Episode Summary
Private equity has become an increasingly important asset class in recent years, as institutional investors have allocated more of their portfolios to private equity strategies. This is due in part to the attractive returns that private equity firms have been able to generate, as well as the diversification benefits that private equity investments can provide.
We invited Miriam Gottfried, the private equity reporter at The Wall Street Journal, to join us on the first episode of Signals by AlphaSense. Miriam and our host Nick Mazing, the Director of Research at AlphaSense, discuss the biggest trends in private equity today.
So, if you want to learn more, keep reading or tune in to the first episode of AlphaSense’s Signals podcast.
Listen to this episode on Apple, Spotify, Google
Guest-at-a-Glance
- Name: Miriam Gottfried
- What she does: Miriam is the private equity reporter at The Wall Street Journal.
- Company: The Wall Street Journal
- Noteworthy: Miriam began working at The Wall Street Journal a decade ago, and for the past five years she has been focused on all things private equity.
- Where to find Miriam: LinkedIn｜Twitter｜Her Wall Street Journal page
Key Insights
🎙️Public markets don’t like unpredictable fee streams. Instead, they want diversified, recurring revenues from more permanent pools of capital. That’s why PE managers that go public must approach growth differently from when they were private and raising funds was enough for growth. ”When these firms first went public, they were not successful public companies because they were growing, but their assets or fee streams were too irregular for the public markets because many of them were based on the performance of their investments. […] As the years went by, the publicly traded firms branched out more into asset classes beyond private equity — where they could amass permanent or perpetual capital.”
🎙️Banking disintermediation led to the rise of private credit options. When borrowers don’t go to banks for loans but directly to a capital market, that is known as banking disintermediation. The financial crisis is the main, but not the only, driver of companies seeking alternative credit forms. ”Apollo is the prime example of the beneficiary of that. As Mark Rowan, the CEO of Apollo, likes to say: in credit, the opportunity is vast because the returns are lower, and there are so many different pockets of returns that you can go after. And as long as the risk-return profile is what your investor is expecting, then the world is your oyster.”
🎙️The democratization of PE products is ongoing. The core idea is to bring large pools of assets to alternative asset managers to manage. This includes retirement accounts, reinsurance companies, private REITs, and “the everyday wealthy.” ”The firms will say, ‘We want to give these investors access to this product.’ But what they want is more AUM; this is the game. They want more AUM, and they want it to be in steady, perpetual products. And these retail products fit the bill perfectly.”
Episode Highlights
Trend No. 1 in PE: Product Proliferation
”The original reason for product proliferation was when a number of [PE] firms decided to go public. When you’re a private firm, you can stick to your knitting. You can raise funds, usually growing your funds bigger and bigger but around the same strategy.
And that is enough for growth because you satisfy your constituents, which are your employees and your LPs. But when you become a public company, you have to grow in a different way.”
Trend No. 2 in PE: Banking Disintermediation
”A lot of it began around the financial crisis. Some of this has been happening for many years. But the financial crisis was a huge catalyst for banking disintermediation because the regulations on banks increased dramatically in the aftermath of the financial crisis.
They abandoned a number of businesses they had been in previously because it wasn’t worth it and paved the way for a big expansion in private credit. […]
Banks are fairly regimented in what they will approve and who they’ll lend to. They can’t if your business model doesn’t fit into the box, and it’s not because they don’t want to. It’s because their compliance people say they can’t, their investment committees say they can’t, their shareholders don’t want them to, and the regulators don’t want them to.
So this has created an opportunity for asset managers who can take a more tailored look at each situation and say, ‘We have a pocket of capital that’s set aside for this exact risk-return profile.”’
Trend No. 3 in PE: Democratization of Private Equity Products
”The idea is to design products aimed at wealthy individuals as opposed to institutions. […]
So there has been a proliferation of products including non-traded real estate trusts; […] there are non-traded BDCs (business development companies), which make loans to businesses. So those are basic opportunities that are private and would never be available to a public shareholder of anything — although there are public BDCs too.
And then, a wealth of other products in between that are being developed now. Apollo is entrepreneurial in terms of the number of products that it’s developing. […]
But the idea is to bring this large pool of assets under the umbrella of the alternative asset managers to allow them to manage it.”
