The encroachment of the asset management industry into territory traditionally the preserve of the banks was further in evidence last month with BlackRock’s $7.5 billion purchase of Swiss Re’s private equity fund of funds business. The two have also entered into a strategic alternative investment relationship, with 46 staff joining BlackRock as part of the deal.
Swiss Re’s private equity fund of funds business specializes in investing in infrastructure funds – a particular attraction for BlackRock. "There are large pools of LP capital and pension fund money that have a great desire for yield," Russ Steenberg, managing director and head of BlackRock Private Equity Partners, tells Euromoney. "Project finance is attractive because it is long-tailed, and offers significant yield, security and low volatility. People like the idea of yield plus upside."
Funds of funds
According to data provider Preqin, 17 closed-end infrastructure-specific funds of funds had entered the market by January this year, raising an aggregate $3.7 billion. Swiss Re’s SR Infrastructure II fund is the fifth-largest infrastructure fund of funds in the market, with larger funds being run by KB Asset Management, Partners Group, Capital Innovations Infrastructure Partners and Macquarie. KB Asset Management runs the largest such fund, at $1.2 billion – the Swiss Re SR Infrastructure II fund stands at $350 million.
The unified platform created by the BlackRock acquisition will have approximately $15 billion in client commitments. In addition to expanding into infrastructure the acquisition enhances the US firm’s European and Asian operations.
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| Russ Steenberg, managing director and head of BlackRock Private Equity Partners |
This is the first big acquisition by BlackRock’s Alternative Investors unit, but it will not be the last. "The world is changing," says Steenberg. "Investment banks are responding to the new regulatory environment and are looking at their core businesses. We have the pre-eminent co-investment platform." Swiss Re was keen to exit the sector as it focuses on its core businesses and the deal is an example of a wider industry trend of consolidation. Lawyers Thomas Bell and Jason Glover at Simpson, Thatcher & Bartlett observed at the end of last year: "A typical pattern in a maturing industry facing declining profit margins, stagnating growth prospects and an excess number of industry participants is consolidation in an effort to exploit economies of scale and tap into the advantage of being able to cross-sell complementary products. In our view, the private equity industry is likely to follow this pattern."
This is being driven both by banks and insurance companies downsizing their activities and also by smaller private equity funds struggling to achieve returns in a markedly changed environment from the one they raised funds in. "This is a trend you are seeing in the fund of funds world," says Steenberg. "It is very fragmented – there are 250 to 300 funds of funds. There will be a very prominent place for both niche and scale players such as ourselves. The middle ground may get squeezed."
A recent example of this squeeze in action is the acquisition by HarbourVest Partners of Conversus Capital’s portfolio of private equity fund interests. HarbourVest completed one of the first take-privates of a publicly traded private equity vehicle with its acquisition last year of Absolute Private Equity, a Swiss-listed private equity fund, and has now followed it up with this latest deal. According to Preqin, HarbourVest and Goldman Sachs are the only two fund of funds businesses to have raised more than $15 billion from investors for publicly marketed funds of funds. It paid $1.4 billion ($22.11 a share) for the Conversus portfolio.
"We have looked at this portfolio for a long time. It is cash generative and quite mature, there is a lot of overlap with our existing portfolio and we like the quality of the managers," says Stuart Howard, chief operating officer, European listed products, at HarbourVest Partners. The deal took advantage of the yawning discounts that have opened up between many listed funds’ share price and their net asset value. In many cases shareholders in such funds are anxious to exit, and the easiest way to close the discount is for the fund to put itself up for sale. The Conversus deal was done at a 14% discount. "We believe there is upside in that," Howard tells Euromoney.
The average discount for the sector is now about 30%, a demonstration of weakening investor confidence in the private equity industry’s ability to generate returns. Not surprisingly, industry practitioners feel this situation does not reflect reality. "In the listed space a discount of 30%/30%+ feels like an overreaction," says Howard. "This year we made 12% NAV return from invested money from a mature portfolio whilst continuing to invest."
Howard is optimistic that private equity will surprise on the upside. "Good deals will still find leverage but we won’t get back to the very high levels of five to six years ago. Investors aren’t going to get double-digit returns from bonds, and pension funds, for example, need double-digit returns. There is more money coming into this space, especially the listed sector. Proven-quality private equity may come into its own," he says.
Steenberg at BlackRock agrees. "I have been in this business for 30 years and there is a defined cycle," he explains. "I always love when people think private equity is dead because it provides more opportunities for us."
