March 25, 2014
Interviewed by: David Snow
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KKR and its Capital Partners

Suzanne Donohoe, who leads all investor relations for KKR, describes the evolving needs of the firm’s institutional investor clients.

Suzanne Donohoe, who leads all investor relations for KKR, describes the evolving needs of the firm’s institutional investor clients.

KKR and its Capital Partners

With Suzanne Donohoe of KKR

David Snow, Privcap:

Today we’re joined by Suzanne Donohoe of KKR. Suzanne, welcome to Privcap today. Thanks for being here.

Suzanne Donohoe, KKR:

Thank you, it’s a pleasure.

Snow: You oversee all of the client relations and IR function for KKR, which, of course, is one of the largest alternative investment managers in the world. I’m fascinated to hear what you are learning from these investors around the world and what is driving their appetites and their demand for product in the market. Maybe we could start with the fact that some of these, or most of these investors are coming out of a certain period of pain and I wonder if you could characterize any residual pain points that they’re dealing with and how that affects their appetite to participate in private capital?

Donohoe: That’s a great question and I was going to mention that in fact even five or six years on from the first cracks that appeared during the crisis, we’re still seeing investors responding to that environment. I think probably the most pronounced thing that they’re still searching for or still addressing is the fact that rates have been very low for a long time now. They’re thinking about how do they meet their liabilities in such a low return environment? Which obviously has implications for pretty much every asset class they’re in, but I think particularly for private asset classes where they can see the opportunity to earn outsized returns and capture the illiquidity premium. So we’ve seen a lot of movement in that direction, particularly as fear of lack of liquidity has started to abate. In the last couple of years, we’ve seen investors return to private markets and be thinking holistically about how can they put money to work in a thoughtful way in today’s environment.

Snow: So what kinds of assets would those be? Are these like real assets, longer-term chunky assets that as you say are quite illiquid?

Donohoe: If there were an “all of the above” category, I’d say that would probably be the right choice here. Whether it’s private equity or in the real asset space in particular I think because people see the possibility of inflation out in time they’re more interested in that space and I think frankly the energy revolution that’s going on in this country is one that’s informing people of the opportunities in that asset class as well. Certainly, I think people feel that there were attractive opportunities created by a flight of capital in the real estate market over a few year period. They’re now interested in coming back into that space. So we really see it across the gamut of private opportunities and today, investors are thinking about the right combination of yield in their portfolio and then long-term return.

Snow: Talk a bit about the appetite for private equity -more specifically defined regular way private equity. Do investors still want it? How do they want it? How differently do they want it from maybe in a prior cycle? 

Donohoe: Sure, it’s a great question. I think for much of the period post-crisis, we had a hangover going on in the private equity market. Clearly, plans had committed large amounts of capital in the 2006-2007 period and for a period of time they felt like they needed to course-correct and pull back from those allocations. We are starting to see that tide change, however, and I think frankly the run up in developed equity markets this year has been a big contributor to that. We’re now seeing the denominator effect go in the other direction. In fact, I had an investor say to me last week that the plan he’s a part of has been committing a couple billion dollars a year for the last several years and is now contemplating a 50 percent step-up in the scale of their commitments.

Snow: To private equity specifically?

Donohoe: To private equity specifically, so that gives you a sense of how the math works through the combination of those historical commitments rolling off. A large volume of capital being returned over the past few years and then the denominator effect in their public market equity programs also contributing to the point where they’re now saying, “Hey, I’m under-allocated again.” So if I think about the latest statistics I’ve seen, I think that there is roughly 350 or 400 billion dollars of dry powder in the buyout space. That number grows to a multiple of probably two to three times that if we look at private equity overall, inclusive of venture and the mid-market and other spaces. But I think there is an ability to forecast that out in time and see a lot more capital getting put to work. I think the other factor that’s at play here is in leverage credit markets, the ability to finance large deals is certainly there today. So deals are getting done at historically low rates of financing and that really is enabling capital to be put to work in a number of different situations.

Snow: Well there is a lot of capital, or there is more capital now that wants to be put to work from the investor’s side. In many cases, the investors want to go into arrangements with GPs that are different from in the past, things like separate accounts, co-investments, direct investments. KKR has structured several successful and very large separate accounts with certain key investors. What is behind the desire for these investors to structure those more cutting edge types of approaches to investing?

