WEBVTT - How Private Equity Lost Its Mojo

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<v Speaker 1>Bloomberg Audio Studios, podcasts, radio news.

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<v Speaker 2>When the FED makes it a little bit easier to

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<v Speaker 2>borrow money by lowering the cost of borrowing money, that

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<v Speaker 2>is sort of a positive vibes move.

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<v Speaker 1>The FED lowered interest rates last week.

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<v Speaker 2>So that's welcome news for people who are looking to

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<v Speaker 2>borrow money, whether it's for a mortgage.

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<v Speaker 1>But that positive vibes move for borrowers came with a

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<v Speaker 1>warning that the job market is weakening and inflation is

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<v Speaker 1>still elevated, and now everyone's eagerly awaiting the Fed's next steps.

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<v Speaker 2>Most officials forecast the FED will use those meetings to

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<v Speaker 2>lower interest rates by another half a percent.

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<v Speaker 1>It will keep lowering rates in order to prop up

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<v Speaker 1>the slowing job market, which would be particularly good news

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<v Speaker 1>for one corner of the finance world, private equity.

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<v Speaker 2>When it is cheaper to borrow money, you can borrow

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<v Speaker 2>more money and therefore do larger and larger deals. And

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<v Speaker 2>as the deals get bigger, the funds get bigger. As

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<v Speaker 2>the funds get bigger, the profits get bigger. As the

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<v Speaker 2>profit gets bigger, the firm grows, and pension funds make money. Ideally,

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<v Speaker 2>the people working at the private equity firms make money,

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<v Speaker 2>and it sort of becomes us like ever expanding as

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<v Speaker 2>a class.

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<v Speaker 1>That's Alison McNeely, who covers the private equity industry for Bloomberg.

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<v Speaker 1>Private equity firms thrive off buying, flipping, and selling companies

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<v Speaker 1>for a profit, and Allison says there's a reason they've

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<v Speaker 1>been hungry for lower rates. After a half century of

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<v Speaker 1>meteoric growth, the industry has found itself in a historic slump.

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<v Speaker 1>But while the recent rate cut could encourage more deal making,

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<v Speaker 1>private equities issues are much larger than what one FED

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<v Speaker 1>decision could turn around.

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<v Speaker 2>What's going wrong with PE is they are having a

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<v Speaker 2>hard time selling assets, returning capital to investors, raising more money.

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<v Speaker 2>It's been harder to sell companies and make profits for investors,

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<v Speaker 2>and harder to raise new money from those investors and

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<v Speaker 2>sort of keep the flywheel going of business.

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<v Speaker 1>Private equity firms across the board are struggling to cash

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<v Speaker 1>out of old investments, raise new funds, and most of all,

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<v Speaker 1>produce the kinds of returns that their investors have come

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<v Speaker 1>to expect, and Allison says privately, many institutional investors in

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<v Speaker 1>PE are tempering their investment expectations for the next decade.

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<v Speaker 2>When the private equity sort of fly machine is working properly,

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<v Speaker 2>you're constantly raising new money in funds, putting that money

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<v Speaker 2>to work, investing in new companies, selling companies, ideally in

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<v Speaker 2>a profit that they've held for a long time. And

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<v Speaker 2>you've got a sort of a constant churn of money

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<v Speaker 2>coming in and out of the funds, being returned to

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<v Speaker 2>investors and allowing the firm to grow.

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<v Speaker 1>So that churn is what's grinding to a halt.

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<v Speaker 2>Exactly.

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<v Speaker 1>I'm Sarah Holder, and this is the big take from

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<v Speaker 1>Bloomberg News today on the show Private Equity at a Crossroads.

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<v Speaker 1>Why pe firms are struggling to buy, sell and fundraise

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<v Speaker 1>the way they did and they're hated, and what that

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<v Speaker 1>could mean for the industry's future.

