📈 Private Capital Worldviews: Blackstone

Last week, we kicked off our “Private Capital Worldview” series with a look into KKR’s “Regime Change” thesis. 

This week, we continue with the world's largest alternative asset manager and corporate landlord, Blackstone.

Slight plot twist: While the majority of asset managers tend to publish regular market outlooks and analyses, Blackstone has a much different approach to publishing – educational programs designed for the wealth management / financial advisory channel instead. 

Why? It all comes back to retail investors.

Let’s dive in, 

-Jake Hoffberg

P.S. Today’s edition builds off the foundational investment philosophy we discussed in the January 17th (Searching for “Truth” in Early Stage Investing) and the January 25th (Turning ideas into investments (that hopefully make money) editions of Private Capital Insider.

P.P.S Looking for back issues of Private Capital Insider?

Go here to read everything we’ve published.

Blackstone and the Quest for Global Retail Money

Blackstone was founded in 1985 by Peter G. Peterson and Stephen A. Schwarzman, with $400,000 in seed capital.

Today, Blackstone is the largest alternative asset manager in the world, with more than $1 trillion of assets under management (AUM).

While there’s plenty of palace intrigue surrounding the nearly 40-year history of the firm…

It’s Blackstone’s efforts to penetrate the retail investor channel that I find the most interesting. 

In the 80s and 90s, the establishment worried about the so-called “Barbarians at the Gate,” as private equity rose to power.

But now, as private equity and venture capital have saturated the institutional markets, the Barbarians of Wall Street are about to face off against the Apes of Main Street.

For the past decade, Blackstone has been working on growing its retail platform; at the end of Q3 2017, 18% of the firm's $387.4 billion AUM was retail investors.

On the company’s 2017-Q3 earnings call, Joan Solotar – head of private wealth solutions at Blackstone – said, “there’s no reason that ultimately it won’t account for half the assets we manage” in the next 5-10 years.

Who do they think those assets will come from? According to Ms. Solotar, “We are targeting the $1 million to $5 million investor. They are really under-penetrated in the alts business.”

Then, on January 14th, 2020, John Finley – Chief Legal Officer at Blackstone – gave a presentation to the SEC titled “Expanding Retail Access to Private Markets.” 

In it, he revealed some rather shocking numbers…

Retail investors represent ~$68T of global assets, with $1-$5m households representing roughly $30T of assets.

But that’s just the tip of the iceberg…

By 2025, the total pool of retail assets is expected to balloon to $106T worldwide!

And with an average five percent allocation to alternatives, even a modest increase to a 10% allocation could represent an extra $5.3T of assets shifting to alternatives. 

If retail matched pensions at a ~30% allocation, it would mean an extra $26.5T of assets flooding into alternatives!

Combine that with the explosive growth of retail traders entering the markets since the start of COVID-19, and we could see a radical shift in the way capital markets function. 

Today, nearly a quarter of Blackstone’s $1T in assets come from private wealth, growing at a compound annual rate of more than 30%.

‘It’s not lost on distribution partners—who are being approached by everyone under the sun—that competitors have seen Blackstone’s success, and are jumping on the bandwagon,’ said Solotar.

“It’s a land grab,” said Matt Brown, chief executive of CAIS, a platform that gives independent financial advisers access to so-called alternative investment products. “You’re seeing the mutual-fund boom 2.0,” he said, referring to the rise in popularity of mutual funds during the 1990s.

According to Forbes,

And this massive push into semi-liquid private funds – also called “evergreen” or “perpetual” funds – is the cornerstone strategy driving…

Blackstone’s $80 Trillion Opportunity

In a stroke of cosmic good luck for my research, on February 5th, 2024, Forbes published a cover story on Blackstone president, Jonathan Gray, and his plan to further expand the Blackstone empire. 

Raised in the suburbs of Chicago, Gray joined Blackstone in 1992, after graduating from the University of Pennsylvania. 

By 2005, at just 34 years of age, Schwarzmann tapped Gray to lead the firm’s growing real estate division. 

According to Schwarzman, Gray distinguished himself with a pair of astute strategic insights, which led to two of Blackstone’s most profitable deals: 

• The acquisition of Sam Zell’s massive Equity Office Properties for $39 billion, and
  

• Blackstone’s $26 billion acquisition of Hilton Worldwide, which included properties like New York’s Waldorf Astoria and Hilton Hawaiian Village

Gray was early to embrace commercial mortgage-backed securities (CMBS), which would allow Blackstone to do larger deals at a lower cost.

Gray also saw that Blackstone could buy publicly traded real estate companies – many whose owners had acquired properties over several years – for less than the sum of their individual holdings.

With most of the firm’s profits coming from the $115 billion real estate business Gray built, Schwarzman named him president and chief operating officer in 2018, succeeding another Blackstone-minted billionaire, former vice chairman Tony James.

Now, Gray is leading Blackstone’s international expansion… and the quest for the estimated $80T of global wealth held by individual investors. 

Interestingly enough, Jonathan Gray was the “founder” of perpetual funds at Blackstone – which is now set up to be the major driver of AUM growth for the firm, going forward.

In early 2017, Gray launched the firm’s first perpetual vehicle aimed at individual investors, the Blackstone Real Estate Trust (BREIT)– a mutual fund-like product for brokers, which had $2,500 minimums, and charged a 1.25% advisory fee, a 12.5% performance fee, and a hurdle rate of five percent. 

