Online brokers like Robinhood Markets Inc. and crypto assets might get the headlines, but the Securities and Exchange Commission’s parallel effort to drag private-equity firms and hedge funds out of the shadows will have far more impact on far more lives.
Private equity especially has exploded in power and reach in the past decade. That’s why SEC Chair Gary Gensler is right to start demanding higher governance standards and more transparency from these firms. Any fund whose returns are destroyed by some extra reporting costs and duties shouldn’t be in business.
The industry has more than $4 trillion in assets under management and in the U.S., private-equity backed companies employ about 11.5 million people, according to data from the American Investment Council, a body that serves the interests of private equity. For comparison, America’s largest commercial employer, Walmart Inc., has about 2.3 million staff.
After a record year of dealmaking in 2021, where private-equity transactions accounted for nearly a quarter of the $5 trillion in total mergers and acquisitions, the industry’s influence will continue to grow. Buyout funds have about $2 trillion to spend if you include the debt they can use for deals. Some bankers think the first $50 billion buyout isn’t far away. The $34 billion takeover of Medline Industries Inc. last year was the biggest since the 2008 crisis and among the biggest ever.
The SEC has proposed rule changes to demand quarterly reporting to investors, annual audits and more disclosure of fees, particularly those that private-equity managers charge to the companies they own. It will also prohibit preferential treatment of some investors over others.
This hasn’t emerged from a vacuum: The rules are designed to combat wrongdoing the SEC has uncovered. Gensler has also complained about the difficulty of tracking and comparing investment returns across private-fund managers.
Industry bodies have been quick to complain that the SEC is overstepping its mark. The regulator should focus on protecting unsophisticated retail investors, they say. Both the American Investment Council and the Managed Funds Association, which represents hedge funds, say the changes would hurt the pension funds, endowments and foundations that put the most money into alternative asset managers.
Sure, the reporting and audit demands will impose some costs, which will detract from returns. Banning preferential treatment for some investors over others will no doubt be costly to those that get better deals. This includes things like lower management fees for some investors, easier or faster access to their money or more information on funds’ holdings. Those that don’t get the VIP treatment will cheer this change as will anyone with any simple sense of fairness.
But what really undermines the lobbyists’ complaints is that sophisticated investors themselves asked for help. A group that represents large investors, the Institutional Limited Partners Association, wrote to Gensler last October asking the SEC to force more disclosure of fees and charges.
The distinction between retail investors and sophisticated institutions is also overdone. The boards that run pension funds aren’t stocked with financial professionals, fresh from careers on Wall Street, who are used to taking apart dizzying schedules of internal rates of return and trying to compare these over a decade with the returns they could have got from the S&P 500.
Ordinary people entrust pension board members with their retirement savings for decades – and those stewards aren’t much more sophisticated than many retail investors. The duration and complexity, along with the lack of transparency, create an accountability problem through the entire system. And at the end of the chain, the people saving for retirement get the least information and ultimately pay all the costs.
By the time a pension fund gets back the money it committed to a private-equity fund – which is the only time you can really be sure what return you have actually made – a decade can have passed and the individuals responsible for making the investment might be long gone. More of the biggest hedge funds are also demanding investors lock up money for longer and investing in private equity too, doubling up on high fees.
Indeed, Gensler’s changes are aimed not only at the $4 trillion private-equity industry and the equally large hedge fund industry, but also state, municipal and private pension plans themselves. This is why he talks about private funds with gross assets of more than $18 trillion that will be subject to the new rules.
More regulation is inevitable, especially at the top of the alternatives industry, where the biggest firms have become more like diversified investment and banking groups. Companies like Apollo Global Management, Blackstone Inc. and KKR & Co. are already directly managing ordinary people’s money through their insurance businesses; in capital markets they’re acting as both buyers and sellers of private and public debt and equity.
Private equity and hedge funds are – by their own reckoning – the best and smartest investors: They can find the right things to buy, make their operations and finances more efficient, move quickly and decisively where companies or other investors need money fast. This generates the excess profits for which investors are meant to give up 20% of their returns.
If spending a bit on audit fees and on extra staff for accounting and investor relations is going to undercut the profits all that investment skill can generate, then maybe that skill was never really worth a great deal at all.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
Read more articles by Paul J. Davies
