General Petraeus, the General Partner

Matthew C. Klein writes for Bloomberg View about the economy and financial markets. He previously wrote for the Economist magazine and its economics blog, Free Exchange.
Read More.
a | A

David Petraeus, the four-star general and former head of the Central Intelligence Agency, has recently been hired by the private equity firm KKR & Co. Bloomberg News reports that Petraeus will be leading a new unit called the KKR Global Institute. He will also be expected to "help the company evaluate investment opportunities in new markets."

Petraeus would hardly be the first person to cash out of a career in government to go into high finance, although most people who follow that path are politicians and bureaucrats rather than military officers. After all, it isn't clear what Petraeus brings to a firm like KKR that it doesn't already possess. As Kevin Roose of New York magazine put it, "his only qualifying resume line seems to have been a lucky friendship with KKR co-founder Henry Kravis."

The good news is that Petraeus can't really be said to be going through the revolving door, unlike, say, the legions of lawmakers, lawyers and lobbyists who regularly flit back and forth between the public and private sectors. This only makes it stranger that KKR would hire him. Friendship with the senior partner always helps, but I think something else is at work.

Friends of mine who work in private equity say that the core business -- buying companies at low multiples to cash flow and then using leverage to goose returns -- isn't particularly challenging. The real skill is getting allegedly "sophisticated" investors to pay you very high fees to do this for them when they could easily go out and do it themselves.

Even retail investors can replicate this basic strategy by buying mutual funds (like this one) that focus on small companies with lots of debt. In fact, these funds' lower fees mean that a retail investor would have outperformed limited partners who had invested with traditional private-equity firms.

Yes, certain PE firms would have provided superior returns to investors, but the implication from the aggregate data is that many firms also would have done far worse than a basic mutual fund. Moreover, it is very difficult for investors to know in advance which firms will generate the best performance for their limited partners. That helps explain why the California Public Employees Retirement System, one of the world's biggest investors, said in February that it was considering switching out of active investment strategies, including private equity.

My hypothesis is that Petraeus was hired to help with the all-important task of asset-gathering. He is a well-known name who may help draw in large sovereign wealth funds and other foreign investors. If that strategy works, Petraeus would be an extremely valuable addition to the KKR team -- from the perspective of KKR, anyway.

As is often the case with private equity, the biggest victims of this decision, if any, will be the limited partners.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.