Friday Letter: Wells Fargo lookalikes

Listening to GPs at the Milken Institute Global Conference in Los Angeles this week, one thing was abundantly clear: the large-cap end of private equity’s evolution beyond its buyout foundations, though far advanced already, is bound to continue as fresh capital keeps on pushing in.

With banks still struggling to fully recover from the global financial crisis, hampered by regulation and in many cases now wary of who they lend to, private equity has stepped in to fill the void, and it’s left some of the largest managers looking much more like Wells Fargo than Gordon Gekko.

The ongoing evolution towards the asset management model has been supported by a broader and more institutional client base. Speaking on one panel, Apollo’s Leon Black noted that in today’s marketplace structures like separate accounts are becoming more commonplace, as is the pressure for managers to charge less. Pension plans are fond of cheap options and steady yield, which on the one hand is driving them into co-investment, and on the other is making them receptive to the kind of credit offerings that many GPs wouldn’t have considered a decade ago.

Investors have impacted the industry in other ways as well. Bigger LP tickets make for larger funds, and the growth of direct and co-investments for pricier companies. Ben Horowitz, co-founder of high profile VC firm Andreessen Horowitz, noted on another panel that institutions are driving up the prices for early-stage growth companies by backing them directly, just like they have traditionally backed blue chip corporations.

Whichever way you look at it: valuations are up, prices are up, and newly raised capital is piling up like snowdrifts. Notably, while almost every GP Private Equity International heard on or off the stage admitted to this being a concern, few had an answer as to how to deal with it.

On the stage, industry heavyweights like Blackstone’s Steve Schwarzman and Robert Smith of Vista pointed to broad sectors of the economy like real estate and energy, as well as specific technologies like 3-D printing, as pockets of opportunity for the near term. Off the stage, GPs were less optimistic and more candid about having to push bolt-ons and carve-outs as a way of mitigating against pricier investments. However, both groups struggled to offer up a compelling answer as to where all the money that’s being raised can be invested profitably.

But again, mixed in with all the conversations around sector investments, technology disruptors and innovative deal sourcing was a common thread: the large GPs we heard and talked to are getting deeper and deeper into the credit markets to provide loans and similar products beyond their more traditional private equity strategies.

Black said during his panel that he was struck by the recent Blackstone/GE deal in real estate, and what it said about the compliance reality for traditional finance businesses. “I think you’re going to see more interest in credit instruments, and for the firms that can provide them there are a variety of options,” he concluded.

For the Apollos of the world, this can only mean one thing: to carry on building out their already vast investment apparatuses so as to be able to be many things to most people. For everyone else, the thousands of smaller managers out there, it means getting ever more creative with their existing private equity strategies. Do stay tuned.