Hamilton lane latest graph

I know I said I would stop commenting on PE performance propaganda but Hamilton Lane has kind of invited me to do so. So, here I am.

Some background: Up until GFC, every consultant was using S&P 500 as a benchmark. Coincidentally, that index did poorly from 1990 to GFC. And so, every product (inc. PE) was looking amazing against S&P 500 and was ALWAYS compared to S&P 500.

S&P 500 captures large cap US stocks and its returns are nearly the same as what academics call the market portfolio which is simply the value-weighted average of all stocks (in the US) and we denote Rm. I take the Rm on Ken French website, so that everyone has access to it and can redo the calculations. It also goes back to 1926 and thus give a longer time period.

Hamilton Lane proposes this interesting exercise whereby you average Rm over any 10-years period and then compare that to PE vintage year returns which is a reasonable exercise.

Taking 1926 to 2020, Rm (think S&P500) average 12.1% p.a. on any 10-years period. The lowest point is reached in 2008 with 1.5%.

Note: This means that Rm has never had a decade with negative returns!! Never! Hamilton Lane never points this out but routinely points out that hardly any vintage years has lost money in private equity. What people hear then is: if you have a well diversified portfolio of PE funds you cannot lose capital (at least historically it never happened) and it therefore sounds low risk. But the same holds true with the US stock-market!! That fact is not mentioned by Hamilton Lane.

Basically, from 2000 to the GFC, on a 10-years past return basis, Rm (thus S&P500 et al.) underperform about everything, and in particular underperforms small/mid cap US stocks (whose size is closer to what PE invest into). But, then, after GFC, large cap US did as well as other US stocks and so from GFC to today returns were high.

I guess you bet what happened then: All the consultants switched benchmarks (there is not much money to be made advising clients to invest in cheap stuff). No more S&P500. Now it was time for MSCI World (and Russell indices, another bunch of chronic underperformers.)

Because many people including highly-respected (and respectful) Pr. Josh Lerner, Bain annual report etc., pointed out that the S&P 500 did as well as PE over the last 10-15 years, I guess Hamilton Lane & friends had to say something about it.

In their annual report (beside the ad-hominen attack on myself), Hamilton Lane provides one central piece of evidence which they also emphasized on their filmed annual conference:

They show a graph where the past ten years of the S&P500 is in its 93th percentile of any past 10-years returns since 1990, whereas PE returns over the last 10-years is only at its 73rd percentile. They present this as the most important piece of evidence: Would you rather invest in an index which is at its historic peak (93% of the past numbers were below that number) or in a different thing (which is what they sell) and that is NOT at its historical peak (73% of the past numbers were below that number). Well, you rather invest in PE — their stuff — right?

Now, I am not disputing that maybe the S&P 500 is more over-valued than PE. I don’t do predictions. I do statistics and facts. Remember the facts: large cap US stocks do badly from 1990 to 2010 then great from 2011 to 2020. PE always does slightly better than small/mid cap US stocks (hence much better than large cap in the early 2000s and about the same in the 2010s).

So here: Hamilton Lane says that the last 10 years of PE is not that high compared to any previous ten years (obviously! and that’s a much nicer way to say that the last ten years were not that great!), then Hamilton Lane takes the large cap US index and, obviously, the 1990-2010 being very bad, the 2010-2020 are going to look super high in comparison. And Hamilton Lane gets the result above.

But, you do not know whether it is because the 1990-2010 were particularly bad or the 2010-2020 particularly good. So what is it?

Well, for that, you should go back in time for example. And I did. And so can you. You go to Ken French website — there you can find annual US stock market returns going back all the way to 1926 to be exact and can easily compute past 10-years returns on any sub-periods. That is one century of data!

Do you want to know the percentile of the 2011-2020 time-period in US stock history?

66th is the answer. The last ten year of US stock market returns are good by historical standards but not exceptional. It is barely top tercile and does not make it to top quartile!!! We are far away from a top 93rd percentile!

As always, I do not care what people invest into, I am not in the business of investment advice. What I find outrageous is that people can produce misleading marketing material, and get away with it. And it is not like the conflicts of interest are not obvious. And to make the irony perfect, these firms have code of Ethics, signs all the responsible investors charters they can find.

And there would be so much more to write about these sort of tricks. For example, in the 1990s, PE returns meant VC and LBOs, then VC did badly, and PE returns were only LBO returns, then so called Real Assets (RA) did well and PE included that too. And then RA did badly and VC did well again and so PE now is only VC+BO. And people benchmark RE separately for example against REITs thereby comparing highly levered value-add real estate strategies (e.g. the LBO of Hilton Hotels) to returns of core real estate (I fail students for that but apparently people are told differently elsewhere). Funds investing in private equity in the natural resource industries are also taken out, on the basis that they are a different asset class. Well, it just happens that they have had terrible returns in the past 15 years because the oil and gas industry has had bad returns, that’s it. It is an industry effect. But, as it happens, the bad performing industries are taken out of private equity but not of public equity (yes, there are companies in NatRes industry too on public markets and they too did not do well, but no-one is taking them out of the stock-market indices!!).

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Phafa Le Hardi Written by: