November 3, 2023 • 16 mins
In this episode, Abdul delves into the world of finance and geopolitics, offering insights into safe haven trades during times of geopolitical tension. The discussion covers key safe haven assets like the Japanese yen, gold, bitcoin, and oil, analyzing their historical performance and their role in hedging against uncertainty. Additionally, the episode explores the evolving landscape of private equity, highlighting the significant changes it has undergone in recent years and the challenges it currently faces.
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Transcript
Episode Transcript
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(00:01):
Good afternoon, ladies and gentlemen.Welcome back to the Investors' Diet podcast,
where we help you work smarter andharder by providing weekly market updates and insights.
We're back again this week with ourregular scheduled podcast, and today's main
topics of interest are in the marketswe're watching amidst the war in the Middle
East and some discussions about private edguityand the problems it's facing. So war
(00:21):
has erupted in the Middle East,and first and foremost, my heart goes
out to all the innocent lives thathave been lost on both sides. It's
truly a shame to see what's goingon today in the world, and really
for how long this war has beengoing on for. But on this podcast,
we're gonna talk about what this meansfor markets and as a trader,
what trades should we fly to whenthings are getting scary in the market.
(00:45):
You know, markets are kind offunny. They have a certain muscle memory,
and when you get economic shocks orgeopolitical shocks, but particularly geopolitical shocks
like the ones that we're seeing recently, there are just certain markets that are
go to. They just perform wellin moments of crisis, and they are
oil, gold, Japanese yen,and bigcoin. So the Japanese yen,
(01:07):
surprisingly is one of them. We'lltalk a bit later about why. And
we have that came about, andthe oil price is one just because of
where the conflict is. It's inthe Middle East, right, And then
you have golden bigcoin, which areStatar trades that you should be taking.
Of course there are other things,but these are some of the really important
assets that you look to get asense of just how nervous investors really are.
(01:29):
So Middle East, right, whenyou have conflict in the Middle East,
that's obviously going to push investors' mindsand we're gonna start questioning what's going
to happen with oil because the MiddleEast remains a key global supplier of crude
oil. And you know, wedid have a recent precedent for geopolitical conflict
(01:49):
that caused a big run up inthe oil price, which was the war
in Ukraine. Right. Russia,like the Middle East, is a major
exporter of oil as well as naturalgas, and in the wake of the
war, we did see a prettysignificant increase in global energy prices. And
so myself and like everyone else.You know, we're thinking that now that
we have this hopeful the Middle East, are we going to see a run
(02:12):
up in prices. We did havea massive rally in oil prices from around
you know, June, and Ithink prices came up about twenty five percent,
and you didn't have analysts talking about, Okay, we're going to get
a hundred dollars barrel again, onehundred dollars per barrel again, maybe even
one hundred and fifty. And thereason for that is not the economy is
kind of you know, firing onall cylinders. You've kind of got this
huge run up in demand for oil. It's because Russia and Saudi Arabia,
(02:37):
really the big dogs of the oldmarket, decided to restrict supply. And
you know, the less supply that'sbeing provided in the markets, the higher
the price goes. Right, justlooking at a supply on the supply side,
and they want support the oil price. And that's really why the oil
price jumped over in June. Andyou can kind of contrast that with copperperprise
(03:00):
to tell you that it's kind of, you know, a global demand story,
But I personally wouldn't be surprised tosee oil trading over one hundred and
twenty five dollars just in wake ofeverything that's being going on. Right,
So that's that's oil. Let's talkabout end, which is kind of a
classic haveing trade, a very weirdone that I only only recently found out
(03:22):
about. Very odd. But youdo have your classic currencies that always perform
well in times of geopolitical stress.You have the dollar. You can't get
away without talk about the dollar,and so you know, you saw this
during COVID in March twenty twenty,and you see this in all sorts of
different occasions. The dollar is akind of classic kind of have in trade.
