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CAIA Conversations: Mark O'Hare, Founder & CEO, Preqin

06-Mar-2012, CAIA Association

Wendy Coleman:

We're here today with Mark O'Hare. He's the founder and CEO of Preqin.  Mark, thank you for joining us.

 

Mark O'Hare:

It's a great pleasure.  Thank you for having me.

 

Wendy:

What do you seeis the future for alternative investments and their role in institutional portfolios?

 

Mark:

I'm incredibly positive.  We're in very strange times at the moment, and this summer and autumn we've seen amazing volatility and uncertainty.  I think putting that to one side I think you've got to ask what role do alternatives have in institutional portfolios and how do we see that evolving.  To an extent I think even the term alternative assets is a misnomer because alternatives are truly mainstream. We're talking private equity, hedge, infrastructure, real estate, all these asset classes.

 

Wendy:

It's becoming increasingly so.

 

Mark: Absolutely.  If you look at the return requirements of most institutional investors – think of pension plans – people like that it's seven or eight percent real.  And looking ahead at what they're likely to earn on their stocks and bonds in the public markets it's three or four percent something in that range.  So do the math; they need extra returns.
Wendy: It's quite a gap.
Mark:

Now.  You look at the history of alternative assets and especially if I may say private equity, and it is quite consistently outperformed at public markets by three to 500 basis points a year.  Now if you go back to the beginning of the financial crisis in '07/'08, there were lots of people who were ready to write private equity off.  These big buyer firms have bought so many companies at the top of the market with loss of leverage they'll go pop. Many of the firms themselves will disappear.  Boston Consulting predicted one-third of the industry would disappear.  What's happened?  Private equity has actually come through the crisis to this point very well.

 


You look at the returns that it has delivered over one, three, and five years, and you ask limited partners as we do all the time, you ask them how satisfied are you with the returns you've earned, and they're very satisfied.  Over 80 percent it's either delivered what they expected, or it's exceeded their expectations, and the proportion who are disappointed even though small is declining further.  So you then ask them, okay, what are your allocation plans for private equity and they're going up.  

 

Wendy:

At the expense of what?

 

Mark:

At the expense of public markets primarily.  Now, how long can that go on?  As one of the panelists said down below, you look worldwide of the market cap of listed equities, of the stock markets around the world, and it's $50 or $60 trillion.  If you look at private equity and it's two.  It's a rounding error, and there is lots of room for growth.  So you've got investors who need to earn great returns, who have objectively earned great returns.  We've tracked from performance, and they've been very good over a long period. And you ask them are you satisfied with it and yes they are, and therefore, you ask them what do you intend to do.  

 


And they say we intend to invest more in this, and that's a pattern we see across the world. We talk to investors everywhere.  So the opportunity for alternative assets, which is no longer alternative, but for what we call alternative assets to grow is great and they will continue growing very strongly.

 

Wendy:

And I do want to pick up again on the private equity space because you mentioned that people are happy with it.  They are increasingly allocating to it, but how would you contrast opportunities in private equity and the associated fees of this strategy with say a pretty astute long/short manager?

 

Mark:

Very good question.  In a sense it's wrong to think of private equity as a fund manager, and it's not the same as putting money with an asset manager.  What you're doing is you are investing alongside an entrepreneur because that's what private equity firms are.  They are entrepreneurs.  They buy companies.  They get very closely involved in the management of those companies and align themselves with the management of those companies.  So that is fundamentally a high cost thing to do, right?  So we shouldn't be surprised that fees and private equity are higher than fees in a kind of either long only managers or long/short hedge funds.

 

Wendy:

And there are different strategies because there's direct and there's indirect.

 

Mark:

Absolutely.

 

Wendy:

And it's a very different story for each.

 

Mark:

And they're doing different stuff.  Fundamentally the process of finding unlisted investments that you want to invest in, investing in them, which is a complicated negotiation and process,  and then actively managing those and developing them, and coaching and building the management, and adding to them, and then exiting from them--that's fundamentally more complicated than being a long only manger.  So the question is not are the fees higher.  Yes, they clearly are.  The question is, is the money you are investing in those fees does that pay off?

