#8 Thomas Meyer: Private Equity Unchained
In this Fund Shack private equity podcast hosted by Ross Butler, Thomas Meyer, co-author of private equity best seller ‘Beyond the J-Curve’, shares insights into the industry’s challenges and the role of regulation, with an emphasis on the need to understand behavioral aspects and not just empirical data in academic input to the industry.
Thomas underscores the importance of considering how people respond in different situations, rather than solely focusing on absolute numbers.
Discussing regulatory initiatives, he criticizes the crude approach taken in some cases. He cites the Alternative Investment Fund Manager Directive (AIFMD) as an example, highlighting how it was driven by the belief that sophisticated investors had failed, leading regulators to become prescriptive in their requirements. He questions whether regulators are better equipped than experienced investors to guide industry behavior.
Thomas notes a limitation of AIFMD: it primarily addresses operational and compliance risks, neglecting financial risk. He recalls experienced limited partners dismissing fund managers’ focus on risk management, emphasizing that smaller buyout and venture funds cannot effectively manage financial risks on a fund level.
Thomas argues that AIFMD has created moral hazard among institutional investors. They assume that regulated funds are safe and no longer prioritize risk management. He likens alternative assets to the “Formula One” of the investment industry, where regulators focus on what they can see and touch, regulating behavior rather than addressing financial risk.
Thomas discusses the challenges in regulating financial risk. Few papers delve into this subject, and regulations tend to oscillate between being overly stringent and diluted cyclically. He suggests that regulation has removed incentives to better understand financial risk.
The limited partnership structure’s historical significance is highlighted, dating back to Arab traders in the desert. Meyer explains how it is a robust heuristic for asymmetric risk-sharing, where limited partners trust general partners to generate returns over a longer time frame.
The concept of “satisficing” is introduced, emphasizing that simplicity can be a virtue in complex environments. Thomas cites the example of hedge funds trying to replicate the efficiency of Black-Scholes models in private equity, which doesn’t apply due to the industry’s unique characteristics.
He discusses the misconception that innovation only needs more money. He suggests that governments should act as buyers of technology, similar to how the U.S. military historically drove innovation in Silicon Valley. The government’s role should be to buy innovative technology, even if it’s unproven, which would drive innovation more effectively.
He concludes by highlighting the need for governments to focus on purchasing innovative technologies and promoting simplicity over complexity in innovation.