“Today, Blackstone reported the most remarkable results in our history on virtually every metric,” said chief executive Stephen Schwarzman in January, introducing the firm’s fourth-quarter earnings presentation. Such unmitigated positivity is rare, though difficult to argue with in this case. While 2021 was good for almost everyone in private equity, it was especially good for Blackstone.

The asset manager’s corporate private equity portfolio appreciated 42.2 percent over the course of the year. Tactical opportunities and secondaries grew by 34.9 percent and 49.8 percent, respectively – the GP’s “best annual returns in over a decade”, said chief financial officer Michael Chae on the same call. Across its platform, Blackstone raised $270 billion, lifting its assets under management by 42 percent to $881 billion. The words “grow” and “growth” were said a combined 58 times on the call.

“At our Investor Day a little over three years ago, we shared our vision of reaching $1 trillion in AUM in eight years,” Schwarzman said. “We now believe it will reach $1 trillion this year – half the time we predicted.” The firm had tripled its annual fee-related earnings in that time, he added.

Last year was one more record-breaker in a hugely successful decade for Blackstone – and the market at large – as investors looked to alternatives for returns in the face of persistently low interest rates. The conditions that spurred this growth, however, are changing.

Covid-19 caused chaos in global supply chains, driving up inflation across markets. What most thought was a transitory phenomenon started to look more entrenched in February when Russia invaded Ukraine, causing oil prices to rocket. The US Federal Reserve in mid-March raised interest rates for the first time since 2018; with US inflation running above 7
percent, further and more aggressive rises are likely.

These rate rises, combined with inflation, helped trigger steep stock market declines in 2022, with significant, if delayed, implications for private market valuations. At the time of writing, the S&P 500 was down 10 percent year-to-date. The NASDAQ100 Technology Sector Index was down nearly 20 percent, as rising rates caused investors to discount future earnings.

Throughout the past decade, asset managers and LPs have looked to Blackstone as a bellwether. As a new paradigm forms, it seemed a good time to catch up with the firm’s president and chief operating officer, Jon Gray, to get his view on what these changes mean for private equity and Blackstone.

The pursuit of excellence

Private Equity International’s meeting with Gray took place on a Thursday afternoon in March, at Blackstone’s Park Avenue headquarters in New York. Schwarzman’s presence was keenly felt; PEI saw no fewer than six copies of his book What it Takes: Lessons in the Pursuit of Excellence on the way from the lobby to the 43rd floor.

On the hour, Gray bounded into the meeting room in a blue checked shirt, fresh from a gathering of Blackstone portfolio company COOs. We had 30 minutes, though it quickly became apparent that a lot could be packed into half an hour with the fast-talking, animated Gray.

“It’s an awful tragedy, what’s happening, and so wrong,” he says, as we start with the topic at the forefront of everyone’s minds: the Russian invasion of Ukraine. “We have very small exposure… For us, it’s much less about the direct impact than the broader impact on financial markets and on the inflation question.”

Catapulting costs

In April last year, Gray was one of the first PE executives to speak publicly about the threat of inflation, describing it as the “major risk that’s out there today”. In the first week of March, Russia’s invasion drove the price of oil past $120 a barrel, while the price of wheat – of which Russia and Ukraine collectively export around a quarter of the world’s supply – reached the highest level in 14 years.

However, since at least the start of 2021, Blackstone has been focusing on what it calls “good neighbourhoods”, such as life sciences and digitalisation – sectors with such strong growth fundamentals that revenue generation can outrun inflation. At the same time, it has seen healthy demand for asset classes that provide inflation protection, such as floating-rate private credit and infrastructure.

Blackstone has also looked to take advantage of the covid recovery play. In February, the firm had an A$8.9 billion ($6.5 billion; €6 billion) offer accepted for Crown Resorts, a Melbourne-headquartered casino operator whose pandemic-related losses have been compounded by myriad legal and regulatory woes. This was Blackstone’s fourth bid for the listed business, which it pursued for nearly a year.

Recent events have made Gray even more cautious about buying businesses with high input costs and minimal ability to pass those costs through the supply chain: “If you think about travel-related assets, they might have labour exposure, but there’s a lot of pricing power. A food manufacturer has got exposure to labour costs, exposure to wheat costs, let’s say, but you can’t charge $20 for a box of cereal.”

New and improved

The high-inflation, rising-rate environment is a reminder of how important it is to be able to hold companies through periods of volatility without being forced to sell. Thankfully, the private equity industry is in better shape than it was before the global financial crisis, says Gray. The loan-to-value ratios of leveraged loans average in the region of 50 percent today, compared with around 70 percent in 2007, according to S&P Global. Blackstone’s loans tend to have no covenants, giving it maximum flexibility when dealing with lenders.

