When an investment company known as an advocate for low fees and full transparency on costs turns opaque, you know something’s afoot. Indeed, Vanguard Group’s foray into private equity for the masses is so laden with fees it’s hard to know exactly what you’re paying, and to whom.
Is there anything more alluring than a private, members-only club — a place only the elite can enter? In the investment world, private equity holds that allure of exclusivity; so much so that now, for the second time, Vanguard has been unable to resist its siren song and after beginning with institutional investors has proffered a private equity option to high-net-worth individuals for a minimum $500,000 commitment.
Vanguard’s partnership with HarbourVest Partners, a Boston-based private equity fund-of-funds manager, is the latest attempt to persuade investors that they should allocate assets to this alternative investment class. Vanguard has been here before — it pulled the plug nearly 20 years ago on a venture with another private-equity firm, Hamilton Lane, before being able to get that first fund off the ground.
While much has been made of Vanguard’s bringing private equity to the masses, even Vanguard can’t get around the fact that private-equity funds are an expensive, illiquid and complicated way to invest. As Vanguard itself has written, “Many [alternative] strategies and asset classes have investment merit. They also have the potential to increase costs, introduce complexity, change the portfolio’s risk-and-return profile, lower transparency, and/or reduce liquidity.”
“ Private equity may offer the potential for greater returns, but there is no guarantee you’ll do better with private equity than you would in the public markets. ”
So, yes, private equity may offer the potential for greater returns, but there is no guarantee you’ll do better with private equity than you would in the public markets, where information and costs, among other things, are far more transparent.
Since Vanguard built its reputation as a low-cost investment provider, what kinds of costs can a Vanguard private equity investor look forward to paying? Let’s just say it isn’t your run of the mill, single-digit basis-point expense ratio.
First, there’s a fee to Vanguard for putting this product together; this ranges from 0.10% to 0.69%. Add to that a separate 0.185% to 0.21% management fee for HarbourVest. That’s not all. HarbourVest will take a performance fee of 12.5% on profits from certain of its investments above an 8% hurdle rate.
Then there are the management and performance (or carried-interest) fees on the myriad venture capital, private partnership and other funds that HarbourVest itself invests in. Plus, legal and accounting fees aren’t always covered by the aforementioned. Nor are the private jets, as the Financial Times recently noted. Add those to the stew.
Yes, there are layers upon layers of fees in Vanguard’s fund-of-funds private equity offering that the company has been loath to enumerate because, well, it’s complicated and expensive, and crucially, isn’t a good look for a company whose website says about investment costs that, “If the money is going somewhere else, it’s not going to you.”
Speaking of money going somewhere else, don’t get me started on the additional costs that individual investors may face when they delay filing their tax returns because of the potential avalanche of K-1 partnership returns that can come hand-in-hand with being a private equity investor. Let’s just call this a full employment program for accountants.
Still, for a high-net-worth investor looking to get into the private-equity world what’s a mere $500,000 anyway? Let’s just say it isn’t one-and-done. If you think you’ll be off to the races by committing to just one of Vanguard’s private equity funds think again.
An important word to remember when talking about private equity investing is “vintage.” Private-equity firms, along with venture capital partnerships, buyout shops, private debt-financers, real estate partnerships and the like, raise money for new funds — creating “vintages” — on a regular basis.
Why? Because success in these various realms requires spreading your bets over many investments over many years. Venture firms whose funds were seeding dot-coms in the late 1990s did horribly but many of those that raised funds to invest during the aughts have harvested big wins.
Success as a private equity investor requires commitments to multiple vintages. Vanguard has already raised a 2020 fund and a 2021 fund. Based on HarbourVest’s plans to invest its vintages over a two- to three-year period, the best course of action for someone investing with Vanguard is to commit to a new fund or vintage every three years or so. The 2021 fund might do well, or it might be lousy but the 2024 fund could be your big winner. So, don’t plan on committing $500,000 to private equity; plan on several million.
But be prepared for a lack of liquidity. Each of Vanguard’s private equity funds is slated to take 14- to 17 years to complete its investment journey. Yes, the plan is to begin generating some returns after four- to six years, but the ultimate performance of Vanguard’s 2020 vintage fund won’t be known until 2035 or so. Good luck with that.
For all the talk that private equity makes up for its lack of liquidity with higher returns, the data is suspect. Because private equity shops invest over a period of two or three years, their proponents often build customized benchmarks that show how, say, the S&P 500 SPX would have performed if you invested in it at the same rate on the same dates as the private equity fund.
The assumption is that this is how you’d invest your $500,000 if you were investing in the public markets. Big assumption. Or, as Vanguard has written, “[W]ith estimated and subjective asset valuations, the lack of objective robust benchmarks, less transparency, and extended time horizons, evaluating performance is a more taxing and less precise exercise.”
The late David Swenson powered Yale University’s endowment to spectacular returns with an early and prescient commitment to private equity, something many endowments and now Vanguard, are trying to emulate. But as Swenson said, “In the absence of truly superior fund selection skills (or extraordinary luck), investors should stay far, far away from private equity investments.” Caveat emptor.
Daniel P. Wiener is Chairman of Adviser Investments, a $7 billion Newton, Mass.-based wealth advisory which utilizes Vanguard funds extensively. He is also co-editor of The Independent Adviser for Vanguard Investors newsletter.