This was frank. You know,if you want to put your money
(03:44):
somewhere in a nice safe Heidi hole, then you know Swissland is a good
place to do it. And thesethings are generally quite beneficial for the value
of the frank, but also theend now very weird again, but everyday
people, you know, we don'thave, you know, very little use
for the Japanese yen. And inreality, it's just it's not a global
(04:05):
currency in the way that the dollaris, or even you can argue the
Swiss frame. But what generally happensis that when you know, when Japanese
investors get some sort of shock.Japanese investors are actually really the big investors
in overseas assets, so when theyget some sort of shock, they tend
to bring that money home, andso the end tends to rise in times
(04:25):
of stress. And sometimes that's youknow, really unwelcome because no one wants
their currency to be too strong.So even though global investors have little use
of the end, people piggyback onthat move. And if you see what
I mean here, that kind oflike people it's an overcreated trade essentially.
So because there's there's muscle memory,bad things happen, yen rises, a
(04:46):
lot of people try to jump aheadand buy the end, and that kind
of really really pushes the price up. So one example that that kind of
springs to my mind is when youknow, Japan had that a horrible earthquake,
a tsunami in twenty eleven, andone anecdote that I heard was that
the international community came together and said, you know what we can do to
(05:10):
help Japan. You know, wecould perhaps some you know, European official
parenty said we could buy some Japanesebonds because at the time, the thing
that Europe did more than anything elsewas international support for its bond market.
So they thought they were being helpfuland saying, maybe we could buy some
of your bonds, and then Japaneseofficials were like, oh, please don't
do that, because the last thingwe need is for our yen to get
(05:32):
even stronger than it already is,you know, and if anything, it
would really help us if you couldactually weaken our currency because we've got too
much strength. So that's what theend does, right the end. This
goes up when the markets go up. So that's that's that, that's the
that's oil. That's the end.Now let's talk about gold and bigcoin.
So gold is your sort of classical, classic geopolitical risk off acid. You
(05:57):
know, gold, thousands of yearsof history, the store of value,
YadA, YadA. I don't wantto sound like a gold bug, but
you know, again, to bringit back to Ukraine, after that war
erupted, you didn't see an increasein the gold price. Also, the
bigcoin price too bigcoin. Again,you could kind of term bigcoin as digital
gold. So everything here I'm talkingabout gold, you could pretty much it's
(06:18):
almost anonymous for a bitcoin, andagain you do normally see bigcoin follow gold
or gold follow bitcoin. So yes, gold did go up during the war
in Ukraine, bigcoin did also,so it wasn't enormous, So gold didn't
really public that much. Bigcoin reallydid. H there was a really a
(06:39):
bigger there was a bigger flight tobigcoin than gold after the Infatian episode of
twenty twenty one. But you didsee some risk off behavior towards gold and
at this time and at this time, sorry, you've seen a little bit
of that too. So you know, gold's only up about two percent in
the past few days, but orsorry, past week, Big one is
up about fifteen percent, so wehaven't seen this big jump in gold just
(07:01):
yet. But really it's been monthssince anyone's ever ever talked about gold or
goal has ever been in my feed. You know. It's kind of the
you know classic oh, like we'renervous about the fear currency system and institutions,
the markets keep you know, themarkets keep taking and therefore I'm going
to hide in the gold market andthat kind of that whole narrative kind of
died down and then really kind oftranslated into crypto. Uh, and then
(07:27):
crypto really did well on the backof this, and then now we're trying
to kind of have that resurgence ofinterest of gold and and the price has
not really caught up to that sofar. But there is some noise again,
and it's not immediately obvious that we'regoing to see that in in in
in the SOG price, in thegold price, sorr. What. But
taking it back a step, let'slook at, you know, the the
(07:50):
fundamental determinants of the gold price,which is the real interest rate. Uh.
This is kind of like the deepeconomic variable underlying a lot of acids,
which is the rate of interest youcan earn on a risk free acid
after you adjust for inflation. Sothat's the real part. So it's adjustice
for inflation. The risk free ratehas been going up. We've talked about
(08:11):
this on and on and on,and you know, long treasury yields are
surging and just as kind of inflationis moderating a bit, and that pushes
the real yield up. When thereal rate is higher, that creates a
higher opportunity. Cause for gold,gold is like a rock. It just
sits there. It does not yieldyou anything. You don't get an additional
five percent of the gold you holdfor however long you're holding it. Same
(08:33):
with bitcoin, right, it's azero yield investment, and so when the
prevailing inflation adjusted, he goes upgold and bitcoin becomes less attracted by comparison.
