critical for obvious reasons.
25% of them will beat the market by 2% or 3% net of fees. That's the top quartile, as they say in the business. Where's the bottom quartile?
It's a disaster. When you add them all together and combine them, you get a mixture of returns that are somewhat below the blended Vanguard funds.
Ben Felix: That dispersion is tough too, right? It's tough to pick. If you pick the wrong one, it's such a big deal.
Jeff Hooke: Yeah. The dispersion, for the sake of your listeners, is the top 25%. Pick a number, might be 4% annually over the market, which means they're hitting the cover off the ball, whereas the bottom 25% might only return 75% of your money.
You're off 3% or 4% a year. That is not something you see in active managers. For example, in the public markets, of course, the index funds, there would be very little dispersion.
You just don't see that. It's a wild swing. You said, well, it's hard to pick them.
I don't know what the scientific basis is for picking them anyway. If you read, let's say you're a trustee or let's say you're a very wealthy person looking at one of the marketing documents of these private equity or private real estate funds or hedge funds, infrastructure funds, whatever, you'll see that, let's say fund six is done pretty well. It's beaten the market.
Fund five has beaten the market. If they're marketing fund six, the sales pitch is, well, five and four beat the market, so number six should beat the market. If you read the investment consultants' recommendations, they will say something like the same.
They'll say, well, we did this thorough analysis of number four and number five and they beat the market because the private equity fund had this strategy and they go into their tactics and so on. But scientifically, it's been proven that if four or five do well, there's absolutely no guarantee that six will do well. It's a totally random process, which surprised me.
Four and five did well. The chances of six doing well are probably 25%. It's just unbelievable.
It's like throwing darts at a dartboard.
Ben Felix: The one argument that I have heard that I think is interesting is that there's no persistence in the top three quartiles, like you said, but the worst funds tend to continue being bad.
Jeff Hooke: Continue being bad, no one should buy them, right? How do they stay in existence? One of the last things I did while I was working with Hopkins was, and I still teach a course there, but I looked at the top 25 LBO fund families.
Anybody can look up this study, just punch my name into the computer and you'll see top 25 LBO family funds. You'll see that even the lousiest of the top 25, you'd think they'd go out of business. No, they can still raise billions for new funds.
That's quite astounding, which would really tend to contradict your theory of the market being efficient.
Ben Felix: I do agree. Based on how things have gone, it doesn't seem sensible that these things are getting so much capital.
Jeff Hooke: When I was working on a legal case with retirees that were suing a pension plan for lousy results, I looked at the recommendations of investment consultants, these big name firms that are supposedly the gatekeepers. The gatekeepers, they wrote these long reports, a bunch of charts and numbers saying, well, basically this fund is going to do well because funds five and four did well. Nowhere do they mention that there've been a couple of objective, independent studies that show, as you say, there's no persistence.
Our recommendation is essentially useless. Persistence, by the way, for your audience is the ability of a PE fund or a hedge fund to duplicate past results. That's tough.
The same problem has been found in active management of stock managers that they might beat the market for three or four years and then they tend to go back to the norm and then they might lose for a couple of years and that's unfortunate.
Ben Felix: We've seen this story arc where these things, as you talk about in one of your papers, they really became popular around the financial crisis and that's when institutions started putting a lot of capital into these to try and recover from the drawdowns and avoid future drawdowns. It's been a while now that they've, as you have documented in some of your research, been underperforming public equities, but now it's come to retail. How do you think these types of investments are going to work out for retail investors?
Jeff Hooke: Let's start off with your basic premise and then we'll move on to real estate investors. So as you accurately point out, the market in the United States dropped 35% in 2009, as I recall, or something close to that. There was a lot of hand wringing, as you point out, at pension plans and universities to say, oh, we can never do this again.
And private equity came to the rescue, so to speak, and said, we're investing in stocks just like the stock market, except our stocks are privately traded. If you look at our results 2008, 2009, they didn't drop 30%. They only dropped 10% or 12% or 20%.
So they dropped a lot less in that they used that argument to say that they were safer than a public stock portfolio. The crazy thing about that is they're investing in the same kinds of companies as public stocks, but they can assign values to their private companies based on what they think it's worth or what they want people to think it's worth. So it's a very subjective exercise that they're going to use in their favor.
So in those two-year periods when things look pretty dark, they use their subjective analysis of values to make themselves look more smooth as opposed to the market going up and down. So that's been one of their sales pitches for the last 15 years. It's obviously been quite effective because a lot of people keep repeating it.
As far as retail goes, I think private alternatives are going to be a disaster because not only are the returns a little shaky, as I've mentioned, but the fees are going to be higher at the retail level because not only does the retail person have to pay the fund fees itself, they then have to pay the distributor or wealth manager. I'm not sure how you guys would call it, there'd be a distribution fee and maybe a fee going to the absolute individual who's advising it. So the fee structure might be another 1% or 2% a year on top of the 2% or 3% the private equity funds are already charging.
So if you're down 5% a year in fees, it's a little hard to see how you're going to keep up with the stock market or the real estate market or the private credit market for that reason.
Dan Borotolotti: So let's talk a little bit about methodology because maybe you can talk about why it's so difficult to answer what seems like a simple question, which is whether in fact private equity has outperformed or underperformed public equity.
Jeff Hooke: Well, these numbers are available. You can look them up on the internet. And as I pointed out, Bain Capital came out recently.
