Friday Letter: Falling in love again

Once again private equity is flavour of the month among the bulge bracket banks. We have been here before of course and external investors in any bank funds would do well to think about a "pre-nup" contract.  

Attention LPs – here’s a term you should demand the next time you commit capital to a partnership managed by an in-house private equity firm. It could be called a key-CEO clause. If the chief executive of the bank suddenly decides he hates private equity and forces the team to spin out, you get your money back.

This clause may be necessary now that the bulge brackets have fallen back in love with private equity. This week, dozens of displaced former in-house private equity pros greeted with wary chuckles two separate announcements that highlight this amusing trend.

First up, monster bank Citi unveiled a “strategic relationship” with Metalmark Capital, a firm that only a couple of years ago was rent asunder from its former parent, Morgan Stanley. In the meantime, Morgan Stanley itself announced the hiring to two professionals from The Carlyle Group and Apollo Advisors to support the coming investment activity out of a planned $6 billion Morgan Stanley Private Equity fund.

It appears to be the case that Citi, Morgan Stanley and other large firms are arriving at places that they vacated only a few years ago, but which rival Goldman Sachs never left. If Credit Suisse and JP Morgan re-enter direct private equity investing in a big way, the circle will be complete. Indeed, one of the more vivid stories of 2005 was the blow-up of two quality in-house investment programmes at Credit Suisse and JP Morgan.

Major clients Blackstone and KKR had complained bitterly that the M&A advisory business of the two banks were compromised by in-house private equity firms competing with independent financial sponsors for deals. The banks responded by banishing their in-house principal investment groups. DLJ Merchant Banking became a middle-market buyout firm and its former heads split to form rival independent private equity firms. JP Morgan Partners was reborn externally as CCMP Partners, although JP Morgan retained a smaller in-house firm called One Equity Partners.

It was noted by all that the biggest, baddest in-house private equity firm of them all – Goldman Sachs Capital Partners – didn’t consider divorce for a moment. Far from it – GS Capital Partners, part of the Principal Investment Area of Goldman Sachs, subsequently grew to become one of the largest private equity firms in the world, breathing the same rarified megafund air as Blackstone, KKR and Carlyle.

Two years later, it is acknowledged by all that the Goldman model – having significant principal investment and advisory businesses under the same roof – works. And now-forward looking bulge bracket CEOs want what Goldman (and Blackstone) have. Morgan Stanley is reorganizing its principal investment groups – private equity, real estate, infrastructure – into a “merchant banking” business that looks very much like the Goldman merchant banking group in structure.

Having spun out the team formerly called Citicorp Venture Capital into an independent firm called Court Square Capital Partners, Citi is now joining forces with Metalmark to “fill a product gap” alongside other alternative platforms including funds of funds, real estate, infrastructure and hedge funds.

Putting an even finer point on the sudden embrace of alternatives by the bulge brackets, Citi has just named as CEO Vikram Pandit, who recently sold his fund of funds business to Citi. With the largest financial institutions in the world desperate to stake a claim in the future of asset management, it’s a good time to be a seller of private equity firms and of any other business that might fit in a 21st Century merchant bank. No one knows this better than Pandit.

PS Our poll is now open for our annual awards. These are the only awards for the global private equity industry voted for by the industry. This is the eighth year of voting. Often called the PE Oscars, this year we have decided to adopt the two-stage voting process favoured by the Academy of Motion Picture Arts and Sciences. The polls for Europe, the Americas and the Rest of the World will be open to the end of the month. We will then use the results to produce shortlists for a final round of voting.

Click here to make your vote count.