Private Equity for dummies – A case study

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An short example is worth more than a long lecture. Here is a real life example of what an investor can really expect from private equity, and why it does matter.

This, is a hot topic. Indeed was I recently contacted multiple times by clients who were “proposed” private equity investments by their private bankers.

They were all promised highly attractive returns ( “Internal Rate of Return” ) and were drawn to it. It was fun, sexy investing. They just wanted confirmation, validation, they were going to do it.

But still… they all noticed the same diffuse smoke in the air, forming a hazy screen of complex figures and arguments, and they could not find its source. Something was not right and they did not know what.

They all received the same advice from me :

Don’t. Just don’t.

I want to explain why. But I will try do it the less boring way I can, which is still far from being fun, I will use a real world example.

So here a real world case of a private equity fund. And here is why it is “not as good as it looks like”, and why anyone interested in finance should be aware of this.

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Hopes & Probabilities

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In investment, as with all economic decisions, we must often pick between hopes and probabilities. The asset management industry uses this to trick us, here is how.

Recently, my older son told me a joke. It was simple and naive. It seemed innocent. It was not.

Toto the boy is playing cards with his grand-mother. After a few turns when he keeps winning, he is busted cheating by his grandmother.

– You are cheating Toto !

– Indeed I am !

– This is unacceptable ! Do you know what happens to cheaters in real life Toto ! ?

– Ummm yes… they win !

This simple joke, albeit deeply cynical, is actually pretty representative of what sadly happens in the grown-up world, on a regular basis. Cheaters often win. Misrepresentation often win.  And even liars, often win.

In my very specific field, investment, this behavior is actually widespread, consciously or not. Part of the industry is, with very different degrees of awareness and gravity, “cheating” to win the money game…

How ?

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I won’t need to work ! The story of an investment trap

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Seeking to live solely on investment returns is both a big fantasy and a big mistake. Avoid it at all cost.

 

“This guy retired at 35 with this amazing and safe investment strategy. Want to know how? Click here”

Biggest financial clickbait. I see it regularly, and you probably do too. It usually features a very handsome young man/woman on a yacht, clearly not working for his/her living, and having a load of money anyway.

Beside the obvious scams that those ads are not hiding very well, the underlying message, the biggest investment myth ever, stay strong. This myth can be expressed by this sentence :

“By investing correctly, you can easily earn enough money to stop working, and your life will be wonderful”.

A lot of websites, including some that are not scammers but true believers, advise how to make it, how to get a life where you will never ever have to fake liking your boss or your client again. What a relief !

As you can read this promise is twofold : it promises you that “you can easily earn enough money to stop working” AND it promise you that “your life will be wonderful” if you do.

Both promises are untrue. Do not believe them.

Let’s get into those one by one…

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What about your mother ?

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Financial analysis education became too analytical and de-humanized. It needs  to get back to more balanced, human, basics.

3 years ago, as every year for 8 years now, I volunteered as a “mentor” in a student financial analysis contest known as the “CFA Research Challenge”. During the French final, one of the student team was confronted with a very harsh and deep-meaning question about investment, a question they did not expect, a question they should have been taught about.

It was memorable because, while anecdotic at the time, it reached to something bigger, a problem that undermine the way young investment professionals (and some older) relate to their job. A question about the meaning of it.

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A battle is lost, war is not over

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The asset management lobby just won one more battle in France. The transfer of life insurances between insurers still won’t happen… for now.

You probably missed it completely, but a few days ago a battle of the highest importance for French investors and the French economy took place. It was short, it was brutal.

Indeed, last Thursday, two brave MPs, Amélie de Montchalin and Joël Giraud, proposed, finally, to allow, finally, French life insurance plans to be transferable.

I do know what you think now: “Wwoooo… This post is going to be so boring…

Think again ! On the contrary, it is of upmost importance for French and worldwide investors to read this as a reminder of what is currently at stake and why we fight !

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Global warming. What can we really do about it ?

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Global warming is frightening, and hope is thin to contain it. So maybe we should start not only fighting it, but also preparing for it.

In my last, and more obscure, post about data-mining bias ( that you should of course read, see here ) I illustrated my argument with the example of extreme weather news reports. To sum it up, my point was that while the increasing regularity of extreme heat/frost waves is probably a consequence of global warming, one separate occurrence was absolutely not sufficient to prove anything about it.

In the meantime however, summer passed in the north hemisphere, and it was hot. Damn hot all around. And while still not proving anything “by itself”, it did make me think about global warming. And I am sure you did too.

Global warming is here. No doubt. What was once upon a time a scientific theory became a few decades ago a scientific and political issue. Now it is starting to turn into a scary and material reality for everyone. And it is probably just the beginning.

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ESG investing – How to improve it

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This post was originally published on October 11, 2016 on my company website. It is still relevant and interesting for those who have not read it yet. I’m posting it here with some minor updates.

Environmental Social and Governance (ESG) investing is a good concept, and its growth is strong. But are the desired goals achieved?

 

It had been a while since I wanted to look at it more closely. Environmental Social and Governance (ESG) investing has always sparked interest in me, even though it was unfortunately a little bit confidential. I always saw it as a very welcomed way to link investment and finance in a positive way.

This is why I gladly accepted when I was offered to go to the “Responsible Finance Workshops” organized by a French company specialized in this investment field.

Environmental Social and Governance Funds (ESG) choose their investments according to financial criteria and social criteria. For most of them, this is expressed in practice by a refusal to invest in companies that are not respectful of the environment, or have a bad carbon footprint, or are not very respectful of their employees. The variations are numerous, but globally those funds have a discriminating approach of investment: they refuse to buy the lame duck.

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The great ETF dissection of active funds

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Active mutual funds can be mysterious black boxes. Here is a method to sneak a peek inside.

Mutual funds are very opaque structures. There is so much we don’t know about them, so much we are refused to access, even when we invest in them.

It is indeed very hard to access the actual composition of their assets (the individual stocks or bonds they own). This information is barely disclosed by managers for various reasons. They might fear to see their ideas and work “stolen”. They might fear being criticized for every decision they make. They might even fear that everyone realize they charging active fund fee level for passive management (which is called “closet indexing”, and is very bad, look out for it).

The main information they often give us about what we really own, is the “benchmark”. This benchmark is supposed to be a good proxy of the fund asset composition and potential risks. But most of the time the benchmark they choose seems a bit off or even misleading. It is always an index, and is therefore very theoretical, but it is not its biggest flaw.

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The 8 deadly investment selling traps

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Financial brokers and private bankers use specific investment selling traps and tricks to get you into buying their products. Here is a list. Read it carefully.

I am always amazed by the success met by dishonest financial “advisors” ( brokers would be more appropriate), private bankers and insurers representatives in selling what could be considered very low quality, even toxic investments. Those products are obviously and ultimately designed in the sole purpose of earning the largest margin for their sellers with very little or even negative interest for their buyer. How is this even possible ? Clients are not stupid, their are prudent and educated people, with professional and investment experience, and well-aware of the inner motivation of those salespeople. So why ?

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Asset management and the risk of moral disruption

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Beware! A disruption can hide another one!

This is quite a good advice, while crossing a railway, always to check for the train coming the other way, hidden by the first one. You know those kinds of signs that say: “Look the other way or you risk death and a $20 fine”.

Well this reminds me very much of the current situation of asset management. They are so deeply obsessed with the disruption train that they see, that they are not watching for the bigger, hidden train coming the other way.

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