It was the summer of 2008 and the credit crunch was in full swing as the editorial team at Private Equity International worked on its September issue. Just a few months prior, Blackstone had revealed it suffered a 90 percent drop in economic net income year-on-year during the fourth quarter of 2007, Carlyle’s $23 billion mortgage bond fund Carlyle Capital Corporation had collapsed and Bear Stearns had received an emergency bail-out.
“The allocation to AIM [alternative investments] has exceeded its target, and it appears highly likely that it may exceed the maximum end of the range in the foreseeable future if the public markets do not recover and if distributions do not return to more normal levels”
From a memo compiled by the California Public Employees’ Retirement System’s investment committee staff
But we – and most of the financial world – still had no idea quite how bad it was going to get. Lehman Brothers was still standing.
Our September issue was peppered with references to the market downturn, with one article referring to the “perfect storm of shrinking denominators and trickling distributions” causing anxiety for GPs on the fundraising trail, and another referencing LPs ramping up commitments to distressed debt.
A chart details a slump in loan volume in Europe, the Middle East and Africa in the first half of the year, down from $1.06 trillion backing 1,196 deals in H1 2017 to $514 billion backing 723 deals.
We looked at private investments in public entities that seemed to have been disastrously timed; Warburg Pincus’s $500 million investment in US bond insurer MBIA was trading at a 75 percent discount to purchase price as the issue went to press.
We reported the firm paid $500 million for 16.1 million shares at a purchase price of $31 per share, a 3 percent premium over the closing price the day before the deal was announced. It also agreed to backstop a shareholder rights offering of up to $500 million, which opened up access to a further 16.1 million shares. In 2015 Warburg Pincus sold 27.25 million MBIA shares at a reported price of $8.73 per share.
That summer, KKR – then going by its full name – was broadening its franchise and bulking up internal operations as it geared up for an initial public offering, set for later that year. This, of course, didn’t quite pan out as the firm had expected. Delayed due to the deepening crisis, KKR didn’t join the New York Stock Exchange until 15 July, 2010, in a listing that, in the words of The New York Times, “went off with a yawn”.
The industry was clearly starting to struggle under the weight of macroeconomic conditions – but it was also displaying its power as a diversifier within investors’ portfolios. A chart showed private equity as the bright light for public pension funds in shrinking investment portfolios. The California Public Employees’ Retirement System, for example, saw $10.3 billion wiped off its overall value, and a 2.4 percent loss from its investment portfolio in the year to 30 June, 2008; its private equity portfolio, however, delivered a 19.6 percent return.
Unfortunately, this was short-lived. By 30 June 2009 CalPERS had seen a 24.8 percent decline in its overall investment portfolio, thanks in part to a 25.9 percent drop in its private equity portfolio.
Some of the September 2008 edition is startlingly familiar. Our secondaries special makes for an interesting comparison with this year’s offering. The 2008 version speaks of the sub-asset class shedding its distressed persona and being embraced by GPs and LPs alike as a “portfolio management tool”. This remains a popular refrain, albeit today it tends to refer to the restructuring of old funds rather than the straightforward sale of fund stakes.
It also discusses LPs that have over-diversified their private equity portfolios and are tapping the secondaries market to trim them back to a selection of core relationships. There is talk of the challenges for large LPs of putting money to work anywhere other than the large-cap space, and over-exposure to mega-buyouts through co-investments. In 2018 the biggest LPs are still wondering how to deploy capital in the volumes they require, and co-investments have only grown as part of that. In fact, Cambridge Associates estimates that co-investment makes up around 30 percent of US private equity activity.
But the desire for co-investment is not just to slake investors’ appetite for exposure to the asset class; it’s also a way to mitigate fees. Barring the references to what was clearly a different point in the economic cycle than we’re in today, our September 2008 feature “Would you like some co-invest with that?” could have been ripped straight out of the pages of one of this year’s issues:
“Taking the old saw about the ‘pendulum of power’ at face value, with the proverbial pendulum swinging toward LPs in bad times and back to GPs in good times, the last private equity downturn arguably gave LPs the gumption to push for some better terms – but lower management fees was not among these,” we wrote then.
“This (bad) time around it would appear that GPs at large firms are willing to negotiate around the sacred management fee without actually having to change any numbers in the partnership docs. In so doing they are exploiting an LP desire that may be even more fervent than the desire for lower management fees – the desire to co-invest.”
To use another old saw – what goes around, comes around.