Monday, November 29, 2021

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    Private equity/IRRs: benchmark too often benefits buyout bosses

    Private equity has several new enemies in the brain. Business scholars are increasingly criticizing buyout groups for high fees, inconsistent incentives, and mediocre or opaque returns. Researchers at Stanford University are the latest swipe researchers. In a recent paper, they spotlight the weaknesses of “internal rate of return.” This is a benchmark for profitability as the industry enters the market.

    IRR has the advantage of simplicity. Private equity fund cash inflows and cash outflows are mapped and reduced to a single percentage that can be benchmarked against other asset classes.

    However, Recent research The author, entitled “The Economic Case of Transparency in Private Equity,” pointed out how IRR can be misleading. For example, a slight difference in the timing of similar underlying cash flows can lead to a significant difference in IRR.

    Another original sin of private equity is high salaries for poor performance. IRR is involved. For many funds, managers only earn a performance fee if the IRR exceeds the hurdle rate. This is intended to adjust incentives. However, if the manager is desperate to reach his goals, the mechanism can encourage a number of massages and excessive risk taking.

    Such criticism frustrates the Masters of the Universe rather than constraining it. Private capital continues to grow. Sovereign wealth funds and government pension schemes are allocating increasing amounts to the alternative asset industry. It currently has about $ 5 trillion in “dry powder” — cash for investment is called. Something like California’s retirement fund Calpers has been allocating from the public market.

    Researchers want to create a more comprehensive and detailed standard for private equity returns. It is based on factors that are broader than a single percentage. Scholars advocate the construction of computer models that enable micro-analysis of transaction risk, conflict and profitability.

    In recent years, pension schemes have been involved in scandals on “pay-to-play” provisions for bailout funds. Some have just lost track of the fees paid to private equity managers. The overwhelming bean counters of state-owned pension offices need a better understanding of the basics of their work. Then they can start thinking about replacing the IRR with a better benchmark.

    The Lex team is interested in hearing more from our readers. In the comments section below, please tell us what you think of Stanford University researchers’ criticism of the IRR.

    Private equity/IRRs: benchmark too often benefits buyout bosses Source link Private equity/IRRs: benchmark too often benefits buyout bosses

    The post Private equity/IRRs: benchmark too often benefits buyout bosses appeared first on California News Times.

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