A lot has been made about Mitt Romney’s career in private equity, which started in 1984 at Bain Capital and ended in 1999 when he left to run the Salt Lake City Olympics. This calculator shows that the annualized return of the S&P 500 during this period was 18 percent (i.e., this was an exceptionally fortunate time for an investor in U.S. companies; the same calculation for the period 2000-2011 results in a 0.5 percent return).
Did Mitt Romney do even better than a passive investor in the S&P 500? Yes, as did most private equity shops during this period. Was that due to the fact that the folks who collected massive fees for managing private equity funds knew something about how to operate a business that had escaped the managers who’d spent their entire lives within a given industry? Not necessarily. Jeremy Grantham, one of the world’s most successful investors, is fond of pointing out that KKR has demonstrated very similar returns to what an investor would have achieved by buying the S&P 500 using the same amount of leverage that KKR used to buy companies. In other words, instead of paying a 20 percent fee to KKR, an investor could have simply bought the S&P 500 on margin and walked away, keeping 100 percent of the fruits of the investment rather than 80 percent. And KKR, instead of working hard to identify exactly the best companies to purchase and the best managers to hire, could simply have bought stocks at random to achieve the same result. (Indeed KKR might have done better with a more hands-off approach; the company offered a full partnership to Ken Lay, the Chairman of Enron, shortly before Enron’s accounting frauds were exposed (see this book excerpt).)
So while there may be other reasons to like Mitt Romney, his ability to outperform the S&P 500 is not necessarily one of them. Anyone who was able to borrow money at an interest rate lower than 18 percent could have beaten the S&P 500 during the period of time that Mitt Romney was involved in private equity.
[Has anyone seen this kind of analysis in a mainstream newspaper article or TV show? It seems odd to report that Mitt Romney was a big success as an investor without noting that so was almost everyone else during the same period of time.]
The other interesting question is if Romney knew (or at least actively predicted) that 1999 was a good time to get out of the investing biz, or was that just a lucky coincidence for him?
Doesn’t the current generation of voters prefer people who are worse with money? If there was a candidate who invested everything he had in Solyndra, he’d beat both of the current guys. Wait. The current guy did invest in Solyndra.
Phil,
At least Mitt actually had a job. Isn’t that a plus compared to President Obama’s past employment history?
J: If Mitt Romney was able to time the market, he would be a statistical anomaly among money managers, to say the least. He graduated from business school in 1975 and assumed the head of Bain Capital in 1984 at the age of 37. Having made a lot of money, in 1999 and aged 52 he decided to try his hand at other challenges. It certainly does not look as though he attempted to time the market.
Fonzie: It is true that Mitt Romney worked in the private sector, but it seems that voters are just as happy or happier with politicians who have never done anything other than collect paychecks from a local, state, or federal government. So I wouldn’t say that it is a “plus” with the voters.
Don’t know about mainstream newspapers but certainly this has been pointed out: http://www.ritholtz.com/blog/2012/08/attacking-bain-for-wrong-reason/
Drawing on The Romney Files: http://www.amazon.com/exec/obidos/ASIN/B008TQ0QWE/thebigpictu09-20
LV: Thanks for the link. Isn’t it odd that journalists are supposedly so anti-Republican/anti-Romney and yet they are too lazy to point out that private equity is mostly a solution to the problem of “top managers and Wall Streeters get depressed watching most of a company’s profits flow out to investors”? And that the only mainstream journalists who did bother to get the data are from the supposedly pro-Republican Wall Street Journal?
Maybe that is the real problem with American politics. Our journalists are as dumb as we are!
>>most of a company’s profits flow out to investors”
Is that actually true? In an unleveraged corporation with $100 of earnings before interest and taxes, $38 dollars go to federal and state government via taxes and $62 are retained or available for distribution to owners.
Let us say a private equity firm can borrow money at 10%.
It then (might) borrow $750 from a bank, add another $250 from its own capital and offer the existing shareholders $1000 for their business (which, recall, earns $62 per year. This would value the firm at the time of transaction at 16x annual earnings. Departing shareholders might or might not be happy with the valuation. They do get a vote.
Assuming the transaction is completed, the newly-capitalized firm still makes $100 a year, but $75 goes to the lending banks as interest. Of the remaining $25, $9.50 goes to the government, and $15.50 goes to the private equity firm.
So to sum up
BEFORE
Bank: $0.
government: $38
old equity investors: $62
Total : $100
AFTER
Bank: $75
government $9.50
new equity investors: $15.50
Total $100
Its the government that’s been disintermediated in favor of the bank b/c of the deductibility of interest. Not the selling shareholders.
If, on the other hand, you wanted to argue that private equity isn’t a socially useful activity, the trick to end it would be to reduce or eliminate corporate-level taxation and reduce or eliminate the preferential treatment of debt (i.e. interest deductibility).
The existence of private equity is but one symptom of the capital-allocation distortions that both those policies cause. We’d be better off without them.