The Economist February 26th 2022 Special report Private markets 5Blackstone’s75-year-oldco-founder,remainstheboss,butmore
day-to-dayresponsibilityrestswithits52-year-oldpresident,Jon-
athanGray.Apollo’sco-founder,LeonBlack,quitinMarch 2021
afteraninquiryintohistiestoJeffreyEpstein.AtCarlyle,oneco-
ceoquitin 2020 afterlosingapowerstruggle.Cannewleaders
keepthemagicgoing?Thechallengeistougherwhen,asStanMi-
randaofPartnersCapital,aninvestmentfirm,putsit,“We’vebeen
throughagolden40-yearperiodinwhichconditionsgrewever
morebenign.It’sbeenincredible—anditmaywellbeover.”
Thisspecialreportlooksattherisksasthetailwindsofthepast
decadedrop,andattheopportunitiesasprivatemarketswinnew
investors.Itconsidersafutureinwhichscoringbigwithbuy-outs
isnolongerenough.Itexploreswhatinstitutionalinvestorswant
andtheburgeoningmarketforprivatedebt;anditlooksatregula-
toryandreputationallandmines.ThereportfocusesonAmerica.
Privatemarketshavebecomemoreglobal,butitremainstruethat
today’strendinNewYorkistomorrow’sinLondonorShanghai.StrategicprioritiesThe great convergence
B
lackstone startedlife in 1985 with $400,000 in seed capital
and plans as an advisory boutique. Its founders, Peter Peterson
and Stephen Schwarzman, wanted to try leveraged buy-outs too,
but struggled to get backing. That was then. In October Mr
Schwarzman called his New York-based firm the private markets’
“reference institution...reinventing the asset class”. It is a justifi-
able boast. Blackstone towers above rivals, with $880bn of man-
aged assets. “Ten years ago we were essentially a small club with a
select group of investors focused on private equity, with a bit of
real estate and distressed debt,” says Mr Gray at Blackstone. “Now
we have a much wider group of investors saying ‘If you can get us a
competitive return across private equity, lending, real estate, in-
frastructure or one of a number of other strategies, we’re happy to
have the capital tied up’.”
pefirms are often said to be the “new conglomerates”, given
increasingly diverse portfolios. Unlike their industrial predeces-
sors, they show capital discipline; owned companies are not
cross-subsidised willy-nilly. The dozen or so firms atop the indus-
try are more than corporate conglomerates. The likes of Black-
stone and kkr“don’t much like the term, but they’re starting to
look more like financial supermarkets,” says Tim Jenkinson of Ox-
ford University’s Said Business School. One sign of this is a prolif-
eration of distinct private-market strategies (eg, mid-cap industri-
als or commercial property).
Listing on public markets was a formative moment for alterna-
tive managers. The two main sources of peincome are manage-
ment and performance fees; the second is known as carried inter-
est (or carry). In the early days, carried interest was pe’s main
source of profit, with management fees designed only to cover ad-
ministrative costs. But the latter are more important now, making
up 60-70% of gps’ total profits, says one study.
Public markets find management fees easier to value than per-
formance fees, which are more erratic. Floating a firm’s shares was
an obvious way to monetise the fees’ future flows (as well as mak-
ing it much easier for partners to cash out). The industry’s latest
ipo, by tpgin January, was structured to give public investorswhat they most wanted, the management fees, while keeping
most of the carried interest for owner-managers.
Once a firm goes public, the incentive is to maximise manage-
ment fees. The best way to boost a share price is to gather assets fu-
riously, not spend time painstakingly choosing the right buy-out
targets. And because alternative managers can charge higher fees
than those in the public markets, they enjoy higher valuation mul-
tiples. Blackstone has an eleventh of the assets of BlackRock, the
world’s largest fund manager, but a higher market capitalisation.
Blackstone aims to reach $1trn of assets within a few years, as
does another giant, Apollo. The race to bulk up will accelerate a bi-
furcation of the industry, says Mr Jenkinson. As giants go for scale
and breadth, a long tail of “artisanal” pefirms will tout themselves
as specialists who make superior returns by focusing on particu-
lar areas or geographies, doing just a few deals a year.
Gone are the days when the big pefirms focused on value, not
growth. Today’s targets are often not the metal-bashers of old, but
zippy new-economy firms. Software, health tech and green tech
are hot. Last year one in three pedeals was classed as tech, twice
the share before 2007-09. Blackstone hopes to become a king of
content as well: its burgeoning media portfolio includes Moonbug
and Hello Sunshine, which make tvshows for kids and women.
The search has led the industry into growth equity, a once-tiny
sliver between venture capital (vc) for startups and buy-outs for
mature firms. Growth equity makes up around 20% of all pe, about
the same as vc, with buy-outs accounting for the rest, says Stan
Miranda of Partners Capital. Growth equity is useful for firms en-
tering adulthood but unsure about going public.
The focus on fast-growing firms has pushed up valuations. The
average price for American leveraged buy-outs has climbed to 11.4
times earnings before interest, tax, depreciation and amortisation
(ebitda); even in heady pre-crisis years it did not exceed nine.
Scott Kleinman, co-president of Apollo, one of the few big pefirms
not to buy heavily at such multiples, suggested that the industry
was gripped by a “collective delusion” on valuations.
Leverage is jangling nerves, too. It has fallen as a percentage of
total capital in buy-outs: from 90% in the 1980s to around 70% be-
fore the crisis, and less than 50% today. Measured against earn-Alternative managers are going mainstream, and vice versa