Ecole hôteliere de Lausanne, a leading hospitality school, recently staged the 2nd annual private markets research conference. Private equity was a major focus this year particularly as the Norwegian sovereign wealth fund had recently decided against investing in this area.
Private equity, or unlisted equity investment, has had an impact on a wide range of industries, including hospitality. A few years ago, Blackstone’s $26 billion Hilton deal was hailed as the best leveraged buyout ever. According to a Bloomberg View columnist, the most profitable equity deal in history was ‘badly timed but brilliantly executed.’
So, what’s the outlook for private equity and private markets now?
The future of private equity returns is heading downward but finance professor Tim Jenkinson of Saïd Business School at Oxford University stressed in a keynote speech at the conference there were ‘surprisingly few vintages when global buyouts don’t outperform public markets.’
“Investing in PE is a long-term strategy.” Jenkinson told Hospitality Insights that if sovereign wealth funds and others want to pay pensions, they’ve got to make money. With stock markets shrinking around the world, “private equity can play an important role in getting the returns you need to achieve your objectives, whether that’s paying pensions, funding universities, funding medical research or whatever.”
However, some major pension and sovereign wealth funds may feel that PE represents an expensive form of financial intermediation. “That’s a fancy way of saying that private equity managers are paid a lot of money and are paid a management fee which is typically between one and two percent per annum. That, in itself, may not the problem but they’re also paid a share of the profits which is typically 20 percent of the profits that are made.”
“We can argue whether it’s right to pay a private equity manager such high sums of money, how much skill there is associated with them, whether it’s morally right – the same sort of arguments we have about footballers and the like – but at the end of the day it comes down to the returns net of those fees, and those have tended to be quite good.”
According to EPFL associate professor of finance, Rüdiger Fahlenbrach, who moderated a roundtable session on future trends in the private markets industry, PE offers diversification benefits which should be attractive to large sovereign wealth funds and other investors, although it may be difficult to control the risks so investments could ‘backfire.’
Fahlenbrach says he’s also somewhat more pessimistic about the outlook for returns in PE as “there’s a lot of money competing for a limited amount of deals … The private equity industry is highly cyclical so if there are a lot of inflows, returns are typically compressed.”
“For me, private equity is a matter of trust,” said Cyril Demaria, head of private markets at Wellershoff & Partners, adding that the outlook for the asset class is ‘quite positive’ although the challenge will be to maintain returns.
About the 2nd annual private markets research conference
Most of the (attendees) told us this is really the first private markets conference in Europe … You have this balance between practitioners and academics; this educational component and research component.
Emmanuel Jurczenko, EHL Professor and conference organizer
The 2nd annual private markets research conference was staged at EHL in association with academic partners EPFL, Dauphine Université Paris, Institut Louis Bachelier and Hes-so, plus corporate partners Adrian, eFront, and Unigestion.
In another keynote address, Ludovic Phalippou, professor of financial economics at Oxford University’s Saïd Business School, outlined the challenges facing mega asset owners such as sovereign wealth funds and pension funds, which hold assets of 100 billion dollars or more. For these MAOs, the public markets are not an investment option as ‘they’re too small and shrinking.’ It’s also becoming more and more difficult to buy stocks – if at all – in car rental firms, restaurant chains, hotels and airlines. Nor are the likes of Uber and Airbnb listed on the stock markets.
Instead, these MAOs, which are seeking good returns, may have to turn increasingly to the private markets – and private equity in particular. Although Phalippou, the author of ‘Private Equity Laid Bare,’ takes issue with the ‘massive’ fees of 700 basis points charged by PE firms and claims of high returns of 25-39 percent which he says are in essence ‘fake’ as they are based on internal rates of return, he told Hospitality Insights that people are ‘crazy’ about PE right now and are ‘just throwing money each time they see private equity written somewhere … It is overheated and prices are very high’.
“I’m very worried about people who have given – especially pension funds – a lot of money to private equity funds over the last few years,” warning that investors in American and European buyouts could face a ‘bloodbath’. Fees are high but returns are uncertain and are expected to be low, he said, “so a big fee is a killer.”
Private markets are a kind of black box. Secrecy is very important and the job of an academic researcher is simply to open the box and (shed) light in the black box.
