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OPINION

Macaskill on markets: Blackstone and the liquidity paradox

The gating of Blackstone’s $69 billion private real estate fund Breit highlights the risks in semi-liquid investment vehicles, even ones that perform strongly. Pitching US private market exposure to European and Asian retail investors may be slowed by the setback.

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Blackstone’s Real Estate Investment Trust (Breit) has been one of the investment success stories of recent years. It has delivered a 13% annualized net return since its launch in 2017, or roughly three times the level of publicly traded real estate trusts.

Outperformance by the private vehicle continued in 2022, with a 9% return in the year to the end of October, against a backdrop of sharply lower public markets, including both broad equity indices and listed property trusts.

This meant that the gating of Breit in early December due to heavy investor redemption demands had a disproportionate impact.

It served as a reminder that strongly performing assets are obvious candidates for sale in times of stress and that a semi-liquid investment vehicle does not – at the risk of stating the obvious – offer full liquidity in the same way as a publicly listed security.

The limits placed on Breit redemptions may also slow down a convergence between private markets in the US and the retail structured product markets in Europe and Asia.

The US dominates global private issuance and the developing secondary market in trading unlisted shares, partly because technology firms such as Facebook often remain private during extended periods of sharp growth. The retail structured product market, by contrast, sees most of its sales in Europe and Asia.

Tapping the wealthy

Breit is the flagship vehicle for an ambitious push by the world’s biggest private equity firm to access retail investors. Other US-based alternative asset managers, including KKR and Apollo, have joined Blackstone in a move to tap wealthy individual investors across the world in marketing drives that are designed to open a potentially huge new base of buyers.

This also presents an opportunity for banks with retail structured product sales networks, such as BNP Paribas, which has partnered with Blackstone to distribute its paper in Europe.

Blackstone has relentlessly promoted its plan for sales to retail investors and the potentially transformative effect this could have on its assets under management.

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Stephen Schwarzman, chairman of Blackstone. Photo: Reuters

Blackstone chairman Stephen Schwarzman noted that the firm is approaching his long-term goal of $1 trillion of assets under management in a quarterly earnings call with analysts in October. He cited research from Morgan Stanley about the expected growth of private market AuM of 12% annually over the next five years and highlighted that the greatest portion of this increase is expected to come from wealthy individuals, whose allocations to alternative managers may more than double in five years to 8% to 10% of portfolios.

The gating of Breit poses a challenge to the marketing of private investment vehicles to wealthy individuals, who may not fully appreciate the limited liquidity of assets that are not publicly traded.

Blackstone has a $50 billion private credit fund called BCred that can also boast of recent outperformance compared with its benchmark sector, in this case partly due to a portfolio that is almost 100% floating rate and so should benefit from rising rates.

The Breit vehicle is only semi-liquid and the publicity around its gating is likely to add to redemption requests in 2023, as well as potentially exacerbating BCred outflows

In a filing on December 5, Blackstone noted that it met all the redemption requests in a tender window for BCred that ran to the end of November, even though those amounted to around 5% of total shares outstanding.

That indicates that BCred might follow Breit in limiting redemptions, even if the fund continues to perform strongly compared to credit indices, as it was a breach of the quarterly 5% redemption limit that prompted the gating of the Blackstone real estate vehicle.

This highlights a liquidity paradox that is familiar to institutional investors – even if it regularly seems to surprise some supposedly experienced wholesale market participants.

A flight to quality when there is a market shock will often give a short-term boost to the US treasury market.

Treasuries are the most liquid fixed income securities, however, and obvious candidates for sale whenever leveraged market participants are forced to meet margin calls on other assets.

This causes a spike in treasury yields and temporarily worsens the impact of a crisis by driving out spreads in other fixed income markets, such as corporate bonds and swaps.

Ensuing periods of price volatility and stress are often only resolved when a regulator such as the US Federal Reserve steps in to restore market stability.

Clear disclosures

The crisis in the UK’s debt market in September provided an example of this dynamic as forced sales of gilts by pension fund managers to meet hedging margin calls drove up yields for all borrowers, before the Bank of England intervened to calm markets.

Semi-liquid private market funds such as Breit and BCred have clear disclosures that explain the limits to Blackstone’s obligation to meet redemption requests.

Retail structured product sales in Europe are also heavily regulated – so much so that the UK in December announced a plan to revoke European Union retail market regulation in an attempt to deliver a Brexit dividend by boosting its own limited structured product sector.

There is accordingly little legal exposure faced by firms that offer semi-liquid investment vehicles.

That does not mean that there is no reputational risk or danger to long-term sales plans from leaving investors with a false impression about the liquidity of their funds.

On Blackstone’s quarterly earnings call with analysts in October, the company’s president, Jon Gray, noted that its private wealth assets had grown by 43% in the last 12 months to $236 billion and stressed the opportunity in what he described as a “vast and under-penetrated market”.

He highlighted the outperformance of Breit compared with public real estate trusts and the robust structure of the fund.

“We run the vehicle with ample liquidity, large amounts of cash and revolvers, large amounts of liquid debt securities,” Gray said. "We met 100% of the repurchase requests since we started six years ago, including throughout Covid, and the structure means we're never a forced seller of assets. So, we feel really good about Breit and its ability to weather pretty much any storm."

Two problems

There were two potential problems with this statement. The first is that Gray was offering a hostage to fortune, as Breit’s run of meeting 100% of redemption requests would come to an end soon after he spoke to analysts.

The second is that he risked creating confusion about two different types of liquidity.

Blackstone’s track record of managing its own liquidity risk is exceptional and Breit may well continue to outperform many of its competitors. Long-term holders of Breit exposure – including Gray and Schwarzman – will no doubt prosper.

But the Breit vehicle itself is only semi-liquid and the publicity around its gating is likely to add to redemption requests in 2023, as well as potentially exacerbating BCred outflows.

This liquidity paradox could confuse some investors and complicate the task of pitching private market exposure to investors around the world.

Blackstone declined to comment on whether it will change its strategy on marketing to wealthy individuals, an area where it has invested heavily, including recruiting staff in multiple European countries.

But there are already reports that it will delay the launch of a new private equity fund targeted at individual investors.

Blackstone’s alternative asset management competitors, and banks looking for a cut of any distribution action, will be closely monitoring its next steps.