Q: Let’s talk private equity returns. Is it time to lower the bar?
A: “Are the 20 percent-type targeted returns people have been touting over the years, in this day and age, are they realistic? Seems to be unlikely that anybody should expect those types of returns today, even at this point going forward, given where the public market is.
“We have to assume the returns we’re going to get in this industry are going to come down. It’s more competitive in the private markets. The low-hanging fruit has been picked. Many of the private equity deals done today are not the classic buyouts that KKR would have done in the ‘80s, where you’re investing in a non-cyclical industry that has very reliable earnings, like supermarkets, lever it up 90 percent and be pretty sure you’ll make a good return with low risk.
“That’s not the buyout business of today. The buyout business today is growth companies. You pay high EBITDA if you believe you can grow this company.”
Q: Speaking of how the industry has changed, how has increased regulatory scrutiny changed the game?
A: “Costs are going up enormously. We have added people everywhere we do business because of regulatory and compliance issues. I think private equity got lumped in with the hedge fund industry and some other players that regulators thought weren’t playing fairly.
“In Europe, the AIFMD, which says European pension funds can’t invest in U.S. vehicles, forced people like us to form European entities that are very costly. It costs investors more, as well, and it doesn’t add an iota of protection to them. High quality funds in the U.S. that don’t need their money aren’t going to pay to create a separate AIF vehicle.”
Q: Did the industry need the SEC to come in and start policing?
A: “It’s a good development. Most of the things the SEC is bringing up are not things that are going to impact returns for LPs enormously, but they’re practices that a lot of LPs didn’t realize took place. It took the SEC to force people to put these things in front of everyone. It’s not as though some of us haven’t raised these questions before. The typical response from GPs is, ‘Oh, nobody else has ever raised this.’”
Q: The LP community has been changing, which is changing the way the industry interacts with investors. What are some of the shifts?
A: “A lot of new investors [such as sovereign wealth funds] basically said, ‘We want a better fee than the small guy. And not only a better fee, but we want our own private vehicle that is our own separate account, that gives us more flexibility, more direct control over assets.’ They also want an educational program so their people can be trained.”
Q: How important has co-investing become?
A: “The jury is out whether or not those who say they want to co-invest are equipped to do that, whether they have the manpower, experience, judgment… Time will tell whether that turns out to be a good thing. All the talk about co-investing — it’s all about fees. People will talk about how they want more control, flexibility, more direct connection to the portfolio companies. But the primary reason for all these things is to lower their fees.”
Q: There’s been talk about shifting away from traditional private equity funds in favor of ideas around perpetual capital. What do you think?
A: “There will always be a place for traditional private equity with a defined life. But even with traditional vehicles, we are seeing people trying to slip 11-year terms into what used to be 10-year terms. With the slowdown in new investments during the global financial crisis, a number of funds had to go back to LPs and get their investment periods extended. Some firms are using the excuse to say, ‘We want six-year investment periods instead of five years,’ and that seems to coincide with 11-year life of funds.”
Q: How important is the effort to bring in investment capital from 401Ks and such?
A: “Defined contribution plans should have the opportunity to invest in this asset class. Various players in the industry, including us, are looking at ways to make that available to defined contribution plans. Some of the issues involved include daily pricing and liquidity. Those aren’t issues easily solved with a 10- or 11-year vehicle.
“The industry has to address that and will address it. Clearly in five years, maybe earlier, there will be answers to that. Defined contribution will become a bigger source of capital for private equity.”
Q: Why do you like Europe so much right now?
A: “Everyone has been negative on Europe for several years. We now have a situation in Europe where you can buy into Europe at a 25 percent lower dollar price than you could six months or a year ago. The euro is now so low in value that a lot European companies will be more competitive in the world market. In addition, the European Central Bank has instituted quantitative easing, which will further stimulate the European economies. And lower oil prices won’t hurt either.
“I like to buy when no one else wants to buy. Everything is cyclical and when things are down, that’s the time to buy.”
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