Perspectives on Private Capital

Steve Kaplan: Private equity barely existed 35 years ago, but that has changed markedly. Buyouts and private credit have both grown to where 10–15 percent of the US economy sits in PE-funded companies—which is part of the reason it gets so much attention.

There’s a lot of misinformation out there about performance, so to set the record straight: Buyout funds have beaten the S&P 500 over the past 25 years, net of fees, which helps explain why so much money has gone in to private equity.

What are some changes you’ve seen over the past decade?

Martin Nesbitt: PE version 1.0 was financial engineering, 2.0 was operating expertise, and 3.0 is: Do you have a real understanding of global economic and policy dynamics and how they affect these industries?

More capital has come in, creating competition and driving up prices. If you want to still meet your return objectives, you have to do something different. For us, that’s more insight—a better strategic and operating understanding of the industries we invest in—and using that insight to create value.

Raymond Svider: The biggest thing that’s changed is access to information. There’s more transparency. It dovetails with what Marty said—to create value, you need to know more. There is still asymmetry of information in today’s world despite the transparency, but you need to work a bit harder for it. In the 1980s, the way we were doing business was similar, with a focus on operational intensity—changing things—and strategy. But we were doing it with a base of information that was incredibly limited because that’s what was available.

Kaplan: One interesting phenomenon is the growth of private credit. Blair, why are you (and Ares) doing this and not the banks?

Jacobson: What we do in terms of private credit is what banks used to do. There’s been a seismic shift in the market over the past 20 to 30 years. In many ways, we believe the banking sector is in secular decline, whereas private-capital providers such as ours are growing their market share.

The reasons are pretty simple. In the 1980s and ’90s, US banks consolidated, and in so doing, they stopped serving smaller and midsize businesses. The second thing that happened was the financial crisis. In Europe, a significant number of banks simply went out of business. The third factor is regulation. The Volcker rule, Dodd-Frank, the Basel regime, and other regulations made it more difficult and less profitable for banks to provide this type of finance to companies, so banks don’t want these assets on their balance sheets.

At Ares, we have nearly 200 bankers in the United States and almost 100 in Europe looking for loans. However, we don’t book them on bank balance sheets. We book them on behalf of pension plans, insurance companies, high-net-worth individuals, sovereign wealth funds, and others who are the new beneficiaries of these attractive loan assets.

Svider: In the lower midmarket or even in the midmarket, you don’t compete with banks anymore, but if you have scale, it’s a great business to be in.

A year ago, if you were looking to raise $1 billion, no US bank would give it to you because volatility made it difficult to price risk and consequently the syndicated market wasn’t there. The syndicated market for larger deals is back now. But if you need a $300 million loan, nobody’s interested. Why? Because it’s not liquid.

Kaplan: How will private equity do in the future?

Svider: There’s been a shift of capital into PE from institutional investors worldwide over the past 30 years. The industry has delivered performance, and at the core of that is a better agency model. It’s aligned incentive. You have money on the line, and it is the level of information, the level of work, and the knowledge you have when you take ownership of a company that are markedly different from the public market.

The agency model will continue to be a better model than the public markets. The industry will continue to evolve, but the returns today are not materially different from what they were 25 or 30 years ago. Throughout cycles, the industry has done relatively well—during the global financial crisis, for instance. Returns are going to go up and down together with the economy and the markets, but on a relative basis, it’s still going to be a better place to put your money to work.

Nesbitt: Because of that agency model, firms are figuring out that they have complementary insights. Each firm has a limited amount of capital to put to work, but they can get better performance if they work together. There’s been a proliferation of firms over the past couple of decades, and I think you’re going to see more and more partnerships evolve and maybe some consolidation happen.

Purcell: From our corner of the world, we look at consumer packaged goods companies and they’re four times larger today than they were 30 years ago. They use M&A as a once-every-four-or-five-year tool. And it can be risky. They’re buying an entrepreneurial venture with people who run fast and may or may not fit well in their larger structure.

What we do is de-risk things for that next corporate buyer. We’re outgunned, we’re outmanned, and we’re certainly out-capitalized, but we’re making businesses better. And I believe the world will continue to have larger and larger companies, many of which will need private equity’s help when it comes to producing M&A opportunities that will benefit earnings and shareholders.

Blair Jacobson, ’99, is partner and cohead of European credit in the Ares credit group at Los Angeles-based global alternative-investment manager Ares Management. Martin Nesbitt, ’89, is cofounder and co-CEO of private-investment firm Chicago-based Vistria Group. Gregory Purcell, ’94, is founder and CEO of Chicago-based Arbor Investments, a specialized private-equity firm focused exclusively on middle-market food and beverage companies. Raymond Svider, ’89, is chairman of London-based European investment firm BC Partners.

Steve Kaplan is the Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance at Booth and Kessenich E. P. Faculty Director at the Polsky Center for Entrepreneurship and Innovation at the University of Chicago. 

For more on Booth’s 71st Management Conference, read Investment Strategy, Inflation Spirals, and the Future of US Healthcare.