Portfolio Design: A Modern Approach to Asset Allocation

BUYOUT FUNDS

Unlike venture capital funds, buyout funds usually obtain a controlling interest in the firms that they invest in. As explained above, the partnership structure and fees are very similar to VC funds, but the types of firms that buyout firms invest in are quite different. Instead of technology startups, buyout firms often buy old-line industrial firms that need restructuring. The most famous buyout of the 1980s involved an old-line firm, RJR Nabisco, which was subsequently broken in two parts, Nabisco being separated from RJR. This buyout, the largest of its time at $25 billion, made Kohlberg, Kravis, and Roberts famous. It also marked the high point for buyouts until the resurgence of buyouts seen recently. Besides KKR, other top tier buyout firms include the Blackstone Group (founded by former Lehman Brothers partners in 1985), the Carlyle Group (famous for its association with former President George H.W. Bush and former British prime minister John Major), Bain Capital, and Texas Pacific (now TPG Capital). Among Blackstone’s most prominent deals were its buyouts of Hilton Hotels, Equity Office Properties, and Allied Waste. Carlyle’s deals have included Hertz and Dunkin Brands.

How do buyouts earn returns for their investors? There are two key elements in the success of buyouts. First, buyout funds often increase the leverage of the firms they purchase. For that reason, buyouts are often labeled leverage buyouts (or LBOs). The debt they issue is often below investment ...