Late last week, Elizabeth Warren sent the private equity industry diving for cover. The Senator from Massachusetts and candidate for the Democratic presidential nomination, led a battalion of allies in the Senate and House, including her party rival, Bernie Sanders, in a broadside attack on PE tax benefits.
In a measured response, the industry correctly pointed out that many of these breaks have enabled managers to generate competitive returns for investors and job growth at many of the companies in which they invest. The skirmish hardly drew blood. Few expect a bill to go beyond the Congressional Record.
Still, she is opening an old wound. Private equity spent much of the Obama administrations fighting proposals to cut back on carried interest deductions. They won, but only narrowly. In the post-financial crisis years, private equity, hedge funds and all things Wall Street, wore a scarlet A.
Credit the industry with good advocacy communications. Unlike hedge funds and banks, PE pros told their story to everyone in Washington who would listen. They marshaled facts about job growth and public employee retirement benefits that took the edge off their claim as the founding fathers of the One Percent.
Now the One Percent, no matter how they make their money, is under assault and Mrs. Warren is leading the charge. An increasingly vocal market is growing around the sentiment that she so relentlessly expresses. It is welling up from below.
At the same time, however, change is underway from within. Today, the business of investing is less myopically focused on returns. Customers, including big pension plan sponsors, foundations and very rich people, are looking for different outcomes from professionals.
Today’s industry is adjusting to a changing market. They are incorporating different measures of value-creation. Moreover, a new generation of financial professionals is inheriting the responsibility of asset allocation. This new generation is wondering if they should be, well, more responsible.
We used to call private equity “merchant banking.” These were businesses within banks that were prepared to own a piece of their clients, not just finance them for a deal fee or a transaction spread. Merchant bankers joined the client’s board and worked alongside management teams.
Some PE firms have tried to bring back some of those old principles, but too few. Now the industry is a collection of very big leveraged buy-out shops. Unlike their merchant banking ancestors, they have shorter time frames, more partners, and much more financial downside at stake. To manage that risk, they have fine-tuned systems for maximizing operational efficiency, continuously monetizing value, and reducing costs — sometimes ruthlessly.
Americans, including the One Percent, are becoming uncomfortable with the notion of disruptive and myopic investment styles. Managers of public funds understand this shift in the market and have responded with ESG strategies, sustainability objectives, female leadership screens, and other innovations. More change and innovation is likely on the horizon. After all, businesses that fail to innovate, cannot survive. Ultimately, that should please folks like Elizabeth Warren. But it should also enhance the credibility and value of investing as a business.