Top Quotes
[08:36] ”Even though private equity has high returns, there’s a relatively narrow opportunity in private equity. You can raise a big fund, but once you have a $25 billion fund, it’s hard to get a $30 billion [fund]. There’s a limit to how big these private equity funds can get.”
[14:02] ”From a regulatory standpoint, you can’t have a regular private equity fund and say, ‘I’m now offering this to my individual investors.’ Individual investors are required to have more liquidity options than an institution would.”
[16:55] ”If you think about what should be the promise of alternative investments, it should be a higher return in exchange for illiquidity and higher fees. That’s the definition of what you expect to get when you invest in an alternative product.”
Full transcript:
[00:00:00] Miriam Gottfried: In credit, the opportunity is vast because the returns are lower, and there are so many different pockets of returns that you can try to go after, and as long as the risk-return profile is what your investor is expecting, then the, you know, the world is your oyster.
[00:00:22] Hello, and welcome to Signals by AlphaSense, where we hear thoughtful insights from business leaders, investors and experts.
[00:00:33] Nick Mazing: Hello, and welcome. You’re listening to Signals by AlphaSense, and I’m your host, Nick Mazing. In this episode, we’re joined by Miriam Gottfried, who covers private equity at the Wall Street Journal here in New York City. We’ll talk about the main trends in private equity, and really private markets is they have grown a lot.
[00:00:49] You can see it in the fund sizes, you can see it in pension allocation percentages, you can see it in the market capitalizations of the major players. Miriam, welcome, and can you tell us a little bit more about yourself?
[00:01:00] Miriam Gottfried: Hi, Nick, thanks for having me. I have worked at the Wall Street Journal for ten years, and for the last five years, I’ve covered private equity. I kind of think of that as private markets because it’s everything that a private equity firm could do, and I cover the firms themselves as public companies,
[00:01:15] if they are public companies, I cover the executives, and their, their activities and, you know, to me, it’s a fascinating area of coverage because it’s truly one of the most dynamic areas of finance, and it involves some of the most colorful personalities on Wall Street.
[00:01:33] Nick Mazing: And what many people don’t know is that, uh, you are the muse for the female protagonist in a book called The Trading Desk, where you’re an investigating reporter and covering a fraud and that the character in the book rides a Vespa from Brooklyn to the Barron’s offices in Midtown Manhattan. Do, do, do you ride a Vespa in, in real life?
[00:01:56] Miriam Gottfried: I do write a Vespa in real life, I have, um, one that I got in 2013, it’s what they call Portofino Green with a brown leather seat. I do not ride it to the office, however, because there’s nowhere to park in Midtown, and it would be sure to get knocked over or stolen or whatever.
[00:02:14] Nick Mazing: Yeah.
[00:02:14] Miriam Gottfried: I do, I ride it, but not, not to the office.
[00:02:17] Nick Mazing: It’s, I, I, I, I think it’ll be pretty brave, not to use other words, to, to ride in Midtown. So, changing gears a little bit, so, that was not, not an intended pun, but it, but it worked, um, we’re here to talk about trends in, in PE and, you know, from my perspective, my immediate association is LBOs, right?
[00:02:36] Leverage buyouts, which has been kind of traditionally how these companies have grown, you know, but now when you look at the large players, Blackstone, KKR, Apollo, Carlyle, TPG, Brookfield, it’s only that classic private equity is only a small percent, you have infrastructure, you have private real estate, you have reinsurance and, and so, so. So, what has been the evolution in, in that, if you can call it product proliferation?
[00:03:02] Miriam Gottfried: So, you know, a big reason for the, well, the original reason, let’s say, for the product proliferation was when a number of these firms decided to go public and, you know, it, when you’re a private firm you can just stick to your knitting, you can raise funds, sometimes growing your funds, usually growing your funds, bigger and bigger funds, but around the same strategy.