McKinsey Capital came out recently. State Street came out recently with their 10-year charts. That means you've got to go to the internet.
You got to look at two or three McKinsey reports to find out which one. Then you have to scroll through it and find the information on page 52 or something like that. So that's a little bit of a problem.
And that only shows the internal rate of return, which can be manipulated by the private equity funds. McKinsey just takes these numbers off a database. Same with Bain and the others.
And so the numbers or even these numbers that show a relatively poor return relative to public benchmarks assume that the unsold values are accurate. So one, there's trouble getting information. If you want to get more detailed information, like how does the particular fund compare to a public benchmark, that's tougher.
You've got to subscribe to a private alternative database that keeps that kind of information. And that's going to cost you $25,000 a year. In my travels, I've learned that neither the New York Times nor the Wall Street Journal, Financial Times subscribes to such a database.
They think it's too expensive. I wouldn't have enough experience with the state pension plans to know if they subscribe to that database. They might.
The Hopkins Endowment does subscribe to it. But the Hopkins Endowment's underperformed to 60-40. So I'm not sure that 25 grand has been a worthwhile expenditure.
It's going to be bad for people that want to get that kind of information. It's just going to be hard to lay your hands on it and then to analyze it. Asking a retail person to do that is really a stretch, in my opinion.
The other thing is that the media has been pumping up private equity hedge funds, et cetera, private credit, claiming these guys are all geniuses. And they've been part of the hype. They've been enablers.
They're getting a little more skeptical the last few years. But with all the hype, it's very hard for someone to get through it. Lastly, the private equity industry or real estate industry or what have you, they've got millions on public relations campaigns.
You can see their advertising on TV now. You guys probably get emails asking you to buy private equity funds. Of course, they have conferences and stuff like that.
So it's an advertising machine. They've also got a pretty powerful lobby here in Washington. Maybe they have the same thing in Ottawa that tries to keep everything super secret.
It's very hard to get through the clutter, the fog of information to get the real truth.
Ben Felix: I think it's even harder than you made it sound. You mentioned the reports from Bain and McKinsey where they show underperformance, but then there's – I won't name them, but there's a Canadian firm that sells private equity to retail investors and they show historical performance going back to 2001 where private equity is beating public equity by almost 3% a year, net of fees apparently. There is a paper like in the Journal of Private Markets 2025 paper that says that buyout funds have outperformed net of fees by 3.8% after adjusting for a whole bunch of factors. It's such a messy thing to benchmark and calculate the performance of that you can have Ludovic Phalippou on one hand saying there's been no outperformance. Then you can have this other paper saying it's been almost 4%. The data are just messy enough where I think you can choose how you want to interpret and report the results.
Jeff Hooke: I agree with you that you can manipulate the results to get the answer you wish. It also depends on what year you pick as the start. If you pick a bottom fishing year like 2001 where the stock market was beat up, then private equity is picking things up cheap.
You might actually beat the market. If you go 20 years back, I don't think it can be manipulated that well. A lot of times, I've seen some of the big firms say on their websites, they beat this and that.
There's often lots of footnotes as you point out. No one's really checking the marketing claims to see if they're true. There's no SEC regulation in this country for private assets, whatever claims they make.
Even if they sound too good to be true, the government doesn't analyze their marketing and say it's exaggerated. I've sent them a few. I'm not an SEC lobbyist.
I'm not a lawyer for some citizens group. If you send something to the SEC as an individual pointing out that one of the big LBO firms is exaggerating returns or just saying bad information. They just tell you to kiss off.
All they want to talk to are big firms and big law firms. That's kind of their purview. It's just tough.
If the government's not checking on any of this stuff, how's an enlightened individual going to get through? It's difficult.
Ben Felix: Our listeners are somewhat familiar with the problems with IRR. We had Ludovic Phalippou on this podcast a while ago and talked about that quite a bit. Can you talk about what performance measures are better for measuring private fund performance that you've used in some of your research?
Jeff Hooke: I think the most accurate one, the most relevant one, is something called the public market equivalent, which is the slang in the industry. It's the PME, public market equivalent. The idea behind that one, which was invented by a couple of professors 10 years ago, was, okay, we're going to look at the cash flow of this private equity fund year to year.
When did they make the investments? When did they cash out? Because these funds last 12, 15 years now.
They would assume there was a hypothetical index fund investing at the same exact time and exact same amounts. Then as time went on, when the fund 6, 7, 8, 9, 10 years later started selling, this hypothetical pretend index fund would then sell their stocks in the same manner and then they could match it up. The public market index fund is designed so if the statistic is one, that means the private equity fund matched the public market.
If anything above one, they beat the public market. Anything south of one means the fund did not beat the public market. I think that's the most accurate one.
The problem with that is the private equity firms in their advertising and marketing documents never mention that because if they did, people would see how lousy they are. The PME is only provided by these big data services. If you want to find out the PME of all the private equity funds that you've heard of, Goldman Sachs, Carlyle, Apollo, all those guys, you got to pay $25,000 to get the number calculated.
That's pretty expensive. A firm like yours, I guess you could buy it and you could distribute the results to your clients. Of course, that might be prohibited under the terms of the contracts with, say, Preqin or PitchBook data services, but you would then have that knowledge and you could then pick and choose, even though, as you said earlier, it's tough to pick and choose because there's very little persistence in the business.