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<v Speaker 2>Proponents of private equity and people who believe in investing

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<v Speaker 2>in it will tell you that it's a great asset

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<v Speaker 2>class because it beats the stock market. If you want

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<v Speaker 2>to make a lot of money, you should invest in

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<v Speaker 2>private companies because there is basically more juice to squeeze

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<v Speaker 2>than investing and say a publicly traded stock or bond

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<v Speaker 2>for that matter. And so they will just say there's

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<v Speaker 2>higher risk, but also higher reward. People who are skeptical

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<v Speaker 2>of private equity will tell you it's a very expensive asset.

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<v Speaker 2>Class fees are higher than say the fee that you

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<v Speaker 2>would have to pay to buy a public stock in

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<v Speaker 2>your brokerage account. The private equity firm takes a bigger

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<v Speaker 2>cut through higher fees, and that they maybe don't produce

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<v Speaker 2>as good or as strong of results as they say

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<v Speaker 2>that they do.

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<v Speaker 1>And there's an ongoing debate about how the industry measures success.

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<v Speaker 2>As the industry has slowed down in the last couple

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<v Speaker 2>of years, people have sort of shifted their focus to

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<v Speaker 2>DPI or distributions to paid in capital. It is basically saying,

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<v Speaker 2>if I give you a dollar, are you giving me

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<v Speaker 2>a dollar back? Are you giving me a dollar fifty?

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<v Speaker 2>Are you giving me two dollars? Or if I give

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<v Speaker 2>you a dollar, are you giving me five cents back.

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<v Speaker 2>I don't want five cents back. I want at least

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<v Speaker 2>a dollar, preferably two dollars. And so as more private

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<v Speaker 2>equity firms have struggled to reach that two or three

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<v Speaker 2>dollars return, people are asking more questions about what the

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<v Speaker 2>value is of private equity.

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<v Speaker 1>The private equity industry peaked in the second quarter of

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<v Speaker 1>twenty twenty one, when quarterly returns for you US firms

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<v Speaker 1>hit around thirteen point five percent according to Pitchbook, But

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<v Speaker 1>then came twenty twenty two.

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<v Speaker 2>That is when the US Federal Reserved raised interest.

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<v Speaker 1>Rates, and that was bad news for an industry that

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<v Speaker 1>runs on debt.

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<v Speaker 2>Firms have the companies that they acquire borrow money to

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<v Speaker 2>facilitate deals, buying and selling. And so when you make

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<v Speaker 2>debt more expensive by raising boring costs, which is what

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<v Speaker 2>the Federal Reserve did in twenty twenty two, that makes

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<v Speaker 2>it less attractive to do deals. And when it's less

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<v Speaker 2>attractive to do deals, that means people aren't buying and

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<v Speaker 2>selling as many companies and they are not generating profits

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<v Speaker 2>for their institutional investors. And so what happens is you

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<v Speaker 2>get a sort of a chicken and an egg problem

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<v Speaker 2>where if you're not selling assets or selling companies and

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<v Speaker 2>returning money to investors, they're in turn going to have

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<v Speaker 2>less money to give you for future deals. Everything kind

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<v Speaker 2>of grinds to a halt.

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<v Speaker 1>The frenzied era for private equity was over. Last year's

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<v Speaker 1>fourth quarter saw USPE firms report returns of just zero

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<v Speaker 1>point eight percent. When Donald Trump took office in January,

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<v Speaker 1>PE firms were optimistic that the new administration could help

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<v Speaker 1>them turn things around.

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<v Speaker 2>The president was perceived and is perceived as being pro

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<v Speaker 2>business and creating a good environment for doing deals, potentially

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<v Speaker 2>less regulation, less anti trust enforcement.

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<v Speaker 1>But according to Allison, a lot of PE firms say

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<v Speaker 1>Trump's tariff policies have made their jobs harder.