Donohoe: A couple thoughts for you on that, first thing is that I think there is actually more conversation that goes on about customized, separate account arrangements than maybe there deserves to be in reality. So those that occur will tend to be high profile and maybe get captured in the press. But by and large I would say our partners are still committing in a more traditional format of a commingled vehicle that will be representative of the GP’s strategy. I think in the cases where the people are looking though for that incremental degree of customization, it’s often driven by planned constraints on their side, or a particular desire to exchange more information or learn more from the GP. Sometimes a customized arrangement can help them to achieve those desires. 

On the topic of co-investment, that is definitely an area where it isn’t just talk. There are more participants in the market directly who are basically looking to leverage their fund relationships and effectively average down their cost, average up their exposure to deals that they find particularly appealing. We have the good fortune of having a pretty active pipeline and having been a good partner in a syndication context for a long period of time. So we find that we work with a lot of those organizations as they develop those capabilities.

Snow: I’d love to learn a bit more about the way that KKR handles co-investment demand and co-investment opportunities. When an investor says to you, “You know what? I’d love to invest in your fund but I really want to co-invest.” what do you say?

Donohoe: We would typically be excited about that because we often pursue opportunities that may in fact require a larger equity check than it would be prudent for our fund to speak for. We like the idea of controlling our own destiny as it relates to new businesses that we’re backing. The ability to both make an LP happy, i.e. share that flow with them and also keep our hands firmly on the steering wheel of the transaction is a win-win from our perspective. 

Having said that, the availability of flow and the availability of ideas is very driven by the environment. In an environment like we’ve been talking about where capital is flowing and where bond markets are open, financing markets are open more generally larger deals are possibilities. I think in a more constrained environment then, it’s less likely that you’re going to be able to deliver that flow. We always try to make sure our investors understand that it’s very conditional on the environment and on what we’re seeing.

Snow: Can you talk a bit about the fact that LPs are different from each other? Some are very well resourced and some are very thinly resourced. To what extent is it ever a challenge for an LP to actually process the co-investment opportunities that might come their way?

Donohoe: Sure, it’s a great question. You’re right, there are different types of LPs. There are some that are incredibly well-resourced, very serious about their desire to build a direct program, operating and thinking very much like we are or like the rest of the GP community, if you will. 

Then there are, on the other end of the spectrum, those who realize that they just don’t have the staff resources to be able to address that part of the market and aren’t necessarily trying. There are a lot of folks kind of sitting somewhere in between. I think where we’ve seen people have the most success is when they’re pretty realistic about the resources they can actually devote to doing diligence on deals. They either have dedicated teams focused on that so they can devote time, or they’ll set a reasonable target for how much capital they want to deploy in that way each year. I think where it may be more of a disappointment for some LPs will be if their eyes are larger than their stomach, if you will, and they’re trying to prosecute ideas, but they frankly just don’t have the staffing to do it. As you know, often, the time horizons can be very, can be very rapid turn-around on some transactions and so you do need to be staffed in order to be able to address that. 

Snow: The relationship between the GP and the LP has evolved over time. KKR has been in the market among the longest of any GP. This is a follow-on to the co-investment separate account question, do you think that the trend is going to be towards greater complexity, greater ranges of formats by which GPs and investors interact? In other words, is that a permanent trend?

Donohoe: I think there will always be a handful of investors that are seeking that higher degree of customization and who may value the control that comes in a more customized format. I think balancing against that however, is typically based on where you are in the waterfall of opportunities For many investors, what they prefer is to know that they’re in the most preferred spot in the waterfall, that they’re in the main fund. That certainly is going to be the most direct beneficiary of ideas that are generated. I think that’s the balancing side of that equation and so I don’t actually see a wave of incremental customization coming in that direction. I think a few years ago people seemed more prone to that, but I actually see a reversal in that desire in the conversations that we’re having.

Snow: So the long-term blind pool limited partnership is a pretty durable format for GPs and LPs to partner?

Donohoe: I think it is a durable format. It’s been in existence for 37-plus years and seems to be delivering attractive returns overall. While there were definitely trends in governance that were in favor of the LP over the past four or five years, and I think frankly were appropriate for the market, I see that as the mechanism that partners are using to become more active investors themselves. As opposed to throwing the baby out with the bath water and ultimately shifting legal format entirely.

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