THERE HAS long been an element of the gentlemen’s club about the private-equity (PE) industry. It is still predominantly male. It has a buccaneering history filled with mystique. It cherishes discretion. And its fees are exorbitant compared with the services it provides. If anything covid-19 has made it even more exclusive. Despite what Preqin, a data gatherer, says was a slowdown in fundraising during the pandemic as in-person meetings stopped, the firms with the longest pedigrees have had the least trouble raising money, doing deals and earning bumper profits.
That includes KKR, a 45-year-old pioneer of the leveraged buyout market, which in five months has just amassed its biggest private-equity fund ever, at about $18.5bn, according to Reuters. It extends to Apollo, which on May 3rd agreed to spend $5bn acquiring two digital-media brands, Yahoo and AOL, from Verizon, a telecoms firm, weeks after taking part in a $6.25bn deal for casinos in Las Vegas. Meanwhile Blackstone, the biggest PE company of all, raised $95bn across all its funds in 2020, on a par with three previous years, and recently reported record quarterly profits.
These companies have vivid pasts that have helped burnish the industry’s reputation for gutsy dealmaking. KKR is the legendary “barbarian” behind the buyout in 1988 of RJR Nabisco, a food conglomerate. In 1990 Apollo emerged from the ashes of Drexel Burnham Lambert, a collapsed junk-bond firm. Blackstone’s founder, Stephen Schwarzman, is on schmoozing terms with many world leaders. Yet no longer does he nor many of his counterparts play the role of company frontman. In March, Leon Black, longtime leader of Apollo, relinquished control of the firm, following revelations of his links to the late, disgraced financier, Jeffrey Epstein.
On earnings calls, a younger generation is at the helm. Their talk is as much of the reliable fees earned from managing vast sums of money, including those coming from financial acquisitions (KKR recently bought Global Atlantic, an insurer, and Apollo merged with Athene, an annuity provider) and credit funds, as it is about the swashbuckling world of buyouts. Increased predictability has helped the firms’ share prices easily outperform America’s S&P 500 over the past five years. Yet they also make the once-snazzy “alternative investment” market look more mainstream. Coupled with pressure on the industry at large to become more transparent, to adopt environmental, social and governance (ESG) standards, and to pay more taxes, it is increasingly hard to tell where public markets end and where private equity begins.
The impetus for transparency comes first from investors—for good reason. One of the articles of faith of private equity is that it is worth the high fees because it reliably outperforms public markets over long periods. Yet recent evidence from Josh Lerner of Harvard Business School, among others, shows that in America, private equity’s biggest market, it has performed only slightly better than public markets during the past decade, and that returns are on a downward trend. Hugh MacArthur of Bain, a management consultancy, says that at the start of the pandemic there was a lot of discussion between private-equity firms and their investors about returns as asset prices plunged, which led to a relatively unprecedented level of disclosures.
But questions remain. They revolve around the flakiness of private-equity data and the industry’s internal measurements of return. These will get fiercer as retail investors, in America in particular, are allowed greater access to private markets that were once the exclusive domain of sophisticated investors. Buyout returns will come under more scrutiny because deals in America and Europe last year were among the priciest ever, making it harder to make money on them. It won’t help, either, if inflation is rising and higher interest rates raise buyout firms’ borrowing costs.
More financial transparency is one thing. PE firms are also under pressure from investors to demonstrate their environmental and social credentials. Some of the biggest firms, such as KKR and Apollo, were early converts to ESG. But scrutiny has always been haphazard. Blackstone has recently taken measurement seriously: within the last year it has set out to cut the carbon footprint of firms it acquires by 15% within three years, as well as instructing companies it owns to report on ESG risks to their boards.
Some will see such efforts as a wise risk-mitigation strategy, as well as a way of appealing to consumers and employees. Others will deride them as a pesky box-ticking exercise. Inevitably, they will be subject to accusations of “greenwashing”. So like it or not, governments are stepping in. From March 10th the European Commission has been phasing in a regulation that obliges asset managers, including private-equity firms, to meet ESG requirements. Since President Joe Biden took office, the Securities and Exchange Commission, America’s markets regulator, has also taken the matter more seriously. Soon even buyout firms without an ESG mandate may be under the cosh.
From PE to PC
The need to be seen as good citizens becomes all the more important as private equity engages in more consumer-sensitive digital businesses, such as health care and fintech, as well as doing more work on behalf of governments, including bankrolling an infrastructure boom in America proposed by Mr Biden. The administration already has the industry in its sights. It is hoping to raise tax revenues by getting rid of “carried interest”—a perk of private-equity investment managers whereby they can pay low rates on long-term capital gains. It is a threat the industry has long evaded. But it has yet to contend with a Democratic Party whose left-wing regularly accuses it of “looting”.
Such accusations are nonsense. By funding and reshaping companies, private equity generates wealth, jobs and growth. It used to do so, though, while revelling in its bad-boy image. It no longer has the option of being so politically incorrect.