That would give you some idea of who's doing well. The IRR, as you said, could be manipulated. The other one, which is popular, is called the TVPI, which is total value in versus paid out.
That one's harder to manipulate as well, and that one is widely distributed. That means if over time, some institution puts $100 million into a fund, after, say, 12 years, the $100 million is won. You put in $100 million.
Then the common TVPI in private equity would be 1.5. All the funds would average to 1.5 over that 10 or 12-year life. You put in $100 million and you cumulatively got back 150. 150 divided by 1 is 1.5. You might say, well, that's pretty good. I'm making 150%. I'm making 50% over what I put in, but that doesn't factor in the time value of money. The math is pretty complicated to do that, but you might only have a return of 7%, 8% a year if you do all the math, which is not as great as they advertise.
Dan Borotolotti: Talk a little bit about how survivorship bias affects private market performance data. This is an issue in most kinds of performance reporting in the investment industry. How does it factor into this methodology?
Jeff Hooke: Survivorship bias is, as your listeners might have already figured out, a lot of the funds that fail, or let's say they don't fail, they don't go bankrupt, but they have returns that are a lot less than desirable. They simply close down. They disappear into the wilderness or into the fog or to space, and you never hear about it again.
They stop filing their returns, and we never hear about it. They might have been in the statistics early on, but when they stopped filing, they disappeared from the statistics. A lot of the losers fade off into the sunset, and the winners are the ones left standing and the ones that go into the databases.
There'd be a somewhat higher rate of return reported by the databases than would be totally accurate for the industry. The other thing I should point out, which is not directly connected to survivorship bias, is the fact that even the biggest and best data service, which I consider Preqin in private equity, only covers about 60% of the universe. The 40% don't report to Preqin.
Reporting to Preqin is voluntary. They don't report to Preqin, so you might say, well, where does Preqin get the data for funds that don't report voluntarily? Under the Freedom of Information Act, they would try to get the data from state pension plans that would tell them what the cash flows in and out of these various non-reporting funds are, but even that has got holes in it.
You've got a lot of information that's simply not there as you would have in the public market, which is just the way the private equity industry likes it. They don't want any accountability. They don't want anybody to really know that their funds aren't doing so hot.
It's a great business for them. It's one of the best businesses ever designed. It's the same with private credit and private real estate.
Ben Felix: The non-reporting, I know it would be hard to study by the nature of the fact that they're non-reporting. Do we have any idea what the performance of the non-reporting funds looks like relative to the reporting funds? Are all these funds that don't report doing worse?
Jeff Hooke: It's hard to say. A cynic might say, well, if they're not reporting, they must have a reason for it. That reason would be we're not doing so well.
I've asked people in the business about it. I say, why don't they report to Preqin or PitchBook? They say, well, our fund is doing so well, we don't have to report.
We don't have to have Preqin or PitchBook, tell everybody how well we're doing. We want to keep it an absolute secret, Jeff. It doesn't make any sense to me.
Why would you do that? I mean, if you're doing really well, you want everybody to know.
Ben Felix: Interesting though that that's what they say because it's plausible, I guess. It is a relatively tight market. It's not like they can go and find investments if they triple their fund or whatever. It's plausible.
Jeff Hooke: If you're doing better than everybody else, I mean, how do you make more money? You go out and raise a couple more funds. If you've got a good track record, you should be able to do that.
The logic for keeping it a secret would seem odd to me.
Ben Felix: That's tricky. I hope one day a study comes out that somehow manages to get a bunch of non-reporting fund data and tells us what it looks like. You mentioned private credit, which we've not talked much about yet. How has it performed relative to risk matched publicly traded securities?
Jeff Hooke: Private credit is the next crazy thing. It's grown by leaps and bounds since 2015. It's probably tripled or quadrupled in size.
In part, the private equity returns, as I've mentioned, have flattened out. Wall Street had to think of another. What do they call Wall Street in Toronto? I forgot because I've been up there a few times.
Ben Felix: Bay Street.
Jeff Hooke: Bay Street. Okay. So Bay Street, they got to think of another product to sell, even though private equity is still selling, it's not quite selling as much.
And so private credit is the next hot thing. And private credit, even though it's supposed to be exotic, super secret, doing all kinds of great returns, the basic idea is that 80% of private credit is loaning to leverage buyouts. So private credit is essentially privately held junk bonds to various leveraged buyouts.
Most of them are small deals, $200 million, $300 million. But some of them are really large. You see some $10 billion deals that have been financed mainly by private credit.
And so they form syndicates, almost like you would have in a big bank syndicated loan. So private credit is growing because they're really replacing the banks in a lot of these smaller deals. They run around with the same claim that private equity does, that they beat their, I hate that word, risk adjusted benchmarks.
I'm not sure what it means. But the professor from UC Irvine and I, who did this study recently, which I know you two know about, which was an independent study. I didn't get paid for it.
I'm not getting paid to sit here like a lot of people in the business. They get paid to show up on podcasts, I'm doing this for nothing. Is that the study pointed out, which is the first study of its kind, you'd say, well, if $2 trillion has been invested in private credit, has anybody analyzed whether it beats a benchmark that's publicly traded, that's totally objective?
No one ever did. I was surprised. No one ever did it.
