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Private equity can no longer rely on borrowing cheap money to fuel returns, and will have to go back to its roots of sourcing good deals and making operational improvements, according to the head of Goldman Sachs’s investment business.
“Private equity will look different over the next 10 years than it looked over the past 10 years,” said Marc Nachmann, global head of asset and wealth management at the US bank, in an interview. “It will be a little bit back to the future in a sense.”
The decade and a half of low interest rates that followed the 2008-2009 financial crisis heralded a boom in private equity, as managers made use of cheap and plentiful debt to embark on acquisition sprees. Falling interest rates raised asset values and cut the cost of capital.
“Over the past 10 years you could rely on lots of leverage, cheap cost of capital and multiple expansion, and you made your returns that way,” said Nachmann. “That will be harder to do going forward.”
While there is growing optimism that US interest rates have peaked after the biggest rise in decades, they are likely to remain high for some time. Nachmann was among those warning that private equity would need a different modus operandi from the one it had thrived on in the past decade.
“When private equity started out, it was about really good deal sourcing and then doing a lot of operational things to improve companies,” he said. “This goes back to the old days when people targeted undermanaged divisions of large companies or private companies that could be improved. A lot of the returns will come from sourcing really good opportunities and then the operational improvements.”
Bankers and industry executives are expecting more corporate carve-outs, when a private equity firm buys a business unit from a large corporation, such as GTCR’s $18bn carve-out of payments company Worldpay from FIS this year.
Goldman runs an internal “value accelerator” platform that works with its more than 300 portfolio companies to build the businesses.
Nachmann said he expected more “performance dispersion [between firms] than we’ve seen in the past few years”. Investors in private equity were “really digging in to see how people have made their returns”, he added, trying to understand how much came from leverage and multiple expansion — selling a business at a higher value than the purchase price — rather than operational improvements at portfolio companies.
Just over a year ago, Nachmann, a trusted lieutenant of Goldman Sachs chief executive David Solomon, was promoted to oversee Goldman’s newly merged asset and wealth management division, which had $2.7tn in assets under supervision at the end of the third quarter.
Expanding this business is crucial to Solomon’s push to revive the Wall Street bank’s stock market valuation and reduce its dependence on the more volatile earnings streams from its investment banking and trading businesses. But the division has been hit by some senior departures, including its chief investment officer Julian Salisbury.
Goldman has earmarked its alternative assets business, which includes areas like private equity, private credit and infrastructure, as a priority for growth. The bank is trying to focus more on investing money from outside clients rather than from its own balance sheet. As a result, its third-party capital in alternatives had grown from $40bn in 2020 to $219bn at the end of the third quarter. Goldman’s alternative funds are on track to raise $225bn from outside investors by the end of 2023, a year earlier than planned.
Nachmann said that the “disadvantage” of its investment bank’s strong position, it ranks top in M&A advisory, was that it runs more sales processes than its rivals, in which its private equity team cannot participate.
“The benefit of our strong investment banking franchise is that we know more companies than anybody else and we have really tight relationships,” he added. “We may see things way before anybody else sees them and you can work through unique situations that don’t end up in auction processes.”
Commenting on the general economic outlook, Nachmann said: “There are still plenty of risks around, but markets feel good barring exogenous issues that are not yet priced. Over the next few years, we expect US stocks to deliver marginally higher returns than bonds or cash.”