Alternative investments are an expanding universe and include categories such as hedge funds and private-equity (PE) funds with PE funds expanding seven-fold since 2002. Over the last five years ending June 2019, hedge funds have done much worse than the S&P 500 (5.5% vs. 10.7%) while private-equity funds have done much better (14.4% vs 10.7%). In some ways, this is sensible as hedge funds are theoretically structured for downside protection while private-equity funds are structured for upside gains and the past five years have been expansive.
As a result of these gains, pensions are flocking into PE funds. Currently, PE funds have over $1.5 trillion in cash to invest along with the likely contribution of an additional $500 billion this year. Institutions are lining up. Much of the dramatic reduction in publicly traded stocks (down 50% over the last 20 years) can be attributed to PE activity, as well as M&A and share repurchasing. As Jim Grant, of the eponymous Grant's Interest Rate Observer says, "On Wall Street, success begets failure. Take a good idea, emulate it and embellish it, drive it into the ground like a tomato stake. Voilà: It's a bad idea." The Achilles heel of PE funds is their leverage. PE funds increase equity returns by levering up. In a slowing economy, PE results would be challenged, as would their bonds. (The location of ownership of these bonds is important.)
But PE funds may continue their winning ways. If that is true, why not invest in the general partners who are collecting these handsome 2% plus 20% fees? For example, Blackstone, Apollo Global and Carlyle all seem to be on the more generous side of these investments. Why wouldn't the institutions simply buy the publicly-traded general partnership interests? Is the avoidance of market to market that extreme by institutional investors?
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