The product was an immediate success in the broker channel, who often tacked on an additional sales charge.

According to Schwarzman,

The success of BREIT would lead to the 2021 launch of the Blackstone Private Credit Fund. 

With more than $1.2 TRILLION in perpetual funds across the industry, it can’t be overstated what a big deal this shift in fund structure means for the private capital markets.

Not to suggest all the kinks have been worked out in this new, retail-facing product line (i.e., the redemption issues with BREIT)...

But the very existence of these products is a watershed moment for two reasons…

• It dramatically expands retail access to private capital strategies (both for better and worse)
  

• The perpetual capital structure allows Blackstone to change from the traditional “buy-to-sell” model, to a longer term “buy-and-build”

While we won’t suggest the corporate-raiding leveraged buyouts that made private equity infamous are dead and dusted…

We will suggest that this could mark the beginning of a new era in private equity ownership – for better, or for worse.

Blackstone’s “Virtuous Cycle” Thesis

To reiterate the point made earlier, Blackstone does not appear to publish the traditional market outlooks and analyst reports other firms do. 

From the firm's website, we know they are all about the energy transition, life sciences, and artificial intelligence (especially AI data centers).

However, we have to piece together some of the details surrounding these ideas, based on a patchwork of sources. 

We’ll start with what appears to be a new publication from Blackstone called “The Connection,” published on January 30th, 2024.

Let’s start with their “Virtuous Cycle” macro outlook:

I’ll unpack all of this in just a moment, but before I do, there are two points I’d like to make first: 

1. When you’re a firm as large as Blackstone, in many ways, you are “the market,” and represent the consensus view
   

2. Logically speaking, asset managers are going to “talk their book,” and put forward viewpoints that support their way of doing business.

For this reason, it should come as no surprise to hear active managers explaining why passive investing is “dead,” and why you should pay for active managers…

Or that the world's largest alternative asset managers think it’s a great time to invest in alternatives. 

With that said, I think the overall thesis regarding the “real economy” diverging from the “financial economy,” is an important one. 

If you really think about it, over the last 10-15 years, “asset light” tech firms were all the rage. 

But as we covered briefly in the most recent Weekend Edition… it appears investors might be growing tired of the AI-narrative pushing the Magnificent Seven stocks to new highs, and otherwise driving the broader market. 

Why? Because there’s simply no ignoring the sheer amount of infrastructure that needs to be built over the next 10-20 years to support the 4th Industrial Revolution narrative. 

And now that the Era of Easy Money is over (for now at least), we’re seeing a return to something that resembles “normal” finance – a focus on cash flows and profit growth.

According to Blackstone,

For this reason, the firm is focused on “high-quality businesses that are growing faster than inflation or GDP, which supports the earnings growth that is critical to driving attractive returns in this environment.”

And of course, Blackstone – like everyone else – is taking potshots at the 60/40 portfolio, touting the benefits of “Just Add Alts!”

We’ve talked plenty about Private Equity and Private Real Estate in previous issues of Private Capital Insider. 

But we haven’t talked much about the current “it girl” asset class – Private Credit.

According to Blackstone’s November 16th article, “Private Credit, Meet ‘Higher for Longer,’”

I promised an unpacking, so let’s get started.

The first thing we need to address is how the problems we’re seeing unfold in the banking sector – namely, rising interest rates causing lending to tighten – are pushing borrowers into the vastly less regulated private, non-bank lending sector. 

We can debate whether or not this is a good thing, but it’s pretty obvious it’s happening.

The second thing we need to discuss is a corporation's ability to service debt – called the Interest Coverage Ratio (ICR).

Today, the private credit market operates at a current average ICR of 1.5x, although 17% of companies operate at an ICR below 1.0x when assuming current base rates. 

While higher interest rates offer investors the prospect of higher yields, they also put pressure on the borrowers. 

As the higher-for-longer rate environment continues, this means we will likely see an increase in defaults down the line.

• Today, nearly 20% of the private credit market has an ICR below 1.0x at 5.5% forward base rates, which implies that nearly 20% of the private credit market does not have sufficient cash flow to cover their debt. 

• Of that 20%, over 70% are companies with $50 million in EBITDA or less. As the pressure of higher rates does build, it will likely be felt first and most acutely by smaller businesses.

And this brings us to the third thing we need to address, which is the key talking point regarding private credit across the industry – the favorable (senior) position on the capital stack.

Why? Because if a company defaults – or otherwise is forced into liquidation – there is an order to who gets paid first, and how much.

When investments underperform, the most senior capital sees materially higher recoveries than capital lower in the stack. 

This is evident in the liquid credit markets, where first-lien loans exhibited a 64% recovery rate vs. 24% for second-lien loans, and 35% for unsecured high yield bonds.

Final Thoughts: A New Era of Alternatives

While I do my best to stay away from making predictions, this ongoing deep dive into the largest alternative asset managers continues to reinforce my assumptions…

Retail Investors are the final frontier of capital.

This means we’re likely going to see more asset managers launch more perpetual vehicles…

And if you’re working with a financial advisor, you’re probably going to start hearing more about why the 60/40 Rule is dead, and instead, the “Just Add Alts!” narrative. 

However, just because you now have access to a wider selection of alternative investments, doesn’t mean you will necessarily see meaningful after fee/tax performance in your portfolio. 

Before you let your advisor talk you into a fully loaded product with all kinds of fees, be sure to ask questions about the impact of those fees on your potential returns.