 

Wendy:

And how long do you have to wait?

 

Mark:

And how long you have to wait?  And yes it's a liquid, but again the evidence is that the returns are there.

 

Wendy:

What is your outlook for returns in other types of alternative investments and private equity as well in terms of the risk premium that you expect over public markets there?

 

Mark:

I think Yogi Berra said predictions are difficult especially as regards to the future, okay.  So trying to predict what returns are going to be in investments generally in the public markets and in private equity and then in hedge funds is very, very difficult.  A betting man would probably say we're in for a difficult and generally lower return environment in the coming decade than we've had in the past decade.  Right?  So we've got to have that as a backdrop.  But you ask yourself the question is there any reason why alternative assets – private equity and hedge funds – should no longer give a premium return the way they have in the past, and the answer is absolutely not.  There is every reason.  

 


The reason for the excess returns are a payment for the liquidity, but also you have the tremendous alignment of interest between the investor, the private equity firm, and the management and employees of the portfolio company.  And that kind of involvement and alignment of interests when everybody's pulling in the same direction is just incredibly powerful and there is no reason why that will change.  So if the question is, am I confident that alternative assets and particularly private equity can continue to deliver three to 500 basis points more than the public markets?  Absolutely.  Every day of the week.  

 

Wendy:

So very bullish on private equity.  

 

Mark:

Absolutely.  Now let me put a caveat there.  I'm very bullish on private equity.  Are many people committing to new private equity funds this month, October 2011?  Probably not because nobody knows what's going on out there, and as a flight to safety and people sitting on their hands and waiting for a bit more clarity and direction.  Absolutely.  So are we in for a tough few months?  Yes.

 

Wendy:

And how much of that is a residual from 2008 when people did have enough of a scare that –

 

Mark:

Absolutely.

 

Wendy:

– it was a major focus on liquidity.

 

Mark:

For sure.  For sure.

 

Wendy:

Do you think that that priority focus on liquidity is still appropriate or is it a little misplaced now and they’re missing some opportunities?

 

Mark:

I think each investor has to think about how much illiquidity they can afford. Now I think in the run-up to 2008 things have been so good for so long that people frankly forgot what illiquidity meant.  And so you had a lot of endowments with very intelligent great investors who didn't pick bad investments, they picked good investments.  They simply had too much of those investments.  They had too many illiquid funds in their portfolios, and by over-committing it was kind of a leveraged game.  They had problems. So the problems were the proportion of the illiquid investments have no portfolio not the investments themselves.  

 


I think investors need to think about that and how the budget for how much illiquidity they can afford.  And that's different for you, different for me, different for an endowment, different for a pension plan.  It depends on each investor.

 

Wendy:

For, say, a pension plan,  what would you say is an appropriate allocation?

 

Mark: You hear lots of institutions increasing their allocations.  It's very rare to hear of institutions decreasing them.  I think the important thing thinking about institutional investors is the global universe investors is undergoing tremendous churn and change at the moment.  So if you look at banks who have been big investors in private equity in the past that will be less so in the future because of all the regulatory changes.  If you look at defined benefit pension plans who clearly they're the biggest investors today, well, looked at over a very long period, defined benefit plans are declining that there will be less and less of them.  That's going to be balanced by both end of the spectrum.

At one end you've got the sovereign wealth funds from Asia, from the Middle East, from Latin America, very large, currently with quite low allocations to private equity alternatives, they're becoming more and more important by the day.  At the other end of the extreme, despite what's going on outside, private wealth around the world is growing.  It is especially growing in Asia and Latin America and the developing world, and within that you then have family offices, foundations, endowments and so on.  So you've got a tremendous churn in the base of investors.  Some will be declining others increasing.  Absolutely great for those providing data on who those investors are.  We love it.

 

Wendy:

So let's talk about that. What are some of the tools that investors need to make the decisions that are appropriate for them in alternatives and I think particularly in private equity?

