On the day of Chief Investment Officer’s first publication in 2009, the S&P 500 opened at 942.45—less than half of its eventual peak. Pension funding had crashed. Universities were cutting capital-intensive projects because of endowment illiquidity.
Today, the S&P 500 stands at 1,971.96. The US economy has been growing steadily, if slower than most would like (but when is that not the case?). Unemployment is down. Investors of all stripes have been made to look good.
And yet I suspect we are about to enter the most interesting time of all.
As much as Seth Klarman (who, along with his cult classic Margin of Safety, I profiled) would laugh at me for predicting the movement of markets and the officials who guide them, general consensus is that the Federal Reserve will begin to raise rates by the end of this year. This, combined with China’s cold (or outright flu?) and continued Eurozone uncertainty, increased volatility significantly in August.
As summer turns to autumn, I suspect we will see more of the same—and I also suspect that, for the first time since before S&P 1,000, we will truly be able to tell who’s lucky and who’s skilled.
One industry in particular is due for a shakeout: private equity. Broadly speaking, there are two ways to make money in that business: improve the management of a company or efficiently manage a spreadsheet. In a time of declining interest rates (the past 30 years) and rising markets (the past six), it was hard not to look good. With the expected inflection point, however, the firms that can truly manage a business will win. I suspect there are far fewer than we think.
This would be of only passing curiosity if it weren’t for one fact: Institutional portfolios are loaded with private equity. More so than other alternative investments, private equity has been a largely uncontroversial segment of nonprofit and pension holdings— at least until recently, when some large American public pensions, along with regulators, started asking uncomfortable questions about the fees being paid to general partners.
I submit, however, that this fee issue is just the beginning of the Great Private Equity Shakeout. To muddle the oldest analogy in finance, when the interest-rate waters recede, we will see which private equity managers have been swimming without their trunks on.
Volatility and shakeouts aren’t great for the business of institutional investing—but they are great for journalism. I fear for our readers’ portfolios, but I don’t for the content of what they’ll see on these pages.