The world of investing is going private—but long-term returns are under threat.
The past decade has seen a flood of capital into hard-to-see, less liquid assets, transforming the scale and scope of the private-equity firms managing this money.
The biggest firms see this as adding to their advantages in an increasingly competitive world. But the fight for assets will inevitably lead to some bad deals, while the growing potential for conflicts of interest in many of their activities seems likely to provoke demands for transparency.
These firms are no longer the simple buyout shops of old, rehabilitating badly run businesses. Today, big private-equity firms are financial conglomerates reaching into all corners of the markets. They act not only as fund managers, but also proprietary investors, traders and investment bankers. In some ways, they are resurrecting the lightly regulated investment-bank partnerships of old.
THE RISE OF PRIVATE INVESTING
The column is part one of a Heard on the Street series on the explosion in demand for private assets.
- Part 1: Why Private Equity Risks Tripping on Its Own Success
- Part 2: Does Private Equity Really Beat the Stock Market?
Big private-capital firms now typically encompass traditional buyout arms plus private debt, real estate, infrastructure and energy funds. The industry’s assets under management have tripled since the end of 2006 to $ 4.8 trillion as at June 2017, according to Preqin, a specialist research firm. That is roughly double the assets of hedge funds globally, according to Eurekahedge, another research firm.
The biggest firms have taken a growing share of the market even as the overall pie has grown: they now have more power and influence in markets than ever.
That can help them cut out the banks. Last summer, KKR won a $ 3.7 billion deal for a Dutch car parks company then used its own capital markets arm to distribute the chunks of debt and equity it didn’t want. Regulators will watch this changing role.
It also helps them jump the queue for assets. For example, KKR and Carlyle can ensure their credit funds get access to loans to each firm’s buyout deals if they want the debt and have the capacity. That is great when competition is so high, but some investors already demand extra reassurance that one fund’s returns won’t suffer for the sake of another’s.
Then there is Blackstone’s recent use of derivatives trading to subsidize lending to U.S. home builder Hovnanian at the direct expense of some hedge funds, which seems to undermine the spirit, if not the law, of that market.
But it isn’t just in markets, their importance to the economy has grown too. Their decisions on whether to invest or cut costs now hold ultimate sway over millions of jobs, from shop assistants to pharmaceutical scientists. KKR’s portfolio companies have almost one million employees world-wide and Carlyle Group’s 650,000. In comparison, Walmart, the biggest U.S. employer, has 2.3 million staff globally and the next largest, Amazon, has about 540,000.
The heft and diversity of the biggest firms is also turbocharging their fundraising. Their stock of money raised and not yet invested (known as dry powder) keeps breaking records. The industry has about $ 1.7 trillion, of which $ 1 trillion is in buyout funds. Apollo Global Management last year raised the biggest buyout fund ever at $ 25 billion.
The greater the fight for assets, the more likely buyers will overpay, especially when so many markets are so highly valued. The industry has a history of overpaying during booms: the deals for energy utility TXU and Caesars Entertainment were two aggressive deals from the last cycle that went wrong.
Private-equity firms’ great advantage is time: investor money is locked up for years, so firms can wait for what they think is the best moment to invest and cash-in. The big firms also argue that their ever-growing ability to use market intelligence from across asset classes and around the world to inform their deal making gives them an edge over smaller rivals and public markets.
But that is exactly the thing investors and regulators should worry about. As more companies and assets are sucked into the world of private capital, the potential for unfair dealing out of the public spotlight will grow.
Growth and success will likely attract increasing regulatory attention—and ultimately costs. That as much as the battle for assets is likely to mean lower returns in time.
Write to Paul J. Davies at email@example.com