The Winner-Take-Most World

Did you know that KKR said it collected $1.4 billion in management fees last year?

And that its annual income from management fees has grown by $710m since 2015?

It blows my mind.

Hats off to the team for executing a bold growth strategy.

But … it just seems like a waste of money, doesn’t it?

The firm collected $6.2B in management fees between 2015-20.

The bulk of that likely flowed to individuals with a low marginal propensity to consume. 

(Comp and benefits accounted for ~70% of expenses between 2018-20, according to the latest 10-K).

And it also flowed to a firm with a low marginal propensity to invest. 

(Based on the historical financials accessed via Koyfin, the firm’s MPI [= ΔI / ΔY] was actually negative comparing 2015 to 2020; it averages out to 0.11 between 2016-20).

What boggles the mind is there are allocators at large institutions who have no compunctions about handing a growing amount of pensioners’ savings over to mega-cap firms, largely to pay the latter’s employees to show up to work.

It’s not as if this is hidden knowledge. It’s laid out in public filings. For instance, here’s KKR’s segmented revenues for 2020:

What an amazing business.
 
(Note that the management fees in the chart are provided on a GAAP basis, and the $1.4B figure cited at the top is based on a KKR presentation featuring recast, non-GAAP financials).

* * *

When I see KKR’s $710m increase in annual management fees, I can’t help but think about several clients that are raising funds and could invest that money in wealth- and health-creating companies. 
 
Alas, these firms aren’t on many LPs’ radar screens because their fund sizes are “sub-scale.” Or they require too much legwork. Or they’re so “risky” that it makes more sense to pay a toll to KKR (and / or Apollo / Blackstone / Carlyle, etc.) than to use it as callable capital.
 
Look. This isn’t just about KKR. They’re a premium brand for a reason.
 
But the specific case is useful for what it tells us about private markets and the world more broadly.
 
And that is that we’re in a winner-take-most economy.
 
The inequalities across multiple vectors have been getting worse for a long time.
 
Just look at this chart from Morgan Stanley global strategist Ruchir Sharma (source):

I believe the consolidation of capital in fewer, large-scale managers is leading to less innovation and more sclerosis. And I think the incentive structures at large LPs and GPs are broken, contributing to poisonous outcomes.

It’s all a bit evocative of Matthew Klein and Michael Pettis’s Trade Wars Are Class Wars, which argues that international trade conflicts are a direct result of domestic inequality. Namely, “a conflict between bankers and owners of financial assets on one side and ordinary households on the other.”

It’s unsustainable.

— Mike


The Caesars Palace Coup

Speaking of mega-cap buyouts, I have a summer book recommendation: The Caesars Palace Coup by Max Frumes and Sujeet Indap.

It’s a riveting telling of the rapacious actions of Apollo and TPG, and the combative restructuring of Caesars Entertainment. 

A taste:

Too many people — and often twenty- and thirty-something-year-old men trying too hard to prove themselves as tough guys — private equity and hedge fund alike, were fighting merely out of vanity. Most of these funds took money from identical pensions — Texas Teachers, CalPERS, CalSTRS. These fights to the death just moved money from different pockets of the same investors.


Mobile Money Metrics

GSMA has released its Mobile Money Metrics portal.
 
Given the vital and growing role that mobile financial services play globally, this is a terrific resource not only to glean insights on the scale of mobile money accounts, agents, and transactions by geography, but also the names of services in each country. 
 
It’s awesome. Check it out.


The Abraaj Fiasco

I wanted to experiment with a different format with the Portico Podcast, and decided to revisit my writings on the Abraaj fraud scandal as they were happening in real time a few years ago.

It’s hard to overstate the impact Abraaj’s governance failures had — and continue to have — on EM private markets. Give it a listen and let me know what you think.


Persistence in PE / VC Performance

fresh look at the persistence of PE & VC funds using Burgiss data.


From the Bookshelf

For decades, the U.S. Treasury’s approach to international finance was driven largely by what made sense for major American commercial and investment banks and the owners of financial capital. The interests of everyone else in the economy were largely ignored, if not outright opposed by counterproductive commitments to maintain a strong dollar. This was always justified on the grounds that deregulating capital and increasing its mobility would lead to the best possible outcomes.
 
The resulting increases in wealth, they explained, would inevitably trickle down to all Americans — never mind that international capital flows are far more likely to be driven by speculation, investment fads, capital flight, and reserve accumulation (often for mercantilist purposes) than by sober investment decisions about the best long-term uses of capital …
 
The world’s rich were able to benefit at the expense of the world’s workers and retirees because the interests of American financiers were complementary to the interests of Chinese and German industrialists. Both complemented the interests of the wealthiest throughout the world, even from the poorest countries. The modern surplus countries do not need colonies to absorb their excess production because they can work with bankers, their willing collaborators in the deficit countries.
 
