BlackRock’s Move Into Private Equity Investment And What That Means For Investors
BlackRock, the world’s largest asset management company is turning its sights on private equity. Although its initial foray into the business will involve a minuscule amount compared to its main business, it could herald the beginning of a push into a highly lucrative segment of the financial services business.
At US$6 trillion, BlackRock’s assets under management dwarf its proposed US$10 billion private equity fund. According to a recent report in the Wall Street Journal, BlackRock will deploy this US$10 billion in purchasing stakes of between US$500 million and US$2 billion in private companies.
The asset management behemoth does not plan to take controlling stakes in the firms that it invests in. Instead, it will be a passive investor and will exit after about ten years. That’s a fairly long time period. Other private equity firms usually have a time horizon of three to five years with a few extending this to seven to ten years.
Why is BlackRock diversifying?
Investors are increasingly moving away from actively managed mutual funds because of the high fees that they charge. Exchange-traded funds (ETFs), on the other hand, charge much lower fees.
According to data compiled by the Investment Company Institute, a trade body representing the interests of the asset management industry, ETFs charge as little as US$3 for every US$10,000 that they manage. The average amount levied by mutual funds is US$131.
As more investors have moved to ETFs, BlackRock’s margins have been under pressure. It has taken steps to promote its active fund business. This segment represents only a third of its assets, but almost 50% of its fees.
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Private equity firms charge their clients far higher fees. The traditional fee structure that investors have to bear includes a 2% management fee and 20% of profits. Although many private equity firms have lowered charges, the business can still be highly profitable.
The fees that BlackRock’s proposed venture will charge have not been announced. But it is likely that the new fund, which is reportedly called BlackRock Long-Term Private Capital, will try to undercut the competition.
The asset management company has been reducing fees in an effort to increase business volumes. Its BSF Style Advantage Fund, a hedge fund that it launched in 2016, carries a fee of only 1.76% and a 0% performance fee. The fund has already raised over US$2 billion.
In view of its success in raising money for its hedge fund, it is likely that BlackRock’s private equity fund will charge fees that are below the market rate.
Raising the funds and investing them
Will BlackRock find it difficult to raise US$10 billion in private equity capital? According to a report by Preqin, a data provider to the alternative assets industry, the amount raised by private equity firms has been rising steadily for the last seven years.
Annual Global Private Equity Fundraising 2008 – 2017
|Number of funds closed||Aggregate capital raised US$ billions|
In 2017, Apollo Global Management raised US$24.7 billion, with its Apollo Investment Fund IX. This has been the largest private equity fund ever raised.
BlackRock’s US$10 billion fund should not have a problem in finding investors. Demand for the fund can be expected to come from sovereign wealth funds, pension funds, and family offices.
But investing the money may be more difficult. Private equity firms are receiving record inflows, but there are not enough deals. The amount of dry powder, which indicates the amounts raised from investors, but not deployed, has now crossed US$1 trillion.
Value of dry powder of private equity companies worldwide from 2009 to 2017 (in billion US dollars)
What are private equity firms doing with all this extra cash? Many are investing in ETFs. Armit Bhambra, Vice President, Institutional Business Development at BlackRock, says, “They can’t afford to have money sitting in cash or similar low-yielding investments. It’s difficult to justify sitting in cash for 24 months…”
One reason that there are fewer deals being finalised is that many private equity firms are of the view that asset prices are at inflated levels. With the stock markets now changing direction, deal volumes may pick up. But it is bound to be a slow process. Private equity firms may take a long time to invest all the money that they have collected.
BlackRock’s private equity fund may suffer from another disadvantage. Since it plans to invest with a ten-year horizon, its fund managers could have to wait for a decade or longer to get compensated. The practice that private equity firms follow is to pay their managers a salary as well as “carried interest.” This refers to the distribution of the 20% of profits when the private equity firm makes an exit.
A homecoming of sorts for BlackRock
BlackRock has come full circle by planning to start a private equity fund. It got its start in 1994 when it separated from the Blackstone Group, a private equity giant.
Stephen A. Schwarzman, the CEO of Blackstone had provided a US$5 million line of credit to Larry Fink in 1988 to start the division that went on to become BlackRock. After the 50-50 joint venture broke off from Blackstone, it grew rapidly and has now become the world’s largest asset management firm.
BlackRock manages in excess of US$6 trillion to Blackstone’s US$434 billion. But profits of the two firms are similar because Larry Fink’s company charges investors an average of only 0.2 cents for every dollar it manages. Blackstone, in contrast, has fees that are nine times higher. That is probably the reason that BlackRock wants to get a foothold in the private equity business.
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