Oren Cass and American Compass Childishly Attack Private Equity
A new think tank by the name of American Compass recently made headlines as a “conservative” foe of private equity by launching its new “Returns Counter.” This project purports to compare the returns of private equity against public capital markets, and was launched with a politicized primer on mergers and acquisitions, private equity, and hedge fund investments.
Wells King, research director at American Compass, opens his post by casting aspersion at private capital markets, asserting that: “the buying and selling of companies, the mergers and divestments, the hedging and leveraging, are not themselves valuable activity. They invent, create, build, and provide nothing. Their claim to value is purely derivative—by improving the allocation of capital and configuration of assets, they are supposed to make everyone operating in the real economy more productive.”
If the question is one of value, then we must ask “value to whom?” As a corporate attorney who has practiced mergers and acquisitions law for over 20 years, I have personally helped many founders of companies realize value upon the sale of the companies they have labored to build. Private capital providers also help emerging companies fuel potential value by providing growth capital. And corporate acquirers make acquisitions to unlock value in other companies by expanding markets and diversifying the applications of technologies acquired from sellers.
Ultimately, value is subjective and is determined by the parties to a voluntary exchange. When privately-held companies, on one hand, and private equity investors or corporate buyers, on the other, transact a deal each party enters into an exchange that he thinks is a good value. The parties are not factoring in “everyone.” Each side sees value in the deal; otherwise they would not close a transaction. The subtle and beguiling message of the primer is that value should go beyond the parties to a deal and benefit the general public.
Comparing Private and Public Investment Returns
King makes much of the idea that returns from private equity (PE) are falling behind returns on investments in publicly traded stocks. This is, in fact, a conversation within the financial industry that is of interest to investors who allocate capital to both PE and public capital markets.
Taking a longer view, Bain and Company’s “Global Private Equity Report 2020” shows that over the course of three decades, returns on investments in private equity buyout firms have clearly outpaced those of public markets. Although public markets have experienced large rallies since the Great Recession, McKinsey & Company “Private Markets Annual Review” indicates that private equity may still be outperforming public markets. Regardless, capital allocators do not make investment decisions based on a single snapshot, but based on expectations of future performance. And PE investors still have confidence in private equity over the long run. As the Bain report indicates, “Private equity investors… continue to believe in the consistent, long-term outperformance that buyout funds deliver. They also continue to vote with their wallets.”
Leaving aside the question about whether public market returns have caught up with PE returns, what possible policy implication is there that public markets outperform PE? Accredited investors (often institutional investors) and their professional advisors who allocate investments between PE and public markets do not need to be protected from their own investment decisions. If they are unhappy with returns from a PE fund, their remedy is to allocate money away from underperforming sponsors to more accomplished PE managers or public stocks. Large investors may also negotiate more favorable fees if they are unhappy with a PE manager’s prior performance.
The Policy Implications
American Compass was recently formed by Oren Cass, an outspoken critic of free enterprise, who scoffs at market “dynamism,” and who is indifferent to economic growth. He is, however, a big believer in expanding the regulation of markets and industries. This can be seen in American Compass’ stated mission to help, “policymakers navigate the limitations that markets and government each face in promoting the general welfare and the nation’s security.”
In a recent piece arguing for robust central planning and managed trade, American Compass authors write, “If anything, government intervention — and thus planning — becomes more necessary when less market and industry knowledge is available.”
This gives the game away.
American Compass endeavors to aggregate and repackage public data about transactions which it dubs a “Return Counter.” The data is drawn from commercial providers who provide information to enable large investors, like pensions and family offices, to make informed decisions about where to invest funds. American Compass’ mission is different. Its goal is not to assist investors, but to justify government intervention into private markets and privately-held businesses.
In introducing the project, King writes, “A robust, competitive financial sector that allocates capital efficiently is vital to a well-functioning market economy.” To that end, King unveils several policy concerns about what he hails as the “serious dangers” of founders selling their companies, emerging companies accepting growth capital, and accredited investors making capital allocations. Presumably, the dangers arise when the parties engage in mundane business decisions without factoring the general welfare and national security to King’s satisfaction.
One of American Compass’ key policy concerns seems to be ensuring lucrative income of financial professionals does not lure talent away from more productive pursuits. You might be tempted to think those more productive pursuits might include research and development of new technological innovation. However, King also decries allocating too much growth capital to emerging technologies. He warns that, “floods of capital intent on ‘disruption’ can dismantle established industries while failing to build sustainable businesses in their stead.”
No Room at the Table
Private market participants, including investors and company founders and CEOs, are well-represented by attorneys, accountants, and certified financial advisors. They are armed with data about commercial terms and financial trends. This American Compass project is about arrogating to itself a role in managing PE investor returns.
In essence, King is angling for the right to vote with investors’ wallets. American Compass seeks a virtual seat at the deal table to ensure private business decisions align with their concept of the general welfare (which seems to involve domestic manufacturing jobs, less international trade, fewer jobs in finance, skepticism of disruptive technological innovation, and an indifference to economic growth).
In the deal space, you get your hand slapped when you reach for something that is not yours. Effectively, American Compass is reaching into the bundle of rights of investors, PE sponsors, and even the owners of small-midsize companies, by seeking greater control over deal decision-making and capital allocations.
Rather than identifying specific policy reforms that might be worth consideration, American Compass broadly casts shade at the financial industry, childishly attempts to lampoon private equity, and calls for “careful scrutiny” of private business and investment decisions. Ultimately, the project’s aim is regulating economic activities merely because American Compass would prefer business owners and investors make different choices with their own assets and capital. American Compass should be more forthright about its policy aims.