Leaders League. Apart from IRR and po-
tential exit multiples, what additional
factors in your view are important when
considering a buyout transaction?
Keith Black. IRR and exit multiples are both
return metrics and should not be looked
at in isolation when considering a buyout
transaction. The other important metric that
needs to be considered in conjunction is the
risk of investment.
In addition, the IRR on buyout investments
should also be compared with returns on the
public equity markets, especially when public
market returns are on the higher side, to see how
riskier private equity investments have fared
against their relatively less risky counterpart.
At the fund level, important factors for the
limited partners to take into account are the
number of deals a fund is invested in, mar-
ket cap of the targets, leverage multiples, and
level of concentration in a single sector or
geographic location. Diversification across
these lines coupled with a reasonable level
of leverage are likely to be characteristics of
a good performing fund.Leaders League. What key issues do you see
affecting the private equity industry today?
Are there any factors creating a mismatch
between the objectives of general partners
and limited partners?
K.B. The primary issue associated with the
buyout industry is cyclicality – high returns
are more likely to occur during times of low
valuations in public equity markets.
The size of funds available for investment is
the key factor creating a mismatch between
general and limited partners. GPs have an in-
herent interest in having more funds invested
because of the obvious reason of being able to
generate higher management fees. The draw-
back of having more funds, given the limited
availability of deals, is the increase in compe-
tition for the same deals resulting in buyouts
at sub–optimal multiples. To avoid this, and
to pay lower management fees, LPs prefer
lower fund sizes. Lower levels of committed
capital also mean that LPs have more cash
available for investment in other avenues.Leaders League. Private equity groups are in-
creasingly turning to hedge funds as they seek
to capitalize on the maturing industry’s rich
fees and growth. Is this model sustainable?
K.B. The strategy is profitable and bound to
be successful only if the buyout is conducted
at the right price and hedge fund investors
are willing to continue to pay higher fees.
Recently however, fee compression has been
observed in the hedge fund industry.
Selling to large private equity players gives
hedge fund managers the incentive of mone-
tization coupled with the benefit of a formal
industry stamp of approval as well as the
chance to use the buyer’s resources to push
growth. Selling a major stake also sets a va-
luation and locks in more permanent capital.Leaders League. How can we assess if
there is a buyout bubble being created?
K.B. To assess whether a buyout bubble is
being created, we first need to analyze the
trend in the size of the capital commitment
per annum.
Second, we need to look at leverage and in-
terest rates. As interest rates rise, it gets in-
creasingly difficult to get deals done while
maintaining a relatively low risk profile.
Third, we need to consider buyout multi-
ples. Deals at high multiples result in less
profits and more risk.
Finally, we need to check the size of the dry
powder. A high level of dry powder leads to
deals being done at sub–optimal multiples,
which in turn increases investment risk.Leaders League. How is the CAIA helping
shape the PE industry?
K.B. The Chartered Alternative Investment
Analyst (CAIA) Association is a thought lea-
der and bar raiser when it comes to alter-
native investments, such as private equity,
commodities and hedge funds. It has over
8,500 members and 27 chapters in more
than 80 countries across the globe.
The Association’s curriculum content and
exams are developed and updated with the
input and advice of industry practitioners and
partners around the world.Important metrics to be considered in a buyout transaction in conjunction with IRR are
the risk factors associated with the investment and returns on the public equity markets.
Important factors at the LBO fund level are the number of deals a fund has invested in,
market capitalization of the targets, leverage multiples, and level of concentration in a single
industry or geographic area.THE BENEFITS
OF ALTERNATIVE
INVESTMENTS FAR
OUTWEIGH THE RISKS
ASSOCIATED WITH
ILLIQUIDITY
“IRR and exit multiples should not be looked
at in isolation when evaluating buyouts”
KEITH H. BLACK
Managing Director, CAIA
ASSOCIATION
EXPRESS BIO
(^) 1990: MBA from Carnegie Mellon
University and start of career as an
Investment Officer at First Chicago
Capital Markets
(^) 1993: Trader and Financial Engineer
at Hull Trading Company
(^) 1996: Sr. Quantitative Analyst at Chicago
Investment Analytics
(^) 1999: Senior Lecturer and Assistant
Professor at Illinois Institute of
Technology (IIT)
(^) 2010: PhD in Management and Finance
from IIT
(^) 2007: Associate at Ennis Knupp
& Associates focusing on advising
institutional investors on asset allocation
and manager selection strategies in
alternative investments
(^) 2010: Associate Director of Curriculum
at CAIA Association
HIS REPUTATION
Listed as one of the “Rising Stars of Hedge
Funds” in 2010 by Institutional Investor
Magazine