At the same time, the business has diversified almost beyond recognition. Today, Blackstone offers 60 investment strategies, compared with 35 just five years ago, Schwarzman said on the Q4 earnings call. Many of the fastest-growing products are inherently low-risk, such as core-plus real estate, direct lending and perpetual capital funds, which accounted for 42 percent of Blackstone’s AUM at the end of 2021.

“Perpetual capital is lower leverage definitionally and much longer hold,” Gray says. “Core-plus real estate, direct lending, infrastructure – they are different types of businesses. I think our firm is much more resilient than if you went back to the old monoline private equity model of the past.”

Change ahead

Lower-risk, lower-return products will only increase as a proportion of Blackstone’s business. One element of the next “big sea change”, Gray says, is the opening of private markets to retail customers. Last year, Blackstone raised $50 billion for its 16 products geared towards the retail market across credit, real estate and hedge fund solutions. Among the more established of these products are Blackstone Private Credit Fund and Blackstone Real Estate Income Trust, which had $30.8 billion and $94 billion in net asset value, respectively, as of the fourth quarter.

The second element of the sea change is increased inflows from insurance companies. In July, Blackstone agreed a deal to manage $50 billion of AIG’s life insurance and annuity capital, rising to around $100 billion over the next six years. Blackstone also acquired a 9.9 percent stake in AIG’s life insurance and retirement services unit. Blackstone receives a steady, predictable fee stream – much valued by equities analysts – while AIG gets access to higher-returning alternative investments.

While more tie-ups of this kind are inevitable, Gray rules out merging with an insurer in the way that Apollo did with Athene: “We want to run a business that’s asset-light. We have a very small balance sheet, virtually no net debt and no insurance liabilities… We also want the ability to serve multiple insurance companies,” he says, adding that perpetual capital would complement, not supersede, its closed-end funds.

Blackstone’s perpetual capital drive has led it to pioneer a process described by PEI as a “secondaries deal without the secondary”. In February, it completed a €21 billion recapitalisation on European logistics company Mileway, in which existing investors were given the option to sell, roll with the asset or roll with an increased stake. The perpetual Blackstone Core+ real estate fund also backed the deal, turning a company acquired by a closed-end vehicle into a perpetually held asset. It did the same thing with life sciences business BioMed Realty in 2020, in a €14 billion deal.

The path to $1 trillion

Blackstone’s push for $1 trillion in AUM is predicated on a $150 billion fundraising cycle across 17 different products, including flagship buyout fund Blackstone Capital Partners IX, which could raise as much as $30 billion. Blackstone is entering a crowded market, with Carlyle and Thoma Bravo – each targeting $22 billion – among a slew of big firms on the road.

As PEI reported in our last issue, even with record distributions in 2021, many LPs are above their PE allocation limits and must make the difficult decision to cut back ticket sizes or not invest at all. Blackstone is “not totally immune” to this capital crunch, Gray notes. However, the problem is basically isolated to PE and to certain types of investor: namely, US public pensions and endowments.

“We are in a bunch of markets where investors are still ramping up their exposure. A lot of clients want access to infrastructure, leveraged loans and private debt, and most investors are not overallocated to real estate,” Gray says, adding that there are many LPs from the Middle East and Asia looking to grow their alternatives exposure, not to mention the universe of individual investors.

Overallocation should also drive secondaries sales, of which Blackstone is well placed to take advantage. Flagship secondaries fund Strategic Partners Fund IX could raise as much as $20 billion, Gray said in October, having collected $12.8 billion in one quarter alone, which would make it the largest fund ever raised for the strategy.

Size is the enemy

With such large amounts of capital to raise and put to work, is there a risk of the largest firms becoming victims of their own success, unable to find enough large, high-growth opportunities to generate big multiples for LPs? Not according to Gray.

The rapid expansion of Blackstone’s product offering gives it more places than ever to invest capital, he tells PEI. Furthermore, the alternatives market is still relatively immature, with few genuinely large players. There are four public companies on the West Coast with a combined market capitalisation of around $10 trillion – Apple, Microsoft, Alphabet and Amazon. This is roughly equivalent to the entire alternatives market, Gray says by way of example.

“In public markets, size is your enemy. If you want to buy $1 million of stock in a company and I want to buy $1 billion, you have a competitive advantage because I’ll move the market. But when you start talking about buying a $20 billion [privately held] logistics company, the number of people who can do that is pretty limited. We continue to find scale to be a competitive advantage. And we don’t think the capital we raise is in any way outstripping the opportunity set.”

A key driver of this opportunity set is also the biggest risk the market faces today, Gray believes. Volatility in public markets often causes investors to panic and throw the baby out with the bathwater. While many offloaded assets will be over-inflated businesses for which a reality check is long overdue, plenty of good companies will have their values marked down to the point where they become attractive to groups that take a longer-term view.

After a record year for realisations in 2021, the challenge this year will be achieving exits, according to Gray. Market volatility has already caused bid/ask spreads to widen on the public equities market, particularly in high-growth sectors, and this will affect private marks in due course.