The perverse result is that deepening globalization and rising inequality have reinforced each other.

— Matthew C. Klein and Michael Pettis, Trade Wars Are Class Wars (Yale University Press: 2020)

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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.

Copyright © by Portico Advisers, LLC 2021, all rights reserved.

Ep. 5: Weijian Shan on Leverage and Turnarounds in Asia



In this episode, I speak with Weijian Shan, the chairman and CEO of PAG — a leading Asia-focused alternative investments firm with ~ $40 billion of assets under management.

Prior to PAG, Shan was a co-managing partner of TPG Asia (formerly known as Newbridge Capital).

It was a real honor to have Shan on the podcast, as his life story is remarkable.

If you haven’t read his memoir Out of the Gobi yet, I heartily encourage you to do so. It’s an extraordinary book that recounts Shan’s experiences during the Cultural Revolution — particularly the six years he spent doing hard labor in a re-education camp — and the transformative impact that the normalization of U.S.-China relations and Deng Xiaoping’s economic reforms had on China generally, and on Shan in particular.

And he’s just written a new book called Money Games, which details the rescue of one of Korea’s largest banks on the heels of the Asian Financial Crisis.

I reached out to Shan after finishing Money Games because — in addition to providing one of the few narratives to detail a private equity transaction from sourcing through exit — I think his book offers tremendous insights into the art of private equity deal-making, and I wanted to explore some of the themes it raises.

In addition to his books, Shan and I discuss the importance of stakeholder analysis when structuring private equity investments; whether there is a problem of too much debt in the Chinese economy; SOE reform, and the prospects for China’s economic rebalancing toward domestic consumption; the institutionalization of private equity in Asia; and, his advice for younger people who wish to pursue a career in private equity, among other topics.

Shan’s thoughtful comments prompted me to rethink some of my own analyses and assumptions. I really enjoyed this conversation, and I hope you will, too.

This podcast was recorded in December 2020.

The Wealth of Nations

A few years ago, my wife and I enjoyed a marvelous walking safari through the bush of Tanzania.

After camping in the village of Nainokanoka, we set off early with Moloton, our Maasai guide, and we trekked amongst the buffalo, gazelles, wildebeest, and zebra on our way to a campsite at Empakaai, a gorgeous crater lake that legions of flamingos call home.

It was positively Edenic … I still can’t believe my wife did it while pregnant …

Anyway, as we walked through some of the villages, I noticed an abundance of domesticated animals grazing around the boma — cattle, goats, sheep, chickens.

Since this was a long hike, I had lots of time to get lost in thought. And I kept pondering one question: who’s wealthier, a Maasai elder or your average American?

I’ve finally written down my take on this thought experiment, which you may read at this link.

Having hit publish on the piece a day after closing on a house (and thus taking on a mortgage for the next three decades), I’ve found myself acutely sensitive to the role credit plays in the U.S. economy. This machine runs on debt … future earnings are earmarked for today’s consumption.

There have been numerous articles of late warning about an impending crisis amongst over-leveraged emerging market companies and governments. A strong dollar / dollar shortage, higher borrowing costs and roll risk are genuine challenges, indeed. As Michael Pettis warned, capital structure matters bigly (see this month’s From the Bookshelf).

However, I think the sensitivity of U.S. households to rising rates is underappreciated. Personal consumption expenditures constitute nearly 70% of U.S. GDP. With higher interest expenses and higher prices due to “trade wars” — and with as-yet-unseen meaningful wage inflation — I think many American households are going to be wondering what happened to the purchasing power of their tax cuts. #youvebeenduped

On the other hand, I think many emerging market countries’ households have stronger, more resilient balance sheets. See, for example, our Maasai elder:

Maasai2

According to EMPEA statistics, only $5 billion was raised for EM PE / VC funds ex-Asia last year, and a measly $397 million in Q1 2018.

The scarcity of long-term capital flowing to these markets tells me that few investors see the world this way. And that may suggest we’re on the cusp of one of the most promising moments for wealth creation that EMs have seen in the last decade.

Have a great summer.

Alla prossima,
Mike

Mekong

Vietnam has been one of the hottest markets of late. Understandably so! It’s an alluring country with tremendous energy.

Chris Freund, founder of Mekong Capital, has been working and investing in Vietnam since the U.S. embargo was lifted in 1994. He has written a refreshingly candid piece on the origin and evolution of his firm, and its role in the development of Vietnam’s private sector.

While the article provides lessons that the Mekong team learned across multiple funds — the perils of strategy drift, the challenges of building strong management teams — it’s also a chronicle that can be read as an embodiment of EM PE’s evolution over the last two decades.