Again, like with oil and withthe yen, there is this broader
kind of force pushing against any tendencyto surge into gold because the world really
got scarier just over overnight, andgold doesn't pay you a dividend, it
(08:58):
doesn't pay you any interest payments,so it's very much indirect competition with yields
on government bonds. And yeah,I guess this is where a lot of
this comes down to, right,is that there's a big uncertainty over have
the situation in the Middle East.It's going to pan out, and so
investors don't want to kind of,you know, jump first and then ask
questions later. But the other thingis that to the extent there is nervousness
(09:18):
around all the things we've spoken aboutthat is absolutely running counter to the big
macroeconomics that are lifting bonds and suppressingthe world price. So it's kind of
a messy picture and there's a lotof big forces kind of pushing against each
other, and the next few weeks, I guess we'll tell, you know,
it will tell us which is goingto which way is going to prevail.
(09:39):
So that's that. Let's move onto private equity. So private equity
has been one of the best returningasset classes over the past all our thirty
years. It's warmed its way intopretty much every institutional investor's portfolio, and
it's generated a fair amount of politicalcontroversy along the way. So the question
that everyone's asking is can privately canprivate equity keep up? So there have
(10:03):
been some reports for a while nowon the fact that private equity funds are
turning to or if you prefer,resorting to increasingly exotic forms of debt financing
to keep their portfolio companies going.So I think a lot of US investors,
like people in the in the press, are looking and saying, you
know, we remember that old storyabout how private equity funds bought companies have
(10:26):
made them better, But now you'resort of doing you know, the sort
of you know, financial engineering cardtricks, and and we're wondering if there's
something unfortunate, anything you know,shady going on behind the scenes. So
we'll get into detail about the reasonsthat they're getting on, you know,
into these these these tactics. Butfirst, what is pe What is private
equity? Most of the time we'retalking about leveraged buyouts. Let's say,
(10:48):
you know, I'm a private equityuh, you know, smarty pants,
Right, I have a large pileof institutional money. I take a pile
of the you know, money,and I buy a company straight up like
cash, all cash, right.And then now the most important feature of
this purchase is that I actually don'tuse that much of my pile of money.
(11:09):
Most of the purchase is paid forby borrowing a lot of money either
from a bank from somewhere. Right. So I own the company in pretty
much the same way most people owntheir first house, with a tiny little
slice of equity or actual ownership,and then a big morgain on top of
that. Right. So the classiccritics, you know, that is the
classic criticism of private equity that theypile a huge amount of big debt onto
(11:33):
you know, virtuous and hard workinglittle companies. And if that company happens
to go bankrupt because of this immensepile of debt, the private equity executives
simply walk away, you know,hands clean, rubbing their hands, you
know, pretty much free, right, And and that criticism is not one
hundred percent fair, but it doesdoes say something very important about the economics
(11:54):
of private equity. Right. So, let's say you're a homeowner you like,
and you're like to be in thehousing market. You'd like to be
in the housing market if rates arelow and falling, which means that your
acid price that you've borrow to purchaseis going up, you'd feel great.
So you feel like a genius.And this is not too dissimilar from how
it's been for private equity firms inthe recent past. It was a pretty
(12:16):
good environment to be in, andnow that great time is over, just
as it is for homeowners who arenow discovering that mortgage rates could actually go
in two directions. So private equityis also discovering that general interest rates the
cost of borrowing can go up,which not only makes your debt more expensive
if you haven't termed it out tothe infinite future, but it also increased
(12:37):
the probability that your asset value isgoing to fall. So a lot of
the favorable aspects of the environment thatprivate equity has enjoined for for so long
there are slowly disappearing. And there'sanother point to make that actually predates the
point about changing grade environments, whichis the changing competitive environment. So in
the early days, going back tolike the eighties, everyone's like, well,
(12:58):
you can buy a big cup.These corporate rates are really serious,
and early on there's a lot moreto someone using a tired metaphor low hanging
fruit in terms of companies that wereout there to buy. They're either poorly
managed or inefficient public companies or youknow, small private companies that sort of
didn't know their own value. Butas you know, private equity has enjoyed
(13:18):
tremendous success. More and more moneyhas flowed into the industry. The number
of private equity firms have colariflated,and the competition for assets has gone gone
totally bananas. So even before theinterest rate environment changed, we were seeing
private equities returns fall because they're havingto pay more in a more competitive industry
environment to buy us in the firstplace. So now it feels like there's
(13:43):
almost a bit of a hangover forpe a lot you know that has come
down a log from twenty twenty oneor so and the cost of funding is
massively higher. And we've talked manytimes in the show. With interest rates
at you know, five plus percent, there's anxiety you know, I would
say among investors about some of themerging tactics in the pe industry. One
of these tactics is new and aggressiveforms of borrowing. So we've mentioned earlier
(14:07):
that the classic of private equity borrowingis happening at the company level, right,
the company they own gets a bunchof debt put under the balance sheet.
