The ‘everything bubble’ is deflating. Stocks, bonds, real estate, and even commodities are seeing a pullback this year. Some believe it’s only a matter of time before the correction spills over into the private market. That could create opportunities for investors who bankroll private equity firms.
New York-based Hunter Point Capital (“HPC”) is one such investor. The team seeks out minority investments in alternative asset managers. In other words, HPC buys a portion of the general partner firm itself, a strategy it calls “GP stake investing.”
CEO Avi Kalichstein claims the strategy has downside protection because GPs earn cash flow in predictable ways. Their income is generated through management fees, carried interest, and steady appreciation in the GP firm’s book value. This makes GP firms ideal targets for long-term investors seeking steady returns.
The performance of publicly-traded GPs seems to confirm this thesis. Brookfield Asset Management, the world’s largest alternative asset manager, has delivered an 11 percent compounded annual growth in stock price over the past ten years. Cash flows have expanded by 14 percent annually over 35 years. Those figures are both higher than the S&P 500 over the same period.
KKR, Carlyle Group, Apollo Management, and Blackstone have all outperformed the S&P 500 over the past five years. Along the way, these stocks have also delivered lucrative dividends and buybacks, boosting total returns for shareholders.
However, HPC doesn’t target publicly-traded GPs. The firm believes private middle-market GPs have lower valuations and better prospects. Earlier this year, HPC made a strategic investment in credit investor Iron Park Capital (“IPC”). IPC had just $4 billion in assets under management as of March 2022, putting it firmly in the middle market category.
Middle-market private equity funds generated net IRRs that were 90 basis points higher than those of large-cap private equity funds since the end of the global financial crisis, according to data published by Pinebridge.
This is “the most attractive sector in today’s environment,” according to HPC’s Kalichstein. He believes middle-market firms are also better positioned for the economic headwinds ahead. “GP fundraising will become more challenging, going forward, given the economic climate. As a result, GPs will seek to partner with GP stakes firms who can provide strategic value and help them to achieve their fundraising initiatives faster and with greater certainty.”
Not everyone shares this optimism. Short-seller Jim Chanos recently said the private equity industry “could have the same wake-up call that hedge funds had after the Global Financial Crisis,” Chanos said on a recent Bloomberg OddLots podcast. He said some private equity firms may find it difficult to justify their relatively “pedestrian returns,” in an environment where interest rates are higher and liquidity is more scarce.