 

Mark: I think if you look at the availability of data today in private equity specifically on the transparency of returns, on what people's allocations are, on kind of what the different funds in the market are, what their strategies are.  On the one hand, it's like being halfway up a mountain.  If you look back down the mountain and look at where things were ten years ago, the level and quality of information hasn't improved hugely.  If you look up the mountain at where listed equities and bonds are in terms of the information you can get on your Reuters terminal or your Bloomberg, it is woefully inadequate.  

And so there are loads of new types of information especially around portfolio management tools and having a good understanding of your private equity portfolio in the context of the whole universe and how that fits in with your total portfolio in terms of risk, in terms of return.  I just predict a decade from now the types and amounts of information and quality of information on alternatives will be a different world from today.  

 

Wendy:

And what are your expectations regarding transparency?

 

Mark:

Transparency is a Pandora's Box.  Once it's opened you cannot close it, and I think the typical pattern that you see and that's happening in private equity is some people give an element of transparency or are forced to.  So Preqin we drove that process by using the Freedom of Information act to get fund returns often unwillingly from investors.  But interestingly once we had a critical mass of funds, we started to get general partners knocking on our doors saying you've got data on three of my five funds, and one of them is six months out of date, and more and more investors are asking me for this.  Here you are have the rest, and that's happening to us all the time, so we've now got data on nearly 6,000 private equity funds and that will just increase.

So transparency is a one-way street.  It's going to improve.  It's going to be better, and that's good because it helps the investor make better allocation decisions and that's in everybody's long-term interest.

 

Wendy:

Certainly more transparency is good for the investor, especially in terms of modeling risk in their portfolios.  There is a slightly different take on it, and I'm curious to get your thoughts on the potential for those who are especially critical of the alternative investment industry to utilize some of the newfound data and the transparency to try to make arguments in cases against the use of alternatives.

 

Mark:

I think that's a good point.  I think ultimately the answer to that is more transparency not less, but let me explain why I believe that's the case.  I think if you look at alternative assets and in particular private equity because that's the area I know best. We cover a whole lot but private equity was our core.  It's a very efficient, very effective way of funding innovation and funding business growth, and that, by the way, is why the returns are good.  It's a better way to manage growing businesses and just remember that in the U.S., in Europe, in emerging markets, it is small growing businesses that create most net employment and net increases in wealth.

 

Wendy:

I think there was a statistic today that 12 million people in this country are employment by the venture capital industry alone.

 

Mark:

It's huge.  It's huge, yeah.  What private equity has been rubbish at has been telling that story, and that's why you get people totally misrepresenting what private equity does.  The Germans talk about locusts or asset strippers or firing people.  That's not what private equity does.  What private equity does is it funds growth, and yes, in certain circumstances it will make businesses more efficient, and that may mean that some people on some on some occasions will lose jobs.  But by and large private equity creates wealth and creates employment, and what private equity hasn't done well is tell that story.  

 

Wendy:

Well, everybody needs their own PR, right?

 

Mark:

Absolutely.   And I think if you have an industry that has a lot of very wealthy people in it, and that hasn't communicated how the money has been made, well, then you're setting yourself up for nay sayers to knock you.  And I think that's what's happened, so I think the answer is more transparency not less because private equity has a brilliant story to tell.

 

Wendy:

Right.  Tell your story before somebody else tells it for you.

 

Mark:

Absolutely right.  Absolutely right.

 

Wendy:

Let me just close by asking about your view on the need for education in the alternative investment industry across all different constituencies, be it the investors or regulators or others who deal in the space.  

 

Mark:

It's huge.  It's huge.  Look, I've said and believe, and the facts support, that alternatives and private equity are going to grow and there's significant growth.  They punch above their weight for institutions in terms of the returns.  They can deliver so they're doubly important, a double whammy, and currently the quality and level of information is here.  And it needs to be and will be up here in years to come.  Put all of those together and what do you need?  Better education, better knowledge, and that will just be so important for the industry.

 

Wendy:

Thank you very much for joining us today.

 

Mark:

Thank you.

 

Wendy: I'm Wendy Coleman for the CAIA Association.