At the end of June the world’s largest money manager, BlackRock, hit a major milestone, its assets under management climbed to a record $6.8 trillion. Yet as BlackRock’s assets swell, its revenues and profits are falling. In public markets, the firm’s clients are increasingly migrating from high-margin active management to low-margin index-linked products; an overwhelming body of evidence indicates that the latter produces the best returns in stock and bond markets.
The sole global investment category where BlackRock’s clients and those of its peers are still opting for high-margin active management is private equity. The investment track record indicates that private equity broadly defined – incorporating strategies focused on real assets, credit and venture capital, as well as buyout and growth – is the only investment style capable of producing returns that significantly outperform stock index investing. Private equity’s secret sauce is the kind of hands-on control that permits the transformation of assets and the creation of value through boom or bust, anywhere in the world and in any investment category, from credit to equity.
The potential to boost the returns of virtually any asset through hands-on control is the trial reason BlackRock and its hitherto public market-focused peers, are following the lead of their clients and investing ever larger sums in private equity. They’re doing this both from funds once exclusively devoted to public equities and from new funds focused on private equity. They’re even reorganizing their corporate hierarchies to do this more efficiently. In July, three days before announcing its record assets under management – and its latest disappointing drop in quarterly revenue and profit – BlackRock revealed that it was moving Edwin Conway, its heavy hitting head of global institutional business, to a new position running its growing, but still relatively small, private asset and hedge fund business. The clear mission of Conway: to dramatically expand BlackRock’s private equity operations and the group’s overall profitability.
Others are likely to follow suit. A recent report from Morgan Stanley and Oliver Wyman notes that with fees under pressure faster than asset managers expected (due to the shift to passive index-linked investment in public markets), all asset managers need to rapidly build up in private equity. The report predicts that private market assets under management will grow 10 percent annually through at least 2023, “as the mix of public-to-private capital raising shifts and investors address under-allocation” in PE. Bulking up in private equity is all the more pressing for asset managers given the report’s further prediction that the pool of actively managed capital earmarked for public markets will shrink by over a third in five years.
The urgency with which both asset managers and their clients are moving into private equity is evident in the booming fundraising market. Across all regions and strategies, some $514 billion was raised by private equity funds in 2018 and a record $189 billion was committed to shadow capital structures, i.e., co-investment, separately managed accounts and direct PE investment, according to Triago, the private equity fund advisory where I’m chairman. It was the third best year ever for capital committed to private equity.
Private equity fundraising and investment is now set to accelerate as large public market-focused asset managers shift their attention to PE. In addition to explosive growth in private equity assets under management, a push by large asset managers into PE should produce the following shifts in the global investment landscape:
- Fewer listed companies – already there are 13,695 private equity-backed companies in the U.S. versus just 4,397 publicly listed companies, according to Pitchbook.
- More purchases of private equity asset managers by generalist managers, along the lines of Brookfield Asset Management’s $4.75 billion acquisition of 62 percent of Oaktree Capital Group in March.
- More mergers between mid-sized private equity firms to combat the competitive threat of large public asset managers. Deals between private market firms already accounted for 35 percent of asset manager mergers and acquisitions in 2018, up from some 25 percent three years prior, according to the Morgan Stanley and Oliver Wyman report.
- Greater pressure for smaller private equity managers to specialize in less crowded niches (in everything from litigation finance to digital infrastructure).
- And perhaps most consequential of all, the opening up of new channels permitting retail investment in private equity. As stock markets shrink relative to public markets and as the trial firms responsible for mass investment in public equities shift their attention to private markets, regulators and politicians are likely to look for ways to open up PE investment to everyone.