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<v Speaker 2>People in the industry refer constantly to Liberation Day as

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<v Speaker 2>being the moment when things might have changed. There is

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<v Speaker 2>a lot more mixed feelings, I would say, among people

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<v Speaker 2>in the private equity industry about the current administration. A

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<v Speaker 2>lot of uncertainty around tariffs and the general policy stance

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<v Speaker 2>on some of these key issues.

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<v Speaker 1>That uncertainty and the threat that tariffs would reignite inflation

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<v Speaker 1>held the FED back from lowering interest rates for months,

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<v Speaker 1>even as Trump pushed for aggressive cuts. And while last

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<v Speaker 1>week's quarter point adjustment could help PE firms borrow from

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<v Speaker 1>the bank, the current economic environment is also making it

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<v Speaker 1>harder for them to raise money from investors.

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<v Speaker 2>When private equity firms go out to raise a new

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<v Speaker 2>pool of capital, they generally have a target. They tell

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<v Speaker 2>their pensions and their endowments. We plan to raise ten

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<v Speaker 2>billion dollars, and hitting that target is an important signal

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<v Speaker 2>to the market that there is confidence in this firm,

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<v Speaker 2>there's confidence in the strategy, and that they are growing.

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<v Speaker 1>Allison looked at one firm in particular that's experienced the

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<v Speaker 1>recent fundraising slump firsthand, Insight Partners.

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<v Speaker 2>Insight Partners invest in venture capital and private equity with

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<v Speaker 2>a focus on technology, a very attractive, high growth space,

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<v Speaker 2>really one of the hottest areas of private markets investing.

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<v Speaker 2>When they went out to raise their most recent flagship fund,

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<v Speaker 2>they indicated to the market that they were looking together

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<v Speaker 2>about twenty billion dollars, which is the same as their

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<v Speaker 2>prior fund.

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<v Speaker 1>Is that a lot for that is a lot.

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<v Speaker 2>That is a lot. That is a big fund. Inside

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<v Speaker 2>Partners put a lot of money to work. They invested

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<v Speaker 2>really during the heydays of investing in technology and software,

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<v Speaker 2>when a lot of deals were getting done at really

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<v Speaker 2>high valuations, and after interest rates went up, the deal

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<v Speaker 2>making environment really changed. You know. They really said to

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<v Speaker 2>LPs and private conversations, hey, we realized that we put

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<v Speaker 2>a lot of money to work really quickly. The market

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<v Speaker 2>was really kind of hot and busy, and we were

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<v Speaker 2>out there with a lot of other folks doing a

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<v Speaker 2>lot of deals.

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<v Speaker 1>But we're really.

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<v Speaker 2>Focusing on distributions and we're really focusing on returning capital

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<v Speaker 2>to you our investor base. However, that message didn't entirely resonate,

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<v Speaker 2>because Inside Partners ended up closing their fund earlier this

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<v Speaker 2>year with around eleven point five billion.

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<v Speaker 1>Dollars, so less than twenty billion, Yes.

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<v Speaker 2>Less than twenty billion, and that was after they revised

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<v Speaker 2>the target down previously, recognizing that maybe the landscape had

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<v Speaker 2>changed and things were not as attractive for investing as

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<v Speaker 2>they had been previously. And Inside Partners is hardly alone

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<v Speaker 2>in having maybe not met their initial expectations for how

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<v Speaker 2>much money they would raise. This has been a problem

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<v Speaker 2>that has impacted many firms across the industry.

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<v Speaker 1>How is this challenging moment for PE sitting with limited partners?

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<v Speaker 1>Are they getting frustrated?

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<v Speaker 2>It's really interesting limited partners, so the pension funds, the endowments,

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<v Speaker 2>you know, traditional institutional investors in private equity will say

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<v Speaker 2>sort of privately that they're very frustrated, but they're hesitant

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<v Speaker 2>to speak out publicly because, in their view, private equity

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<v Speaker 2>has been a good asset class to invest in for decades.