Increasingly, what is happening is theprivate equity funds, right, the
ownership vehicles of these companies are themselvestaking on debt, and that has a
lot of investors concerned are we goingto get these fifteen to twenty percent returns
(14:28):
that you know, these borrowing onthe fund level, Because if there are
defaults on the company, which weare seeing nationwide, a slow bristeady in
the default rate, If these thesedefaults continue on these companies and the fund
itself has borrowed money, that couldreally really hurt in terms because that money
has to be paid back. Butof course the change in the asset price
(14:54):
environment is implicated as well. Whydo these little companies owned by PE or
these medium sized big co companies ownedby a PE need to borrow money in
the first place because the PE funddoes not want to sell them right now,
because they don't think they'll get agood price. Either the businesses operations
are struggling, or the environment foran IPO or you know, or for
sale to someone else in the industryisn't as good as it once was.
(15:18):
And at the headquarters of the PEfund, they're like, well, maybe
in six months, maybe even ina year, things will get better.
We can pop this thing up later, inject a little more capital, and
maybe the sun will come out tomorrow. The problem we're seeing today is sometimes,
or not just today, but generally, sometimes the sun does not come
out tomorrow. Number one and numbertwo. The longer the private equity fund
(15:39):
holds the acid, the lower itsreturns are likely to be. Right,
they're dividing the total increase in thecompany by a large number of years,
so that you know, what wecall the internal rate of return sinks the
longer you own the acid. Sothat's the picture broadly speaking of it's getting
harder, not necessarily at the financialcrisis, right, but it's getting harder
(16:00):
to be a private edguity firm thatturns out those fifty or twenty percent returns
year on year. So that's thewrap for this Investors Diary podcast. Thank
you very much for tuning in withus. Did another episode of the Investorsdary
podcast. We have some exciting guestlight up for the coming episodes, so
stay tuned for those. Thank youagain for listening and peace
Good afternoon, ladies and gentlemen.Welcome back to the Investors' Diet podcast,
where we help you work smarter andharder by providing weekly market updates and insights.
We're back again this week with ourregular scheduled podcast, and today's main
topics of interest are in the marketswe're watching amidst the war in the Middle
East and some discussions about private edguityand the problems it's facing. So war
(00:21):
has erupted in the Middle East,and first and foremost, my heart goes
out to all the innocent lives thathave been lost on both sides. It's
truly a shame to see what's goingon today in the world, and really
for how long this war has beengoing on for. But on this podcast,
we're gonna talk about what this meansfor markets and as a trader,
what trades should we fly to whenthings are getting scary in the market.
(00:45):
You know, markets are kind offunny. They have a certain muscle memory,
and when you get economic shocks orgeopolitical shocks, but particularly geopolitical shocks
like the ones that we're seeing recently, there are just certain markets that are
go to. They just perform wellin moments of crisis, and they are
oil, gold, Japanese yen,and bigcoin. So the Japanese yen,
(01:07):
surprisingly is one of them. We'lltalk a bit later about why. And
we have that came about, andthe oil price is one just because of
where the conflict is. It's inthe Middle East, right, And then
you have golden bigcoin, which areStatar trades that you should be taking.
Of course there are other things,but these are some of the really important
assets that you look to get asense of just how nervous investors really are.