They just didn't have the information or they just didn't feel like it. There are a couple of people that touched on the subject, but nobody just sat down and did it, which is what we did. And it was published in a journal and people can look it up.
A lot of people called us after the article was published because it was such a novel approach and something original. And so we looked at 200 private credit funds, North American private credit funds, as I said, mostly invested in leveraged buyouts. So it's all floating rate debt.
So it'd all be junk bond rated because it's a very leveraged company. So junk bonds might be single B credit by Moody's and S&P or triple C, sometimes they're B plus or double B minus. So they're junk type quality.
We looked at the returns just for seasoned funds that have been around between five and 10 years. And there was no evidence that they beat a public ETF that invests in floating rate junk bonds. No evidence at all.
It was basically very similar. It surprised me a lot. The other thing we noticed, which again, surprised me a lot, surprised my colleague, Mike Imerman of UC Irvine, which by the way, just hired the tallest college basketball player in the world, seven foot nine.
They just hired him yesterday or enrolled him in the school, by the way. So we looked it up and the junk bond ETF, the returns were very similar. Now, the thing that surprised me and Mike was that a lot of the loans in the eight to nine, 10 year age range, you think would have been fully liquidated, fully paid off.
But no, 30 or 40% of the loans had not been paid off or not been sold. So again, you had an overhang of unsold or unliquidated loans, much like private equity would rate a big overhang of unsold companies. There've been some articles about unsold or unliquidated loans that private debt funds are keeping them alive by letting them defer interest in principle.
I've heard these stories, but this is a private business. It's very hard to get your hands on the information. I'm quizzical about why everybody's flocking to private credit when there's no real evidence that it beats the public market equivalent, yet the fees are quite high and you're locked in for 10 or 12 years.
So another strange happening in the alternative space.
Ben Felix: The seven foot nine transfer, by the way, is Olivier Rioux, who is Canadian.
Jeff Hooke: Oh, really? Okay.
Ben Felix: He's from Quebec.
Jeff Hooke: There's a lot of good basketball players that come out of Canada.
Ben Felix: Not bad. I played basketball at Northeastern University in Boston.
Jeff Hooke: Oh, okay. Fine university.
Ben Felix: I'm six foot 10. You can't tell when I'm sitting down.
Jeff Hooke: Yeah, I used to play a lot of pickup for like 20 years. So I enjoyed the sport.
Ben Felix: Nice, nice. You have a published paper on private credit performance. After you wrote that paper, Cliffwater, who is one of the big private credit managers and a consultant in that space, they wrote a big long response, which I've read, saying that your analysis was basically wrong. What did you think about their response?
Jeff Hooke: I had talked briefly to him before the paper was published. Then he did that two or three page, or four or five page critique. A couple of things.
One is his critique really focused on business development companies, which are kind of similar to private credit funds in that business development companies, or BDCs as we call them, invest heavily in private debt. So they would do the same kind of deals or investments that private credit funds do, except some BDCs are publicly traded, a lot are private. His is mostly private, I guess.
It's not quite apples to oranges. There are significant differences between the BDCs and the private credit funds. Secondly, we asked for where he sourced his data that proved our report wrong.
And we offered him the chance to publish his findings in a journal. We never heard from him. So I'm not sure whether he thought he got enough public relations impact from writing that report or not.
I wasn't quite sure, having read his critique, whether he fully accounted for the fees that the BDCs charge, or whether he was just calculating the returns that were gross of fees. I think he included some of the fees, but again, he wouldn't really reply to us. So it was kind of hard to figure out what his critique was all about.
Exactly. I'm a little skeptical of it because I thought if he really wanted to tear us apart, he ought to just publish a paper. A lot of his employees just write it, crunch all the numbers, but he decided not to do that.
Dan Borotolotti: Interesting. Jeff, how well do you think retail investors specifically understand the relatively poor performance of private equity and private credit that you've enumerated here?
Jeff Hooke: I don't think they really do. If they did, they'd stay away from it. But as I said, there's been an ongoing hype in the media, business newspapers, podcasts, websites, business magazines.
They've just all been pushing this for so many years. As I said, they've gotten kind of skeptical. You've got to think of human nature.
Wealthy people just don't want to put their money into an index fund because it doesn't sound sexy enough. So they always want put some money into an exotic private equity fund or a private credit fund or a hedge fund so they can tell their friends at the tennis club, I just did this with Carlyle. I just did this with XYZ real estate fund.
It just sounds better. They're not able to withstand the hype. It's a little tough to do that.
So there's kind of ego reasons and maybe illogical motivations that the three of us might think don't make sense. But for the average retail person, they don't quite get it. I can understand putting a little play money of your portfolio in some of these exotic things just so you got something to talk about and follow.
I might say 5% or 6% of a portfolio. I'm not in your business and you got to realize a lot of people in your business, they got to generate fees and you get higher fees from pushing alternatives as opposed to public ETFs.
Ben Felix: There's a chart recently from the Financial Times showing the amount that has been paid from private funds. I'll see if we can find the chart and put it in the video.
Jeff Hooke: I think I saw that article. It's like $200 million a year.
Ben Felix: And it just keeps going up, up, up. So there's potentially a conflict of interest there where if wealth managers are being compensated to place dollars in these funds, that would be an incentive to do that.
Jeff Hooke: Yeah. I mean, look, the concept of fiduciary obligation, which is something you hear tossed around the United States a lot, I think that's been dead and buried for years. If it was enforced like it should be enforced, there would be very little private equity and private real estate outstanding.
Most of the money would have gone to some kind of index ETF or some public equivalent.
Ben Felix: I think it's harder than that because as you said, it's hard for you to get an audience to talk about all this stuff. It's a lot easier for the folks who say, well, actually no, private equity has performed really well. If we're in a situation where we have to say, what does a fiduciary invest in?
I think there are enough people who would say and try and convince other folks that as a fiduciary, you have to invest in private equity.
Jeff Hooke: That's what the US government has been selling. This came out with this new ruling, this stuff, private equity and private real estate, et cetera, 401k funds. If you look at the executive order and so on that's trying to promulgate this policy, they're saying the exact same thing.
I just don't think it's true. I've talked to a few wealth management conferences, not much, but sometimes occasionally the organizer of a conference might want some kind of contrarian view to entertain the spectators. I feel like a skunk in a party.
It's very hard to get them convinced. While they think what I say is somewhat amusing and different, I don't think many of them really take it seriously. Probably even fewer of them look up the source data for the studies I've written with my colleagues.
Ben Felix: It's like trying to convince the world that smoking is bad when all the doctors are still endorsing it.
Jeff Hooke: Same with lots of other things, smoking, drinking, pot smoking and so on. It's hard to get people to veer off from pre-established beliefs.
Ben Felix: You've talked a little bit about this, but when we talk about the returns of private funds, how much of an impact do unrealized investments like non-market tested valuations for companies that have not been sold, how much of an impact does that have on the performance that we see reported by funds?
Jeff Hooke: Well, the performance is largely based, even for seasoned funds that haven't fully liquidated, in large part based on these unsold values. If you've got 20% or 30% unsold after 10 years and you're computing the IRRs, a high percentage is based on these unrealized gains. Before I was writing this article out of curiosity, I picked up something by a money management advisor called Upwelling Capital, and they actually went through the trouble of looking at how did these unsold values from year 10 to year 15, when they were fully liquidated, how did they evolve?
Were they accurate unsold values? Upwelling concluded that they were overestimated by about 20%. Let's say you had a billion dollar fund and you've liquidated 700 million by year 10, that leaves you with 300 million you haven't sold.
Upwelling concluded that looking at dozens of funds, that that 300 million really wasn't worth 300 million, it was worth about 20% less, so that would be, what, 240 million. 60 million of your claimed unrealized gain was phony at year 10, and you used that phony claim to help you market new funds. Again, you might say, well, gee, doesn't that sound crooked?
Isn't that illegal or something like that? But there's no regulation in private equity or private credit. The government, at least the United States, is totally absent from regulating this industry, even though it's very large.
They regulate a lot in the public debt space. They have a lot of regulations in public stocks, as everybody knows, but in private equity, it's the Wild West. There's no sheriff in town.
Dan Borotolotti: Just to clarify, you had mentioned 30% as a number of unsold holdings. Was that just as an example or that is pretty close to the average one would expect?
Jeff Hooke: Well, if you look at public equity funds, you can't expect the public equity fund that's only been around four or five years to have sold much. They only started buying it a few years back. But if you look at older private equity funds, nine or 10 years old, yeah, it's 30%.
The stuff hasn't been sold yet. And for some of the funds I looked at last year when I was doing that study, it's as high as 50 or 60, which is remarkable. You say, gee, if they started 10 years ago, you'd think they'd sold most of that stuff by now.
But I think that's a little surprising to see. And as I pointed out a few minutes ago, in private credit, it's the same problem. You still have a high percent of the assets that are not sold.
From the perspective of the industry, if you're running a private credit or private equity fund or private real estate fund, you start with one fund in, let's say, 2016, 10 years ago, and you spend all the money by 2019 or 2020, then you're ready to open a new fund. The tendency is to exaggerate how valuable the unsold assets are for the prior fund so you can motivate people and institutional investors to buy into the next one. So it's a great business.
You basically have the private equity funds grading their own homework. They're telling investors, this is what it's worth. Now, when I presented this dilemma for institutions like Illinois Teachers Association or some college in Delaware, but I pointed out this issue, I said, why don't you guys, before you invest in one of these funds, send in a SWOT team of experts, accountants, lawyers, to look at the underlying values of each company in the fund before you buy the next one?
Despite these funds having billions of dollars, they say, well, we can't afford to hire a team of experts to look at it. We have to take the fund manager's word for it, which is a complete opposite of when I was in the M&A business. Some company was buying a $50 million business in an acquisition, they would send in accountants, lawyers, IT experts would cost them hundreds of thousands of dollars to investigate everything about the business to make sure the numbers were accurate.
Ben Felix: We were acquired about a year and a half ago and we went through that and we have now done a few acquisitions of our own since being acquired and we have similarly gone through that on the other side.
Jeff Hooke: Well, then you know exactly what I'm talking about. The buyers are lifting every rock, seeing what's underneath, they're checking all your numbers and legal documents, but strangely in the private alternative investment world, there's none of that. The LPs as they call them, the limited partners, which are the big institutions, they don't do any checking at all.
Now they would say, well, it's up to the gatekeeper to do the checking. That's what I'm paying them for, but the gatekeepers don't do it either.
Ben Felix: Something that I'm really curious about and I've seen mixed information on is what effects does private equity have on the operational performance of the private companies that they invest in?