[00:03:28] And, you know, and that is enough for growth because you’re satisfying your constituents which are your employees and your LPs. But when you become a public company, you have to grow in a different way. And when these firms first went public, they were not successful public companies because they were growing,
[00:03:46] but their assets or their, their fees, their fee streams were irregular, were too irregular for the public markets, um, because many of them were based on the performance of their investments, and the public markets don’t like things that aren’t predictable, you know, they like recurring revenue, they like things that you can model.
[00:04:06] And so, as the years went by, the publicly traded firms just branched out more and more into asset classes, uh, that went beyond private equity and asset classes, specifically, where they could amass what’s called permanent or perpetual capital, where you can generate, you can raise a large pool of money that you don’t have to return right away, or over a, you don’t have to return over a set period of time like in a traditional private equity fund, and you can continue to charge fees on it forever in perpetuity.
[00:04:42] And the public market has applauded the shift to those business lines. So, it’s both the need to grow AUM and the need to grow AUM in a certain kind of way that has promoted the, the rise of these various business equities.
[00:05:00] Nick Mazing: And, and I think around the same time, uh, for index inclusion purposes, they switch from the publicly traded partnerships to, to actual corporations if I, if I recall correctly.
[00:05:10] Miriam Gottfried: That’s actually a more recent development that happened, um, as a result of the Trump tax cut for corporations, um, so, that basically, that, that tax change allowed the firms to kind of make a decision that they had been waffling about for a long time, which was, you know, whether to get rid of their publicly traded partnership status
[00:05:32] because the publicly traded partnership status prevented a lot of investors from owning them. Many investors are not set up to receive K-1s, which is what you get from a tax status, you know, every year when you own part of a publicly traded partnership. So, there were a lot of hedge funds, um, and mutual funds that couldn’t own them be, because of their publicly traded partnership status and would’ve wanted to.
[00:05:57] Miriam Gottfried: So, um, lowering the corporate tax rate kind of encouraged them to make the switch, and in the end, it turned out to be by far the right decision for these firms ’cause, you know, their ownership, uh, base expanded significantly, and they’re, they’ve been included in a lot indices and will be included in more going forward.
[00:06:17] Nick Mazing: Mm-hmm. I like that you use indices rather than indexes, which, which I tend to use a lot. So, so besides pro, prolific
[00:06:24] Miriam Gottfried: Well, I don’t know which one we use in Wall Street Journal style, actually.
[00:06:29] Nick Mazing: Besides pro, proliferation, one of the other trends that we discussed was, was the disintermediation of the traditional banking system being providing of credit. There was a very interesting quote by the CEO of Apollo in the, um, third quarter, uh, uh, 2022 conference call that, you know, happened, happened very recently, I think,
[00:06:48] I think something, like, only about 20% of the credit in the economy right now is provided by the traditional banking system. So, what’s going on with the banking dis, dis, disintermediation, I’ll never say this word right?
[00:07:02] Miriam Gottfried: Well, a lot of it, um, began around the financial crisis, not all of it, some of this has been happening for many, many years before, but the financial crisis was a huge catalyst for banking disintermediation because the regulations on banks increased dramatically in the aftermath of the financial crisis in terms of their ability to take risks, their capital requirements,
[00:07:28] um, the hurdles to, um, you know, getting approval for various things, they just basically abandoned the number of businesses that they had been in previously because it wasn’t worth it. And that paved the way for a big expansion in what we call private credit, which includes a vast number of things.
[00:07:47] And Apollo is the prime example of the beneficiary of that, I would say Apollo’s the leader in various forms of alternative credit. There, you know, there are others who you might say are direct lending leaders, which, you know, that’s specifically the lending of money to other private equity firms or business owners to do M&A for the most part or finance their, their, um, acquisitions.
[00:08:13] But Apollo has, you know, gone into many, many, many different areas of lending, and driving that has been, um, their recognition that, um, in, insurance companies were a great client to have, or a great source of assets to manage. And that, you know, even though private equity has high returns, there’s a relatively narrow opportunity in private equity, there’s, you can raise a big fund, but you can’t, like, once you have a $25 billion fund, it’s really hard to get a $30 billion, like, it’s, there’s a limit to how big these private equity funds can get.
