A CDO for Secondaries?
A year or so ago I floated the idea of an index fund for EM private assets.
What if there were an asset manager that could agglomerate a sufficient pool of capital through a publicly listed vehicle (e.g., a super-SPAC) to go out and purchase — in whole or in part — scores of PE-backed companies across EM?
Would a diversified portfolio — at scale — provide better risk-adjusted returns than existing public and private equity funds?
My bias had been toward equity.
But what if the answer is debt?
And not just any kind of debt, but securitized debt?
* * *
Andrew Lo — Director of the MIT Laboratory for Financial Engineering — recently gave a fascinating lecture on new funding models for biomedical innovation as part of the Markus’ Academy series of webinars at Princeton’s Bendheim Center for Finance.
Lo argues that, whilst we’re living amidst a revolution in a variety of ‘omics’ (e.g., genomics, proteomics, microbiomics), to actualize and commercialize scientific and medical advancements, we need a revolution in economics — particularly in how we finance innovation.
At first glance it might seem like an odd proposition.
Even if U.S. venture is exhibiting a ‘diversity breakdown,’ biopharma companies are sitting on $1.5 trillion in ‘firepower’ to fund transactions.
Isn’t there enough funding available already?
Lo asks us to ponder whether it’s worth making a $200m investment in something with the profile of a single anti-cancer compound (i.e., 5% probability of a positive payoff after 10 years of R&D). If successful, annual profits would be $2B / year for 10 years (a present value of $12.3B).
At a 95% failure rate, investing makes little sense.
But Lo points out that if you could invest in 150 programs simultaneously (totaling $30B of capital), the probability of 3 successes out of 150 attempts is 98.18%, and the Sharpe ratio increases from 0.02 to 0.34.
* * *
What if we translate this idea to the EM private markets index?
Would we see:
- A lower cost of capital for EM companies?
- Longer runways for value creation?
- Higher risk-adjusted returns for investors?
- Lower fees?
- Greater liquidity (e.g., coupons)?
I don’t know.
But I wonder: maybe — maybe — the solution for the artisanal industry of EM private markets is diversification and massive scale?
Viktor Shvets on The Great Rupture
In the latest episode of the Portico Podcast, I speak with Viktor Shvets, a global strategist at Macquarie, and the author of the deeply thought-provoking book The Great Rupture, which investigates the past and interrogates current trends to probe the question: do we need to be free to be innovative, prosperous, or even happy?
You may want to grab a pen and some paper to take notes for this episode because Viktor is a polymath who will engage your brain in some important — and at times, unsettling — thought experiments.
Viktor and I discuss:
- Why he wrote a book that looks for lessons in the 12th to 15th Centuries to guide us through the next two decades;
- Whether the ‘operating system’ of open markets, property rights, and open minds that generated prosperity in the past is in retreat — and even if it were, would it matter;
- The confluence of the information and financial revolutions, and how these two forces are hollowing out the core frameworks of society;
- The state’s usurpation of the free market and what it means for capitalism and commercial banking;
- The prospects for emerging markets in an era of de-globalization and the importance of EMs’ non-tradable sectors;
- Whether universal basic income might liberate people from scarcity and empower them to live lives of their choosing.
But there is so, so much more.
Check it out on Apple Podcasts | Google Podcasts | Spotify
Does PE Investment in Healthcare Benefit Patients?
- “Our estimates show that PE ownership increases the short-term mortality of Medicare patients by 10%, implying 20,150 lives lost due to PE ownership over our twelve-year sample period. This is accompanied by declines in other measures of patient well-being, such as lower mobility, while taxpayer spending per patient episode increases by 11%.”
- “We find that going to a PE-owned nursing home increases the probability of taking antipsychotic medications — discouraged in the elderly due to their association with greater mortality — by 50%.”
- “We find that PE ownership leads to a 3% decline in hours per patient-day supplied by the frontline nursing assistants who provide the vast majority of caregiving hours and perform crucial well-being services such as mobility assistance, personal interaction, and cleaning to minimize infection risk and ensure sanitary conditions. Overall staffing declines by 1.4%.”
- “A puzzle is why nursing homes are attractive targets given their low and regulated profit margins, often cited at just 1-2%. Using CMS cost reports, we find that there is no effect of buyouts on net income, raising the question of how PE firms create value. There are three types of expenditures that are particularly associated with PE profits and tax strategies: “monitoring fees” charged to portfolio companies, lease payments after real estate is sold to generate cash flows, andinterest payments reflecting the importance of leverage in the PE business model (Metrick and Yasuda, 2010; Phalippou et al., 2018). We find that all three types of expenditures increase after buyouts, with interest payments rising by over 300%. These results, along with the decline in nurse availability, suggest a systematic shift in operating costs away from patient care.”
Bain’s Global PE Report
A few highlights from the year in review:
- Global buyout deal value reached $592m (up 8% yoy) whilst deal count declined by 24%;
- ~70% of U.S. buyouts were priced above 11x EBITDA whilst ~80% of deals are leveraged 6x or greater; and,
- The number of global buyout exits appears to have fallen below 1,000 — the worst year since 2009.
Hugh MacArthur and Mike McKay ask: Have classic buyout funds run their course?
When I look at the data points highlighted above, I think the answer will turn out to be a resounding ‘yes.’
MacArthur and McKay point to the rise of specialist funds, carving out space for a discussion on the evolution of Vista’s strategy, among other things.
Look. Buyout firms absolutely need a differentiated value proposition.
But in a world of capital superabundance, the average buyout firm offers declining utility as an allocator of capital.
Speaking of Vista.
By now you will have heard that Vista’s founder, Robert Smith, struck a non-prosecution deal with the U.S. government in which he admitted to evading taxes for 15 years.
There are some lawsuits alleging mismarked assets and self-dealing.
Amidst all the talk about ESG, do institutional LPs value good governance?
In the case of Vista, one seems to. Several don’t.
But it’s a much bigger question (Abraaj: Redux 👀).
Do institutional LPs actually do their homework on larger funds?
Or are the investment teams too cozy with their contractors?
Zhou Xiaochuan and the eRMB
Caixin / Nikkei Asia published an important article from former PBOC governor Zhou Xiaochuan on the landscape for a digital renminbi. This is a space worth watching.
From the Bookshelf
Human history is indeed filled with endless possibilities; and the Renaissance saw this more clearly than either classicism, Catholicism or the Reformation. But it did not recognize that history is filled with endless possibilities of good and evil. It believed that the cumulations of knowledge and the extensions of reason, the progressive conquest of nature and (in its later developments) the technical extension of social cohesion, all of which inhere in the “progress” of history, were guarantees of the gradual conquest of chaos and evil by the force of reason and order. It did not recognize that every new human potency may be an instrument of chaos as well as of order; and that history, therefore, has no solution of its own problem.
— Reinhold Niebuhr, The Nature and Destiny of Man: Volume II. Human Destiny (Charles Scribner’s Sons: 1964)
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