Private equity: Everything you always wanted -2-

At last check, about 12 million people in the U.S. work for companies backed by private-equity firms, and they earn an estimated $1 trillion in wages, according to data from the American Investment Council, a trade group for private-equity firms. The entire U.S. private-equity sector accounts for about 6.5% of U.S. gross domestic product, or about $1.7 trillion, according to the AIC.

The total number of private-equity firms topped 12,000 at last check, up from fewer than 6,000 in 2013, according to investment-data company Preqin.

While the median business backed by private equity has 69 workers, many larger, widely known companies such as Uber Technologies Inc. (UBER), Airbnb Inc. (ABNB), Yeti Holdings Inc. (YETI), Dunkin, Safeway, PetSmart, Hilton Hotels, Toys R Us, RJR Nabisco and Kinder Morgan have been backed by private-equity firms.

If you own stock, you've probably seen some of your publicly traded companies being gobbled up by take-private leveraged-buyout deals led by private-equity firms. A historic case would be KKR & Co.'s (KKR) $25 billion buyout of RJR Nabisco, which put private equity firmly on Wall Street's radar in 1988 as one of the largest-ever mergers at the time.

A fresher example is that of retailer Chico FAS (CHS), which is being acquired for $1 billion by Sycamore Partners, a private-equity firm that manages a portfolio of retail brands such as Staples, Hot Topic, the Limited, Talbots, Dollar Express and Nine West.

This transaction type has drawn criticism because leveraged buyouts often involve loading up the target company with expensive debt. If the company manages to match growth projections at the time of the deal, this is not usually a problem.

In some cases, however, a particular industry or an individual company could fall on hard times, leaving private-equity portfolio companies with weak balance sheets or facing bankruptcy.

One high-profile example was the buyout of Toys R Us, which was acquired for $7.5 billion by Bain Capital, Vornado Realty Trust and KKR & Co. in 2005. Prior to the deal, Toys R Us had less than $2 billion in debt, but after the deal closed, that figure grew to $5 billion.

Impacted by steep debt payments and competition from retailing giants such as Walmart Inc. (WMT) and online competitors such as Amazon.com Inc. (AMZN), Toys R Us went bankrupt, resulting in about 33,000 layoffs in 2018.

Employees at Toys R Us won a $2 million severance settlement a year later, while separately, KKR & Co. and Bain Capital committed a combined $20 million to launch the TRU Financial Assistance Fund in late 2018.

Such a move would have gained support from one of the biggest investor groups in private-equity funds, public pension funds.

Several private-equity firms are publicly traded

While public pension funds and other institutional investors continue to plow money into alternative investments, most 401(k) plans for individuals are not tapping into private equity.

For now, private-equity firms continue to expand their reach to individuals mostly through the registered investment adviser network for moderately to extremely wealthy individuals with at least $1 million in assets outside of their primary home.

A specific type of fund called a 40 Act Fund is a publicly filed vehicle that invests money from individuals into private equity. One larger example of this fund type is the Partners Group Private Equity (Master Fund) LLC, with $13.6 billion in net assets for the fiscal year that ended March 31.

Getting access to the funds themselves allows investors to gain from the roughly 80% of the profit of buyout and other deals.

When you buy stock in a private-equity firm, the stock's value is partly based on the 20% carried interest that the management company gets on private-equity deals, not on the lion's share of the profits.

But if the 20% will suffice, individual investors may buy shares of several private-equity firms with stock listings in the U.S.

Blackstone Inc. was the first major U.S. private-equity firm to go public, in 2007. Nowadays, stocks are available from many other major firms, including Brookfield Corp (CA:BN), Apollo Global Management Inc. (APO), Carlyle Group Inc. (CG), KKR, TPG Inc. (TPG) and others.

Many of the largest private-equity firms, however, are not publicly traded. Some of those include Thoma Bravo, GTCR, Lone Star Funds, Bain Capital, Vista Equity Partners, Global Infrastructure Partners, TA Associates, Warburg Pincus, General Atlantic, Advent International, Cerberus Capital Management, Fifth Street and Silver Lake.

Many specialty finance stocks, such as business-development companies, lend to private companies or take part in other alternative businesses. Some examples of lenders include Ares Management Corp. (ARES), FS KKR Capital Corp. (FSK) and Blue Owl Capital Inc. (OWL). Blue Owl also invests in ownership stakes in private-equity firms.

Other public companies with exposure to private markets include Hamilton Lane Inc. (HLNE), StepStone Group Inc. (STEP) and PJT Partners Inc. (PJT).

Many of these corporate private-equity firms have diversified beyond private-equity buyout funds into credit, secondary, real-estate and infrastructure funds, to name a few. Private-equity funds remain the largest component of that pie.

In a sign that private equity may be ready for prime time in terms of stock investing, Blackstone this year reached a couple of milestones: It hit $1 trillion of assets and was recently named a component of the S&P 500.

Other private-equity firms with publicly traded stock may soon join the S&P 500, so investors may be hearing more from the sector as time goes on.

Key to whether investor interest in private equity continues will be the performance of the asset class, which has been boosted by the past era of low interest rates, which ended last year with a series of rapid rate hikes by the U.S. Federal Reserve and other central banks.

"These low interest rates were a boon to private-equity investment volume and returns and hit the attractiveness of investment-grade bonds," said DePonte of Probitas Partners. "On a going-forward basis, we are likely to see higher interest rates, returning more toward historical norms -- with more stress on private-equity returns and leverage."

Calpers is a fan of alternatives

Private-equity and other alternative investments have made up a significant portion of the retirement savings of 34 million people in the U.S., especially from public pension funds.

One of the largest examples is the California Public Employees' Retirement System, or Calpers. About $59.7 billion of its assets under management, or 12.9% of its total portfolio of $463 billion, is invested in private equity, and $10.3 billion, or 2.2%, is invested in private debt.

As big as public pension funds are, they only account for about $7.7 trillion of U.S. retirement assets, which totaled $35.4 trillion as of March 31, according to figures from the Investment Company Institute.

As the largest single piece, individual retirement accounts account for $12.5 trillion, followed by $9.8 trillion for defined-contribution plans, including 401(k) plans.

For now, a large portion of the client business for private equity comes from the world of institutional investors, including public pension funds, endowments and foundations, sovereign-wealth funds and family offices.

Some wealthy individuals who meet the U.S. criteria for investing in private-equity funds as so-called accredited investors also take part.

The goal of these investors is to balance their portfolios of public stocks and bonds with private-market returns from the alternatives. Such holdings increase diversification by offering access to private companies that often grow at a faster rate than larger public companies.

A December 2022 study by the Georgetown University Center for Retirement Initiatives concluded that target-date funds with alternatives included produced "positive" benefits.

"The amount of annual retirement income that can be generated by converting a participant defined contribution [such as 401(k) plans] has the potential to improve by 17% in the expected case and by 11% in a worst-case or downside outcome," according to the study's executive summary.

-Steve Gelsi

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10-28-23 0947ET

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