(01:29):
So Middle East, right, whenyou have conflict in the Middle East,
that's obviously going to push investors' mindsand we're gonna start questioning what's going
to happen with oil because the MiddleEast remains a key global supplier of crude
oil. And you know, wedid have a recent precedent for geopolitical conflict
(01:49):
that caused a big run up inthe oil price, which was the war
in Ukraine. Right. Russia,like the Middle East, is a major
exporter of oil as well as naturalgas, and in the wake of the
war, we did see a prettysignificant increase in global energy prices. And
so myself and like everyone else.You know, we're thinking that now that
we have this hopeful the Middle East, are we going to see a run
(02:12):
up in prices. We did havea massive rally in oil prices from around
you know, June, and Ithink prices came up about twenty five percent,
and you didn't have analysts talking about, Okay, we're going to get
a hundred dollars barrel again, onehundred dollars per barrel again, maybe even
one hundred and fifty. And thereason for that is not the economy is
kind of you know, firing onall cylinders. You've kind of got this
huge run up in demand for oil. It's because Russia and Saudi Arabia,
(02:37):
really the big dogs of the oldmarket, decided to restrict supply. And
you know, the less supply that'sbeing provided in the markets, the higher
the price goes. Right, justlooking at a supply on the supply side,
and they want support the oil price. And that's really why the oil
price jumped over in June. Andyou can kind of contrast that with copperperprise
(03:00):
to tell you that it's kind of, you know, a global demand story,
But I personally wouldn't be surprised tosee oil trading over one hundred and
twenty five dollars just in wake ofeverything that's being going on. Right,
So that's that's oil. Let's talkabout end, which is kind of a
classic haveing trade, a very weirdone that I only only recently found out
(03:22):
about. Very odd. But youdo have your classic currencies that always perform
well in times of geopolitical stress.You have the dollar. You can't get
away without talk about the dollar,and so you know, you saw this
during COVID in March twenty twenty,and you see this in all sorts of
different occasions. The dollar is akind of classic kind of have in trade.
This was frank. You know,if you want to put your money
(03:44):
somewhere in a nice safe Heidi hole, then you know Swissland is a good
place to do it. And thesethings are generally quite beneficial for the value
of the frank, but also theend now very weird again, but everyday
people, you know, we don'thave, you know, very little use
for the Japanese yen. And inreality, it's just it's not a global
(04:05):
currency in the way that the dollaris, or even you can argue the
Swiss frame. But what generally happensis that when you know, when Japanese
investors get some sort of shock.Japanese investors are actually really the big investors
in overseas assets, so when theyget some sort of shock, they tend
to bring that money home, andso the end tends to rise in times
(04:25):
of stress. And sometimes that's youknow, really unwelcome because no one wants
their currency to be too strong.So even though global investors have little use
of the end, people piggyback onthat move. And if you see what
I mean here, that kind oflike people it's an overcreated trade essentially.
So because there's there's muscle memory,bad things happen, yen rises, a
(04:46):
lot of people try to jump aheadand buy the end, and that kind
of really really pushes the price up. So one example that that kind of
springs to my mind is when youknow, Japan had that a horrible earthquake,
a tsunami in twenty eleven, andone anecdote that I heard was that
the international community came together and said, you know what we can do to
(05:10):
help Japan. You know, wecould perhaps some you know, European official
parenty said we could buy some Japanesebonds because at the time, the thing
that Europe did more than anything elsewas international support for its bond market.
So they thought they were being helpfuland saying, maybe we could buy some
of your bonds, and then Japaneseofficials were like, oh, please don't
do that, because the last thingwe need is for our yen to get
(05:32):
even stronger than it already is,you know, and if anything, it
would really help us if you couldactually weaken our currency because we've got too
much strength. So that's what theend does, right the end. This
goes up when the markets go up. So that's that's that, that's the
that's oil. That's the end.Now let's talk about gold and bigcoin.
