Direct Investing with a Twist
Giants jump on the platform trend of long-term investing.
The institutional investment community has been captivated by “disintermediation” for the past five years. This is understandable, as insourcing does (we now know) improve investment performance. But while direct investing remains a hot topic among the Giants, there’s something new reverberating in the industry. The buzzword of the moment is now “platforms.” Everywhere I go, I seem to hear CIOs talking about launching platforms for infrastructure, real estate, agriculture and a variety of other private (though normally real) assets. It’s gotten to the point where enough people have asked me about this structure that I feel obligated to dig in and explain what’s going on here. But before I get into that, let me first offer a bit more detail on in-sourcing, as it’s important in understanding the rise of platforms.
The direct investment trend began in the late 1990s with Canadian pensions, but the widespread appeal really only began after the global financial crisis (“GFC”). The GFC appeared to illustrate, in rather stark terms, that much of the asset management industry was not operating in the interest of their clients. So much so that some asset owners asked, “Hey, can’t we do at least some of this ourselves, for a fraction of the cost and get better outcomes?” In a bid to answer that question (and others), we at Stanford and Oxford kicked off a multiyear research project focused on in-sourcing asset management. The project resulted in a series of papers on a range of topics, such as: advice on in-sourcing; in-sourcing infrastructure; theoretical justifications for in-sourcing; the economic geography of in-sourcing; the global expansion of in-sourcers; the recruitment of talent by in-sourcers; collaboration and co-investment among in-sourcers; performance attribution; global tactical asset allocation and lots more. You get the point.
There was, and remains, a lot to say about asset owners managing their assets internally. Part of the reason for the prolific publications above stemmed from the obvious appeal of internal management and the implications for the broader industry if in-sourcing really took hold in the mainstream. But another reason for all the papers — more relevant to this article — was the fact that direct investing was and is very hard to do. To put this bluntly, we wanted to paint a realistic picture of in-sourcing so that Giants with no business doing direct investing could avoid the pain in trying. And, through the research, we came to understand that getting the right management, strategy, and governance in place to be an effective direct investor is quite difficult (though clearly doable, with the right principles and policies implemented).
It’s in this context that I think platforms have become increasingly popular, as they offer a hybrid approach to insourcing and outsourcing — one that allows for many of the in-sourcing benefits without subjecting internal organizations to the high burdens of end-to-end in-house asset management. Indeed, some Giants I’ve spoken to look at platforms as a cheaper and more aligned way to access certain assets — particularly infrastructure — than traditional fund investing. Other folks look at platforms as a way to bolster internal, direct teams. While the Canadian funds, for example, may have lots of direct investment professionals, they rarely have the operators and engineers that can deal with the day-to-day maintenance of their directly held assets.
Platforms, I would argue, are a combination of both: They represent a way to bypass traditional funds by bolstering the reach and capability of internal teams. At their core, platforms are about finding a more efficient and scalable way to invest.
“Hey, that’s not new,” you say, “private equity firms have been using platform companies for a long time!” Fair point. Private equity GPs, Warren Buffett and many others have used platforms for decades. It’s actually a useful, and sometimes a bit sneaky, way for funds to bypass short investment periods — although, yes, there are many more reasonable reasons to use them. But the idea of pensions or sovereign funds using platforms to help themselves bypass GPs (the very same GPs that claim to use these platforms) is, in my humble opinion, interesting.
To the Giants, platforms generally refer to independent companies operating in attractive investment niches. They are particularly common in emerging markets, and in acquiring and maintaining real assets, such as ports, dams, airports, timberland, energy, toll roads and sometimes even specialized industrial companies, among other things. The idea here is for a financial partner — the Giant — to take a meaningful position (ideally a control position) in a company and then use that company to make follow-on investments or acquisitions in other assets within a certain niche. The Giant provides capital to help roll up a variety of operating and development assets, while the company sources, screens and invests in the assets while simultaneously managing them. The best platforms are those in which the Giant has an existing and trust-based corporate relationship and knows a team possesses appropriate expertise and experience. After solidifying this relationship, the idea is then to scale it, injecting additional capital in the platform and asking the team to seek out more assets.
Over time, a growing number of large asset owners have taken to using platforms. The first was almost certainly Singapore’s Temasek, which gets credit only because that’s the way in which it was set up by the government: In 1974, it received large stakes in big state-owned companies and was instructed to try to professionalize and grow them. As luck would have it, Temasek’s development objective — its extra-financial objective — helped to unearth what has since become a highly sophisticated and cost effective financial strategy. Heretofore, Temasek has continued to use platforms to deploy capital around the world. But others have started to join in, too. For example, the Kuwait Investment Authority recently invested in Spain’s Gas Natural and intends to position a subsidiary company as a platform to expand internationally. Similarly, the China Investment Corp. has announced that it is partnering with a domestic steel maker to fund overseas expansion and operations. And, comparable to Temasek, Malaysia’s Khazanah is working via IHH Healthcare to develop a regional healthcare platform. Looking to emerging markets, even the big Canadian pensions have taken to using platforms.
From the perspective of these investors, platforms offer a cheaper and more aligned access point to attractive assets. This is particularly true for long-duration investments, where the exit is not easily anticipated at the time of the deal closing. It also offers the investor valuable governance rights, as the Giant is often a big player in the company (rather than a small shareholder in a fund). This may include a right of first refusal on all deals, or oversight of internal budgets and compensation.
From the company’s perspective, platforms also offer quite a few benefits. For example, Giants are aligned partners that often want to drive long-term growth, which means companies are far less likely to be subject to the shorter-term liquidity needs of GPs (associated destabilizing, value-destructive effects). Also, by working directly with a Giant the company will get continuity of governance. Rather than swapping in a new 33-year old Wharton MBA/GP partner every five years, the platform can hopefully get a single pension (and potentially even person) for decades. Finally, when the CEO of a company knows that he has smart money and lots of it available for M&A, it’s a nice warm fuzzy feeling. That’s priceless.
While there are many positives to these new platforms, it’s not all roses. First, it actually takes a ton of time to get them right. I sometimes think of platforms as just seeding new managers within a legal structure amenable to long-term holding periods. Second, let’s not forget that you are buying an operating company, which means it’s likely to have an engineering or construction management culture (which is especially pertinent in infrastructure). Turning that kind of company into a platform that can roll up niche assets will mean overlaying a certain number of M&A and finance folks. In short, it would mean helping transition a company culture in such a way that it maintains the original integrity of the firm — which is what attracted you to the company to start with — while ensuring the platform’s successful scaling.
Clearly, a platform is not simply a replacement to a fund manager that lets you allocate and close your eyes. You really do have to engage in the sector to identify the companies that could be platforms. Moreover, you have to be engaged in the companies themselves to make them work. So, ironically, adopting this hybrid approach to direct and external investing actually demands quite a lot of internal investment expertise. At the same time, platforms help to extend the reach of internal investment teams, bolstering capabilities in ways that no pension fund could have internally otherwise.
In short, this is not about a new type outsourcing or disintermediation. It is about re-intermediation via platforms. It is about being a long-term investor and launching a vehicle that can live up to that descriptor. And I find it fascinating.