Investor Alert

Brett Arends's ROI

Aug. 3, 2020, 12:54 p.m. EDT

The stock market is cheating us all—and here’s by how much

We should be getting as much as 30% more, study suggests

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By Brett Arends, MarketWatch

Courtesy Everett Collection
Robert Redford and Paul Newman as Those Wall Street Guys

For most of the middle class, the stock market is going to make the difference between retiring with dignity or not retiring at all.

We haven’t got gold-plated, “defined benefit” final salary schemes, we didn’t inherit trust funds, and we know that Social Security is there to provide a basic level of existence but little more.

So if we want to escape the rat race and kick back, sooner or later, it’s going to come down to what we manage to save in our 401(k)s, IRAs and other retirement accounts each year, and how much that money earns in annual returns.

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But this week there dropped into my inbox a document which proved, once again, that you and I are getting shortchanged, every year. Big time. And that’s even if we do everything “right.”

The document? The latest annual Public Pension Study from the American Investment Council, the trade body that represents the private equity industry.

It demonstrates, once again, that private-equity funds continue to beat the “public” stock market funds available to everyone else, by a country mile too. It may sound innocuous, or technical, but it isn’t. It means quite simply that the stock market is failing to extract the full value out of companies. Vast amounts of money are being left on the table—for private-equity funds, and especially their managers, to gobble up.

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The great journalist Michael Kinsley used to point this out every time there was a big buyout deal and a company was taken private. We all know the story. Amalgamated Widgets is trading at $40 a share. Along comes a buyout fund offering $50 or $60 a share. Five years later the buyout fund sells Amalgamated Widgets (rebranded, probably) to someone else for $150 a share. Good for them, bad for us. But if the company was really worth $150 a share, or even just $60 a share, how come the public markets were only able to squeeze $40 in value out of it on their own?

We’re getting robbed. Incompetent managers and overstaffed bureaucracies are effectively stealing large sums of money from the stockholders, right under our noses.

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The latest study gives an idea of the size of the offense. Private-equity funds owned by state pensions earned an average of 13.7% a year over the most recent 10-year period, a full percentage point a year ahead of their public stock market investments, according to the AIC.

That may not sound like much, but it’s huge, because these return figures are net of fees—and in private equity the fees are enormous. Typically they’re around 2% of the assets under management each year, plus 20% of the profits. Factor these in and the private-equity funds must have earned somewhere around 19% a year on their investments, gross.

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So under hard-charging, value-oriented, incentivized management, companies could generate around 19% a year instead of 12.7%. Imagine what you could do with a 19% annual return on your investments. Imagine when you could retire.

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