Q&A: The Carlyle Group's David Rubenstein

Q: To what extent is the amount of capital entering private equity a cause for concern?

A: People are giving enormous sums of money to private equity firms – the question is can they invest it sensibly and get the returns investors want. Nobody really knows. Overall, the private equity industry has been established as an important part of the financial services world and I think it provides a very good service, but I always worry about whether we can deliver the returns investors want. Today, investors are willing to accept lower rates of return than they were 5-10 years ago. They are happy to get a 15% net IRR and I think that’s more achievable than 20%, which is what they used to want.

Q: Are comparisons to the pre-global financial crisis period fair?

A: Before the global financial crisis, people thought there was a lot of debt on the balance sheets of individuals and maybe there was too much debt. That’s not so much of a problem today. There’s probably more government debt today than there was then, and that’s a different type of challenge. Generally, I don’t see a great recession happening again, but I do think there will be some slowdown at some point. We’ve had recessions in the West, certainly in the US, every seven years on average since World War II. We are now eight-and-a-half years into a growth cycle so at some point it seems inevitable there will be some slowdown. To that point, will the people who paid 11x, 12x, 13x EBITDA for companies look as smart then as they do today?

Q: What is the rationale behind Carlyle’s private equity model?

A: We have different funds for every jurisdiction – the US, Europe, Asia, Japan, Latin America and Sub-Saharan Africa. It does have some higher costs in implementation but generally we think it produces very good rates of return. I can’t say other models aren’t working for other organizations, but this model works for our organization. 

Q: How do you expect the business to develop in Asia?

A: We have a buyout fund in Asia, a buyout fund in Japan, a growth fund in Asia, a renminbi fund in China, and a real estate fund in Asia. We must evolve and see what the market wants. Right now Asia is still a relatively small part of the global private equity world. If 83% of all private equity dollars are invested in the developed markets, that leaves only 17% in the so-called emerging markets. If all of Asia together is roughly 30% of the world’s GDP, and if dollars in private equity is going to reflect GDP, you have a fair amount of room to grow. I think that growth will occur over the next 5-10 years.

Q: Certain global and regional firms are raising larger pan-Asian funds with each vintage. Will this continue?

A: I think the market will be trifurcated: smaller and medium-sized indigenous firms; regional or global organizations with India-only funds or Japan-only funds or mid-sized regional funds; and the largest private equity organizations with funds focused just on Asia. You see some of that now and I think you will see more.

Q: What investment themes do you find interesting in Asia?

A: What we tend to do in Asia is focus on things that reflect the emerging middle class – companies that are likely to grow by selling products and services to the middle class in China, India or other parts of Asia. In Japan, we think there needs to be a willingness to sell off subsidiaries by large corporations and as that increasingly occurs there will be more corporate carve-outs than you’ve ever seen before. Our current Japan fund has done quite well, and I suspect the next fund will be bigger. However, what we’ve decided to do is marry our Asia fund with our Japan fund in one respect. When our Japan fund has attractive opportunities that are bigger than it can do by itself or with co-investment, we will have our Asian fund – if it wants – look at the transaction and perhaps co-invest with the Japan fund.

Q: Carlyle has exited the hedge fund business in the last year. Why was this?

A: We owned 55% of hedge funds but we didn’t really control their investment processes. We decided that was a model that didn’t really work. Right now, our focus is on private equity and private credit and not so much the liquid market that hedge funds tend to focus on. Our private credit business is not as well known or as large as our private equity business, so we have a lot of room to grow there. The attraction is you can manage money with a lot fewer people, which means the margins are higher and it can be more profitable if you do a good job. Some of our peers have built out larger private credit businesses and we hope to build out a comparably sized private credit business that will be as significant to us in the future as our private equity business is today.

Q: What progress is the PE industry making in cultivating retail investors?

A: There are wealthy retail investors who are going into feeder funds raised by Goldman Sachs or J.P. Morgan. We have a large and robust business there, as do our peers. There are other types of retail investors who are represented by regional firms. They have smaller amounts of money they can put into feeder funds but we do see that and we have a pretty good business there as well. Then there’s a third group, the mass affluent, who are not really represented by the money management firms. They have money they want to invest directly in funds like ours and that hasn’t been as big a business for us yet. We hope to build more of a presence in that market. And at some point, we believe, smaller retail investors will be able to invest in private equity products just as wealthier and larger investors do.

Q: How significant will these investors become as a source of funding?

A: A much greater percentage of money will come from sovereign wealth funds in the future than has been the case in the past, and a much larger percentage will come from family offices and individuals. I believe US public pension funds will still be significant, but they won’t be as dominant as they have been. As the wealth of these pension funds remains roughly static or goes up a little bit, you will see sovereign wealth funds growing by double-digit numbers, so they will become a more significant force. You will see more interest from global pension funds as well. Sometimes they aren’t allowed to invest in private equity outside their own country, but that may change in the future. 

Q: To what extent are the sovereign wealth funds also a competitive threat? 

A: Some of them are interested in coming into funds, some of them are interested in separately managed accounts, some are interested in competing, in the sense that they want to do deals directly. There is room for all those opportunities. I think organizations like ours from time to time will perhaps compete with sovereign wealth funds, but they might be simultaneously investing with us. In the future, you will see some large buyouts being led by sovereign wealth funds, but more likely they will be co-general partners with private equity firms that might have some skill sets that the sovereigns don’t have themselves. 

Q: Why do executives of listed PE firms often say their stock is undervalued?

A: There are three reasons. First, we are all publicly traded partnerships and they are not able to be in stock indexes. If you are not in an index people don’t have to buy you. Second, the people that analyze these stocks like to be able to predict your earnings a quarter in advance or a year in advance and it’s very hard to do that with private equity firms. They are frustrated that so much of our earnings are from carried interest or incentive compensation – it’s hard to project that – so they choose not to focus on that kind of organization. At some point, we must do a better job of educating people who buy our stocks on the value of the carried interest. Third, the people running these firms are spending so much of their time with investors in their funds that they maybe aren’t spending as much time convincing people to buy their stocks. There are two different sets of constituents.

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• Topics
• North America
• GPs
• Buyout
• The Carlyle Group
• David M. Rubenstein
• USA
• Asia