WHAT RECESSION?
Why the markets have it wrong on the U.S. economy. Rosenberg,
Many of the world’s most revered institutional investors, from university endowments such as those at Yale and Harvard to massive public funds like the Canada Pension Plan, heavily invest in private equity and real estate for a simple reason: They diversify risk and enhance returns over the long run.
In some cases, these investments are made directly, but in most cases they are made as part of a comingled group of investors, usually in the form of a limited partnership (LP) managed by experienced firms with long track records of delivering excellent risk-adjusted returns.
It is well known that the managers of these private funds can become fabulously wealthy as a result of the management and performance fees they collect. It is also well documented that it is difficult — practically impossible — for ordinary investors to access these types of investments for their own portfolios.
A recent thought piece distributed by Jamie Grundman of the Friedman Investment Group at CIBC offers an interesting perspective on how best to gain access to and profit from the outsized successes of many of these funds: invest in the managers’ publicly traded companies instead of the funds themselves.
Over the past 15 years, the private-equity and alternative-asset-management industry has ballooned to more than US$3 trillion in assets under management. Many household names populate the managers’ universe, including Apollo Investment Corp., Carlyle Group LP, KKR & Co. LP and Blackstone Group LP. Indeed, most of the largest and most revered management companies are now publicly traded.
Most of the industry’s largest players started off in private equity, a business where earnings come from performance fees, which are lumpy in nature. In recent years, they have expanded into other fields such as real estate and private debt where the business is less constrained by scale and earnings are more predictable.
“I would argue that these companies make attractive stock market investments and are generally misunderstood by public equity investors because of their relative newness, perceived earnings volatility, and complex accounting,” Grundman notes.
Today, half of Blackstone’s assets are in funds that it didn’t have eight years ago — energy funds, credit funds and Asian and European real estate. Its assets are divvied up as follows: 24 per cent in credit, 20 per cent in hedge funds, 28 per cent in real estate, and the rest in private equity.
From the company’s June 2007 initial public offering to August 2015, the stock returned more than 89 per cent (dividends reinvested) or 8.1 per cent annually. The S&P 500 returned 5.6 per cent annually over the same time frame.
If you were to make this comparison starting from the March 2009 bottom of the market, Blackstone returned 35 per cent while the S&P 500 returned 18 per cent.
In an interview last year with Barron’s magazine, Blackstone chief executive and co-founder Stephen Schwarzman elaborated that the company has grown assets 2.5 times since the 2008 crash while most institutions have shrunk. He pointed out that over 30 years, the firm’s funds generated around 10 per cent over the stock market, after fees.
“In a low interest-rate environment, if alternative asset funds can generate 17% to 18% over time, investors don’t have a better place to put their money,” Schwarzman concluded.
Investing in the asset manager rather than the funds it manages also gives investors a level of diversification that they otherwise wouldn’t have.
“I could invest in one of Blackstone’s many limited partnerships but I will only have exposure to the returns of the one fund,” Grundman noted. “By owning a stake in the firm, I will have leverage on movements of all their assets. It’s a blanket exposure to all alternative asset classes.”
Of course, investing in publicly traded entities necessarily exposes investors to the vagaries of potentially volatile market forces, meaning that prices can fall (especially in the short term) in spite of sound fundamental analysis. Taking a public markets approach to investing in private markets, therefore, is not for shortterm investors.
But huge sums of money will continue to flow into alternative assets. In the short run, this trend is unstoppable. Owning a stake in the asset management companies that manage these funds diversifies investors into the alternative asset class and the opportunity to make money from this growing trend.
It also provides a rare opportunity for investors to align themselves with the largest institutional investors on the planet.