[cameronh90]

This is just the design of a PE fund. They run on a fixed cycle, so early on they heavily invest into their portfolio with the aim of resolving that risk and maximising the sale value by the end of the cycle.

In principle, I don't think there's anything wrong with this. All investment expects a ROI over some time horizon. Public companies do the same thing. Anyone who founds a start-up is doing it too. The only real distinguishing feature of PE is how successful they have become at aggressively optimising for market value.

The issue is that the sale value at the end of the cycle can be massively influenced by cynical financial engineering. This seems to me to be more of an issue with how every institutional investor apparently now prices companies purely on reductive metrics like EBITDA x the industry standard multiple.

The cause of the rot is widespread over-confidence in dumb financialization models shaping the system.

(Or, since it's HN: if your machine learning model is training well, but misaligned with real life: do you blame AdamW?)

[mcphage]

> how successful they have become at aggressively optimising for market value

They use money to turn value into money, which they then use to turn more value, into more money. And in the end, they have a lot of money, and all of the value is gone.

[cameronh90]

That's only possible if the financial system is valuing things systematically incorrectly.

IFF a company is truly, honest to god, less valuable than the sum of its parts, then it (or the subset that would have more value to someone else) SHOULD be dismantled, and those resources sold and reallocated to more productive use. You probably make these sorts of decisions in the capacity of your own personal finances without even thinking about it.

On the other hand (and what I believe is likely happening is) if cynical financial engineering is allowing you to turn a useful company that's valued poorly by the market into a useless company that's is paradoxically highly valued by the market, in the short term, and that keeps happening over and over again, then the tools used to calculate the market value are wrong.

This is illustrated by how PE commonly trashes trusted brands. A brand doesn't show up in your EBITDA. If you trash a brand quickly enough by cutting costs and quality, some institutional sucker will buy the company because they haven't clocked that the current EBITDA is elevated due to asymmetry in how quickly the costs come off and how quickly the revenue falls off after burning the brand.

They've simply valued the company wrong.

[mcphage]

> That's only possible if the financial system is valuing things systematically incorrectly.

Well… yeah. I mean, it seems clear that the market is pretty bad at valuing companies. At the very least, valuations are based on a combination of (a) measurable attributes, and (b) vibes. (a) will always be incomplete, and runs into all of the same measurement problems that everything else does. And (b) is really unreliable.

Plus, PE companies are not especially interested in long timelines, whereas companies can eventually provide a lot more value that they’re worth right now.

And that’s not even getting into situations where they own enough of the market to not care about losing customers.

[cameronh90]

> PE companies are not especially interested in long timelines, whereas companies can eventually provide a lot more value that they’re worth right now.

The value of a company does include the value of future returns. The standard model is net present value. In theory, if the market is valuing those future returns correctly, a PE fund would probably just do the value maximisation through investment and genuine business rationalisation, and skip the financial engineering phase of the cycle. I believe this is actually what most PE managers would prefer to do. They generally don’t actually want to burn their efforts for a short term fake valuation boost. They are still people after all. It just seems to be what the market wants them to do, and they prefer money.

> the market is pretty bad at valuing companies

The market has always been bad, but probably more randomly bad, historically. Different people had their own finger-in-the-air methodologies and an estimated market value of a company had a lot more random noise around it.

The issue is now that ~every large institutional investor is valuing companies in the same wrong way, which creates opportunities for, essentially, an arbitrage between reality and their dumb models which these types of PE funds are exploiting.

It also creates systemic risk to the financial system. When everyone is making the same mistake, “independent” market participants aren’t really independent. This is in essence what any bubble is, but usually isolated to people misreading the fundamentals of a particular sector. If the techniques behind financialisation are themselves a bubble, however, we could be in for one hell of a pop if the market realises. Like when the market realised they’d been valuing subprime mortgage books wrong in 2008.

[samat]

Language is the house of the being

I believe you are using the wrong language

> some institutional sucker will buy

They are committing fraud in the high trust society. Literally sucking blood from our kids and grandkids who would have to rebuild, if that’s even possible

[everybodyknows]

> some institutional sucker will buy the company

What sort of institutions would try to take on operating such a business? And when does word get around, and the pool of suckers dry up?

[lmm]

> What sort of institutions would try to take on operating such a business?

Essentially anyone - other PE funds, competitors merging, the general stock market if you take it public. And they're not wrong want to buy it - there's a valuable business there - they're just bad at assessing the right price.

> And when does word get around, and the pool of suckers dry up?

One born every minute. And it's hard to even notice you're being taken for a ride as opposed to mismanaging the business you bought or just being unlucky.

[freejazz]

>That's only possible if the financial system is valuing things systematically incorrectly.

...have you looked around? Some of the biggest companies in our economy basically just serve ads...

[mint5]

“ In principle, I don't think there's anything wrong with this. All investment expects a ROI over some time horizon”

Huh? Why is there nothing wrong? Yes they wouldn’t make the investment if they didn’t think they had a way to get ROI, but how does that entitle them to one at any cost or make it necessarily moral?

As an extreme example, If I invest to create a company that is clearly exploitive and addictive, nothing is wrong in principle and I’m entitled to my roi?

[cameronh90]

Bringing morality into it opens a whole can of worms that I don't think we have the tools to answer.

My view is companies don't have a conscience, and any expectation that they are going to independently act with moral righteousness is unrealistic. Any perceived conscience is either for marketing (green/pinkwashing), or the sum of the morals of their owners multiplied by their willingness to exert any moral authority over the company.

Besides, if you try to imagine a company having an independent conscience, what even would that conscience be based in? I'm vegetarian and think it's immoral to eat meat, but obviously I'd be insane to expect companies to divest from meat based on my peculiar moral position.

In most cases, people do not exert any moral authority over anything they own. Do you actively select your pension investments based on your morality and vote in the shareholder meetings? If you do, I'm genuinely pleased and happy that someone is. But the reality is most people don't give their investments any thought beyond "line goes up", so companies end up acting as ROI maximisers.

So: the main way we enforce morality on companies is ultimately the government. If you want companies to act morally, you set the rules such that an ROI depends on following our democratically agreed set of regulations. Maybe that even harms economic growth but we still consider it worth it (which is typically how we think in Europe, but look at our economies are doing!). However, the company and its investors are still acting as ROI maximisers.

[mint5]

That is a baffling response, no one suggested corporations have consciousness.

The poster said “I don’t think there’s anything wrong with this” are they a corporation? If they are, apparently they do have consciousness because they say “I think”

And yes some people do in fact try to vote with their dollars. Canadians are doing it plenty right now for an easy example.

That companies’ sole purpose is to maximize shareholder value, usually near term, is basically a toxic social construct and fairly recent. It’s not grounded in anything other than greed.