Why private equity is essential in today’s complex markets

Key Concepts

• Private Equity (PE): Investment in companies not listed on a public stock exchange.
• Evergreen Strategy/Vehicles: A type of private equity fund structure that is open-ended, allowing for continuous investment and redemption, unlike traditional closed-end funds.
• Public Companies: Companies whose shares are traded on a public stock exchange.
• IPOs (Initial Public Offerings): The process by which a private company becomes public by selling shares to the public for the first time.
• Public to Private Transactions: The acquisition of a publicly traded company by a private entity.
• Corporate Carveouts: The divestiture of a subsidiary or a non-core business unit from a larger conglomerate.
• Corporate Governance Reform: Improvements in the way a company is directed and controlled.
• Deflation: A general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy.
• Asset Allocation: The strategy of dividing an investment portfolio among different asset categories, such as stocks, bonds, and real estate.
• Risk-Reward Profile: The potential return on an investment relative to the risk involved.

The Importance of Private Equity in a Portfolio

Alisa Wood, a KKR private equity partner co-leading the firm's private equity evergreen strategy, emphasizes the growing importance of private equity in investment portfolios, especially in the current economic climate. She highlights several shifts that make private equity a compelling asset class:

• Decreased Number of Public Companies: There are 40% fewer public companies today compared to 20 years ago, limiting traditional investment avenues.
• Reversed Asset Class Correlations: Historical correlations between different asset classes have changed, making diversification more complex.
• Return Compression: Certain asset classes that were historically strong performers are now experiencing a compression of returns.

In this complex and volatile environment, Wood argues for investing in businesses where investors can actively influence change and drive their own returns.

Debunking Common Private Equity Myths

Wood addresses and debunks several prevalent myths surrounding private equity:

Myth 1: Private Equity is Too Risky

• Argument: The risk is not inherent in the asset class itself but in the selection of managers.
• Supporting Evidence: The existence of thousands of private equity funds, each with varying risk profiles. Wood states, "It's the who, not the what. It's the managers and the people that you select to put that capital to work that makes the difference at the end of the day." This implies that thorough due diligence on fund managers is crucial.

Myth 2: Private Equity is Not Accessible

• Argument: Historically, private equity was accessible only to large institutional investors. However, the advent of evergreen or open-end vehicles has broadened accessibility.
• Supporting Evidence: Evergreen structures are designed to reduce complexity and inefficiencies, making private equity more approachable for a wider range of investors.

Myth 3: IPOs are Dead

• Argument: While IPOs remain a viable exit strategy for some companies, relying solely on them for capital return is becoming increasingly difficult.
• Supporting Evidence: Wood explains that value can be realized through various exit routes, including strategic corporate sales, sales to other private equity sponsors, or sales to families. Not all businesses are suited for public markets, and there are numerous other opportunities for capital deployment.

Opportunities in Private Equity: A Case Study on Japan

Wood uses Japan as an example to illustrate current private equity opportunities:

• Market Dynamics: Japan presents a unique investment landscape due to:
  • An aging population.
  • An economy emerging from decades of deflation.
  • A strong focus on corporate governance reform.
  • A relatively large number of public companies compared to other regions.
• Investment Themes: These market conditions create opportunities in:
  • Public to Private Transactions: Acquiring public companies and taking them private.
  • Corporate Carveouts: Buying non-core assets from large conglomerates.
• Key Investment Trends: KKR is focusing on themes such as automation, worker productivity, digitization, and health and wellness.

Conclusion and Actionable Insights

Wood concludes by emphasizing the need for investors to understand the evolving market landscape and to invest with the right partners.

• Due Diligence: It is essential to "take the time to do the work to understand what those risk-rewards are and how that will interact with other parts of your portfolio." This involves understanding the specific strategies of fund managers and how they align with an investor's overall portfolio objectives.
• Manager Selection: The success of private equity investments hinges on selecting experienced and capable managers who can navigate market complexities and drive value creation.
• Diversification: While private equity can be a valuable addition, its impact on a portfolio depends on the quality of the managers and the specific strategies employed.