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<v Speaker 2>They have done well by allocating money towards it, but

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<v Speaker 2>also a sense at this point that they want to

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<v Speaker 2>kind of wait and see and if the conditions for

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<v Speaker 2>doing deals improve, maybe we're just going to go through

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<v Speaker 2>a bit of a bumpy patch and things will get better.

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<v Speaker 1>So just how are private equity firms adapting to this

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<v Speaker 1>moment and will their strategies be enough to turn the

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<v Speaker 1>industry around. That's after the break. The struggle is real

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<v Speaker 1>for private equity firms and for the institutional investors who've

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<v Speaker 1>given them money. The efirms are reporting lower quarterly returns

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<v Speaker 1>and sitting on mountains of cash they haven't yet deployed.

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<v Speaker 1>According to an estimate from the management consulting firm Vein,

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<v Speaker 1>the industry was holding about one point two trillion dollars

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<v Speaker 1>for potential deal making as of midyear. Bloomberg's Allison McNeely

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<v Speaker 1>says some firms are leaning on new tactics to get

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<v Speaker 1>back on track.

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<v Speaker 2>There's sort of an emerging it's not even emerging at

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<v Speaker 2>this point. It's a fast growing, robust area of private

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<v Speaker 2>markets called secondaries. When a private equity firm goes out

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<v Speaker 2>and buys a company, does a deal that's called a

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<v Speaker 2>primary investment. So they raise a fund it's going to

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<v Speaker 2>be in business for ten to twelve years. They're going

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<v Speaker 2>to buy and sell deals out of that fund during

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<v Speaker 2>the time, and then they're going to ideally like wind

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<v Speaker 2>it down, sell everything off, and move on to the

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<v Speaker 2>next fund. And that essentially means raising a new fund

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<v Speaker 2>that has the express purpose of buying that existing investment

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<v Speaker 2>out of the old fund, resetting the clock on it,

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<v Speaker 2>bringing in new money to back it up, and buying

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<v Speaker 2>themselves more time.

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<v Speaker 1>So they're selling a company to themselves, and they're buying

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<v Speaker 1>that company.

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<v Speaker 2>They're effectively selling a company to themselves out of an

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<v Speaker 2>older fund into a newer fund, and then simultaneously with

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<v Speaker 2>the newer fund bringing in new investors.

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<v Speaker 1>So does that mean the investors in the old fund

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<v Speaker 1>get paid out at that point.

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<v Speaker 2>They can if they want to. And so they say,

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<v Speaker 2>we recognize this investments getting a little long in the tooth.

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<v Speaker 2>We should be you know, selling it by now. We've

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<v Speaker 2>brought in these new investors to cash you out if

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<v Speaker 2>you want to be cashed out. But then also some

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<v Speaker 2>investors are like, no, I believe in you I like

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<v Speaker 2>this asset, I'm comfortable rolling over into the new fund

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<v Speaker 2>and like sticking around for the ride.

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<v Speaker 1>So this is something that private equity firms have done

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<v Speaker 1>for a long time, but it's becoming more common in

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<v Speaker 1>this kind of deal making environment.

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<v Speaker 2>Yeah, these transactions, they have grown very quickly in the

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<v Speaker 2>past couple of years as sort of an alternative because

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<v Speaker 2>traditionally a private equity firm will sell a company by

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<v Speaker 2>selling it to another private equity firm, by selling it

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<v Speaker 2>to another company, or ipoing it listing it on the

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<v Speaker 2>stock market. Those paths have been more difficult, and so

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<v Speaker 2>essentially selling the asset to itself and other investors in

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<v Speaker 2>these fund transactions is another way to kick the can,

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<v Speaker 2>get some cash and kind of preserve optionality for the

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<v Speaker 2>potential rebound of the deal market in the future.

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<v Speaker 1>Does that raise any alarm bells?

