What's driving Carlyle's amazing run? | CEO Kewsong Lee on creating a modern firm | Bill Gross trashes bonds

The Sharpe Angle: Kewsong Lee

The Carlyle CEO on what's driving the stock's run and creating a modern private equity firm

Kewsong Lee is closing out one trip around the sun as sole CEO of The Carlyle Group. It was a unique year for the private equity firm — which oversees more than $270 billion in private assets — with the multitude of challenges brought on by the pandemic. However, the market has been rewarding Lee and his stock price, with Carlyle nearly doubling over the last year.

Here's Kewsong Lee, in the latest Sharpe Angle conversation for Delivering Alpha, on the stock's performance, keeping up with the rapid pace of dealmaking in his industry during his inaugural year, and how he's shaping Carlyle into a more modern type of private equity firm.

Leslie Picker: It has been quite a year for you as CEO. Of course, the pandemic has created its own sorts of challenges, yet Carlyle's stock price up more than double since its pandemic lows around April 1 or so of 2020. Were you surprised by the recent stock price performance? And what do you attribute that to?

Kewsong Lee: We've got our strategic plan, all our priorities, and we're working hard and the team's doing a great job. We're very focused on being the best investment firm we can be. We're very focused on operating the firm better than we've ever managed to before in the past. And, you know, we're pleased that the results are starting to show. But there's lots of work to do, a lot more work to do to execute and continue that momentum. And I'm confident with the team that we've got and all the hard work, it's going to continue to accelerate.

Picker: How is it working so far with regard to people being in the office? I know, you made the announcement that employees have to be fully vaccinated, you were quite early on that front. But are you finding that culturally, it's possible to really work that way, especially as you're doing diligence, as you're doing — sourcing deals, as you're meeting with clients, meeting with LPs? I mean, is private equity possible, in this kind of hybrid fashion?

Lee: Health and safety is the number one priority, so that goes above all else. But we've now been managing through a pandemic, globally. We're in five continents, over 30 offices, and we've been seeing how to manage through this in different cultures, different areas, different industries. And we've adapted, we pivoted. We're using the best of virtual, we're using the best of physical meetings in safe ways and we're able to move faster. We're able to pivot because of all of our expertise and we're able to bring quickly on to situations. And so I think the pandemic has forced us all to be better.

Picker: On your last earnings call you spoke about how velocity has increased in virtually all areas of your business. You noted that deals are completed on shorter timelines, financings executed more quickly, exits possible much sooner than before. Funds are raised faster and we've seen basically a record amount of dry capital right now, dry powder. What do you think is the risk that the industry is moving too fast? And will we look back on this time and say, yes, it moved quickly but returns were sacrificed?

Lee: We're moving fast in order to compete and invest well but we're not cutting corners. You got to do the diligence and you have to be very thoughtful, know well ahead of time what it is you want to buy so that you can move quickly and our platform positions us well, to move quickly. But there are some folks, probably, who are reacting or they're trying to keep up and I think in those instances, mistakes can be made.

Picker: Your publicly traded peers have opted to branch out into areas such as real estate and credit and insurance, but Carlyle is still probably the closest to maybe a pure play private equity firm, at least in the publicly traded markets at this time. Do you have this sense or do you feel this pressure to branch out into other areas? Or do you think that Carlyle should be sticking to its core competency in private equity?

Lee: We're a pure play investment firm at global scale and we're known for private equity, because that's our origins and our history. But we have a very large private credit business, 60 billion of them and growing. We have a huge influx of solutions business that we've developed out, our real estate business here in the United States is thriving, and we're building out our infrastructure platform. And so we have diversified, and we're much beyond that of just private equity…the way we've been able to adapt the way we've been able to invest in ourselves to pivot, we're a modern day version of what you call private equity.

Picker: What does that mean a modern player in private equity?

