Korea’s $38bn Man Likes Private Equity

But Scott Kalb, the CIO of the Korea Investment Corp., told the delegates at today’s IFC/EMPEA conference that the GPs he backs must offer reasonable fees and significant co-investment opportunities.

Scott Kalb, a veteran of the alternative investment management industry, is nevertheless dismayed at the amount of money private equity general partners have made from fixed management fees. Now, in his role overseeing Korea’s $38 billion sovereign wealth fund, he is well positioned to push hard for a better deal. “It’s not my job to make people rich,” he said, referring to GPs and speaking on a panel today at the Global Private Equity Conference in Washington DC. “It’s my job to grow these assets for the people of Korea.”

Kalb was at the conference, organized by the Emerging Markets Private Equity Association and the International Finance Corp., to share his views on private equity in the emerging markets. His comments offered fascinating insights into the investment priorities of a chief investment officer who since 2009 has run among the most ambitious and nimble investment institutions in the world.

With regard specifically to the emerging markets, Kalb worried that the immense investor demand in emerging markets would swamp the available investment instruments. He said he recently attended a special conference for sovereign wealth funds – “there was a couple of trillion dollars in the room” – and among the revelations was the fact that these well capitalized institutional investors are most interest in allocating to emerging markets equities, followed by emerging markets debt. “If they increase their allocations [to these two asset classes] by 1 percent they will kill the markets,” he warned, referring to the collective buying power of his fellow sovereign funds.

Setting aside risks specific to the emerging markets, Kalb clearly believes the private equity model has much to recommend it. He particularly likes its long-term lock up of capital, which he argued may be a key reason why private equity has the ability to outperform the public markets. Holding assets over the long term, such as over an entire business cycle or longer, seems to be correlated with higher returns and lower volatility, he said. As an organization with very long-term investment objectives, “Why should we be concerned with what happens in the next quarter,” Kalb asked.

Indeed, Kalb is a fan of the private acquisition of business assets in part because doing so “takes them off the table” for “a very long-term investment horizon.” By contrast the performance of public equities clearly can be “swayed by sentiment,” turning stock investors into “bystanders.” Kalb said he has data that shows stock market performance is only barely correlated to GDP growth, and therefore investors hoping to use emerging market stocks as a way to ride economic expansion may be disappointed.

Kalb added that private equity, by dint of its long-term approach, allows investors to better execute a strategic plan for the businesses they control. He therefore looks for GPs who know how to “roll up their sleeves and try to add value.”

Kalb made clear, however, that he is not interested in signing up for private equity business-as-usual. Fee drag is clearly a big issue for him. Citing research conducted by Oliver Gottschalg of HEC Paris, Kalb said that over a period during which the largest 15 private equity firms in the world earned $12 billion from fees, only $4 billion of that was from carried interest, which gets paid out based on the success of the investment program. This statistic drew groans from the audience.

He wondered aloud why GPs have failed to introduce a “scale concept” into their fee structures – the idea that as funds get bigger their management fees, meant to pay for the operations of the firm, do not need to grow at the same rate. Kalb complained that it is “very, very expensive to access this asset class,” and that as much as 500 to 600 basis points in returns can get eaten up by fees and program expenses.

Rather than receiving a “liquidity premium” return in exchange for having an organization’s capital locked up for a long period of time, Kalb warned that high fees means an investor has to take that premium and “turn around and pay it right back to somebody.”

To minimize fee drag, the KIC is attempting to build true partnerships with the private equity fund managers that it backs. A GP that only wants money from KIC is advised to go elsewhere. Kalb’s organization expects co-investment opportunities at least equal to the amount of capital committed to the core fund, and it wants the co-investments on a no-fee basis.

Kalb also revealed that the KIC is becoming among the most significant investors of direct private equity in the world. Over the last nine months, he said, the KIC has put to work some $1 billion in direct private equity investment, in deals sourced either through its partners or its own network.

If Kalb’s KIC is the limited partner of the future, the future of private equity will be one in which investors play a much more active role in the deployment of long-term capital, and they will take a dim view of PPMs that include unreconstructed fee terms. The good news is that KIC wants more private equity. The bad news is that much of the product on offer today doesn’t meet Kalb’s standards.