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<v Speaker 2>Yeah, there are some people who don't like them because

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<v Speaker 2>these transactions, which they're called continuation funds. Don't worry about it,

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<v Speaker 2>very jargony, But people don't like these funds because there's

0:13:23.520 --> 0:13:26.439
<v Speaker 2>an inherent conflict when the same party is both the

0:13:26.440 --> 0:13:29.160
<v Speaker 2>buyer and seller. Proponents of the deals will say, well,

0:13:29.160 --> 0:13:32.360
<v Speaker 2>that's why we bring in new investors, they validate the price,

0:13:32.440 --> 0:13:35.320
<v Speaker 2>they validate the value of the asset, and they basically

0:13:35.360 --> 0:13:37.200
<v Speaker 2>make sure that transactions on the up and up.

0:13:38.640 --> 0:13:41.920
<v Speaker 1>Meanwhile, the industry is also looking at other ways to

0:13:41.960 --> 0:13:46.280
<v Speaker 1>bring in more capital, like getting private equity investments included

0:13:46.400 --> 0:13:51.080
<v Speaker 1>in retirement portfolios. Allison. In August, Trump signed this executive

0:13:51.160 --> 0:13:53.680
<v Speaker 1>order that's supposed to pave the way for private equity

0:13:53.760 --> 0:13:57.080
<v Speaker 1>to enter into four oh one K's something we've talked

0:13:57.080 --> 0:13:59.720
<v Speaker 1>about on the show before. What is the status of

0:13:59.760 --> 0:14:02.120
<v Speaker 1>that push right now and what kinds of implications could

0:14:02.160 --> 0:14:04.640
<v Speaker 1>it have for the industry and for people with a

0:14:04.679 --> 0:14:05.320
<v Speaker 1>four oh one K.

0:14:05.800 --> 0:14:09.160
<v Speaker 2>The four oh one K executive Order and just broadly

0:14:09.320 --> 0:14:13.960
<v Speaker 2>the signaling of the current administration that they are open

0:14:14.160 --> 0:14:17.760
<v Speaker 2>to private assets being in the hands of individual investors

0:14:17.800 --> 0:14:21.320
<v Speaker 2>like this is the most exciting thing for the industry. Ever,

0:14:21.520 --> 0:14:27.240
<v Speaker 2>it is potentially billions, if not a trillion at some

0:14:27.320 --> 0:14:32.160
<v Speaker 2>point of dollars of new money. So the four to

0:14:32.200 --> 0:14:35.080
<v Speaker 2>on K market to find contribution plans are about twelve

0:14:35.120 --> 0:14:38.760
<v Speaker 2>point five trillion dollars in assets under management. They're almost

0:14:38.920 --> 0:14:41.600
<v Speaker 2>entirely invested in stocks and bonds. If you can carve

0:14:41.640 --> 0:14:44.320
<v Speaker 2>off even a sliver of that. You open up a

0:14:44.560 --> 0:14:48.800
<v Speaker 2>massive new pool of money that can come in and

0:14:48.840 --> 0:14:52.040
<v Speaker 2>start investing in private equity funds at a time when

0:14:52.080 --> 0:14:55.000
<v Speaker 2>private equity firms have struggled to raise capital from their

0:14:55.000 --> 0:15:00.560
<v Speaker 2>traditional investor base. The potential for you know, regular people,

0:15:01.080 --> 0:15:03.000
<v Speaker 2>you and me and anyone else with a four one

0:15:03.040 --> 0:15:05.600
<v Speaker 2>K plan to start investing in these funds as well

0:15:05.920 --> 0:15:10.320
<v Speaker 2>opens up a really significant pool of money at a

0:15:10.360 --> 0:15:13.160
<v Speaker 2>time when it is really needed by these firms.

0:15:14.520 --> 0:15:17.760
<v Speaker 1>Allison says some of the PE experts she's talking to

0:15:18.120 --> 0:15:20.480
<v Speaker 1>see this as a pivot moment for the industry.

