In an industry where performance is king, KKR has thrown down the gauntlet, claiming a victory in the long game of investment over the iconic Berkshire Hathaway fund. This bold assertion by the 553 billion dollar private equity behemoth not only challenges the storied legacy of Warren Buffett. It also sparks a fiery debate on the true measures of success in the high-stakes world of private investments.
Kohlberg Kravis Roberts, the New York-based private equity giant known as KKR, recently reported an impressive cumulative gross internal rate of return (IRR) of 25.5 percent annually since its inception in 1976, surpassing not only Buffett’s record but also leaving the S&P 500’s 11.9 percent gross IRR far behind.
Its claim, published in a 530-page SEC filing dated 29 February, sets the stage for a debate: if one had invested just one dollar in KKR at its inception, it would have burgeoned to 54,000 dollars today, a feat seemingly outshining Buffett’s Berkshire Hathaway’s growth to 44,000 dollars from a single dollar invested in 1965.
Private equity narrative questioned
KKR’s claim resonates with a broader narrative asserted in the private equity world, including in Luxembourg: private equity entails lower risk compared to public markets. The conversation in financial circles now veers from sheer performance metrics to the veracity and implications of these claims.
Trym Riksen, head of portfolio management at Norway-based asset manager Gabler A/S, argued that the figures presented by KKR are, borrowing the words of philosopher Harry Frankfurt, essentially “bullshit.” “The naïve investor may ask how it can be that KKR creates much more value than Warren Buffett. Is Buffett hyped up? The short answer is: Bullshit,” Riksen wrote in a LinkedIn post.
Well known for a similar sentiment was Charlie Munger, Warren Buffett’s long-time partner, who since 2019 repeatedly accused private equity firms of manipulating numbers to attract investments. “All they’re doing is lying a little bit to make the money come in”, Munger said. Buffett’s response to Munger’s assertion was succinct and telling: “Yeah, that sums it up.” Munger passed away at the end of November, aged 99.
Relevance of IRR disputed
The use of IRR as a measurement has come under fire from academics as well, including Oxford financial economics professor Ludovic Phalippou, who as early as 2008 highlighted the irrelevance of IRR. Phalippou’s remarks on KKR’s IRR figures add academic heft to the scepticism. The low volatility and risk associated with private equity is, he argued, in many cases, an illusion – a sentiment shared by many in the financial academic community.
“What do you call an elephant that doesn’t matter?” Phalippou wrote. ”An IRRelephant!”
Private equity funds calculate the IRR by projecting that the proceeds from the early sales of portfolio companies will persist throughout the fund’s typical lifespan of eight to ten years, which encourages specific patterns of conduct. Phalippou estimates that 12.3 percent per year is a “reasonable number to work with” when reviewing KKR. “Hopefully people will understand that an IRR has absolutely nothing to do with a rate of return, and is an absolutely useless piece of information. Hopefully,” he said.
The figures presented by KKR and other private equity firms are not just numbers on a balance sheet; they symbolise the narratives that the investment community chooses to believe and propagate within the industry. They raise a fundamental question, Riksen said.
“The real question is not if KKR has had higher returns than Buffett. The real question is why finance people tolerate bullshit. Why are the many PE people of integrity silent?” he said.
Measuring investment success
Returns, while important, are not the only metric for investment success. Risk, ethical considerations, and the broader impact on stakeholders are increasingly critical factors that investors take into account. As this debate continues, the responsibility lies with both investors and firms to critically assess the veracity and implications of the performance data that drive investment decisions. In a world where data reigns supreme, the ability to discern fact from fiction has never been more paramount.
Against the backdrop of industry discussions on opening private equity markets to retail investors, with new products such as the second generation European Long-Term Investment Funds, or Eltifs, such performance claims deserve to be treated with scrutiny. In the end, it’s not just about beating benchmarks or legendary investors; it’s about fostering a culture of transparency and integrity that upholds the core values of the investment community.