You Know that Private Equity is Cooking the Books When

Even the Pink Paper, aka The Financial Times, calls out the industry for the fictitious returns that the industry reports:

Ever wondered about the extraordinary performance figures that listed private equity firms trumpet in their official stock market filings?

Take, for instance, the latest Form 10-K issued by Apollo, one of the world’s largest buyout groups. This claims that its private equity funds have “consistently produced attractive long-term investment returns . . . generating a 39 per cent gross internal rate of return (IRR) on a compound basis from inception through December 31, 2019”.

Or how about the one from KKR, which says it has “generated a cumulative gross IRR of 25.6 per cent” since the firm’s inception back in 1976?

It’s not just the eye-popping scale of these returns that captures the attention. It’s their amazing “since inception” consistency. Not only do the firms generate stratospheric numbers — far higher than anything produced by the boring old stock market — but they can apparently do it year in, year out, with no decay in returns.

………

Take Apollo, for example. Its long-term IRR has barely moved from the 39 per cent level over the past several decades. True, it did hit 40 per cent in 2008, before dropping back by a full percentage point the following year. But since then it has been like a stuck record. Financial crises? Great recessions? Market fluctuations? It seems that nothing can knock it off that 39 per cent.

It’s a similar story with KKR. The firm's IRR since inception has fallen by just 0.7 of a percentage point in the years since 2007 and, at 25.6 per cent, remains barely below the 26.1 per cent return generated by its early “legacy” funds between 1976 and 1996.

………

But what’s concerning is the ease with which this mathematical circularity has been allowed to create a distorted impression. The main audience for private equity to date has been large, so-called “sophisticated investors”. The fact that these absurd numbers still get headline exposure makes one wonder whether these investors understand them. That is disturbing.

Even more worrying is the way that policymakers appear to have set these financial pig-iron statistics in stone. The industry standard for reporting — the Global Investment Performance Standards — actually makes it mandatory for private equity to report a since-inception IRR or “money-weighted return”.

………

Realistic numbers matter. The US authorities are thinking of letting the American public loose on private equity with their 401(k) pension plans. Retail investors need to know what they are getting into. It’s time the way private equity reports performance was rethought.

This is conscious fraud, no different in intent, and larger in scale than anything that Bernie Madoff ever imagined.