Friday, February 27, 2015

Private Equity Discovers Warren Buffett?

Simon Clark of the Wall Street Journal's MarketWatch reports, Blackstone wants to invest like Warren Buffett:
Blackstone Group is talking to its biggest investors to create a “coalition of the willing” that can buy control of large companies outside of its existing funds, according to Joe Baratta, head of private equity at the New York-based firm.

Blackstone (BX) usually buys control of companies through its main private-equity fund. It is talking to a select group of large investors who may want to own a company for longer than the usual term of private-equity ownership of five to 10 years and target lower returns.

Baratta likened the potential new approach to the style of Warren Buffett, whose Berkshire Hathaway Inc. doesn’t have a time limit on its investments because it doesn’t buy assets through a fund.

“I don’t know why Warren Buffett should be the only person who can have a 15-year, 14% sort of return horizon,” Baratta said at the Super Return private equity conference in Berlin.

Several large private equity groups recently started exploring ways to buy big companies in partnership with large investors outside their existing funds. The potential new approach comes as major institutional investors, such as pension funds and sovereign-wealth funds, which are clients of the big private-equity groups, look for steady returns in an environment of persistently low global interest rates.

An expanded version of this report appears at WSJ.com.
William Alden of the New York Times also reports, Blackstone Considers a Lower-Return, Longer-Term Approach to Private Equity:
Private Equity firms have always offered a high-octane investing experience, attempting to multiply investors’ capital over a period as long as a decade.

But some of the largest firms are now considering taking a more sedate approach with some of their biggest clients in the latest sign that the industry is moving away from its former free-wheeling spirit.

Joseph Baratta, the head of private equity at the Blackstone Group, the biggest alternative investment firm, said at a conference in Berlin on Tuesday that the firm was speaking with large investors about a new investment structure that would aim for lower returns over a longer period of time.

Mr. Baratta, whose remarks were reported by The Wall Street Journal, said the investments would be made outside of Blackstone’s traditional funds, which impose time limits on the investing cycle. Invoking Warren E. Buffett’s Berkshire Hathaway, Mr. Baratta said he wanted to own companies for more than 10 years.

”I don’t know why Warren Buffett should be the only person who can have a 15-year, 14 percent sort of return horizon,” Mr. Baratta said, according to The Journal.

His remarks, at the SuperReturn International conference, were only the latest example of chatter about this sort of structure in private equity circles.

News reports last fall said that Blackstone and the Carlyle Group, the private equity giant based in Washington, were both considering making investments outside their existing funds. Such moves would let the firms buy companies they might otherwise pass on — big, established corporations that don’t need significant restructuring but could benefit from private ownership.

Another private equity giant, Kohlberg Kravis Roberts, has increasingly been making investments from its own balance sheet in addition to its funds. While this differs from the approach Mr. Baratta discussed, it similarly allows for new types of investments and provides a more stable source of capital. K.K.R., for example, has used its balance sheet to make minority investments in fast-growing companies like Arago, a German software maker, and Magic Leap, an augmented-reality start-up.

The holy grail that these private equity firms are chasing is what they call “permanent capital,” exemplified by Berkshire.

Blackstone, which has not yet deployed such a strategy, might gather a “coalition of the willing” investors to buy individual companies, Mr. Baratta said. This approach could be attractive to some of the world’s biggest investors, including sovereign wealth funds and big pension funds, which, though they want market-beating returns, also want to avoid taking too much risk.

Mr. Baratta said Blackstone and the coalition of investors could buy consumer goods companies like H.J. Heinz, which Berkshire Hathaway bought with the Brazilian investment firm 3G Capital, or infrastructure assets, according to The Journal.

”It opens up a whole universe of opportunities that we’re not currently accessing,” he said.
I must admit, when I read these articles earlier this week, I started chuckling and getting all cynical. Why? Because I was thinking to myself that in a low-return world awash in liquidity where it's getting harder for these private equity giants to compete with each other and with strategics (ie. corporations with record profits and inflated shares), all of a sudden they're discovering the virtues of the Oracle of Omaha's approach and the long, long view that Canadian pensions have been touting for a very long time!

But don't kid yourself, this "new shift" among private equity giants is nothing more than a clever ruse to garner ever more assets so they can keep collecting that all important management fee, which they collect no matter what (on multibillions, it really adds up!). The New York Times article above talks about "permanent capital" but I prefer an expression Derek Murphy, the head of PSP's Private Equity group, once cynically quipped to me: "The only reason these guys want to talk to us is that they view us as a source of perpetual funding" (he used more colorful language but I'll spare you the details).

"Murph" is absolutely right, PSP Investments, CPPIB, and other mega large global pensions and sovereign wealth funds are nothing more than a source of perpetual funding to these private equity giants. Facing pressure from investors and more regulatory scrutiny, they are lowering fees but looking to make it up by shifting focus on the longer term to collect increasingly more assets from their biggest clients.

