Occasionally, we publish blog posts, speech transcripts and other commentaries of interest to the Washington business community. Here is an excerpt from a recent Carlyle Group “Value Cast” podcast , featuring co-founder David M. Rubenstein and Director of Global Communications Christopher W. Ullman.
Ullman: Today, we’re going to talk about the top 10 changes to the private equity industry following the Great Recession. First up is increased regulatory and public scrutiny.
Rubenstein: Following the Great Recession, the government in the United States and governments in other countries looked at private equity and other types of financial industry management and they did toughen up regulation and toughen up oversight. For many smaller firms, that is a difficult burden. For a firm of the size of ours, we can handle [that] regulatory oversight.
Ullman: Number two: The emergence of the individual investor.
Rubenstein: Historically, private equity got most of its money from large public pension funds or other institutions that were considered to be institutional investors. In recent years, we’ve begun to see that the individual investor is saying “I would like to get some of the high returns that these institutional investors are getting,” and they’re saying that in particular because many of them who have bank deposits are realizing that they’re getting very, very little returns, if any returns, on those bank deposits. So increasingly, large institutions are rounding up these individual investors [in feeder funds].
Ullman: Number three: Sovereign wealth funds and high net-worth individuals have taken over as the fastest-growing investor segments.
Rubenstein: Public pension funds were historically 35 percent or so of the investor base for large private equity firms like ours. However, in recent years, that percentage has gone down a bit, as sovereign wealth funds from all over the world, and high-net worth individuals, are now coming increasingly into private equity ... I suspect that their percentage increase in private equity will continue over the next couple of years.
Ullman: Number four: Capital coming in from new geographies.
Rubenstein: You’re seeing enormous amounts coming in from all the emerging markets: Latin America, the Middle East, Southeast Asia, India, so forth. And I think that reflects the fact that these parts of the world now have much more money than they did, relative to five or 10 or 15 or 20 years ago.
Ullman: Number five: How fundraising dynamics have changed.
Rubenstein: Fundraising has always been relatively difficult for private equity because you have to take a long time to raise the money ... Private equity funds typically take a year or more to raise. Now, the average is taking about 17 months to raise ... The reason it’s taking so long now is that investors are just more cautious than they were before. They’re demanding better terms, and negotiations take longer. And there’s much more competition.
Ullman: Number six: Institutional investors are looking for more than just [returns].
Rubenstein: What investors want is information beyond good returns. They want to know what we think about geopolitical developments, they want to know what we think about asset allocation formulas, they want to know what we think about what’s going on in the industry. And ... they’re also quite interested in how we value the companies that they have invested in.
Ullman: Number seven: Traditional private equity firms are becoming alternative asset managers.
Rubenstein: You’re seeing an increasing percentage of investors saying “I want to be with somebody that can invest around the world, that’s very stable, going to be around for a long time, and can do many different things for me, not just the same thing that one fund can do.”
Ullman: Number eight: Fee pressure is real.
Rubenstein: Traditionally, private equity professionals were compensated by getting a management fee, which largely covered their costs, and, 20 percent of the profits or carried interest. There has been some pressure on the management fee, but not all that much. There has been some pressure on so-called transaction fees and deal fees, and they have largely gone away, though not completely so. But there’s been relatively little pressure on the carry, the 20 percent. It’s generally viewed that 20 percent incentive compensation is a very fair way to compensate private equity managers.
Ullman: Number nine: The institutionalization of the industry.
Rubenstein: Historically, private equity firms were more or less mom-and-pop organizations. When KKR did the famous RJR deal in 1989, [it was] a firm of probably less than 10 investment professionals. Today, you’re seeing a number of firms becoming institutionalized, in the sense that they have large infrastructures, they operate all over the world, and they’re not as dependent on one or two very good investors.
Ullman: And finally number 10: Increasing focus on operational improvement versus financial engineering.
Rubenstein: In the early days, very little equity was put in, and complicated financial structures were used to enhance the returns. Today, it’s recognized that good returns really have to come from better operational management of a company that has been purchased. And so the private equity firms have added enormous numbers of people with experience in operating companies that are helping to either run these companies, serving on the board or serving as adviser to these companies.