So gold is your sort of classical, classic geopolitical risk off acid. You
(05:57):
know, gold, thousands of yearsof history, the store of value,
YadA, YadA. I don't wantto sound like a gold bug, but
you know, again, to bringit back to Ukraine, after that war
erupted, you didn't see an increasein the gold price. Also, the
bigcoin price too bigcoin. Again,you could kind of term bigcoin as digital
gold. So everything here I'm talkingabout gold, you could pretty much it's
(06:18):
almost anonymous for a bitcoin, andagain you do normally see bigcoin follow gold
or gold follow bitcoin. So yes, gold did go up during the war
in Ukraine, bigcoin did also,so it wasn't enormous, So gold didn't
really public that much. Bigcoin reallydid. H there was a really a
(06:39):
bigger there was a bigger flight tobigcoin than gold after the Infatian episode of
twenty twenty one. But you didsee some risk off behavior towards gold and
at this time and at this time, sorry, you've seen a little bit
of that too. So you know, gold's only up about two percent in
the past few days, but orsorry, past week, Big one is
up about fifteen percent, so wehaven't seen this big jump in gold just
(07:01):
yet. But really it's been monthssince anyone's ever ever talked about gold or
goal has ever been in my feed. You know. It's kind of the
you know classic oh, like we'renervous about the fear currency system and institutions,
the markets keep you know, themarkets keep taking and therefore I'm going
to hide in the gold market andthat kind of that whole narrative kind of
died down and then really kind oftranslated into crypto. Uh, and then
(07:27):
crypto really did well on the backof this, and then now we're trying
to kind of have that resurgence ofinterest of gold and and the price has
not really caught up to that sofar. But there is some noise again,
and it's not immediately obvious that we'regoing to see that in in in
in the SOG price, in thegold price, sorr. What. But
taking it back a step, let'slook at, you know, the the
(07:50):
fundamental determinants of the gold price,which is the real interest rate. Uh.
This is kind of like the deepeconomic variable underlying a lot of acids,
which is the rate of interest youcan earn on a risk free acid
after you adjust for inflation. Sothat's the real part. So it's adjustice
for inflation. The risk free ratehas been going up. We've talked about
(08:11):
this on and on and on,and you know, long treasury yields are
surging and just as kind of inflationis moderating a bit, and that pushes
the real yield up. When thereal rate is higher, that creates a
higher opportunity. Cause for gold,gold is like a rock. It just
sits there. It does not yieldyou anything. You don't get an additional
five percent of the gold you holdfor however long you're holding it. Same
(08:33):
with bitcoin, right, it's azero yield investment, and so when the
prevailing inflation adjusted, he goes upgold and bitcoin becomes less attracted by comparison.
Again, like with oil and withthe yen, there is this broader
kind of force pushing against any tendencyto surge into gold because the world really
got scarier just over overnight, andgold doesn't pay you a dividend, it
(08:58):
doesn't pay you any interest payments,so it's very much indirect competition with yields
on government bonds. And yeah,I guess this is where a lot of
this comes down to, right,is that there's a big uncertainty over have
the situation in the Middle East.It's going to pan out, and so
investors don't want to kind of,you know, jump first and then ask
questions later. But the other thingis that to the extent there is nervousness
(09:18):
around all the things we've spoken aboutthat is absolutely running counter to the big
macroeconomics that are lifting bonds and suppressingthe world price. So it's kind of
a messy picture and there's a lotof big forces kind of pushing against each
other, and the next few weeks, I guess we'll tell, you know,
it will tell us which is goingto which way is going to prevail.
(09:39):
So that's that. Let's move onto private equity. So private equity
has been one of the best returningasset classes over the past all our thirty
years. It's warmed its way intopretty much every institutional investor's portfolio, and
it's generated a fair amount of politicalcontroversy along the way. So the question
that everyone's asking is can privately canprivate equity keep up? So there have
(10:03):
been some reports for a while nowon the fact that private equity funds are
turning to or if you prefer,resorting to increasingly exotic forms of debt financing
to keep their portfolio companies going.So I think a lot of US investors,
like people in the in the press, are looking and saying, you
know, we remember that old storyabout how private equity funds bought companies have
(10:26):
made them better, But now you'resort of doing you know, the sort
of you know, financial engineering cardtricks, and and we're wondering if there's
something unfortunate, anything you know,shady going on behind the scenes. So
we'll get into detail about the reasonsthat they're getting on, you know,
into these these these tactics. Butfirst, what is pe What is private
equity? Most of the time we'retalking about leveraged buyouts. Let's say,
(10:48):
you know, I'm a private equityuh, you know, smarty pants,
Right, I have a large pileof institutional money. I take a pile
of the you know, money,and I buy a company straight up like
cash, all cash, right.And then now the most important feature of
this purchase is that I actually don'tuse that much of my pile of money.
