Biggs Sees Bubble in Private Equity

The former Morgan Stanley strategist predicts weak returns.
Author:
Publish date:

Barton Biggs says the record level of cash being raised by private equity firms is a financial bubble in the making.

The former

Morgan Stanley

(MS) - Get Report

market strategist says institutional investors are setting themselves up for some major disappointments down the road, if they keep betting that buyout firms will continue to keep delivering better-than-average market returns.

Biggs says investing in private equity is the flavor of the month for institutional investors who are not content with the returns generated by the stock market. But he says private equity firms are so flush with cash, they don't know what to do with it.

"In the history of the world there is no asset class that too much money cannot spoil," says Biggs, who spoke Tuesday at conference in New York, sponsored by DealFlow Media. "Investors in private equity have excessive expectations."

Biggs, now a managing partner with the hedge fund Traxis Partners, predicts that once the current buyout craze ends, private equity investors are looking at years of poor returns. He notes the hefty management fees the managers of private equity firms take in each year.

Private equity firms typically charge management fees of 1% to 2% and can skim off up to 20% of the profit a fund generates from its investments. Over the past several years, private equity firms have generated fat returns by buying up struggling companies, sprucing them up a bit and then quickly unloading them for a tidy profit.

In light of those solid returns, the private equity world has been on fire, raising more than $160 billion from investors this year alone. Yet despite a number of megadeals such as the proposed buyouts of

HCA

(HCA) - Get Report

,

Harrah's

(HET)

and

Freescale

(FSL)

, only a fraction of that newly raised money has been put to work.

Cynics like Biggs worry that with private equity firms sitting on so much money, they'll be forced to spend it on ever bigger and bigger deals. The fear is that some of these debt-laden transactions will end up going bust, or the acquired businesses will prove too difficult and costly to slim down and turn around.

Yet despite his worries about the looming private equity bubble, Biggs says he's bullish on the market. He says many hedge funds and institutional investors have shied away from stocks, looking for better returns elsewhere. But with the equity markets performing strongly the past few months, he expects institutional investors to scramble back into stocks.

"I'm very bullish here," says Biggs. "You could have mutual funds and hedge funds scramble to get aggressive."