David M. Rubenstein, co-founder and managing director of The Carlyle Group, has a professorial demeanor and a dry wit that takes a person by surprise. A lawyer by training and practice, Mr. Rubenstein whiled away the 1970s practicing law in private law firms in New York and Washington. In between law firm stints, he served as chief counsel to the U.S. Senate Judiciary Committee's Subcommittee on Constitutional Amendments and later, deputy assistant to the president for domestic policy during the Carter administration. In 1987, he left the White House to form a private equity shop, Carlyle Group with four other partners. He was the only attorney in the group that included two businessmen, a banker and a former member of the Federal Retirement Thrift Investment Board.
Today, executives at the private equity behemoth are busy these days adding new investment strategies, in part, by buying into other investment firms like AlpInvest Partners Inc. and, most recently, hedge fund Emerging Sovereign Group. Carlyle is also seeking new sources of capital. Firm executives have long thought about going public and now they are purported to be in discussions with underwriters for an initial public offering possibly as early as the third quarter. But in an interview with Pensions & Investments, Mr. Rubenstein declined to answer questions concerning a possible IPO.
The firm gained early notoriety outside financial circles for hiring some heavyweight advisers including former President George H.W. Bush and former Secretary of State James A. Baker III. Mr. Rubenstein now says that hiring politicians and Washington insiders got the firm noticed and was a big draw at its investor conferences. But firm executives do not expect to continue the practice in the future.
Why are you buying AlpInvest? AlpInvest is in an area that we know something about. It's a private equity fund-of-funds business. ... Firms like ours are increasingly diversifying out of the core buyout business and adding by acquisition or organic growth, new products that might be available to our core investors.
So, this is something which would enable us to go to our investors and say if you are interested in the fund-of-funds business or the secondaries business or the direct co-investment business but with organizations that are not Carlyle, specifically, we have a product that you can invest in. So it is an add-on to what we already do, and it is part of a diversification strategy that other firms like ours are already employing.
How does this fit into the long-term vision for Carlyle? We started years ago a process that others have followed. It's a process of having many different funds, centralizing the approval process and the fundraising and accounting and the legal and tax and so forth and letting the fund managers run their own funds, with central oversight and the approval of deals, but taking advantage of our contacts around the world.
Our strategy now is to basically build ourselves into a well-recognized, leading global asset management firm. And in that regard, what we are finding now is that the other large American private equity firms are basically doing the same thing. I'm not saying they are following our model but if you take a look at it, you have seven organizations in the United States, which more or less have a global brand of private equity and they are moving quickly to diversify out of private equity and into other alternative areas. These would be Blackstone, TPG, KKR, Carlyle, Apollo, Bain, Oaktree. These are all global brands.
The U.S. is now about a fifth of the global (gross domestic product) but (has) close to 100% of the global private equity firms. That probably won't continue forever but at least for the next five or six years, it is very difficult to believe that other countries can build these kinds of private equity firms because it takes five or six years to raise this kind of money.
Do you still consider pension plans reliable sources of capital? Historically, in private equity, the biggest source of capital has been public pension plans in the United States. They were anywhere between 25% and 30% of the buyout funds in the United States. These days, they have less capital to deploy for two reasons. One, their overall corpus went down. So, if they had a certain allocation to private equity, they might be over that allocation. Secondly, they are making distributions to their pensioners all the time but they are not getting back taxes or contributions commensurate with the distributions. So you have a bigger unfunded problem then you might have had before. As a result of that, public pension funds might not have as much capital in relative terms than before to put into private equity.
So private equity funds and firms are looking to other sources as well, and there are sovereign wealth funds that do not have to pay anything out to pensioners. Secondly, high-net-worth individuals increasingly like the returns they have read about or seen actually in private equity and so private equity, as it always does, is looking for new sources of capital and public pension funds will continue to be a big source but they won't be as relatively big a source as they had historically been.
Do you think the secondary market has a place for private equity firms? It's possible. We've sold minority stakes and others have as well, such as TPG.
I think what you are seeing now in the whole public pension fund space is a recognition that private equity has yielded pretty good rates of return and they still are interested in the asset class and, if you read surveys, they say that they want to increase investment in private equity. Now what is the reason they want to increase? ...
(W)hen the Great Recession hit, stocks went down and private equity valuations went down. Now private equity never said that we are absolute return: markets go down and we go up. Our theory is if the public markets go down by X percent, we go down by less. Public markets go up by Y percent; we go up by more because the theory is that private equity is better than the public markets. If it weren't, people wouldn't invest with us, right? So, what happened was when the private markets went down, a lot of people were nervous about their stocks and a lot of people were nervous about their private equity valuations.
In other words, why would somebody invest in private equity? Why would somebody do that? The reason to invest in private equity is not because the founders of these firms are so charming and good looking, right? It's more that investors have looked at these statistics and they have seen over one, five, 10, 15 and 20 years private equity returns overall have outperformed public equity but not so much so that you would contort your life to go into private equity. It's only the top-quartile funds that so dramatically outperform the public market returns that people spend an enormous amount of time trying to figure out, “How do I get into the top-quartile funds?”
Is it true that Carlyle invested Bin Laden family money? Ten years ago, it was publicly disclosed that many private equity organizations and many financial institutions in the United States including the absolute best known had relationships with Saudi Bin Laden Corp., which was a construction company that the U.S. government had used itself. So they had invested with us, as they had invested with others, a modest amount, and we returned it after 9/11.