Earlier this year there was a fantastic interview with Henry Kravis of KKR (KKR) on Bloomberg on the occasion of the private equity firm's 40th anniversary. The legendary investor was asked what had changed over his four decades in the private equity business and he said at the time, "Our focus used to be much more on the micro, which meant we focused on the company and didn't look at the macro enough, and that's something you have to take into account if you want to be a good investor. Certain times we got into trouble and made mistakes; I think there were macro issues that were really out of management's control. But with that said, shame on us. We should have known that this would happen or would be an issue."
To help develop a macro backdrop for the firm's investing activity, KKR hired a global strategist, Henry McVey, away from Morgan Stanley (MS) and he heads up its macro group. The great part about McVey and his macro team is that they publish their findings twice a year on the firm's website and we can use their expertise to help understand the current market and economic environment. While I am not a fan of forecasting, a general understanding of the macro backdrop is useful, and knowing what a firm with tens of billions of dollars to invest thinks about the world is very helpful.
McVey and his team are cautiously optimistic but believe we may be entering a new world of lower return expectations. The report summed up by saying, "Also, as we outlined earlier, many of our models suggest more limited upside to asset class returns than in the recent past. Accordingly, we continue to favor a strategy that takes advantage of idiosyncratic opportunities, particularly those that enjoy better pricing during periods of market dislocations as well as those that harness complexity to their benefit. On the other hand, we continue to shun simplicity and/or areas of the market where we believe recent inflows have been too exuberant, particularly around visibility of earning streams."
That is pretty much in line with what I have been saying in recent months. Buy severe price declines, look for special situations and avoid the things such as blue chips that have seen their prices and valuations soar due to yield-seeking buyers. The report says that the firm is short four large-cap consumer brand companies that trade at an average price/earnings multiple of 22 and EV (enterprise value)/EBITDA ratios of 14.2 as they believe the downside could be significant. They don't identify the stocks, but it would not take a rocket scientist to come close to figuring out which four large consumer brands they were selling. Better yet, just avoid all of them.
The firm continues to see opportunities in the private credit markets. McVey writes: "In fact, performing Private Credit, particularly at the large end of the market, remains our highest conviction risk-adjusted return idea again in 2017." This bodes well for business development companies as private credit is pretty much what they do. I continue to favor those with strong private equity connections such as Apollo Investment (AINV) and Ares Capital (ARCC) along with Gladstone Investment (GAIN) at current prices. They offer high yields and experienced management that should deliver strong total returns over time.
KKR also likes income-producing real assets with an emphasis on real estate and energy infrastructure. The report says, "At the moment, we think that opportunistic real estate, midstream assets, certain MLPs and 'last mile' infrastructure projects all make sense. Importantly, our research also shows that Real Assets tend to outperform in a modestly increasing inflation expectations environment." This outlook favors some of our income-producing REIT favorites such as Brookfield Properties (BPY) and the newly formed Colony Northstar (CLNS) .
The KKR macro team likes MLPs right now. They think oil prices will be relatively stable this year with OPEC's action supporting prices but hedge-related selling and increased rig counts when oil is above $50 a barrel. Long term, it has a base price of $60 to $75 a barrel. If this proves even close to correct, then the high yield on infrastructure MLPs is going to be very attractive. I sold my MLP closed-end fund holdings way too soon last year and would be interested in revisiting the idea if we had some price disruption that causes some selling in the sector.
KKR is one of the largest private equity and investment management firms in the world. It has boots on the ground and seats on the desk in pretty much every region of the world and sector of the market. Being aware of its thought process when it comes to the overall macro situation as we start the year is just good business.