Jeff Hooke: The advertising campaign is maybe we are paying a little more for the companies than we used to, but we have the management expertise as private equity fund managers to improve the business and streamline costs and boost revenue and that sort of thing and make it a better company. There's only one problem with that marketing tactic is it's never been proven. It's very tough for independent observers who tend to be in academia to get the information.
Some of them have said, you know, I've looked at companies that were taken private and then taken public again five years later, and then I compared those companies to public companies that were somewhat similar and the private ones seem to do a little better, but it's very hard to get the right data points. And then you've had other academics that have somewhat proved the opposite, but they're very inconclusive studies and you really can't trust the Private Equity Managers Association, private equity managers themselves. They have a lobbying group in Washington that churns out some reports, but you really can't trust them.
And so if the independent experts can't come to a conclusion, I don't know how they can keep running around and saying that, but like I said earlier, there's nobody stopping them. The government doesn't stop them from making these claims. And I don't think any of the investors that have been hurt by losses are ready to step up to the plate and sue them.
Dan Borotolotti: So we've talked a lot about the performance differences between public and private equity and credit. Let's talk a little bit about the various risks with a focus on retail versus institutional investing. What are the different risks that one would face with private investments as opposed to public ones?
Jeff Hooke: Let's forget the returns for a second. The main risk from an individual investing in one of these private alternatives is you're kind of stuck with them for 10 or 12 years. So let's say you need the money for health problems or you want to buy a house in Florida or what have you.
It's tough to liquidate them. There might be a small secondary market, but there's going to be a big spread between the bid and ask. And so you're going to feel ripped off if you only get 60 cents on the dollar for your secondhand private real estate fund.
Now, some of the funds for retail, every three months, you can put some of your interest back to the fund manager and get paid that asset value, I think. But that's only 5%. So it would take you a few years to liquidate it if you needed the money.
So that's the main risk is just getting your money back if there's some kind of emergency.
Ben Felix: The risk gets underappreciated. A good example is in Canada recently, we've had a bunch of private real estate funds that have done reasonably well for a while and the returns looked super smooth if you put them next to a public REIT. But then recently, real estate prices in Canada dropped quite a bit and a lot of those private real estate funds that had done well and looked super smooth going up, all of a sudden you couldn't get your money out.
Jeff Hooke: Well, did they have a three-month option to liquefy some of your holdings? But I mean, just the average investor in that fund.
Ben Felix: There's a couple of different things going on. One of them is going to go public. They're going to go through an IPO process, which is going to be interesting to see the outcome of.
One of them does have a redemption option that is available. It's like you said, it's a limited amount that can be redeemed. The point is that you don't see the volatility.
Then when you want liquidity at that smooth value that things have been reported at, you can't get it. When times are bad. In good times, it's fine.
Jeff Hooke: Well, let's say, didn't Blue Owl want to merge its private fund with a public one and then the private one had a net asset value of a hundred bucks a share and the public one had an asset $80? If you merged it to the illiquidity discount of a closed end fund and all that sort of thing, the private investors could only sell at 80. I guess there was a rebellion that happened a couple of months ago.
Ben Felix: Tricky stuff. There was one other private debt and real estate fund in the US, not in Canada that did go through an IPO and immediately its market price fell way below its previously reported net asset value.
Jeff Hooke: What did the Canadian government do about that?
Ben Felix: Well, that was an American one. I think in Canada, it seems that the regulatory stance is that these are generally in Canada what are called as exempt market products, where the regulation is a lot more chill. It's exempt market and so the regulators, I believe their stance has largely been, these are exempt market products. We're not going to do much.
Jeff Hooke: That's what I'm saying here then. It's very similar.
Ben Felix: Yeah. Which then puts the onus on the investor, on the end investor when they're signing those exempt market documents to realize this might be risky.
Jeff Hooke: Yeah. Assuming they read them. I mean, when you look at documents like that, they're like 10 pages long of legal mumbo jumbo.
I mean, there's probably three sentences that are relevant, but it's hard for the uninitiated to pick out those three sentences. It's sort of like when you read a private equity or private credit document for the investors, it might be 80 pages long. And if you look at like the carried interest section, I've done many merger deals and private credit deals and all that sort of thing.
If you look at the 80 page document, you look at the four or five pages covering carried interest. I mean, it looks like hieroglyphics to me. It's very hard to decipher and figure out the formulas.
I can't do it. How someone, even a trained lawyer, with some finance experience supposed to do it, or even take the LP who's the Harvard endowment or whatever that's got a limited staff and doesn't like going over legal ease, it's going to be challenging for them.
Dan Borotolotti: We've talked a lot about the costs of private investments. In fact, Ben, even right off the top, you'd kind of mentioned that a lot of these funds actually do show some outperformance gross of fees, but not net of fees. So Jeff, can you give us an idea of the range of fees that you will see in private markets and how that might compare to public equities now, which have become so extremely cheap?
Jeff Hooke: Let's take a private equity fund then I'll talk about private credit. So a private equity fund at the institutional level might be one to one and a half percent of commitments. So it's really not one and a half percent of the assets invested because it takes several years to invest.
So it's one or 2% on commitments. So if your commitment is a hundred million, you're paying 1.5 million a year, even though first few years, it may only invest at 20 or 30 million. So the fees could be seven or 8% for the first two years.