Serge Darolles, Professor of Finance, Université Paris-Dauphine
Phalippou foresees some disintermediation in financial markets and greater specialization, with power going into the hands of the mega asset owners. They could hire their own PE fund managers and use a common platform to trade and rebalance their assets with other MAOs, he says, perhaps using initial coin offerings to do this at very low cost.
The objective of PE is clear: to make as much money as possible, he says. “We do see them generating quite an increase in earnings and making quite a lot of money but they take it all in fees. So the best paid people on the planet are private equity fund managers, along with a few football players and the like. Yes, they generate money by buying cheap and selling higher and increasing the earnings a bit. But they take quite a lot in fees.”
The conference highlighted the case of the one-trillion-dollar Norwegian sovereign wealth fund. Norway’s finance minister had asked academic Per Strömberg of Stockholm School of Economics to set out the pros and cons as to whether the fund should invest in private equity. The Government Pension Fund Global is a “big deal for Norwegians,” Strömberg said in an interview with Hospitality Insights, “so they have to be super-careful because everything they do is very, very scrutinized.” In the end, the oil fund which ‘has a habit of taking things slowly’, decided not to proceed with PE investments. “My interpretation,” Strömberg said, “is that private equity is not off the table forever, but is off the table for now.”
In the roundtable discussion, Demaria said he wasn’t surprised by the decision. “They don’t want to take any risk. ‘If it blows up I shouldn’t be there.’ That’s a typical consequence of the blunder they had with Formula One where they invested and got stuck.” He also cited as an example Toys R Us which had gone into liquidation, leaving tens of thousands of workers out of a job without severance pay. Such a scenario would have spellt trouble for the fund.
That said, it may be a missed opportunity for the Norwegians because it’s a ‘learning curve,’ Demaria told Hospitality Insights. The Norwegians are learning “how to walk” and they may later regret the decision, he said.
In this industry there are a lot of issues (related to) fees and performance as private markets outperform public markets. There were no ‘langues de bois’ (‘officialese’) and people were very happy to have another perspective where nobody's here to sell anything but (rather) to present the results by experts.
Emmanuel Jurczenko, EHL Professor and conference organizer
SIDEBAR Initial coin offerings: The wave of the future?
There’s been plenty of hype about virtual currencies. Professor Ludovic Phalippou of Saïd Business School at Oxford University believes that – if used correctly – initial coin offerings or ICOs can bring benefits. However, there have been cons and scams.
“A lot of them were just like coins, so that’s very tricky” he says. “When somebody says ‘give me cash as I’m going to pay myself to work on a project and I’ll give you a coin that may or may not be worth something,’ that doesn’t feel quite right.” On the other hand, if the coins represent, say, one percent of a building and that’s written into a contract, “then that’s fantastic because it’s at zero cost.”
Phalippou proposes that mega asset owners such as sovereign wealth funds should consider using virtual currencies and a common platform in order to trade their privately-held assets with other MAOs when rebalancing their portfolios.
Rüdiger Fahlenbrach, an associate professor of finance at EPFL and senior chair at the Swiss Finance Institute, told Hospitality Insights that although the ICO reperesents a ‘hot market’ and an interesting mixture of crowdfunding and initial public offerings or IPOs, “it’s a bit of a mistake to compare ICOs with IPOs.” Yes, there may be trading of rights on a secondary market after the ICO, but he likens it more to angel financing.
For Cyril Demaria, head of private markets at Wellershoff & Partners, talk about ICOS, crowdfunding and cryptoassets signals that markets are “very bubbly” and “we’re reaching the top of the cycle.”
“Crowdfunding may be good to finance a florist and ICOs might be good to fund certain specific projects,” he says, but he warns there has been ‘massive fraud’ in the cryptoasset market. “There are a lot of unknowns which are just being discovered now.”
Per Strömberg, SSE Centennial Professor of Finance and Private Equity at the Stockholm School of Economics, takes a different perspective. “Blockchain and cryptoassets are very interesting”, he says, calling them ‘super speculative assets.’ “I don’t think they’re going to replace currencies ... Blockchain has tons of important end users. I don’t think Bitcoin (another cryptocurrency) is going to be the best example of the use of Blockchain technology when we look back at this.”
The 2nd annual private markets research conference was held at Ecole hôteliere de Lausanne on July 5-6 2018.