0:15:20.960 --> 0:15:24.760
<v Speaker 2>There are people in the industry who very much think

0:15:24.840 --> 0:15:28.480
<v Speaker 2>that private equity needs to get back to its roots

0:15:29.000 --> 0:15:33.320
<v Speaker 2>of buying and selling companies at multiple times what they

0:15:33.360 --> 0:15:36.920
<v Speaker 2>paid for them, and making big bets and getting slam dunks.

0:15:37.040 --> 0:15:39.280
<v Speaker 2>There are also people who will say, you know, these

0:15:39.320 --> 0:15:43.240
<v Speaker 2>secondary transactions, the four one K money, all of this

0:15:43.720 --> 0:15:49.680
<v Speaker 2>is actually just reflective of the growth and the maturation

0:15:50.280 --> 0:15:54.440
<v Speaker 2>of private equity and private markets investing more broadly, that

0:15:54.760 --> 0:15:58.240
<v Speaker 2>even if the deal market comes back in a meaningful way,

0:15:58.480 --> 0:16:02.600
<v Speaker 2>all these sort of newer developments are here to stay

0:16:02.720 --> 0:16:05.480
<v Speaker 2>and are just part of the range of options that

0:16:05.640 --> 0:16:09.320
<v Speaker 2>firms have for how they raise capital and how they

0:16:09.360 --> 0:16:10.520
<v Speaker 2>manage their investments.

0:16:12.320 --> 0:16:16.040
<v Speaker 1>Could this moment lead to any broader soul searching at

0:16:16.080 --> 0:16:20.120
<v Speaker 1>these PE firms about how they might build back differently

0:16:20.320 --> 0:16:21.040
<v Speaker 1>moving forward.

0:16:21.520 --> 0:16:24.760
<v Speaker 2>I think the soul searching that has occurred at private

0:16:24.760 --> 0:16:27.400
<v Speaker 2>equity firms over the past couple of years has really

0:16:27.520 --> 0:16:33.880
<v Speaker 2>been around distributions and potentially also the pace of growth.

0:16:34.240 --> 0:16:37.000
<v Speaker 2>And I think in some corners of private equity there

0:16:37.000 --> 0:16:40.560
<v Speaker 2>are some soul searching happening that you know, maybe twenty

0:16:40.600 --> 0:16:43.680
<v Speaker 2>billion dollars for a fund is big enough. Maybe we

0:16:43.760 --> 0:16:47.160
<v Speaker 2>don't need twenty five. Maybe we don't need thirty billion dollars.

0:16:47.240 --> 0:16:48.480
<v Speaker 1>Maybe eleven is enough.

0:16:48.720 --> 0:16:51.960
<v Speaker 2>Maybe eleven is enough because if we have a smaller

0:16:52.000 --> 0:16:55.840
<v Speaker 2>pool of capital, we can focus on doing the right deals,

0:16:56.680 --> 0:17:00.720
<v Speaker 2>being strategic and not trying to be so big.

0:17:00.920 --> 0:17:05.520
<v Speaker 1>Yeah. Maybe it's a reset of expectations that boundless growth

0:17:06.040 --> 0:17:07.880
<v Speaker 1>doesn't always have to be the goal.

0:17:08.359 --> 0:17:13.280
<v Speaker 2>Just strategic growth, focusing on your knitting, focusing at the

0:17:13.320 --> 0:17:17.320
<v Speaker 2>end of the day on buying and selling good companies

0:17:17.840 --> 0:17:21.160
<v Speaker 2>and making returns for your investors.

0:17:25.480 --> 0:17:28.040
<v Speaker 1>This is the big take from Bloomberg News. I'm Sarah

0:17:28.040 --> 0:17:30.800
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0:17:30.840 --> 0:17:34.520
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0:17:34.560 --> 0:17:38.880
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0:17:39.000 --> 0:17:41.320
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0:17:44.960 --> 0:17:47.160
<v Speaker 1>Thanks for listening. We'll be back tomorrow