BlackRock’s Russ Steenberg on the evolution of private equity

Russell Steenberg, managing director at BlackRock, helps oversee about $24 billion of assets under management as global head of BlackRock Private Equity Partners. In his most extensive interview to date, Steenberg sat down in BlackRock’s headquarters in New York City to talk about a wide range of topics including co-investments, pressure from LPs on fees and the firm’s latest fund.

As global head of BlackRock’s Private Equity Partners unit, Russell Steenberg has mapped out just about every corner of the GP world. From 1983 until 1995, he co-headed a $3.6 billion PE portfolio for AT&T’s pension fund. He then co-founded and was managing director of the middle-market buyout shop Fenway Partners. His tenure at BlackRock dates to 1999, including work with Merrill Lynch Investment Managers, which merged with BlackRock in 2006.

For his team, Steenberg, 64, said he seeks out others who share his passion for private markets as a way to drive better money-on-money returns than public investments or government bonds. In a wide-ranging interview with Buyouts, Steenberg cited lessons learned in decades of managing buyouts, investing in funds, and handling billions in institutional investments in private equity. 

Overall, do you think of yourself as a GP or an LP?
We are both. We sit in the nexus between both. Because when we raise a commingled fund or when we have a customized separate account, which is the fastest growing part of the BlackRock Solutions business, you are general partner with all of the responsibilities of a general partner in the private equity world. If we’re investing in funds, we invest in funds as an LP. We’re on both sides of the fence.
BlackRock’s newly raised BlackRock Private Opportunities Fund III closed on $630 million in commitments in May. How is that going?
We have a healthy pipeline. It is a diversified co-investment fund. I believe it should reflect the world’s investment capital flows. And clearly private equity is a worldwide business now, and the co-investment business is also a worldwide business. We believe very strongly that in co-investing, clearly you get an advantage because the fees and carry are essentially half of what an investor typically pays in a standard private equity fund.
This economic advantage is especially true for large co-investors who can position themselves as strategic trusted equity partners who do not pay additional fees and carry to the lead sponsor. So if you get the same return in a portfolio — for your partnership portfolio and your co-investment portfolio — your co-investment portfolio is going to have a better return just because of the math of the lower fees.
Plus, we believe that with proper due diligence and selection, a co-investment portfolio can outperform a partnership portfolio before fees. Fund I of this series was mainly for high-net-worth individuals and family offices. The second one had more institutions in it. And the third one is almost a pure institutional fund.
But BlackRock doesn’t just write co-investment checks to GPs about every deal that comes along.
No. Over long periods of time, I’ve seen — time in and time out — that strategy fail. Because the negative self-selection bias that’s in the deals that GPs show is clearly there. We’re big believers in the other end of the pole. You want to have great relationships with your general partners. You need to be viewed as a team that has the skills and the experience, so you can work side by side with the GP as they’re going through their due diligence and not [hinder them] because it can be a time-consuming process. [If] you’re getting in the way, then the odds of being able to do it again with that general partner go down significantly.
And you want to make sure that you have enough capital so you can be viewed as a financier of the equity layer of the transaction and not just another limited-partner mouth to feed during the course of the fund. We’re also big believers that you have to do your own independent due diligence, not only with the GP but on top of the GP, so you get a double layer of due diligence. And the resources of BlackRock and the information advantage we have utilizing the information flow of this firm is immense.
Certainly BlackRock is familiar with investors’ passion for lower fees in its traditional asset-management business through the rise of exchange-traded funds. That mentality has now permeated the institutional-investor world?
There is no question that the focus on fees is stronger today than it ever has been. … Back in the 1950s and 1960s in the United States, trust banks for big pension plans put everything into things called balance funds. In the 1970s and ’80s that started evolving with money going into specified funds such as a value fund, a growth fund, a Russia-only fund, a U.S. S&P 500 fund. The private equity world started with the venture capital model in the 1970s. Then private equity partnerships started in the 1980s. The partnership is still the dominant collection vehicle for assets today. What you’re seeing, though, is large pools of capital now in the private equity world, taking the same view that has evolved in the traditional asset-management world, which are large separate accounts. They’ll hire people like us or our competitors, to do large, customized separate accounts, which are no different than what you’ve had in the traditional asset-management world now for decades.
