David Rubenstein, Co-CEO and a co-founder of The Carlyle Group, provides his views on the global macroeconomic and political landscape and how it could impact private equity investing going into 2017.
Mary Cahill: 2016 was an interesting year from a political perspective with Brexit and the US election results. In your opinion what is driving the anti-establishment voting?
Thirdly, and I think most significantly, you have an apparent dysfunction in government – services aren’t getting delivered, politicians aren’t getting bills passed, government seems to be stalled and people just seem to be bickering. I believe this has led to residual impacts and was, in my view, reflected in the votes.
MC: Do you think we’ll see an increase in protectionist policies around the world?
DR: It’s too early to predict with any certainty but I believe protectionist policies may increase slightly. I’m not sure we will face significant increases in tariffs but the rhetoric about global trade will probably stay for now.
MC: Have the election and the policies outlined by the US President-elect materially changed your outlook for the coming year?
DR: The experts were wrong on Brexit, they were wrong on the US election, and now the experts are wrong on the economic impacts of these votes. What we are seeing is that the markets have reacted more positively than anticipated because the presumption is that there will be greater economic growth, greater stimulus, lower taxes and therefore all these outcomes will help the economy.
So right now I think the principal material change is that most people who are looking at the economy think that it’s likely to push a recession further down the road, it’s likely to produce greater economic growth and likely to produce a stronger dollar and higher interest rates.
MC: There has been a lot of concerns raised about the build-up of debt in China. Is this something you are particularly worried about?
DR: For the last 30 years or so China grew on average roughly 10% a year. In the history of the world, there is no known economy which grew by an average of 10% for 30 years in a row. So yes, China has slowed down but it is still growing at roughly 6-7% per year.
There are economic challenges in China beyond the growth rate. Because of its massive population it needs to produce an enormous number of new jobs every year and that’s always difficult. Another challenge is the effort to make the economy more of a consumer-focused rather than an export-oriented economy. This is happening but the transition can be painful and slower than anticipated.
The debt that China now has is fairly significant. However, I don’t obsess over it because I think that much of the debt is owed by state-owned enterprises to government entities or to government-backed banks. The government has enormous foreign reserves, well over $2 trillion, and so they have the ability to mitigate some of the effects of the excess debt if it was necessary.
The entrepreneurial part of the economy is in reasonably good shape in terms of debt, and the personal debt of people in China is not actually that high. In fact the personal debt of the Chinese on average is less than the personal debt of people in the United States prior to the great recession.
So I think it’s really a question of the corporate debt which is owed by state-owned enterprises and due to state-owned banks and I think China can manage that. I don’t think it’s going to produce any type of hard landing or any type of economic calamity.
MC: Europe faces a number of challenges, both political and financial, next year. What are your views on Europe in general?
DR: What happened in Italy recently is of concern because the Italian banks have a significant amount of debt. Overall I think Europe has been aided by the incredible leadership of Mario Draghi at the ECB (European Central Bank). I think his ability to convince the governments to allow a Quantitative Easing programme has been very helpful, but Quantitative Easing cannot continue forever. So at some point I think it’s likely that interest rates will probably have to be more normalised.
I think Europe will probably see a period of low economic growth for a while. I think the United States is probably going to grow this year about 1.5% or so, Europe may grow around that or slightly lower than that on average. But Europe has really divided into Northern Europe and Southern Europe – it used to be East and West. Southern Europe (Spain, Italy and Greece among others) have had more challenges and are the ones where Europe is most exposed. The European regulators realise this.
MC: Are you actively looking at investment opportunities in Europe?
DR: I think Europe overall is an attractive place in which to invest. At Carlyle, we tend to find that prices for European assets are lower compared to what they have been in the United States for comparable assets. European companies produce extraordinary products that are well liked all over the world. I think companies which produce products that are shipped outside of Europe are not as dependent on the European economy and are good companies to invest in as we’ve done.
We tend to find that when there is uncertainty or any disequilibrium in the markets, that’s actually a good time to buy things, and a good time to try and fix things up. So I’m not worried about Europe in terms of a place to invest – we’re probably investing much more money right now in Europe than we are in the United States.
MC: You have been investing in Ireland recently. Do you plan to make any more investments?
DR: We have a fund, Carlyle Cardinal Ireland, which invests entirely in Irish companies. Ireland is not a gigantic economy; it’s an economy of roughly four million people, but I would say it’s an economy where we’ve already made a number of strong investments for the fund. They are all doing well, so I just wish the Irish economy was even bigger because it’s clearly a very attractive place to invest. We have a dedicated team on the ground looking for further opportunities.
MC: We’ve seen many institutional investors increasing their allocations to private equity at a time when prices are high and competition has increased. Why do you think that is?
DR: People are always predicting doom and gloom for the private equity industry and that’s been going on for the 25 or 30 years that I’ve been in the sector. Right now, I believe private equity is recognised as a very valuable way to enhance one’s investment returns. Private equity returns have been fairly consistent over the last 5, 10, 15, 20 years. The rates of return have pretty much exceeded any other asset class on average for a long period of time.
There is no doubt that prices have been high but that has actually been good for selling companies. If the economy slows down at some point and prices come down, as I suspect they will, it would be a good time to buy.
When I started Carlyle with a number of other people, there were probably 250 private equity firms in the world. Today there are 6,555, so it has clearly been a successful asset class and there’s a lot more competition today also.
The principal attribute that makes private equity attractive to investors, despite the high prices and despite the fact that there is a lot of competition, are the returns. Those historically investing in private equity did so because they expected a net internal rate of return of 20-25% net of fees. Today most of them recognise that is unrealistic on a consistent basis so investors seem comfortable with somewhat lower net internal rates of return.