Steve Schwarzman's Fuzzy Math on Alternative Investing

Photographer: Scott Eells/Bloomberg

Stephen Schwarzman, chairman and chief executive officer of Blackstone Group LP. Close

Stephen Schwarzman, chairman and chief executive officer of Blackstone Group LP.

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Photographer: Scott Eells/Bloomberg

Stephen Schwarzman, chairman and chief executive officer of Blackstone Group LP.

When you read about private equity billionaire Steve Schwarzman, you expect to see big numbers. Even so, one number Blackstone's chief executive officer threw out recently was startling. “The alternative class, the stuff we do, tends to make somewhere around 1,000 basis points more than the stock market,” he said.

That was in response to a question from Bloomberg TV’s Stephanie Ruhle about Blackstone's move to attract more individual investors. Blackstone and others are pushing to include alternative assets -- a catch-all category for non-traditional investments such as hedge funds, private equity, commodities and real estate -- as an option in the $4.2 trillion universe of U.S. 401(k) retirement funds. By not having alternative assets as an option in retirement plans, the average individual is disadvantaged and left behind, according to Schwarzman.

Who wouldn't want returns of 1,000 basis points, or 10 percentage points, more than the stock market? Unfortunately, it’s almost impossible for sophisticated investors to get that in any investment. As a group, alternative investments don’t produce anywhere near those returns. After their hefty fees, many kinds of alternative assets actually do much worse than stocks.

“There’s not a single thing on the planet that performs 10 percent more than the stock market,” says University of Oxford business professor Ludovic Phalippou. Returns that large for an entire asset class would be simply unsustainable over long periods of time, he says.

The latest and best research suggests private equity investing – the buying, holding and selling of private companies, which Blackstone has excelled at – beats the S&P 500 by about 5 percentage points per year, Phalippou says. And private equity’s edge has shrunk by about a third, investment firm Commonfund estimates, as more investors joined Schwarzman in the private-equity game.

On top of that, a comparison with the large-cap S&P 500 Index may be the wrong approach to take. Most private equity firms specialize in buying small and medium-sized companies, and private equity on average performed “on par” with small- and mid-cap stocks over the last 15 years, Oxford’s Phalippou says.

Finally, private equity is only one of several kinds of alternative assets. There’s venture capital, which the same studies find significantly lag stock markets. Real estate funds have also underperformed, Phalippou says, especially over the past decade. Ditto for hedge funds, which were 23 percentage points behind the S&P 500 in 2013, the fifth consecutive year of underperformance.

So why did Schwarzman say alternative assets outperform by 10 percent per year? Despite what he seems to be saying about alternative investments as a class, Schwarzman "was really referencing Blackstone's outperformance" alone, said Blackstone spokeswoman Christine Anderson. His own private equity funds can boast of a realized internal rate of return of 20 percent per year since the firm’s inception in 1987.

The thing is, Schwarzman is an outlier. Unless someone like Schwarzman is managing your money, the data suggest alternative investments are rarely worth their costs and complexity.

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