Mekong reportedly plans to go to market with Mekong Enterprise Fund IV.

I wish them well.

LP-GP Fit

The majority of times I meet with GPs, they’re eager to start pitching — which is often why we’re meeting in the first place and is an exciting part of my job. But I usually like to ask if I can talk to you about Sapphire first to give an overview of who we are what our investment thesis is.

That way, we can find out early in the conversation if there is alignment between the fund you’re raising and what we’re investing in. If there isn’t alignment, you’ve just been spared making your well thought out pitch only to find out that your fund is out of scope for Sapphire. Additionally, often times a LP will offer critical clues about what they care about which will allow you to tailor your pitch to what that LP cares about.

So when you walk into a meeting with an LP, pause to ask them about their business first, instead of jumping right into your pitch.

Brad Feld of Foundry Group recently circulated an article by Elizabeth Clarkson of Sapphire Ventures on the issue of LP-GP fit. While it’s focused on the top questions U.S. venture firms should ask prospective LPs, the nine questions are germane to managers of all types of vehicles, in all types of geographies.

I would encourage all GPs to read it.

Know your audience.

The Perils of Business Travel

So there I was — a few hours into a 15-hour flight, staring at the seat-back screen, watching as the icon of our plane crawled northwest on the map, one interminable pixel at a time. Each pixel representing some untold number of miles further from my family.

Locked in that aluminum can, arcing toward Asia at 35,000 feet, in a most calm and reasonable manner, I said to myself, “F@&! this s@&! man! F@&! it!”

It was then that I decided I was going to take a break from air travel, and I have just about reached the end of my self-imposed one-year flight ban.

It has been as great as I thought it would be.

Alas, as I began gearing up mentally to hit the skies again, I came across an article in HBR — “Just How Bad Is Business Travel for Your Health? Here’s the Data.”

The conclusions are pretty jarring:

  • Compared to those who spent one to six nights a month away from home for business travel, those who spent 14 or more nights away from home per month had significantly higher body mass index scores and were significantly more likely to report the following: poor self-rated health; clinical symptoms of anxiety, depression and alcohol dependence; no physical activity or exercise; smoking; and trouble sleeping.
  • A study of health insurance claims among World Bank staff and consultants found that travelers had significantly higher claims than their non-traveling peers for all conditions considered, including chronic diseases such as asthma and back disorders. The highest increase in health-related claims was for the stress-related disorders.

Maybe I should extend the ban …

Sharing Is Caring

Nearly two months have gone by, and I’m still thinking about the ODESZA concert I attended.

Their music won’t resonate with everyone, but if you’ve got a soul and enjoy funky beats, it’s pretty dope. Their jams easily boost my productivity by 33%.

ODESZA’s hitting Singapore, Jakarta, and KL in July, and the show is so good that — all protestations about air travel notwithstanding — I’m tempted to make the trip.

My only reservation is that it just takes so long to get there.

And by that I mean from Soekarno-Hatta to the venue.

There’s a 16-minute teaser of one of their earlier albums, but it’s just the tip of the iceberg. Bon appetit.

From the Bookshelf

Although there are significant differences from country to country and from region to region, from a corporate finance point of view these markets actually have far more in common than they have in differences, and they respond in very similar ways to external shocks …
 
An examination of sovereign debt history suggests that there is no obvious conclusion to be drawn about the correlation between, on the one hand, liberal economic policies and sustainable economic growth, and, on the other hand, industrial policies and economic stagnation. During periods of ample global liquidity, most economic policies seem to ‘work’ because of foreign capital inflows, while they all ‘fail’ when liquidity dries up …
 
The once-conventional and still dominant explanation of capital flows focuses on what are called ‘pull’ factors. This approach … argues that rich-country investors continuously evaluate profit opportunities at home and abroad and, when growth prospects in less developed countries seem favorable, they make the decision to invest … The focus of analysis is on local economic fundamentals, and the basic assumption is that improved growth prospects precede and cause investment inflows 
 
The alternative approach … focuses less on local economic conditions and more on changes in the liquidity of rich-country markets. It posits that when investors have excess liquidity — more than can be invested in traditional low-risk markets at home — they look elsewhere for investment opportunities … Here the basic assumption is that capital inflows precede and cause growth

Because the lure of capital inflows is so powerful, it creates a huge incentive for local policy-makers to implement whatever development policies are currently fashionable among rich-country bankers.

I want to stress the word ‘fashionable’ because there is little historical evidence that previous policy packages that were praised and rewarded by investors were, in the end, successful in generating sustainable wealth.

— Michael Pettis, The Volatility Machine (Oxford University Press: 2001)

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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.

Copyright © by Portico Advisers, LLC 2018, all rights reserved.