“[It’s about] navigating around public markets and being disciplined if the market is not there to take our time to make sure we get the right execution on sales,” says Gray. “We are moving from this period of very low inflation and low rates to something very different.”

Incoming: ‘An enormous amount of secondaries volume’

For several years, Ardian and Lexington Partners jockeyed for the largest pool of dedicated secondaries capital, writes Michael Baruch.

Blackstone Strategic Partners has traditionally been in a close third place behind these two firms, though that could stand to change with its ninth flagship programme: after raising $12.8 billion in the fourth quarter, Strategic Partners is on track for a $20 billion flagship secondaries fund, according to Gray.

Limited partners including Cathay Life Insurance, Fubon Life Insurance and Minnesota State Board of Investment have backed Strategic Partners Fund IX. If successful, it will be nearly twice as large as its 2019-vintage predecessor. It will also be the biggest secondaries fund in history, replacing Ardian and Lexington Partners’ $14 billion current flagships, according to data from affiliate title Secondaries Investor. Ardian and Lexington are both targeting $15 billion for their newest flagship vehicles.

Secondaries is one of Blackstone’s “good neighbourhoods”, according to Gray, meaning there are strong alternatives tailwinds that the firm hopes to capitalise upon. This is particularly true in the context of LP overallocation to the asset class. After the strong performance in private equity over the last 12 months, which has dominated the overall return picture for LPs, investors will look to the secondaries market for portfolio management. “LPs are saying, ‘I want to re-up with my best managers and the only way to do that, because I’ve got an allocation cap, is to clear out some of my older stuff’,” says Gray. Because of this, it feels like it will be a “very active” deployment year, he adds.

The momentum for the secondaries market represents an evolution from a more tempered optimism in the early days of last summer. Nik Morandi, who heads European secondaries for Blackstone, told Secondaries Investor in May that “a desire to refresh portfolios… a desire to take advantage of co-investment flow that’s offered during investment periods of funds… [and] a compression of the fundraising cycle and the speed with which managers are coming back to market” will continue to drive volume on the LP side of the market.

Despite the rosy picture, volatility in public markets, exacerbated by the conflict in Ukraine, could prove a headwind for the secondaries market. As equities trade down, particularly in technology, the market could face an environment in which buyers ask for deeper discounts than LPs are willing to transact at, according to Gray.

While pricing was high in the fourth quarter, at an estimated 97 percent of net asset value for buyouts, market participants now expect pricing to weaken. Portfolios with valuations priced off 30 September NAVs no longer reflect market dynamics. Year-end marks become available in late March/early April, and first-quarter marks are not available until around May. Conceivably, sales of some of the portfolios on the market could be delayed until summer, when pricing may become more certain if some of these factors begin to ease.


Bulking up

While certainly not the only large asset manager, Blackstone is uniquely positioned to note the advantages of scale in alternatives investing, given its $881 billion in AUM and first-place ranking in the PEI 300 group of largest fundraisers, writes Michael Baruch.

Blackstone’s ability to incorporate themes across almost every sector is a “huge competitive advantage”, according to Gray. During his interview with PEI, Gray drew a comparison between the real estate developments that have gone on in Brooklyn, New York, and the opportunity for similar projects in Oakland, California.

In venture and private equity, fintech companies can leverage Blackstone’s connections with Wall Street, or a corporate asset could benefit from an enterprise software product in the growth equity bucket. That synergistic lens also gives the firm confidence to move into new areas, Gray adds.

Besides increasing value for the firm, the breadth of Blackstone’s offerings allows the firm to take on something like an advisory relationship with its counterparties. “Often, sponsors or companies will come to us, and they are not sure what they want,” says Gray. “The ability to be a broad-based capital solutions provider has become very advantageous.”

Another aspect is simply the ability to take down more complex and sizeable transactions. In secondaries, Strategic Partners owns stakes in more than 4,000 funds; the strategy can absorb a portfolio of 40 managers with little trouble. That is untrue for all but a small handful of players in the market currently, according to Gray.

Finally, the firm’s bulk isolates it from the additional costs that smaller managers will likely have to pay to comply with whatever version of disclosure rules end up being passed by the US Securities and Exchange Commission. The reality is that a firm like Blackstone, with robust infrastructure and an army of lawyers and marketers, can already, or with minimal incremental effort, produce the required documentation, whatever it ends up being. Smaller firms, who lack those advantages, will have a much harder time complying.

That said, there are disadvantages to being a behemoth. Smaller funds typically have a broader set of exit options, which can produce multiple expansion opportunities, according to a senior consultant who advises US institutional limited partners. Having a financial buyer, a strategic buyer and a public listing in the mix heightens the competitive dynamic.

Further, the consultant adds, the time and cost of performing due diligence to find the best fund and manager in each asset class is worth it for LPs to seek return premiums across their alternatives portfolio, as opposed to just going with a supermarket approach.

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