Friday Letter Where's my safe eight

The search for yield and publicly listed private equity firms have investors buzzing.

At this week's Milken Institute Global Conference, a high-powered shindig in Los Angeles for some of the world's leading thinkers in finance, economics and public policy, two topics dominated conversation among the private equity contingent.

One was The Carlyle Group's imminent IPO, which finally priced on Wednesday afternoon as the conference was drawing to a close. Not surprisingly, given the negative sentiment around private equity stocks at the moment, it came in below its forecast range (although it has traded upwards slightly since).

Views about the offering were mixed. Some GPs argued that Carlyle going public might be helpful in the industry's ongoing quest to persuade Wall Street equity analysts of its value, thanks to the increased profile it will give to eloquent advocates like co-founder David Rubenstein.

LPs were less impressed, however. CalPERS CIO Joe Dear told Private Equity International that although the Carlyle float would be good for the giant pension fund in one sense (since it owns a portion of the management company), his worry is that markets continue to value fee income rather than fund profits – so going public just incentivises managers to keep fees too high. CalSTRS CIO Chris Ailman, meanwhile, also has reservations about the way private equity firms are treating public shareholders. (Click here to see an exclusive video interview with Dear and Ailman on the matter.)

The other big topic of conversation at Milken was Europe; specifically, how bad is it, and how bad is it going to get? The prevailing view among the (largely American) audience was decidedly pessimistic: there was much talk about the enormous amount of deleveraging still to be done by Europe's banks, and the potentially heinous consequences of a euro break-up.

There's a school of thought that this sort of uncertainty and dislocation should be good for private equity. And yet dealflow in Europe appears to be going backwards. This is partly a pricing issue, as the bigwigs on Tuesday's private equity panel discussed: sellers in Europe are still reluctant to sell at distressed prices, in no small part because the public markets remain (strangely) buoyant. And given the wretched growth prospects of most developed economies – plus all the other macro risks – buyout firms are, not unreasonably, reluctant to pay a big premium.

TPG’s David Bonderman suggested the best approach in the current market is to seek out pockets of growth – geographies or sectors “where the wind is at your back”. Since there won't be many of these in Europe, it's no wonder that lots of big firms are cutting back their buyout activity on the continent.

That's not to say opportunities no longer exist, however; they may just be of a different type. On a separate panel, Apollo founding partner Marc Rowan highlighted his firm's push into credit (which now accounts for about half of Apollo's assets under management). In Europe (a.k.a. “the world's largest distressed market with good food”), the real opportunity lies in filling the void created as the banks retrench, he said – which is why Apollo is buying up big portfolios of credit card loans, mortgages, SME loans and so on. It's a tough area to get right, but the rewards for those who do may be substantial.

Across all the panels at Milken, there was a consensus that the biggest issue on most investors' minds was the search for yield; according to Rowan, the question Apollo hears a lot these days is “where's my safe eight?” Investors will need to keep putting their money into alternatives in the current market, because it's the only way they'll be able to meet their return targets – but they're unlikely to rely on buyouts alone.

As such, it seems to follow that those managers who are most diversified – in terms of strategies as well as geographies – are best insulated from the current challenges. That might not be enough to please the public markets in the short term (Carlyle has a very broad franchise, and Apollo's credit push hasn't stopped its shares falling in value). But it will surely prove a winning strategy for investors who are willing to take a longer term view.