Lee: If you go back and look at how returns are driven, usually private equity would focus on capital structure, cost, buy low, sell high. It's so competitive, we're paying high prices. Capital structures now are commodities. Everybody can focus on costs. A modern day firm needs to know how to really drive top line, really create transformational change. It's digital strategies to drive the top line, it's redoing your procurement in fundamental ways to capture structural savings, it's human capital assessment and talent, making companies more diverse, it's improving sustainability. When you do all these things, you drive fundamental top line value creation. You're making these companies better. When these companies are better, they perform better, and the returns are there.

Picker: But those things that you're talking about, those are really hard. Driving the top line driving value creation, all of that takes a lot of time. Costs, on the other hand, can be done, you know, within a matter of years. So how do you square that with this need and pressure to be moving much more quickly in the way that you do things?

Lee: I like that it's hard to do, because that's what gives us a competitive edge or differentiation. And that's why people want to partner with us. It is hard to do. With the long term lens though, our platform and everything we put into investing in it, partners want to work with us. Entrepreneurs want to work with us because they know when we work together, we're growing. We're focused on growth. If we can keep driving and making these companies better, the value comes and that's why we're seeing so many partners wanting to work with us.

Picker: I have to ask you about Washington because you are now CEO and you come into this role at a time where there certainly has been some critical voices in Washington where Carlyle is based. Does that concern you at all? Are you worried about additional regulation facing the private equity industry? Is additional regulation warranted?

Lee: There are always a lot of issues, right? Whether it's geopolitics, whether it's domestic policies, regulatory issues. We've been around the block, we've been in business for over 30 years, we've navigated through all types of environments and it's really what enables us to continue to pivot. And change creates opportunity. If there's one thing I learned during COVID, it's our platform enables us to see things in real time and when things change, we can pivot to opportunities. So when the buyout market shut down here in America, we were investing in India, we were investing in China. When mature deals and mature companies were trying to figure out what to do, we pivoted to growth. When bank loans started to stop, in terms of issuance, we pivoted to credit opportunities. So, yes, Washington, the issues of the day, obviously, we're focused on them. But we've navigated this type of stuff in the past, very confident in our ability to do that in the future.

Picker: One that gets a lot of attention, of course, is this idea of taxing carried interest as ordinary income as opposed to capital gains. It does raise a concern for you, especially as it relates to talent retention? It's become very competitive in the financial services industry so far, obviously, everyone would face the same changes to taxation as you would but in terms of the ability to pay people, is that something that you're worried about?

Lee: We're always worried about our human capital, making sure they're aligned. We have really talented people, they're working really hard to drive great investments. But we converted to a C Corp and we only have one share of one class of shares. We only have one tax rate I'm worried about and that's the corporate tax rate. You know, it simplifies things, when really all of us are on the same page and now as a public C Corp, that's what's happened. And so for me, the biggest issue is really the corporate tax rate. That's what we're focused on.

Picker: I have to ask you about ESG environmental, social governance, because that has been a very heavily covered topic in the public market, less so I feel like in the private markets, although I know a lot of people in the industry have been pursuing ESG strategies and so forth. What is Carlyle doing in particular, that kind of fits into this world?

Lee: Diversity and driving diversity of portfolio companies is something we've been doing for years. Climate, working on sustainability initiatives with our companies have been something that we've been working on with all of our portfolio companies. And the reason it's so important for us is it's all about making companies better. Our studies have shown that diversity drives better performance and better earnings growth. We've studied our portfolio companies, those portfolio companies with diverse boards within the Carlyle ecosystem, grow their earnings 12% faster than those that are less diverse. So, there's nothing more important to us than making sure ESG initiatives are pushed throughout all our portfolio companies, but also at Carlyle because it makes us better. It makes better decisions and when we can make companies better, our investment performance improves. And that's what you know, that's ultimately what it's really all about.

