Daniel D’Aniello co-founded The Carlyle Group with David Rubenstein and Bill Conway in 1987 and the firm currently has $212 billion of assets under management across 339 investment vehicles.
D’Aniello is now chairman emeritus, but is still involved in Carlyle’s day-to-day business. He spoke at Private Equity International‘s CFOs and COOs Forum in January and after his session, PEI sat down to get his take on the industry and world today.
PEI: How are you feeling about private equity as an asset class?
Daniel D’Aniello: What makes me so bullish about it is that in some regards it’s a very viable option to the standard go-to-IPO routine that was more or less the only way that entrepreneurs could fund themselves to scale.
Nowadays, private equity has enough money to hold high quality and high growth companies much longer in their life. And by the way, the entrepreneurs involved have the ability, therefore, to earn a lot more from their life’s work.
What’s the knock-on effect for society in terms of individuals not being able to invest in the economy around them?
You’re talking about retail investors coming into the asset class, and that could eventually occur; everybody’s working on the formula for it. But, you know, it starts with feeder funds and things of that nature through the investment banks. And of course, not everybody has the ability and patience for an illiquid position.
And by the way, it’s interesting that the trend – at least for some of the larger investors – is to want to have the money invested for longer terms. So you see these longer-dated funds. And as private equity develops more yield-based alternatives, you will find many more private individuals being attracted to invest. And in some regards, they can invest now, in MLPs [master limited partnerships], in RICs [regulated investment companies], in BDCs [business development companies], in REITS [real estate investment trusts], though these tend to be less traditional private equity and more private credit, energy and real estate.
Okay, taking a step back, what is the most recent lesson you learned about private equity? The most recent realization you’ve had?
Two thoughts come to mind. One is that the capital formation side of the business is as dynamic as the investment side. We have pretty much survived and done well through a number of cycles over the last 31 years. At the very beginning it used to be high-net-worth, insurance companies and money center banks. And then it sort of grew through the public and corporate pension plans. But what happened 10-15 years ago – with the advent of sovereign wealth – changed the industry.
And what you see now is that high-net-worth and sovereign wealth are growing faster on a relative basis compared to other investor types. Although we see almost every one of our investor types thinking about increasing their allocations. And why would that be? When you look at the history of the industry over the last 25 years, if you’ve invested in the MSCI you made about 5 percent a year; if you’ve invested in the S&P 500, about 9 percent; if you’ve invested in the average or median private equity firm, you’ve made something like 13; and if you’ve invested in a top quartile, you’ve made over 25. Now those spreads are likely to tighten as the market softens. But on a relative basis? I’m still thinking that private equity has 600 to 1,000 basis points advantage over public markets.
Given what we’ve talked about in terms of tilt away from the public markets to private markets, is one logical progression that the way public markets are regulated or structured could change a little bit, and you would have more firms like Carlyle – or its funds – taking big stakes and publicly listed firms?
What you have to be confident of is that you can tell your LPs that you bring more than money if you want to invest in a public company and not control it, because LPs can go direct. And how do we do that? Well, we work with management on a pre-agreed plan to provide value-added resources to augment the success of their strategy.
But in the US, there is also an issue of the time period within which a minority investment, a PIPE, aligns with the future business plan of that company. Because we have a clock on our money – on a closed end buyout fund. We want to be compatible with the financial structure of the company, as well as understand our role in helping the company with skills and capabilities that augment their growth opportunities and profitability. The shoe has to fit, you can’t just say, “Oh, I love how this shoe looks”. If it doesn’t exactly fit, it causes problems.
You mentioned two realizations…
The second realization is that I’m amazed at how difficult it has been for public investors and Wall Street analysts to understand the space. When you have a 30-year track record on carried interest, and you have dozens of funds in six of the seven continents, you have to ask the question: do you get any diversification credit in terms of your ability to create performance fees?
Now, the way most Wall Street analysts do it is they take fee related earnings, which are management fees minus expenses, and give them a really high multiple. Then they determine what remains for carried interest – maybe a 2-, 3- or 4-times multiple when, in fact, it should be getting a much higher one, especially if it’s been consistent for many years. When we went public, we tried to message this to Wall Street – that you cannot look at a private equity firm on a quarterly basis. You have to look at it over time; you have to look at it on a 12- to 18-month rolling basis in order to get a sense of flow.
Is there much overlap between the LPs in your funds and those who hold your public stock?
This is the thing that’s amazing, very little. Really very little. It’s a really interesting phenomenon.
Especially when you consider that so many LPs of unlisted private equity firms are basically trying to get a piece of the action…
And they did so with us, with Mubadala. Before Mubadala was CalPERS, and before CalPERS, it was the Mellon family. That’s the most direct way of participating; you can earn an augmented return – one from fund investments, plus a portion of the GP’s share of return.
If you were down to your last $10 million and had to make a single concentrated bet or investment, what would you do today?
Wow, what a question. Are you asking me what some of the great opportunities are in the world today to invest in? Well, let me just give you one.
Undervalued Carlyle stock?
Yes, but I’m 72 years old. And I’m already very long on Carlyle stock. However, another great investment in my opinion in the world today is healthcare in China. And I say that for the following reason.
China has an ageing population. It’s moving from herbal remedies to pharma. It has the largest and growing middle class, maybe not fastest growing, but the largest newly-minted middle class in the world. And what’s the priority when you become a little bit more secure financially? First priority is probably education for your children and then health, or depending on what your health is, the reverse. But China is currently under-facilitated, and they’ve recently opened the market to foreign direct investment in the healthcare sector, which for many years was not accessible.
Now that’s all predicated on the assumption that we’ll work things out with China both geopolitically and trade-wise, which I believe will eventually happen because our economies are so important to the world. Hope springs eternal in that regard.
Thinking about the business of running a private equity firm, not necessarily a listed one, what do you think the top priorities should be for either the COO or the CFO? Away from investing, what should they be taking care of now to protect their firm in the next three, five years?
For the next three to five years, the number one situation is to make sure you have a strengthened balance sheet and you have reserved liquidity for downside events. This mirrors what we do on the investment committees. When we review portfolio companies for investment, we look for what value we can add, and what we can put in place for downside protection. We work for upside, but we are maniacally focused on downside protection.
Daniel D’Aniello was interviewed at the CFOs and COOs Forum in New York.