So that would diminish the returns as I'm sure is obvious to you. When you do all the number crunching and there's a performance fee, that's usually based off a minimum return. The number is usually 8%, sometimes it's seven.
So if the fund returns a cumulative investment of 8% a year, anything over that is essentially split between the manager and the fund investors. On average, the fees annualizes and get out the calculator and computer and spreadsheet and all that. You'll probably see that on average, the funds are two to 3% a year in cost.
The ETF, as you guys know, big ETF, that's basically mirroring an index of some kind might be one 10th of 1%, which would be 10 basis points is what we call it. The private funds would be about 25 times more expensive. You just have to be a good investor of private companies to beat the overhang of fees of over 2% a year.
You got to be a really great investor. And most of them are pretty smart, but they're not that good to beat that difference in fees, which cumulatively, as you imagine, is 15 or 20% of your investment. So if you're a football fan, the publicly traded equity index fund starts at the 20-yard line to get to the goal line.
And the private equity funds starts at the goal line. They got to go an extra 20 yards to just match them, much less beat them. So the fees are very high in private equity.
And that, I think, hurts the performance. Now, there's been some fee pressure in the business as a result, but it surprisingly hasn't been that effective. The other thing, when I learned studying private credit, I looked at it.
I was in it for a while. But the funds there are very expensive as well. So you would think with private credit, it'd be easier and therefore cheaper for the private fund manager to make investments because they're fixed income.
They're not as risky as equity. You just don't have to study the company as much. But the fees there are usually around 1% to 1.25% fixed per year. And then there's a performance fee, which I think is around 7% per year. And once it breaks 7% cumulative annual return, then I think the split might be 15% of the profits to the manager and the rest 85% go to the investors. The interesting thing about that was this 7% return, you say, well, gee, that sounds pretty good.
But treasuries are around 4% or 4.5% US treasuries. And these junk bond loans that usually are 4% or 5% above the treasury, so they might be 9% or 10% in some cases. And the 7% was never adjusted for the rise in interest rates.
You look at subsequent private credit documents. So I think the private credit is probably a better business than private equity for the industry. The fees are similar.
I think the returns will be more stable. And the performance fee is pretty good. The other thing that's great about private credit versus private equity is in private credit, the fund manager only has to put up 1% or 2% of the principal of the whole fund.
So if it's a billion-dollar fund, they only have to invest 10 or 20 million. In private equity, they're supposed to put up 40 to show their confidence in the fund. So in the case of private credit, you'd recoup your entire investment in two years.
Private equity might take a little longer.
Ben Felix: We've touched on this a little bit, but in Canada, and I know in the US too, because I've seen your writing on this, there's been a bit of a regulatory push to make private markets more accessible to retail investors. What effect do you think that will have on retail investors?
Jeff Hooke: Well, as I said earlier, I think it's just going to reduce the amount of retirement income they have, whether they got a retirement pension plan or whether they have their personal savings that they put part of their salary into every month or two. It's just going to hurt their returns a little bit. It's not going to be a lot to notice.
As I said, CalPERS with all their sophistication and complexity underperforms by about 1.3% a year, but the average retail person is not going to have the microscope or the magnifying glass and look at all the fine print and see how they did. They're just not going to do it. It's not going to be very noticeable to them, but it is going to hurt their retirement.
I try to point this out at the institutional level with state pension plans and the union trustees and all that. It's hard to look at how they decrease retirees' income, but if the returns on a fund are not so great, then the state can't raise the retirement payments every month. If the returns were great, they could raise them a little more.
It's going to be the same thing for an individual. They won't be able to go out that extra restaurant meal every month because their pension payment would be a little lower.
Dan Borotolotti: As you can imagine, as a portfolio manager who uses only boring index funds, I do have a lot clients who are looking for something a little bit more exciting. I think we do a pretty good job of restraining that impulse, but over the years, I've changed my opinion on how much I think people should allow themselves to scratch the itch by going outside of those core holdings. I'm interested in what you feel.
Jeff Hooke: I don't invest money for people. I was an investment banker, so I was doing mergers and acquisitions and IPOs and private loans and all that, but I've had a lot of people ask me about that, the exact same thing. Just your average person, as I said, wants to dip their toe in the water of private equity or private credit because it just sounds sexy.
I was working with some lawyer. He read all my stuff. We were working on some complicated case where I had to write a paper about private equity as it had to do with this particular deal.
He was curious about it. Finally, he emailed me a couple months ago. He said, yeah, I just bought into a private credit fund.
He knew all the dangers, but he just thought he had to pull the trigger on one or two of them. I don't think it was a huge part of his retirement account, but it could have been 100,000 or something.
Dan Borotolotti: Yeah. I usually try to tell people, if you can keep it to 5%, please do, whatever dollar amount that happens to be. I feel like that's probably enough to make you feel like you're doing something a little more exciting.
Even if it were to go completely belly up, probably wouldn't cripple you.
Jeff Hooke: It's not going to go completely belly up. It's just not going to happen. The worst private equity fund I've ever looked at, maybe 50, 60 cents on the dollar.
Even a private credit fund, the private credit funds are going to be a little more diversified. They're senior loans. In the case of a few bankruptcies, they're probably going to pay out 60, 70 cents on the dollar.