Leslie Picker | Reporter, CNBC
@LesliePicker

Hedge funds slash exposure to China amid ongoing crackdown

Hedge fund exposure to Chinese equities and indexes listed in the U.S. has dropped to a two-year low due to a sharp reduction in prices and selling of positions, according to a new client note by Credit Suisse.

The firm showed a decline in so-called net exposure — a way of showing riskiness to swings in Chinese equities — from upwards of 2 percent at the end of last year to roughly 0.75 percent as of August 25.

The move comes as one-third of hedge funds held ADRs at the end of the second quarter, according to a Goldman Sachs analysis of the latest 13F filings from 813 funds. ADR stands for American Depositary Receipt, which serve as proxies for shares of foreign companies that list in the U.S.

A slew of regulatory actions have sent the average Chinese ADR plummeting. The government has largely focused its crackdown on areas like data security, for-profit education and gaming. President Xi Jinping is looking to encourage "common prosperity" by narrowing the wealth gap in China.

The market has been responding to uncertainty about what this heightened regulation means for the private sector. The Nasdaq Golden Dragon China ETF, which tracks companies listed in the U.S. that do a majority of their business in China, declined 1.6% in the month of August but that followed declines of more than 22 percent in July.

Credit Suisse says that "2021′s sharp drop in ADR net exposure owes to both price declines and client reductions as investors priced in regulatory uncertainty."

Third Point's Dan Loeb told investors that he had pared back almost all of his exposure to China in recent months out of fear that Xi would "continue to exercise his power over financial markets, the Wall Street Journal reported, citing an unnamed investor on the call.

While not considered a hedge fund, Cathie Wood pared back her exposure to China through several of her Ark ETFs in late July, selling some of Tencent, Baidu and JD.com, and more recently, reclaimed more JD.com. Tencent and Pinduoduo on the dip.

Specific stock picking has been key. During August, crowded China shorts are down more than 4 percent, benefiting managers betting against the names by profiting on the declines. On the long side, crowded longs are lower by just 0.2 percent for the month.

Goldman said that the recent selloff in Chinese names has put a dent in hedge-fund returns. Equity-oriented funds were in the red during July, posting losses of 0.76 percent on an average-weighted basis, according to HFR. Those were the first monthly declines in about 10 months, the data showed.

Leslie Picker | Reporter, CNBC
@LesliePicker

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Big thoughts from the big money

One-time bond king Bill Gross says Treasurys are trash

Bill Gross, the one-time bond king who co-founded fixed income giant Pimco, is now comparing his long-favored asset class to garbage. The 77-year-old investor believes bond yields are poised to shoot up as the Federal Reserve begins tapering the massive monetary stimulus that supported the economy throughout the pandemic. Bond prices fall as rates rise, eroding the asset's value so significantly that it would be as useless as cash, Gross said. "Cash has been trash for a long time but there are now new contenders for the investment garbage can," Gross wrote in a blog post. "Intermediate to long-term bond funds are in that trash receptacle for sure, but will stocks follow?"

John Paulson bets big on inflation

John Paulson, who made billions of dollars betting against subprime mortgages in 2008, believes inflation could shoot a lot higher than consensus expectations, and gold stands to benefit from this environment of high price pressures. "We believe that gold does very well in times of inflation," the 65-year-old investors said. "The money supply was up about 25% last year and the best indicator of inflation is money supply. So I think we have inflation coming well in excess of what the current expectations are."

Ed Hyman sees a solid outlook into year-end

Top economist Ed Hyman issued a solid outlook for the rest of the year, saying the U.S. economy is on the right track for a full recovery from the pandemic. In a note titled "Solid economy, solid outlook," the Evercore ISI chairman said: "The S&P trading above 4500 further clinches the case that the US economy is powering ahead." Hyman believes the spread of the delta Covid variant will recede soon and the reopening will lift economic activity in 2022.

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What's driving Carlyle's amazing run? | CEO Kewsong Lee on creating a modern firm | Bill Gross trashes bonds

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