Another way fees may be lowered is by holding investments longer than four to seven years in a PE fund.
Big pools of capital want to be like long-term owners of companies. They want to buy great companies and hold them forever and take the transaction costs from one private equity firm selling to another private equity firm. If you’ve got a great asset, why not hold it for a while? There are a number of big firms that are raising pools of capital to buy things and hold them for long periods of time. I think there are some real issues there. How are the GPs and LPs going to get compensated? How do they get their money out? How are you going to manage it? Are the GPs buying second-class assets because it wasn’t put into a main fund?
So all of this is putting pressure on fees?
In the GP world, if you have a wonderful brand and if you have strong historical performance, you’ve been able to maintain your fee levels. Big funds have had smaller management fees, but the volume of the fees being paid off the assets is huge. Then, of course, there’s the layering effect of one fund still being in place while another comes on and another comes on, which then increases the revenue for the individual firm in a large way.
On the other hand, there’s not been any pressure on the carried-interest side. And carried interest, ironically, has never been priced to risk, if you will. A mezzanine fund has a 20 percent carried interest. And a big buyout fund has a 20 percent carried interest. Those are two very different risk approaches to investing in the marketplace. And yet they still have the same carried interest. That’s always been an interesting fact that still exists and still hasn’t really been challenged. The fee side, however, has seen downward pressure.
Another thing LPs are doing is buying things on their own via direct investments. Is that a focus for BlackRock?
We will be as active as we can on boards and in the creation of value once the transaction is done. But we look to the general partner to be the driver of that. For us, we always want to be clearly on one side of the ledger, which is as a friendly financier of the general partners’ transaction.
There’s a lot of focus around LPs putting money in distress and the lower middle market right now, among other categories such as growth capital and large buyouts. Is BlackRock shifting its asset allocation at all within PE?
If I put a crystal ball on the table today, and ask you which sector in the next five to 10 years is going to be the hot sector to sell into, you would have opinions and there isn’t a person at BlackRock that wouldn’t have opinions. And we’d all be wrong.
I want to make sure that we have a diversified portfolio that covers those sectors you mentioned and more, such that when one of those sectors gets hot in the future, I can sell into it and not chase it with new capital.
Having said all of that, let’s focus on the word “tactical.” There are some definite secular trend lines there that emerge in every cycle, that play through a cycle and you always need to identify them and watch them. Energy is one — the world’s economies are growing, the energy needs to drive those economies [are] going to fluctuate depending on pricing and the commodity cycle. But energy itself is still a long-term play.
Does BlackRock work with fundless sponsors to find deals?
Yes. This is another development that is more prevalent today. This is a business of relationships. It’s always been a business of relationships. It always will be a business of relationships. When you have strong relationships, whether it’s with a GP that has funds or with an individual who is putting deals together, those relationships are the basis of doing business.
Does BlackRock prefer IRRs as a benchmark or another metric?
We are looking at public-market-equivalent returns. Matching cash flows for every dollar invested and realized, and comparing those return profiles across markets, is a much better way to go about it. And most people use that analysis today. That’s become a common benchmark.
At BlackRock, we’ve gone way beyond that. We’ve developed a range of quantitative tools that we use to evaluate partnerships and portfolios and individual assets. We believe these tools allow us to be in a position to have a better understanding of value creation in an asset. You’d be surprised how many GPs say, “It’s all from operational value once we buy it.” But when you do the analysis using the proprietary tools we developed, it’s really by making a market call and not by providing operational value. Those firms are not the people we want to invest with.
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Photo of Russell Steenberg courtesy of BlackRock