The real, I guess, concern one might have is that a lot of these funds, both private equity, private credit, private real estate, they borrow money on top of the money that the portfolio companies borrow. If I was in your shoes and some of my clients, rightly so, said, we want to try something a little more exotic, I guess that's the thing I would look at. I would look at, okay, jump into the swimming pool and buy a private credit fund or private equity fund, first let's see what the governance rules say. How much can they borrow on top of the borrowing? That's all.
Dan Borotolotti: Yeah. It's not quite the same as taking a flyer on a penny stock or something that could easily go to zero.
Jeff Hooke: It's a little more conservative. I mean, the governments, at least the United States, the Federal Reserve and the SEC, I guess, express some concern about the loans that the banking industry has made on top of these funds. There's been some pearl clutching in Washington and New York, but there's no real action yet.
There's just not a lot of data on it. If you look at marketing documents, you'll see a lot of these funds have debt on top of debt.
Ben Felix: I mean, it's true for the real estate example I gave earlier, those Canadian funds, some of them are now gated or locked up. They're still, the assets are fine. They're just not worth as much as the reported net asset value was.
Jeff Hooke: Everybody who's following this, and I assume that's a lot of your listeners, they know that these business development companies or BDCs or these REITs, they're trading at 80% or 85% of their net asset value, their claim value. That just reflects partially illiquidity and partially, I guess, investors' belief that the net asset values are just wrong, that they're inflated.
Ben Felix: Yeah, that's interesting. All right, Jeff, this has been a great conversation. We have one final question for you. How do you define success in your life?
Jeff Hooke: Well, my definition of success is you want to have a decent career. I've done a lot of different things internationally, domestically. I've written books, professor, investment banker, private credit, private equity investor.
For me, I've had a decent career. I've also had a good family life. I've been married to the same woman for 39 years, and I have a couple of kids, one of whom has an engagement party tomorrow, by the way.
Ben Felix: Nice.
Dan Borotolotti: Congrats.
Jeff Hooke: I do want to leave making this world a better place, so I do a lot of pro bono work. I've done other things besides preaching against private equity and private credit and so on. I think that's important to do.
I do it usually for nothing. I do it for free as a public service, but I've done other things along public service lines that tend to have some relation to my financial background, so that's been kind of rewarding. It's also something unusual in Wall Street people that they do this kind of pro bono work, but it's been very interesting.
Those are the three legs of the stool that I like to think about when I go over what I've been up to.
Ben Felix: Very nice. I can tell you that we and our listeners very much appreciate you coming on this podcast to talk about private equity stuff and private credit.
Jeff Hooke: My pleasure. Thanks, fellas.
Dan Borotolotti: Thank you.
Ben Felix: Thanks, Jeff.
Disclaimer:
Portfolio management and brokerage services in Canada are offered exclusively by PWL Capital, Inc. (“PWL Capital”) which is regulated by the Canadian Investment Regulatory Organization (CIRO) and is a member of the Canadian Investor Protection Fund (CIPF). Investment advisory services in the United States of America are offered exclusively by OneDigital Investment Advisors LLC (“OneDigital”). OneDigital and PWL Capital are affiliated entities, and they mostly get on really well with each other. However, each company has financial responsibility for only its own products and services.
Nothing herein constitutes an offer or solicitation to buy or sell any security. Occasionally we tell you not to buy crappy investments in the first place, but that’s not the same thing as telling you to sell them.
This communication is distributed for informational purposes only; the information contained herein has been derived from sources believed to be “truthy,” but not necessarily accurate. We really do try, but we can’t make any guarantees. Even if nothing we say is fundamentally wrong, it might not be the whole story.
Furthermore, nothing herein should be construed as investment, tax or legal advice. Even though we call the podcast “your weekly reality check on sensible investing and financial decision making,” you should not rely on us when making actual decisions, only hypothetical ones.
Different types of investments and investment strategies have varying degrees of risk and are not suitable for all investors. You should consult with a professional adviser to see how the information contained herein may apply to your individual circumstances. It might not apply at all. Honestly, you can probably ignore most of it.
All market indices discussed are unmanaged, do not incur management fees, and cannot be invested in directly. Which is a shame, because it would be awesome if you could.
All investing involves risk of loss: including loss of money, loss of sleep, loss of hair, and loss of reputation. Nothing herein should be construed as a guarantee of any specific outcome or profit.
Past performance is not indicative of or a guarantee of future results. If it were, it would be much easier to be a Leafs fan.
All statements and opinions presented herein are those of the individual hosts and/or guests, are current only as of this communication’s original publication date. No one should be surprised if they have all since recanted. Neither OneDigital nor PWL Capital has any obligation to provide revised statements and/or opinions in the event of changed circumstances.
Is there an error in the transcript? Let us know! Email us at info@rationalreminder.ca.
Be sure to add the episode number for reference.
Participate in our Community Discussion about this Episode:
https://community.rationalreminder.ca/t/investment-banker-what-private-equity-doesn-t-tell-you/42194
Papers From Today’s Episode:
Links From Today’s Episode:
Stay Safe From Scams - https://pwlcapital.com/stay-safe-online/
Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder on Spotify —https://open.spotify.com/show/6RHWTH9iW7hdnA7eAg7ukO?si=fe7f60349b584026
Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/
Rational Reminder on YouTube — https://www.youtube.com/channel/
Benjamin Felix — https://pwlcapital.com/our-team/
Benjamin on X — https://x.com/benjaminwfelix
Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/