The Economist - USA (2022-02-26)

4 SpecialreportPrivatemarkets TheEconomistFebruary26th 2022

WallStreet.Today’sbusiness­schoolgrad­

uatesmaynowbemorelikelytoseeka ca­

reerinprivatemarketsthanininvestment

banking.LastyearBlackstonehad29,000

applicantsforjustover 100 analystjobs.

Thegrowthofprivatemarketshasac­

celeratedsincethefinancialcrisisof2007­

09,outpacingpublicmarkets.Atitspre­

crisis peak, the private­capital industry

hadsome$2.2trnundermanagement.To­

dayitmanagesfourtofivetimesasmuch,

a littleoverhalfofit inNorthAmerica.

Theprivate­marketspartyhasboosted

profitsandshareprices.In 2021 theindus­

try’supperrankspostedrecordresults,and

publicly listed pefirms enjoyed bench­

mark­beating share­price gains. Black­

stone’sand kkr’s share prices doubled.

The average profitability of alternative

managersiswellabovethatofbanks(albeitmorevolatile).The

BostonConsultingGroupreckonsalternativemanagerstookin

morethan40%ofglobalasset­managementrevenuesin2020.

Sincetakingoffinthe1980s,pehasseentwoboom­and­bust

cycles.Thefirstboomwasdrivenbyswashbucklingdealmakers,

epitomisedbykkrco­foundersHenryKravisandGeorgeRoberts.

Itsemblematicdealwasthehighlyleveraged$25bntakeoverof

rjrNabiscoin1988.Thefirstbustsoonfollowed.The second

boom,startinginthelate1990s,sawtheindustryscaleupandex­

pandbeyondequityandoutsideAmerica.Severalmanagers,start­

ingwithBlackstone,tookadvantageofittolisttheirownshares,

monetisingfeeincomeandgivinggps moreexitoptions.More

havesincedoneso.tpg, a SanFranciscoleveraged­buy­outfirm

withsome$110bnofassets,listedontheNasdaqinJanuary.

Boombackbigger

Thefinancialcrisishitpe, butitbouncedback,fuelledbycheap

debtasinterestratesfell.Eventhearrivalofcovid­19in 2020 did

notknockit forlong.Dealmakingfrozebriefly,butpefirmsmoved

toshoreupportfoliofirmsthatneededhelporasanopportunity

tobuycheapassets.m&aactivitytookoffagainlaterthatyear.

Privatemarketshavebeenpropelledbypushandpullfactors,

saysMohamedEl­Erian,chiefeconomicadviseratAllianz,anin­

surer,andaformerbossofpimco, abond­fundmanager.The

mainpushfactorwasultra­loosemonetarypolicy,whichdrove

investorstowardsilliquidmarketsthatofferedhigheryields.An­

otherwastheretreatofbanksinresponse

totoughercapitalrequirementsandpost­

crisislaws(suchasDodd­FrankinAmeri­

ca)thatdiscouragedor prohibitedthem

from betting with their own balance­

sheets.Privatefundsgleefullytookupthe

slack.Amongpullfactorsareinnovations

suchasprivate­debtandproperty­invest­

mentfundsthatweredesignedtoappealto

wealthyindividualsandinstitutions.

Asprivatemarketshavegrown,more

youngfirmshavechosentodelaygoing

public.Theaverageageofcompaniesdo­

inganipoinAmericawaseightyearsinthe

1980sand1990s.Theaveragesince 2001 has

been 11 years.“Privateequityhasredefined

itsroleasa waystationtothepublicmar­

kets,”saysChipKaye,bossofWarburgPin­

cus,apefirmfocusedon thinvesting.

Ascompaniesstayprivatelonger,“moreinv s arelooking

togetinatthatpre­ipostage,asthat’swhenm ofthewealth

creationhappens,”saysBenMengofFranklin leton,a fund

manager.Somefirmsoptnottogopublicatall, dentofrais­

ingenoughcapitalprivately,saysByronTrott,h fbdtCapital

Partners,a merchantbankforfamilyfirms.Ofthe 40 companies

bdthasinvestedinsince2009,onlythreehavegonepublic.

Notthatthepublicmarketsaredownandout.Lastyearwasa

recordoneforipolistings.Firmsgoingpublicalsohaveother

routes,suchasdirectlistingsormergerswithspecial­purposeac­

quisitioncompanies(spacs),whichlandedwitha bumpaftera

boomin2020­21but areunlikelyto disappear.Yet ataround

4,000,thenumberofpubliclylistedAmericanfirmsisfarbelow

itspeakofnearly6,000inthemid­1990s.Onereasonisthatinves­

torsseedisadvantagesinpublicownership,includingonerous

disclosurerequirements,quarterlyearningspressureandattacks

byactivistinvestors.

Atpe­ownedfirms,theactivistsareontheinside.Ownerswork

closelywithmanagersto shapestrategyandcapitalstruct

Theyrewardsuccesshandsomelywhilepunishingfailurefa

thantheownersofpublicfirms.Donecorrectly,thiscanincr

valuebynarrowingtheinformationgapbetweensharehol

andmanagement,reducingagencycosts.Theendowments,pen­

sionfundsandotherinstitutionalinvestorsthatfuelprivatemar­

ketsarebelievers.Theythinklargeallocationstoalternativein­

vestmentsofferthebesthopeofhittingannual­returntargetsfor

theirportfoliosthataretypicallyinthehighsingledigits.

Butastheindustryentersitsthirdage,it faceschallenges.One

istheprospectofsustainedhigherinflationandinterestrates.

Cheapdebtispe’s lifeblood.A riseofa coupleofpercentagepoints

inthecostofborrowingisunlikelytoleadtosurgingbankrupt­

cies.Butmorethanthatmight.Asmorecapitalhasflowedinto

privatemarkets,pricesforassetshaverisensofarthat“thereislit­

tleroomforerror,”saysBain&Company’sMrMacArthur.Forbuy­

outstheaveragepricetagrelativetoearningsisatanall­timehigh.

Asecondworryisgreaterscrutiny.Privatemarketsarelightly

regulatedandopaque.Regulatorswantmoretransparency,espe­

ciallyonfeesandperformancemeasures.Supervisorswantto

knowhowprivatemarketsmightaffectfinancialstability.Thein­

dustrymustalsonavigategeopolitics,notablythereassessmentof

thevirtuesofforeigncapitalbyChina,untilrecentlya bigpartof

manymanagers’plans.ThecollapseinSeptemberofBlackstone’s

$3bndealtobuysohoChina,a propertydeveloper,augursill.

Thefinaltestcomesfromwithin:generationalchange.Many

whoshapedtheindustryareleaving.MrKravisandMrRoberts

handedoverto newco­headslastyear.Stephen Schwarzman,

A private party

Global asset values, 2000=100

Source:McKinsey *H1

1,500

1,250

1,000

50

500

250

100

2000 05 10 15 21*

Publicmarket

capitalisation

Private equity net

asset value

America leads the way

Private markets, assets under management, October 2021, $trn

Source:BankforInternationalSettlements *March 2021

Restofworld

Asia

Europe

NorthAmerica

6543210

Drypowder*

0.03

0.5

0.8

1.

Private equity Realassets Privatecredit Venture & growth capital