This gives new meaning to the term "glorified asset gathers," which is why I've long argued the large hedge funds, private equity funds, real estate funds and mega alternative investment firms managing multibillions need to slash fees, especially their management fee (it should be a nominal fee, 25 basis points or less).

In other words, just like overpaid hedge fund gurus, realizing they had to do something to respond to increasing regulatory scrutiny and pressure from investors, overpaid private equity titans came up with this "ingenious" new way to garner more assets from the "coalition of the willing" to keep adding to their obscene wealth, which by the way, they amassed through the blood, sweat and tears of public sector workers contributing to their pensions (Piketty needs to revise his treatise on inequality).

Alright, let me be more open minded and stop being such a hopeless cynic. The truth is unlike hedge funds, private equity funds provide a better alignment of interests with pension funds and other investors focusing on a long period. So perhaps these private equity firms are shifting focus, aiming for lower returns over a longer period, because they're responding better to the needs of their biggest clients.

Also, I don't mean to take swipes at Blackstone's co-founder and CEO Steve Schwartzman. He has assembled a great investment team. Their success is well earned as they're printing money over there. I would invest with a David Blitzer or a Jonathan Gray any time because these guys are truly the cream of the crop and unlike other shops, Blackstone has a better governance structure and real succession planning, which is why they're the global leaders in alternative investments and why their shares are finally surging higher (click on image):


But I agree with TPG's co-founder, Jim Coulter, there are 'titanic shifts' going on in private equity:
The structure of the traditional private equity fund is under threat as investors seek new ways to buy and own companies without paying high fees to buyout firms, according to TPG co-founder Jim Coulter.

“I’ve never seen a period of time when we’ve had the extent of titanic shifts in the industry that we are seeing right now,” Mr. Coulter said at the Super Return private equity conference in Berlin. “The first is really the shift from funds.”

Investors usually commit to private equity funds for 10 years. They typically pay fees on undrawn commitments to private equity firms as well as lower fees on commitments that have been drawn to buy assets. Undrawn is money committed to a fund but not yet used. Drawn is money committed and used to buy a company.

The fees that private equity firms charge investors on capital that has been committed but not used are likely to decrease, Mr. Coulter said.

Investors such as sovereign wealth funds are increasingly demanding to invest money alongside private equity firms or through separate managed accounts to reduce the fees they pay.

Mr. Coulter said he expects the share of companies acquired through traditional private equity fund structures to decrease as new models emerge. Blackstone Group and CVC Capital Partners are among firms experimenting with new models,  people familiar with the firms have said.

One reason for the change is the fees on undrawn commitments usually cause private equity funds to show poor performance in their first years.

“That fee drag in the early years of a fund actually becomes difficult,” Mr. Coulter said.
As I stated above, facing pressure from investors and heightened scrutiny from federal regulators, some of the largest private equity firms are giving up their claim to fees that generated hundreds of millions of dollars for them over the years. But the private equity giants are adapting and looking to make up any drag on fees by increasing the assets they manage over a longer period.

Maybe these private equity giants are concerned that we're heading into a protracted period of global deflation, and they're thinking it's a wise business decision to shift focus to generate more modest returns over a longer period. I don't know but there are certainly 'titanic shifts' going on in the industry right now.

On the last point, Chad Bray of CNBC reports, Private Equity Executives Offer Differing Views on Industry’s Future:
Guy Hands and David M. Rubenstein gave vastly different views on Wednesday about the future of the private equity industry. But that may be a result of where they are perched.

Mr. Rubenstein is co-chief executive of one of the world's largest private equity firms, the Carlyle Group, and Mr. Hands is the founder of Terra Firma Capital Partners, a smaller, privately held firm.

Speaking at the SuperReturn International conference in Berlin, Mr. Hands said he believed the industry, outside the large, publicly traded firms like Carlyle, would go back to its roots and focus on smaller fund-raising and on being more closely tied to its clients.

Most important, he said, they will go back to being "more genuinely private," while the large firms will continue to move beyond traditional private equity to become generalist asset managers.

"It means being more aligned with your investors, putting much more of your own skin in the game, giving them what they really want, minimizing their fees, maximizing their returns," Mr. Hands said.

"That way private equity will go 'back to the future,'  " he said. "To take advantage of these opportunities and create alpha, the future for private equity lies in its past."

Mr. Rubenstein offered a bit of a different view on a separate panel at the conference.

He sees private equity opening up to a much larger client base in the next decade, including individuals managing their 401(k) investments in the United States. He also sees sovereign wealth funds playing a larger role than they ever have.

And, he predicted, the industry will discuss its returns and its operations in a more standardized and public fashion.

"People will actually know what a top quartile fund is," Mr. Rubenstein said. "There will be a standard definition and a standard organization — government or nongovernment — that will certify someone is a top quartile. People will not be able to say they are top quartile, when they are not."

