PE will be disrupted, but not by robots

Fee rancor, rather than technological change, will ultimately shake up the private equity world order.

Blackstone’s CFO Michael Chae believes that private equity will not easily be disrupted.

Many in the industry will no doubt agree: the idea is laughable that the alpha that a good private equity manager brings could be in some way be synthesized. Is there a killer app that can visit a manufacturing company, look the owner in the eye and make them believe that they have found a valuable partner for the next stage of their growth? Doubtful.

Yes, artificial intelligence or machine learning will drive efficiency in deal sourcing, make fundraising a smoother process, or take out some of the more arduous elements of portfolio company valuation, as our upcoming valuations roundtable will discuss. But for most firms even back office efficiency gains will be marginal. As one private equity firm CFO told us recently, a new piece of software might mean “people working until nine rather than 10pm” in a small firm. “Your head count doesn’t go down, you don’t get more money – you spend it instead.”

The robotic revolution can at times seem pretty distant.

“I don’t see in the near term a wholesale dislocation or disruption to the business like it might the [you might in the?] traditional liquid investing world,” Chae told us in January. “I think in the continuum of asset management [control-oriented illiquid strategies like private equity are] probably the least disruptable.”

When people discuss disruption in asset management, the go-to benchmark is what Jack Bogle and Vanguard dramatically did to stock pickers. One wonders whether in pre-Vanguard days, richly paid asset managers considered themselves to be vulnerable to disruption… possibly not.

There is plenty to recommend the view that PE is future proof. So if tech will help, rather than scupper, the incumbents, could something else knock them off course?

The 2-and-20 fee model has been the subject of much debate but has budged very little since the industry was first conceived. The majority of capital under management commands a 1.5 percent headline management fee, according to research by law firm and fund services business MJ Hudson, while most funds (by number rather than capital) are closer to 2 percent. Investors are voting with their feet: fees – high as they are – continue to be deemed worth it.

As returns decline – as most agree they will – it is unlikely that this will remain the case. The real challenge to the private equity world order will be when a manager capable of delivering alpha decides that there is merit in reinventing the model. For example, look at holding companies like Cranemere Group; it has raised $1.5 billion with a mandate (and an investor base) that looks a lot like private equity, but with a totally different way of aligning interests. Or Public Pension Capital, established by former KKR partners Perry Golkin and Mike Tokarz, which operates with a management fee set annually by a board of directors. Or Auxo Investment Partners, whose 2018 debut fund has no management fees and every investor has a stake in the management company.

These are the types of disruptor I would have my eye on.

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