(11:09):
Most of the purchase is paid forby borrowing a lot of money either
from a bank from somewhere. Right. So I own the company in pretty
much the same way most people owntheir first house, with a tiny little
slice of equity or actual ownership,and then a big morgain on top of
that. Right. So the classiccritics, you know, that is the
classic criticism of private equity that theypile a huge amount of big debt onto
(11:33):
you know, virtuous and hard workinglittle companies. And if that company happens
to go bankrupt because of this immensepile of debt, the private equity executives
simply walk away, you know,hands clean, rubbing their hands, you
know, pretty much free, right, And and that criticism is not one
hundred percent fair, but it doesdoes say something very important about the economics
(11:54):
of private equity. Right. So, let's say you're a homeowner you like,
and you're like to be in thehousing market. You'd like to be
in the housing market if rates arelow and falling, which means that your
acid price that you've borrow to purchaseis going up, you'd feel great.
So you feel like a genius.And this is not too dissimilar from how
it's been for private equity firms inthe recent past. It was a pretty
(12:16):
good environment to be in, andnow that great time is over, just
as it is for homeowners who arenow discovering that mortgage rates could actually go
in two directions. So private equityis also discovering that general interest rates the
cost of borrowing can go up,which not only makes your debt more expensive
if you haven't termed it out tothe infinite future, but it also increased
(12:37):
the probability that your asset value isgoing to fall. So a lot of
the favorable aspects of the environment thatprivate equity has enjoined for for so long
there are slowly disappearing. And there'sanother point to make that actually predates the
point about changing grade environments, whichis the changing competitive environment. So in
the early days, going back tolike the eighties, everyone's like, well,
(12:58):
you can buy a big cup.These corporate rates are really serious,
and early on there's a lot moreto someone using a tired metaphor low hanging
fruit in terms of companies that wereout there to buy. They're either poorly
managed or inefficient public companies or youknow, small private companies that sort of
didn't know their own value. Butas you know, private equity has enjoyed
(13:18):
tremendous success. More and more moneyhas flowed into the industry. The number
of private equity firms have colariflated,and the competition for assets has gone gone
totally bananas. So even before theinterest rate environment changed, we were seeing
private equities returns fall because they're havingto pay more in a more competitive industry
environment to buy us in the firstplace. So now it feels like there's
(13:43):
almost a bit of a hangover forpe a lot you know that has come
down a log from twenty twenty oneor so and the cost of funding is
massively higher. And we've talked manytimes in the show. With interest rates
at you know, five plus percent, there's anxiety you know, I would
say among investors about some of themerging tactics in the pe industry. One
of these tactics is new and aggressiveforms of borrowing. So we've mentioned earlier
(14:07):
that the classic of private equity borrowingis happening at the company level, right,
the company they own gets a bunchof debt put under the balance sheet.
Increasingly, what is happening is theprivate equity funds, right, the
ownership vehicles of these companies are themselvestaking on debt, and that has a
lot of investors concerned are we goingto get these fifteen to twenty percent returns
(14:28):
that you know, these borrowing onthe fund level, Because if there are
defaults on the company, which weare seeing nationwide, a slow bristeady in
the default rate, If these thesedefaults continue on these companies and the fund
itself has borrowed money, that couldreally really hurt in terms because that money
has to be paid back. Butof course the change in the asset price
(14:54):
environment is implicated as well. Whydo these little companies owned by PE or
these medium sized big co companies ownedby a PE need to borrow money in
the first place because the PE funddoes not want to sell them right now,
because they don't think they'll get agood price. Either the businesses operations
are struggling, or the environment foran IPO or you know, or for
sale to someone else in the industryisn't as good as it once was.
(15:18):
And at the headquarters of the PEfund, they're like, well, maybe
in six months, maybe even ina year, things will get better.
We can pop this thing up later, inject a little more capital, and
maybe the sun will come out tomorrow. The problem we're seeing today is sometimes,
or not just today, but generally, sometimes the sun does not come
out tomorrow. Number one and numbertwo. The longer the private equity fund
(15:39):
holds the acid, the lower itsreturns are likely to be. Right,
they're dividing the total increase in thecompany by a large number of years,
so that you know, what wecall the internal rate of return sinks the
longer you own the acid. Sothat's the picture broadly speaking of it's getting
harder, not necessarily at the financialcrisis, right, but it's getting harder
(16:00):
to be a private edguity firm thatturns out those fifty or twenty percent returns
year on year. So that's thewrap for this Investors Diary podcast. Thank
you very much for tuning in withus. Did another episode of the Investorsdary
podcast. We have some exciting guestlight up for the coming episodes, so
stay tuned for those. Thank youagain for listening and peace
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