He also thinks the industry will go by a new name: Private equity does not fully describe what the industry does today, if not tomorrow, he believes.

"Everything will be known to the public," Mr. Rubenstein said. "Everybody's performance will be known. Everybody's valuation will be known."

"Everyone will feel the industry is as transparent as the public equity industry is," he said.
I actually agree with both Guy Hands and David Rubenstein. There is a bifurcation going on in private equity. I see smaller private equity and venture capital funds with much better alignment of interests sprouting up and they will be courted by family offices, smaller pensions and endowments who are looking to build strong, long lasting relationships with excellent smaller funds.

But Rubenstein is absolutely right, the mega pension and sovereign wealth funds, the so-called "coalition of the willing" that write huge tickets in the hundreds of millions are looking for scale across global private markets which is why they'll be focusing their attention on truly top quartile alternative investment firms that offer investments in private equity, real estate, hedge funds and anything in between. Some are even venturing into infrastructure, although there the CPPIBs of this world invest directly just like in farmland.

The problem with the generalist alternative investment model is how will the Blackstones, Carlyles and KKRs keep delivering exceptional results to these big investors and keep alignment of interests? Importantly, as they grow their assets, they will increasingly be perceived as asset gatherers, and some will really start scrutinizing their performance and fees, questioning whether this is the right approach (Canadian funds are already going more direct, bypassing PE firms as much as possible).

As far as opening up private equity to the masses investing in their retirement accounts, I'm a lot less sanguine or enthusiastic as Mr. Rubenstein. I prefer to see enhanced CPP or an enhanced Social Security where well-governed, large public DB pensions invest in private equity for the masses instead of introducing private equity as an option for retirement accounts. This would be in everyone's best interest.

If you want to invest in these private equity giants, just buy shares of Blackstone (BX), The Carlyle Group (CG), KKR & Co. (KKR), Oaktree Capital Group (OAK), or Apollo Global Management (APO). They offer great dividends and some will see substantial capital appreciation but keep in mind the discussion above and realize there are 'titanic shifts' going on in the industry right now and if global deflation strikes, it will hurt everyone, including private equity giants.

If you have any comments you want to share on this topic, feel free to send me an email (LKolivakis@gmail.com). I'm taking a week off to recharge my batteries but will have access to my emails. Please remember to show your appreciation for this blog and donate and/or subscribe via PayPal at the top right-hand side. The information you read here and the way I tie it all together to the bigger macro picture is truly unique. Please show your appreciation through your financial support.

One final note. I read a lot of nonsense in other blogs on the "Greek crisis," especially on Zero Hedge but also in more reputable blogs like Naked Capitalism which just posted something silly on the alternative in Greece. If you really want to understand why Greece is in such a mess, take the time to read an op-ed the New York Times published by Aristos Doxiadis, What Greece Needs. It is truly superb and he explains it all in that short comment (another great article you should all read is Ambrose Evans-Pritchard's latest, Humiliated Greece eyes Byzantine pivot as crisis deepens).

Below, David Rubenstein, co-chief executive of the Carlyle Group, discusses trends in private equity, where bubbles are forming and where he sees the best global investment opportunities. Take the time to listen to his comments, he's one of the smartest private equity gurus in the world and a tireless philanthropist, just like Blackstone's Jonathan Gray.

More hedge fund and private equity gurus should follow their lead and ignore Forbes' silly list of the world's richest. Sitting on vast wealth is pointless, just ask Buffett, Gates and other billionaires, including Blackstone's co-founder, Pete Peterson, who understand the meaning of enough (see the 60 Minutes clip below).

Update: Warren Buffett released his annual letter to Berkshire Hathaway shareholders on Saturday, written with his usual mix of business facts, common-sense advice and showmanship. This year marks the 50th anniversary of Buffett's time heading the sprawling conglomerate. You can read highlights here.

The Oracle of Omaha provides advice that could make you rich. My favorite is #3: don't listen to experts. "Anything can happen anytime in markets," writes Buffett. "And no advisor, economist, or TV commentator -- and definitely not Charlie nor I -- can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet."

Lastly, Buffett has a message for public pensions, colleges and the like: Stop pouring money into expensive, high-end money managers:
"The commission of the investment sins listed above is not limited to 'the little guy.' Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades," Buffett wrote in his latest letter to Berkshire Hathaway shareholders.

Buffett has long been a critic of so-called alternative investing, a category that includes hedge and private equity funds, among others. The reason is the cut they take for their services, which can make billions of dollars for the managers but far less for clients, according to the man sometimes called "The Oracle of Omaha."

"A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool's game," Buffett wrote on underperformance.
When Warren Buffett and George Soros are on the same page, you know they're on to something and it's high time U.S. public pensions scrutinize the fees they're paying to external managers.



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