Apollo is one of the largest alternative investment firms in the world with arms in private equity, credit and real estate.
Apollo's Senior Managing Director Josh Harris sat down with Steve Forbes for a comprehensive interview as detailed below:
Forbes: Now, Apollo, as you well know, is known as one of the alternative investments, investment class. Why has there been such a growth in that in the last 20 years? How would you define it, and why the growth?
Harris: I’ll start with the macro, and then I’ll get into the micro. On the macro side, certainly with the lowering of interest rates over the last decade, many, many pension funds and other institutional investors have liabilities, health care costs, primarily, that are growing at 7%, 8%, based on what’s going on today. So when the Federal Reserve lowers rates, and when rates go down to 1.6% for the Ten Year Treasury, and the corporate bond market falls, many of these firms had asset allocations of 50%, 60% fixed income, 30%, 40% equity.
And they had a tiny bit of what they called alternatives. Alternatives was the sort of corner office down the hall that no one paid attention to.
What’s happened is that as rates have come down, the pension funds have gotten underfunded. So firemen, policemen, teachers want to be able to count on getting their benefits. And so as they’ve gotten underfunded, the big plans have three choices. They have the choice of cutting benefits, which they don’t want to do, and people don’t want them to do. They have the choice of raising taxes on the general population, no one wants that. And so the third choice is to move down the risk curve intelligently. And firms like Apollo, amongst others, have been able to pour every dollar they’ve been given, give back $2.40 on the private equity side, or on the debt side, generate double digit rates of return. So better risk adjusted returns.
What that allows these pension funds to do is to catch up and pay their health care costs. So pension funds have gone from about 5% of their assets in alternatives, to about 20% now. That’s one big megatrend.
Another big megatrend on the other side is that the government, in both Europe and the U.S. and all over the world, they’re really looking at the banks that are guaranteed, and saying, “Wow, we’re not necessarily sure we want to have these banks in some of these riskier asset classes, because ultimately, there’s a guarantee by the FDIC. So if we make the wrong bet, we go out of business, and our investors suffer, and it’s all on us. If a bank goes out of business, then the depositors suffer, and the taxpayers have guaranteed those deposits.” So the government, the Volcker Rule, Dodd Frank, and then in Europe, it’s even worse. We’ll come back to that, because the banks are way bigger.
Forbes: Right.
Harris: They’re too big. They’re almost too big for the entire country. The average banking system in Europe is four times the size of the country. Here, in the U.S., the banking system, on the whole, is only 80% GDP. But in any case, for all these reasons, the banks are being told to get out of some of these riskier businesses. And they’re being replaced by people like us teamed up with the institutions that have long term liabilities. So there’s this shift out of liquid risky assets by the banks, and people like us are being left to manage those assets, and the spread, the value, the returns we can get, are going up a lot, and we’re able to manage those on behalf of the pensions funds. And so, that’s kind of what’s going on, on the macro. On the micro, we’ve just had the best returns. We generated 26% net returns for our investors in private equity over 23 years.
In credit, we continue to beat the benchmarks, and so if every time someone gives you a dollar, you give them back $2.00, they give you another dollar, our challenge is, as we grow, and we’re now $115 billion of assets, approximately, is to continue to be able to accept the capital, but also generate the returns. We’re only as good as our last fund, and your track record’s very important.
Forbes: Why then, given the long term trend, since you’ve gone public, why the drag, not just you, on private equity stocks? Why haven’t they? Or is it just too early?
Harris: I think that it’s a new asset class. So you’re referring to the fact that, in general, alternatives are valued at low multiples.
Forbes: Yeah.
Harris: So for example, the industry, you know, our growth rate is above 30%, in terms of assets.
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