Perhaps rumors of asset management’s demise have been premature. This week Goldman Sachs announced that it had raised $2.5 bn in “permanent capital” to make investments in private equity funds. The “permanent capital” here suggests that there is no planned exit date (a la Warren Buffett style investing) and the focus has moved from its former focus on buying stakes in hedge fund firms to buying stakes in private equity firms. Despite concerns of crowding, which drives deal multiples higher, and agitation regarding high fees and low transparency, the private equity industry had its best year since 2007 in terms of fund raising in 2017, raising over $360 billion. It is true that much of that has flowed to larger funds, and that significant barriers to entry remain for smaller funds.
The conventional wisdom is that returns will be more muted in private equity going forward as competition for deals increases. Indeed the annualized total return for the strategy for private equity (ex credit and real assets) was 8.9% for the 10 years ending June 30, 2017 (data from Hamilton Lane) v. 7.3% for US equities and 3% for hedge funds. This is hardly much of a premium (<2%) to receive for the dramatically lower liquidity involved in such investments. But it is clear that sophisticated investors (such as Petershill) are following the money. The economic interest of such investments (and their attractiveness as a cash cow) is the annuity like fee income that will accrue from such investments – thanks to the (mandatory) stickiness of investor capital and meaningful fee load. While strong underlying fund performance will enhance the carried interest component (and hence the return) it is not essential if the management fee share is already attractive enough. So it seems that interests may not always be fully aligned in these investments with underlying fund investors.
Given that all of the major players in this area (Dyal, Petershill, Blackstone and now Carlyle) have evolved to focusing on buying stakes in private equity firms, where does this place their erstwhile interest in hedge funds? It must be a clear case of “follow the money”. While rumors of the hedge fund industry’s demise have also been exaggerated – last year it surpassed a $3 trillion milestone, it is certainly a scene of higher attrition for funds, more investor flight and a harder case to make on the asset raising front. It is a “troubled child” while private equity remains a darling. The huge apparent attractiveness of the private investment area stands at odds with the pariah status of much active management traditional equity firms today. As they continue to bleed assets to passive mandates and struggle to pivot to strategies in greater demand, all while facing pressure on fees, the existential crisis that has coursed through this industry for a decade now is continuing to bite.
In a later post we will explore whether the bifurcation in investor offerings – from the highly liquid to the “permanent” is reflective of investor demand or manager self-interest. We will explore the risks inherent in each of these strategies and see if there is, in fact, a better way for investors to meet their own needs.