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Hello, I'm David Rubenstein. I'm the co-founder and co-chairman of Carlyle. In recent years, I spent a lot of time on history, American history, but I also know a fair bit about and would like to talk to you about the history of private equity. Let me begin at the beginning.
When investments first began hundreds of years ago, all investments were private. People who had money to invest basically invested with banks and they would buy bonds for their clients or they might eventually buy privately held companies. As the public markets developed in the 1800s and 1900s, obviously a lot of capital went into public markets, but when private equity began to blossom, the world changed and let me explain what happened.
For the first half of the 20th century, the major investments that were made by people that had extra capital to invest, families and others, was made in public markets. Money managers would buy stocks for them or they buy bonds for them and that was really the history of money management and it was said that in the end, if you were going to have your money managed, you have a let's say a 60/40 ratio. 60% of your money would be in equities and 40% would be in fixed income and that was pretty satisfactory to everybody.
But interestingly, the early investments made by people who wanted to make returns on their money were actually private investments. In the early part of the 20th century, one or two large private equity kind of deals were done. For example, in 1901, one of the wealthiest man in the country, J.P. Morgan, a famous banker, actually bought Carnegie Steel that had been built by Andrew Carnegie and he paid roughly $480 million for that steel company and a lot of it was leveraged that he used [music] and that was money people think the first real leveraged buyout in the United States. It turned out to be a successful investment, but not many other people had the wealth of J.P. Morgan. There weren't a lot of private equity funds in those days, essentially none and as a result, there weren't a lot of other people following what Mr. J.P. Morgan had done. Some of his investors, like Henry Phipps, became very wealthy as well. The use of borrowed money to buy assets rather than paying in cash or stock was unusual and novel at the time, though it didn't set off an immediate trend.
The industry that we now know as the private equity industry really didn't grow in the United States and elsewhere until after World War II. After World War II, a number of people came back from the military service who had technology backgrounds began to say that they would like to build companies and use their technology skills and they did so. They began to go to investors and say, "We want to create new companies. We'd like to help develop new technologies." And they got money from very wealthy people, sometimes banks, sometimes insurance companies. These people backed the first what was then called adventure capital. It was such an unusual thing, they didn't call it venture capital, they called it adventure capital. A good example, one that became a very famous company, was Digital Equipment or DEC, an early computer company, began to fuel more and more people saying, "I would like to go into adventure capital." On the West Coast, engineers returning from World War II formed early venture capital firms and companies like Fairchild Semiconductor, which was backed by wealthy individuals like Mr. Fairchild. The phrase venture capital itself came about because these early investors saw their bets as real adventures. They didn't know what would succeed. The same thing happened at Stanford University. Silicon Valley emerged as a hub for technology, investments and innovation. They began to follow the lead of Hewlett-Packard. It was fueled by some early venture money, further inspiring efforts to find high-growth companies and giving high rates of return to investors.
When this industry started, the early venture capitalists or adventure capitalists uh said, "We're a little different than people who invest money in you for you on stocks and bonds. What we'll do is we'll invest your money, but we'd like to be actively involved and to be actively involved, we would like to get a piece of the profits." And ultimately, they took charge, they 20% more or [music] less uh carried interest or piece of the profits and that became fairly standard. In the 1960s and '70s, the industry really took off. These early firms also adopted a management fee structure inspired by Alfred Winslow Jones, the two and 20 model, a management fee on capital committed, not just invested, as well as a share of the profits. Early hedge fund managers had understood that if they were adding value rather than just picking stocks, they deserved better compensation.
In the latter part of the 1970s, a new phenomenon arose and that was something called a leveraged buyout where a small amount of capital was put in as equity and a large amount was borrowed. As investors saw what these early buyout pioneers were doing, traditional investors, 99% of whom still put most of their money in public markets, began to take notice. But it was still considered not quite prudent under the prudent man rule to put your money into those kind of investments. But that changed in 1978. The US Labor Department ruled that leveraged buyouts and venture capital should not be excluded from pension investments, allowing public pension funds to invest in alternative assets. Oregon and Washington were the first public pension funds to move in, followed by others. Until then, portfolios were originally 70/30 or 60/40 with almost no alternatives allowed. With this change, venture capital and buyout funds grew rapidly while Silicon Valley flourished in the late '70s and early '80s as the personal computer industry took off. And as these firms grew, so did the pool of capital. By the late '80s and early '90s, nearly every major pension, endowment and corporate fund was allocating to private equity, fueling a major boom. Firms like Gibbons, Green and Clayton Dubilier were early buyout pioneers.
In the late 1970s, a group of financiers left Bear Stearns to start their own firm after being told that using the bank's capital for buyouts wasn't the business. At Bear, they had already been experimenting with small leveraged buyouts. Around a decade later, RJR Nabisco became one of the most high-profile leveraged buyouts in history, capturing public attention and later chronicled in Barbarians at the Gate. The transaction and the aggressive use of leverage, sometimes as little as 1% equity and 99% [music] debt, helped transform the industry.
I started Carlyle with a number of partners in 1987. Over lunch at the Carlyle Hotel in New York, Bill Conway, Dan D'Aniello and I began discussing the idea that would become Carlyle. At the time, private equity was still taking shape and largely concentrated in the United States, but we believed there was an opportunity to take this emerging model and apply it on a global scale. So, the industry had not yet even taken on the name private equity. We were still called leveraged buyout firms. And as Carlyle grew, so did other firms like ours and we began to do several different things that hadn't been done before. In addition to doing leveraged buyouts, we began at Carlyle, as did other firms, to offer other investment opportunities, including real estate or growth capital or even debt opportunities in private credit.
The modern era featured increasingly globalized business, firms expanding to new continents, recruiting both local and US talent. And as the industry grew and grew and grew, the rates of return continued to be pretty attractive. Now, there were of course ups and downs, there were cyclical movements, there were times when there were recessions and things went a little bit haywire, like during the Great Recession, buyout firms faced failures and criticism, but many adapted, innovating again with strategies that would lay the foundation for private credit becoming a major asset class. During the financial crisis, for example, firms like Carlyle bought back their own debt at deep discounts, a move that yielded outsized returns when the market bounced back and demonstrated the versatility and innovation of leading private equity players.
Today, the industry is more mature and it's expanding in many different ways. One of the ways it's expanding is more and more money has been put into private credit, a whole new, very large category that was very modest many years ago. More recently, high-net-worth individuals and family offices, often via big banks, have become a growing source of capital and efforts are underway to access the vast pool of 401k and IRA money. The combination of technical innovation, bold risk-taking, strong financial performance and global expansion has made private equity a cornerstone of global financial markets. And so, I think the best years are not behind the private investment markets. I think they're ahead of us. And so, I think in the future, rates of return that are still attractive will be realizable by firms that know what they're doing and have a fair amount of expertise to invest these [music] dollars. And that's how I believe the private markets will continue to flourish. Thank you.