Hedge funds vs private equity: private assets avoid the public rout

The numbers at first seemed like a typo. Calpers, the massive California state pension fund, said its public equity and fixed-income investments had each recorded losses of nearly 15 per cent for the 12 months ending in June. Yet its private asset portfolio in private equity and real estate recorded gains north of 20 per cent.

Admittedly, part of that 35 percentage point swing was timing. A data collection quirk meant private portfolio numbers reflected the 12 months ending in March. They did not capture the rout in the June quarter when the S&P 500 crashed 16 per cent.

Still, large private equity firms, including Blackstone and Apollo, recently marked down buyout funds by less than 7 per cent in the second quarter. This seems odd, given the likely combined effect of buyout leverage and a down market.

Private equity firms, however, get some flexibility in how they mark investments. They might also be better investors who simply deserve their hefty management and incentive fees.

The public/private divergence is especially notable when looking at hedge funds that charge high fees themselves but deal in public stocks whose valuations are not subjective.

Tech-heavy Tiger Global recently told investors that its flagship fund fell a staggering 50 per cent after fees in the first half of 2022. It blamed these disastrous results on inflation, which unexpectedly hammered tech stocks. Curiously, a “crossover” fund that had public and private investments dropped just 37 per cent.

Hedge funds, particularly ones that hold long or short positions of listed stocks, have had a rough first half. They have failed to live up to the description in their names.

Private equity appears to be a superior model. Capital is locked up for years. Owners control companies. Choppy cycles can be ridden out.

The caveat is that optimistic valuations can keep buyout investments running over thin air for longer than hedge fund portfolios. Final assessment of relative returns will have to wait until cash is returned to backers. That is a figure no one can massage.