Can Channeling Warren Buffett Help This Asset Manager Disrupt Private Equity?

BlackRock is following the Berkshire playbook so far

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Feb 07, 2019
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This is the tenth installment of an ongoing series on managed funds. Here are the previous articles:

  • Part one: using the Sharpe ratio to assess fund performance.
  • Part two: identifying appropriate benchmarks for private equity funds.
  • Part three: evaluating common measures of private equity performance.
  • Part four: understanding the negative impacts of pension fund complexity.
  • Part five: revealing the perverse incentives of pension fund managers.
  • Part six: demystifying co-investment.
  • Part seven: fighting back against hedge fund fees.
  • Part eight: pension funds’ hunt for yield.
  • Part nine: private equity's resilience to external disruption.

As we discussed in the last entry in this series, private equity’s apparently unassailable position has led some industry leaders to conclude that they are beyond the power of the disruptive forces transforming the public markets landscape. Indeed, at Private Equity International’s recent CFOs and COOs Forum Blackstone CFO Michael Chae described private equity as the “least disruptable” segment of the investment management sector. That is a strong stance to take, but it is unwise to ignore the opinion of a top-ranking executive at the world’s largest private equity firm.

Still, the confidence expressed by Chae and other like-minded industry professionals seems overdone. In our last research note on this topic, we discussed how various technologies and new competitors might make things far less comfortable for the likes of Blackstone. But there are more immediate threats to the structure of the private equity sector that we failed to discuss adequately at that time.

A major test of private equity’s resilience to external disruptors is already in the works, courtesy of asset management juggernaut BlackRock Inc. (BLK, Financial).

BlackRock enters the fray

With a staggering $5.98 trillion in assets under management, BlackRock is a force that cannot be ignored even by the largest alternative investment managers. Thus, its decision last year to establish a serious beachhead in traditional private equity territory deserves attention. Last February, BlackRock announced that it was raising more than $10 billion for a fund that would invest in closely held companies with a holding period of more than 10 years.

In essence, BlackRock’s new fund emulates a business model made famous by Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial). This “long-term private capital” vehicle is designed to foster a long-term time horizon and to seek out closely held, usually private companies that are well managed and attractively valued.

For many years, Buffett’s business model at Berkshire has involved much the same idea; he likes to own good companies -- often outright these days -- that do not need him or his team hovering over them. BlackRock is aiming for the same strategy, which, if done right, can deliver the sorts of returns expected of private equity, but at significantly lower cost.

Undercover disruptor

Of course, BlackRock’s new long-term capital fund is not entirely like Berkshire. It commands fairly high fees, though not so high as those charged by established private equity players. But it is early days yet for the new vehicle.

Professor Ludovic Phalippou of Oxford’s Private Equity Institute recently offered a short thought on the potential of BlackRock to take on the private equity industry:

“Blackstone last week said that PE is least disruptive part of asset management. Would be quite ironic if Blackrock was the disruptor Blackstone did not see coming.”

Given Blackstone’s recent display of swaggering confidence in private equity’s safety from disruption, it might prove fitting that it be disrupted by the investment colossus that was once its subsidiary.

What the future may hold

Still, at present this new fund is more novelty than serious threat to the industry. But that does not mean it may not become one in the coming years, as a Bloomberg report pointed out in the days after the fund’s launch:

“Depending on how returns shape up, it's possible that over time, longer-duration funds...may cannibalize some investor interest in traditional funds. While they tend to generate slightly lower returns than regular buyout vehicles, longer-term funds are also lower-fee by nature and that could be a draw. BlackRock could place greater pressure on incumbents by setting the bar with even lower management fees.”

If BlackRock can attract significant capital to its private funds, it might well prove to be the thin end of the wedge when it comes to the private equity industry’s usurious fee structure. The asset manager certainly has a track record as a disruptor, helping to spearhead the rise of passive investment vehicles alongside the likes of John Bogle’s Vanguard. BlackRock has been a key driver of lower asset management fees across the industry. Whether it can achieve the same results in private equity -- and whether it really even wants to -- remains to be seen.

Verdict

BlackRock’s dalliance with private equity might end up as a mere novelty with little impact on the vast universe of private equity funds. On the other hand, its long-term private capital investment vehicle could prove to be the start of something far bigger. It has the track record for disruption, and its success could easily attract imitators, which would put further pressure on cushy fee structures.

Whether BlackRock can leverage lower fees to disrupt private markets in the same manner it has done with mutual funds and ETFs remains to be seen. In any event, private equity is poised to face perhaps the greatest threat to its comfortable status quo. It will take a few years to know anything concrete, but investors would be wise to keep a keen eye on the fortune’s of BlackRock’s latest venture.

Disclosure: No positions.