Meena: Welcome to the Center for Investment Excellence. 

Larry: Thank you, Meena. I’m very happy to be here!

Meena: At our annual meeting in March, we shared a chart with our clients that showed institutional investors are reinvesting their private equity gains to maintain their target allocation. According to a survey by Preqin at the end of 2018, approximately 60% of investors were still below their PE targets – so it’s no surprise that as we look at PE fundraising the numbers have been robust in recent years. 

So this leads to my first question, what are your thoughts and concerns about today's market? And would you compare it to what we saw back in 2006-2008 time period? 

Larry: Yes, thinking about the question, I think implicit in there is that the market is cyclical and has cycles. And when you think about today's market, and this is something we've been saying for a number of years, is that the concerns from an investment perspective are the fact that prices have continued to rise and there I’m talking about prices as multiples of companies’ cash flow so paying more for the companies. 

And there's a lot of money in private equity. In fact you could make the case that over the last three or four years, there's as much money in private equity as we have ever seen. And so that’s clearly become a concern. Think about prices - there's more leverage being used and from an investment perspective, those are the areas that we're concerned about. In regards to your link to the 2006, 2007 we’ll talk about what we now can look back and say was the last peak in the market. 

What’s interesting about market cycles is that investors have a tendency to repeat a lot of the same behaviors. So if you look at about 2000 - late 2006 or early 2007, the 10 largest leverage buyouts of all time done over a 9 or 10 month period. So while in retrospect we were at the top of the market, investor behavior certainly didn't act as if they knew they were at the top of the market. 

So when I see sort of parallels between the two periods, certainly I think when people look at cash flow multiples of - paid for business, when they look at fundraising, when they look at the amount quote unquote dry powder, there are a lot of comparisons that make sense and so the concerns that we have now are not dissimilar to concerns that we had back in 2006, 2007. 

I’d say differences are the rate of debt, the amount of debt as expressed in multiples today. And that’s been inching up over the last several years but typically we're talking about five, six, seven times cash flow in terms of the leverage multiples. Compares that to back in 2006 and ’07 where, you know, there was 8, 9, 10, 11 times depending on how it was measured. Also as I referenced earlier the fact that the, you know, the 10 largest deals of all time were being done, there was a lot of activity where the investment was taking large companies or divisions of large companies private. That’s less so today. 

I’d say overall the overall economic environment has been good, so earnings have supported that and companies are doing well. But there's no doubt that the macro environment is a factor, and I say the macro environment, pricing, leverage and cash flow, and the amount of cash that you have to be very disciplined in terms of making investments today. So it’s certainly a reason for caution, it’s not necessarily a reason to not make investments. And I think, I can look back at 2006 and 2007 and say we made some very good investments during that period of time so despite a more difficult environment, so. 

Meena: Private equity firms today, and we've seen this firsthand, they're not shy about raising larger and larger funds given that it’s still and difficult time to invest but if you look at the four, call it, mega funds out there in the last two years I think they raised like $500 billion. And I think that’s also a concern. And what are your thoughts about that? 

Larry: Yes, it’s been a very good fundraising environment. Performance from private investments has been very good. And the amount of capital that’s available is a concern – I think you can point to the fact that in private equity there's a fair amount of incentive to raise capital because the economics incent people to raise capital. 

In regards to the four funds you reference, so if you look at the 2018 McKenzie Report, the report suggested that over 2017, 2018 just over $1.6 trillion has been raised in what they reference as private markets, so that would be private equity, that would be infrastructure, private credit, private real estate, which is an awful lot of money in retrospect. And I think one area in particular, if you look at private credit, you know, your earlier question we were talking about the market in 2006, 2007, investors generally weren't allocating money to private credit at all. And today there’s so much money. 

The four firms that you referenced, kind of interesting to have these big private market firms be public because you know what they did. And if you tally up the four large public or largest public private market firms, they in fact did. So not only was there a lot of money raised but close to 30% of it was raised by three firms. So clearly the amount of capital that’s out there is a concern. 

Meena: So let’s switch it up and talk about venture capital and growth. We're living in the innovation age. There’s a lot of disruptive companies, many of which have been private for a very long time. And as we all know, Lyft made headlines with its recent IPO and there's a long list of unicorns in the pipeline that could also go public, Uber, Pinterest, WeWork, Cloudflare, Slack, etcetera. So is this is the year of the unicorn IPO? 

Larry: Well it certainly - so far it is. You referenced Lyft and Pinterest, as we sit here today is in the market doing their road show, there’s strong speculation that Uber and Slack, which has announced a reverse listing, are also, you know, going - or are going to attempt to go public. The public markets seem receptive and our sense is that as long as the public markets are receptive, these companies will go public. 

You also referenced, I think which is also very important point, which is these companies have been around, you know, for a very long time. And this is not different in the sense that, you know, the last number of years what we've seen is a lot of these young growing innovative companies have stayed private for much, much longer periods of time and when they do go public they're more substantial companies and they're valued much higher, you know, probably classic would be Facebook which I believe went public back in 2012, was nine plus years from founding to going public and went public at $100 billion market capitalization. 

Lyft went public at a market capitalization that was close to $30 billion. So these are big substantial companies with hundreds of millions of dollar of capital. Now they can stay private longer because they can choose to. They can finance. And so the amount of companies that - the amount of money that many of these companies have raised as private companies are also somewhat unprecedented. 

