Historical inevitability

abnormalreturns
April 19th, 2006

It seems like the shift of private equity from a niche product available to only the most affluent individuals and institutions to a mass market product is a historical inevitability. While there are some vehicles today, like business development corporations (BDCs) and some one-off companies that act like private equity or venture capital funds they are by and large a minor sideshow.

Henny Sender in the Wall Street Journal reports that Kohlberg Kravis & Roberts (KKR) is raising over a billion dollars in capital for a Euro-listed publicly traded private equity vehicle. This provides the PE firms with so-called "permanent capital" and provides the founders with a chance to create a lasting legacy. KKR has already made one move in this direction with the real estate focused KKR Financial Corp. (KFN).

Going Private understands why KKR might undertake such a deal, but has issue with the structure itself. Their fear is that the public nature of the fund would change the focus of KKR's managers from the long term to the short term.

While KKR's Amsterdam funnel fund (a "fund of KKR funds"?) doesn't appear to adversely impact the the ability of KKR to remain long-term focused, a publicly listed sort of approach (particularly if we start seeing the partnership broken into a more traditional share and option based compensation strategy a la Goldman Sachs after its IPO) suddenly aligns the incentives of the partnership with short term fluctuations. This defeats the structure of a buyout firm, which is nearly entirely about avoiding short-term temptations.

Dealbook reports the KKR roadshow is kicking off today. With the help of top-tier investment banks, the KKR deal is generating a great deal of publicity. Not that anything KKR does is low profile.

Investment banks have always had a push-pull relationship with the world of private equity. While they act as bankers for the large (and small) private equity shops, they also compete with them for deals. Heather Timmons in the New York Times reports that the inherent conflicts has changed the way some investment banks do business. While the boom times in private equity and mergers and acquisitions have glossed over some of these issues, it will be interesting to see what happens during a downturn.

A report at InsitutionalInvestor.com reports that a number of banks are preparing private equity vehicles that would be made available to less affluent customers.

In an era of rising asset class correlations a new investment vehicle is a welcome sight. (Although public PE will probably be well correlated with the equity markets.) The ultimate attractiveness of these deals will depend in large part on the terms and details of these publicly traded private equity vehicles. That caveat aside, they could become useful vehicles for sophisticated investors who understand the private equity business. This trend will inevitabily overshoot and hurt a number of bandwagon jumpers, but in but for patient investors looking for additional asset class diversification some further research is warranted.