[00:09:00] But, you know, as Marc Rowan likes to say, the CEO of Apollo, “In credit, the opportunity is vast because the returns are lower and there are so many different pockets of returns that you can try to, you know, go after, and as long as, you know, the risk-return profile is what your, your, your investor is expecting, then the, you know, the world is your oyster.” So, they, they like to play up and down the risk-reward spectrum, and the opportunities in credit are vast, and there’s, you know, tons of lending that can be done
[00:09:38] in areas where banks won’t go, I mean, now, banks are fairly regimented in what they will approve, in terms of who they’ll lend to, they, they can’t, if your business model doesn’t quite fit into the box, they can’t really lend to you. And it’s not because they don’t want to, it’s because their compliance
[00:09:57] people say they can’t, their, investment committees say they can’t, their shareholders don’t want them to, the regulators don’t want them to. So, they, so, this has created an opportunity for asset managers that can take a more tailored look at each situation and say, “Oh, we have a pocket of capital that’s set aside for this exact risk-return profile
[00:10:20] and these institutions that are invested in it, whether it’s an insurance company or others, are totally prepared for that level of risk and that expected return because that’s why they’re invested in this vehicle.”
[00:10:34] Nick Mazing: Mm-hmm. And, and, and, just came to my mind, uh, uh, BlackRock is in our, in AlphaSense as capital to share exactly with that sort of, uh, specific product, right? It’s, it’s a, uh, it’s not a traditional bank, it’s, it’s, it’s, it’s, it’s BlackRock. So, now, uh, let’s talk about distribution, and, and more specifically how things are getting democratized and, and obviously, hello,
[00:10:58] that word was pretty popular across a number of, uh, not, not just in the financial world, but it was for a while, it’s popular to democratize things, but, you know, historically, truly, private equity has been a institutional level product completely, completely out of the reach of regular investors. So, let’s say a pension fund or an endowment would make a certain allocation to certain P strategies and that’s it.
[00:11:26] Uh, now what happens over time and just in, in the financial world, when you look at any product, uh, in general costs are lower. So, when you look at the average mutual fund costs or the average GTF costs, et cetera, just costs or commissions, they’re now free depending on, you know, which, for stock trading, depending which broker you use, um, well, nothing is free, obviously, but, you know, you, you have to read the
[00:11:50] Miriam Gottfried: But costs have come down a lot.
[00:11:52] Nick Mazing: Costs, costs have come down a lot, and accessibility is higher. So, in other, in other words, literally, I don’t know if it’s anybody, but you can buy, you know, let’s say, uh, uh, co-override ETFs, co-override, uh, mutual funds, uh, et cetera. It, it becomes a lot, things become more accessible. And, uh, on top of that, specifically when we talk about the 401(k) plans, which for our non-US listeners are one of the, uh, voluntary, private, uh, what’s called a defined contribution plan, where people can contribute on a pre-tax or after-tax basis, certain amount of money.
[00:12:27] What is allowed to be in those plans also changes, even though they’ve been dominated by target date funds, uh, I think there was a recent inclusion about of, um, annuity. So, what can you tell us about,
[00:12:38] Miriam Gottfried: And crypto, too, in some plans.
[00:12:40] Nick Mazing: and what can you tell us about the, uh, democratization of private equity products?
[00:12:47] Miriam Gottfried: Well, first, I wanna talk about what’s driving the democratization of private equity products. It’s not, you know, the firms will say, “Oh, we wanna give these investors access to this product.” But what they really want is more AUM, right? This is, this is the game, they want more AUM, and they want it to be in steady, perpetual products, as I said.
[00:13:08] And these retail products fit the bill perfectly because, um, they can rate, there’s a huge pool of money out there sitting in the hands of the everyday wealthy that, that could, you know, people with, you know, 1 to 5 million in asset, in investible assets, and, you know, the firms previously have not really had a lot of access to those investors, as you said.
[00:13:33] So, um, when you’re already huge, and you need to grow, there aren’t that many new pockets of capital out there, and this was one of them. And, um, Blackstone really led the charge in, in moving into this area, and everyone has followed suit, and it will be, will continue to be a big growth area for the industry, and the idea is to design products that are aimed at this, these wealthy individuals as opposed to institutions.
