Does the emerging markets private equity asset class scale?
No. I don’t believe it does.
In fact, I think the absorptive capacity of EM PE / VC is as low as $16 billion in new flows per year, compared to the $40 billion in fundraising we’ve seen on average since 2011. At least, that’s my finding in Portico’s most recent research piece: Does the Emerging Markets Private Equity Asset Class Scale?
The inspiration for this think piece comes from Fred Wilson, co-founder of Union Square Ventures, who wrote a fascinating blog post in 2009 on “The Venture Capital Math Problem.” If you haven’t read it, you should. In it, Fred concluded that the volume of exits in U.S. venture right-sized the industry between $15 billion and $17 billion in flows per year, remarkably similar to the conclusion I reached.
While this piece isn’t likely to win me many friends, I hope that it provides some food for thought, and that it sparks some lively conversations. I’d love to hear your feedback!
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Happy holidays to you and yours, and best wishes for health and happiness in 2018.
A mea culpa is in order. In last month’s newsletter, I (somewhat cheekily) called out IFC for committing $25M to Carlyle’s $5B Asia Partners V; it was actually to their ($1B target) Asia *Growth* Partners V. Sloppy mistake. I apologize. Thank you to the discerning reader who noticed my error and called me out on it.
That said, I still don’t understand why IFC is funding a fifth-series Carlyle fund. According to IFC’s disclosure of the commitment, as of 31 December 2016, Carlyle held approximately $158B in AUM. This figure is ~70% greater than IFC’s total assets, ~4x the value of IFC’s total investments, and nearly 12x the value of IFC’s equity investments (as of 30 June 2017; see IFC’s consolidated balance sheets at this link).
KKR Quits Africa
We’ve dedicated a decent number of pixels in our newsletters to the issue of large-cap deal flow in Africa. Late last month, KKR decided to disband its Africa team for good. Several of the team’s dealmakers left earlier this year, in part, it seems, because they were investing out of KKR’s European fund and were losing out to French, German, etc. deals in IC meetings.
But a KKR spokesman breaks it down pretty plainly: “To invest our funds we need deal-flow of a certain size. It was especially the deal-size that wasn’t coming through.”
Invariably, KKR’s spokesman continues, “There was enough deal-flow at a smaller level.”
The Power of Compounding
Albright Capital recently released an enjoyable piece on “The Power of Compounding” in an EM portfolio. The firm compares the returns that three hypothetical long-only investors would have received from the MSCI EM, based on their (in)ability to time the market.
It’s an original thought experiment with results that might surprise you.
Will Robots Disrupt Private Equity?
McKinsey Global Institute released its analysis of the impact of automation on jobs. They estimate that “up to 375 million people may need to switch occupational categories” by 2030, with up to one-third of the U.S. and German workforces—and half of Japan’s—needing to learn new skills and pursue new occupations.
Will “private equity investor” be one of these disrupted occupations? Could robots do a better job at allocating capital? Given the recent performance figures, at least in EM, one could be forgiven for thinking so.
There’s an alluring argument that private markets are less ripe for disruption than public markets: not only is there less data available, but also the manager can apply sophisticated judgment and hard-earned pattern recognition skills to source proprietary deals, construct a quality portfolio, and create value.
I’m not entirely convinced. Consider an analysis from Dan Rasmussen of Verdad, who, whilst at Bain Capital, examined 2,500 deals representing $350 billion of invested capital:
About one-third of the deals analyzed accounted for more than 100% of profits (no surprise there) and the majority of the deals in the sample fell well short of the forecasts built into the financial models. The biggest predictor of whether a company would be a big winner or not was the purchase price paid. The dividing line seemed to be 7x earnings before interest, taxes, depreciation and amortization (EBITDA). When PE firms paid more than 7x EBITDA, their chance of success plummeted — regardless of how much managerial magic they threw at it. The 25% of the cheapest deals accounted for 60% of the profits. The most expensive 50% of deals accounted for only about 10% of profits.
In other words, all the fancy analysis and financial models performed worse than the simple rule “buy all deals at less than 7x EBITDA” [emphasis added]. A simple quantitative rule worked better than expert judgment.
I was recently speaking with Abby Phenix—formerly of Advent International, now assisting PE firms with customer due diligence—and we ended up riffing on this topic for a bit. In the past, she raised some thought-provoking points about the automation prospects for manager selection (think funds of funds) and investment analysis (think associates), which could enhance productivity and reduce costs (think management fees).
What is it that investors want? Cost-effective exposure to the investable asset or the privilege of paying fees to the middleman?
Is it Possible to Short Graduate Schools?
This statistic surprised me: the stock of U.S. student loan debt ($1.3 trillion) is now equal to the size of the U.S. junk bond market. Astonishing.
Estimates from The New America Foundation suggest that upwards of 40% of this is tied to graduate school debt. If I could short the graduate education market directly, I would.
Consider that in 2012, 25% of graduate students were burdened with at least $100,000 of student loan debt. Meanwhile, in 2016, the median incomes for master’s degree holders in the United States were roughly $80,000 for males and $58,000 for females. The math doesn’t work, prospective students know it, and there’s a broad-based slowdown in applications (see below).
Effectively, the market for graduate education experienced a debt-financed positive demand shock, universities expanded supply, and now there is a negative demand shock. Schools will need to cut tuition and take a hard look at which costs can be cut.
If you’re keen to learn more about just how much of a mess this is, I wrote a piece about this on my personal blog (source of the exhibit above).
Lots of data. Lots of charts. Oodles of other content.
From the Bookshelf
I returned, and saw under the sun, that the race is not to the swift, nor the battle to the strong, neither yet bread to the wise, nor yet riches to men of understanding, nor yet favour to men of skill; but time and chance happeneth to them all.
For what is a man profited, if he shall gain the whole world, and lose his own soul?
(Matthew 16: 26)
— The Bible: Authorized King James Version (Oxford World’s Classics: 2008).
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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.
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