So it may or may not be. Certainly it looks to be the case but I think the market should be very receptive. The market can easily absorb these companies. As you know, you know, if you go and you look at global equity markets back to 2011, those markets - the net equity issuance since 2011 globally has been a negative $9.7 trillion. 

And if you look at these companies with - they're very big, you mentioned unicorns in there, over $1 billion, and you mentioned the Lyft IPO, they're still relatively small relative to say, the, you know, the S&P 500. In fact the projected largest company, that being Uber, might be, from a market capitalization, might be within the top 100. So our sense is that the market can absorb, the market is also looking for growth so I think that’s the case. 

But then more importantly, and I think this is something that you referenced, which I think is very important, which is we've been in a very innovative and disruptive space. And it’s hard to sit back and see how that doesn’t continue. And if it does continue, there are a couple things to reference which I think are important. 

One, I think it’s an opportunity for investment and the other is what we have seen is that innovation, certainly go back to your earlier question, you know, the peak of 2006, 2007 and the market aftermath in terms of the financial system pressures and the recession that we saw in 2008 and 2009, innovation is not generally impacted by macro factors. 

So our sense is that there will still be opportunities but also capital abundance and pricing but there’s still going to be very good and very attractive opportunities. 

Meena: So given the dynamics you just discussed, we talked about the buyout market, elevated fundraising, peak dry powder, etcetera, the obvious question is, is now a good time for investors to commit to private equity? So how should investors think about private equity investment in this part of the cycle? 

Larry: Our view, it’s a good question, and it’s interesting because we talked before about market and market cycles. And I mentioned the fact that we look back, and now your question is, the last peak and the last peak was, you know, 2006, 2007, and I pointed out that during that period of time the 10 largest buyouts of all time were during the peak. So obviously the real time behavior did not suggest the peak. 

I think one of the things, and you touched on it, I think really important and we've talked about which is the fact that fundraising has been so good and that many investors have been under allocated. And a lot of the fundraising tends to be this idea of maintaining your allocation. I think the way we think it makes sense is that every environment private equity has some real advantages in terms of governance and diligence, which make it very attractive to invest. 

But the macro factors of high pricing and capital is something to consider, and our view is that you want to be very disciplined and you want to be opportunistic. I would also suggest that - so a lot of the behaviors to maintain this allocation and our sense - my sense would be is I would not be surprised, and we saw this a little bit when you look at the fourth quarter and we saw global equity markets back up, you know, quite a bit, had that been sustained my sense is that you would have seen a lot less appetite for private markets coming in. And that's simply the sole sort of allocation desire. 

Our sense is you want to be opportunistic, you want to look for opportunities and you want to recognize that there are opportunities in all markets, it’s just that sometimes the macro factors can be something whether they be plus or minus, that should impact your decision making. And so market timing is not something that we're an advocate of. Certainly market cycles present opportunities which you should take advantage of, but the overall concept of market timing is not something that we would strongly advocate.

There's actually a recent academic paper that was written by Steve Kaplan at the University of Chicago which looked at a lot of private equity data. And those people who are interested - I cite it because the purpose of the paper was to address your question about market timing. And I think they looked at a lot of the data. You can certainly draw your own conclusions. But their conclusions were that it would be very difficult to time and they would not suggest investors do that. 

Meena: I also think in private equity it’s very hard to read economic data or the macro environment and make a decision on whether you should or should not invest, right? And so when we, in our group when we think about investing in private equity it’s about the underlying investment. And we've made investments in 2006 in restaurants, right, where at that time you think why would you do a restaurant deal? And so talk about that because I think that’s an important…

Larry: Yes, no, I think you can always find opportunities, right? You can always find good businesses with good teams. So I believe that that's not macro dependent. And you're right, I mean, you could invest in consumer businesses, we did in the last cycle and they suggest that those turned out to be very, very good investments. 

I think the other thing - and you and I and we very much always position with clients this idea that we're not going to make an investment. So we try to take advantage of the fact that we don't have to make investments and we want to be very disciplined. A lot of our clients have a different issue. And that I think is also a factor here today in 2019 that maybe didn't exist in other periods, which is they’ve got a portfolio and they typically have needs, objectives, whatever it is that you want that requires them to find places to meet those return objectives. 

And, you know, there was, you know, recently, you know, a public pension plan here in the US which significantly increased its private equity allocation. And they were very clear about why they were trying to do it. They have a 7% rate - return on asset assumption and didn't feel that their other portfolio would allow them necessarily to meet that. And if they don't meet that obviously it affects well, pension security but more importantly the cost of providing pensions. 

So if you look at, and I think this is not only the - a big factor in today's market, and reference the earlier things that you talked about in terms of amount of money, so investors are looking at their portfolio. And they're looking at where interest rates are, which they continue to be, you know, very low, horribly around the world, credit spreads, very tight, public equity market not a market forecaster, but you know, historically PE rates are sort of high. 

And they're looking at all of these alternative investment scenarios and they're saying, I think, at least - and we've had discussions, as you know, they're saying okay, well maybe I’m going to get less on my private equity return than maybe I would have gotten, you know, five or six or seven years ago but it’s still relative to what I’m looking at attractive and it helps me meet objectives. 

So I think there’s a rationality to it, but like anything else, but very much so in private equity, it’s ultimately what you do at the investment level which is going to drive those returns. It’s not an asset allocation decision or a macro effect that’s going to drive that so implementation is really, really important. 

Meena: Great. Thanks, Larry. Thanks for joining us on the Center for Investment Excellence. 

Larry: Thank you, Meena.