[00:14:02] And from a regulatory standpoint, you can’t just have a regular private equity fund and say, “I’m now offering this to my individual investors” because individual investors are required to have more liquidity options than an institution would. With a regular private equity fund, obviously, you get, you put your money in, and then you expect to get it back with your profits in, within about 10 years, you know, as an institution.
[00:14:33] But individuals need to have access to more liquidity, and they need to be able to write smaller checks. Um, so, there have been a proliferation of products including non-traded real estate, real estate investment trusts, like BREIT, which is the most famous one, but a lot of people have copied BREIT and done their own version.
[00:14:54] Um, there are, there are non-traded BDCs, business development companies which make loans to businesses, um, and they’re, and so those are basically opportunities that are private and would never be available to a public shareholder of anything, although there are public BDCs too. And then there are, are a wealth of other products in between that are being developed right now.
[00:15:21] Um, Apollo is, is one that’s being very entrepreneurial in terms of the number of products that it’s developing, and I’m probably not even on top of whatever their latest thing is, they are developing a lot of new products. Um, but the idea is to, to bring, uh, this large pool of assets under the umbrella of the alternative asset managers, uh, to man, to allow them to manage it.
[00:15:47] The, the trick will be, um, you know, with the market turmoil as it’s been this year, and, you know, with interest rates continuing to rise, whether investors will get burned on these products or whether they’ll have a good experience and what, you know, whether these products will grow beyond this market downturn that, that’s occurring now.
[00:16:10] Nick Mazing: And, and specifically, do you have any thoughts on, on how the, you can call it asset-liability mismatch release scandal, obviously, that big, that one specific, very large private traded reit, um, you know, they gated redemptions, but that’s not an emergent thing that the reason why, you know, that opportunity exists unlike some other processing in the UK that, you know, we had a real mismatch.
[00:16:35] It’s specifically for that, and to me, it sounds, like, when, when you think about, you know, let’s say a real estate strategy or, or a, or a kind of a long-term fund, it kind of makes sense it’ll be in a retirement fund with a very, like, if you are, you know, you don’t expect to touch it for, you know, decades in some cases.
[00:16:53] Miriam Gottfried: It makes sense to me too, and if you think about what should be the promise of alternative investments, it should be a higher return in exchange for illiquidity, right? That’s sort of the definition of, in exchange for illiquidity and higher fees, but that’s sort of the definition of what you expect to get when you invest in an alternative product.
[00:17:16] But because of the way these products were set up, BREIT, the Blackstone real estate product has monthly liquidity in where, you know, investors can go and tender their shares and Blackstone can buy them back, although it doesn’t need to, or BREIT can buy them back. And the mismatch you’re talking about exists, but it, they have, you know, the structure was designed to prevent,
[00:17:43] um, you know, what you’re descri, like a, a collapse, um, like a run on the bank’s type scenario. So, the, the limiting of withdrawals from BREIT is a way to protect the capital that’s there and prevent Blackstone from having to go out and sell, do a fire sale of all of its real estate assets, um, that are in this vehicle,
[00:18:07] I mean, BREIT has a pocket of liquid, of liquidity, it has cash and it has, you know, marketable debt securities, um, and it does sell properties from time to time. But the worst thing for your returns as an investor would be for the, for Blackstone to be forced to sell the assets because then you don’t know what kind of price you’re getting.
[00:18:31] So, it, it’s a, it’s a challenging thing, I think it, it does put the individual investors to the test, too, it puts their, their ability to, you know, demonstrate stamina during this time and have a strong stomach, like, can you hold on? If you were a pension fund, you wouldn’t have a choice, right? You would just be holding on, and you would just wait it out, and maybe you would make money in the end.
[00:18:55] But the question is whether individual investors with their various liquidity needs will have the same inclination and whether they will trust that Blackstone will return their money in the end.
[00:19:08] Nick Mazing: We’re speaking with Miriam Gottfried, who covers private equity for the Wall Street Journal, and, uh, this was certainly very informative, uh, thank you for joining us today.
[00:19:16] My name is Nick Mazing, and this is Signals by AlphaSense. You can subscribe to us on all of the major platforms. Thank you for listening.
