Top executives continue recouping lion’s share of rewards

By Paul Mackintosh - 31/03/14

The Carlyle Group is in the news again, with some reported moves that highlight where the top end of the private equity (PE) spectrum is going. First is its very high-profile headhunting coup, with the hire of Michael Cavanagh, hitherto co-CEO for corporate and investment banking at JPMorgan Chase & Co, as its new co-president and co-COO. This could position Mr. Cavanagh for one of the top slots in the firm, and potentially even as a successor to David Rubenstein and Carlyle’s other founding partners. It also illustrates just how profitable and remunerative high-end private equity is right now, with resurgent capital markets allowing big-buck IPOs and recapitalisations of portfolio companies. Reuters reports that Carlyle’s founders received salaries and dividends almost five times the US$20 million base compensation of JPMorgan head Jamie Dimon in 2013, to say nothing of their personal rewards from direct commitments to Carlyle investments. Plus, private equity firms are out of the post-2008 regulatory crosshairs, and their top execs are able to act more freely and pursue opportunities more aggressively than the newly constrained banks.

If only the public markets would buy the story. Because Mr. Cavanagh’s past relations with Carlyle go back to his support for the firm’s flotation in 2012 – where, however, its equity valuation has still lagged traditional asset management firms. Carlyle is hardly alone in this, with Reuters, which picked up on the problem; pointing out that its stock currently trades at 10.3 times projected earnings, versus 14-18 times for more traditional peers. Reuters noted that Apollo Global Management LLC and KKR & Co also trade in the same range. It’s this that has inspired, according to Reuters sources, Carlyle to consider picking up the Russell Investments unit of Northwestern Mutual Life Insurance in order to add an old-school asset manager to its capabilities, and to garner commensurate investor recognition.

Would that happen? The precedent of Fortress Investment Group’s purchase of Logan Circle Partners LP is not encouraging – no sign of a major rerating, according to Reuters. Commentators blame the unpredictable nature of private equity investment returns, harder to calculate than money management fee income, for the continuing discount. But I suspect the real problem is continuing lack of investor understanding of exactly how private equity works, and how lucrative it can be. The latest performance figures from Cambridge Associates and elsewhere confirm that the asset class continues to outperform public benchmarks as advertised, pre and post GFC. For now, it looks as though the top firms’ executives themselves, rather than institutional and individual shareholders, will continue to recoup the lion’s share of the rewards. That sounds like quite a good problem to have. Mr. Cavanagh should worry.