Originally published in Nikkei Asia's “Henry Kravis: My Personal History"
Chapter 9
Don't forget who you work for
In 1978, we arrived at a major turning point. Until then, the institutions that invested in our funds -- our clients -- were mostly a handful of financial institutions like insurance companies. Everything changed when we landed an innovative and important partnership with the state of Oregon.
Our co-founder Jerry Kohlberg had a friend who introduced us to Roger Meier, who was chairman of the state of Oregon's pension system. In our first meeting, Meier was impressed by our briefing on the firm's investment performance, noting how our returns were substantially higher than theirs.
At that time, pension funds only invested in traditional securities like stocks and bonds, seeing single-digit returns. Like today, many were generally struggling to avoid being underfunded due to revenue shortfalls. In contrast, we had been achieving double-digit returns consistently since we had left Bear Stearns.
Of course, they were unfamiliar with the acquisition business, now called private equity, that we specialized in. We spent a lot of time meticulously explaining how private equity worked and how they could expect higher returns from owning stakes in companies this way compared to only investing in stocks and bonds.
The Oregon public pension fund ultimately entrusted us with $10 million in 1978. This was the first instance of a U.S. public pension making an "alternative investment." Then in 1981, Oregon made a massive commitment of $178 million to a single KKR deal -- the $420 million buyout of Fred Meyer, a Portland, Oregon-based grocer. We could not have done this deal without their capital. The state of Washington, right across Oregon's border to the north, followed suit and became our second pension fund investor.
The chief investment officers of the two states knew each other. As our reputation grew, pension funds from Michigan and New York also entrusted us with their capital. That's how we came to be in the retirement business.
Few people make this connection when they talk about who profits in a private equity investment. Now we were suddenly responsible to millions engaged in public service. We don't look at these institutions just as funds; we believe we are investing on behalf of the people whose names are on those pensions. These individuals are teaching our kids in classrooms, keeping our streets clean and safe, and literally putting out fires. They are running our states and communities.
As we acquire and hopefully create value in companies, we are investing in people and in communities. When we do our job well, everyone in that ecosystem benefits. The company is stronger, is contributing more revenues to its community, the employees have a good workplace and many today are also receiving shares in their companies. And when we exit through a sale or an IPO, they and those pension fund investors (or sovereign wealth funds supporting whole countries) reap the gains. Millions of individuals whose pension managers entrusted us with their money also benefit.
When done well, this is capitalism at its best. These returns are still making a lasting impact for those pension funds, sovereign nations and individuals they support. Since inception, we've had a 26% compounded rate of return for our private equity business (19% net).
Subsequently, our public-sector customer base expanded from the U.S. to many other parts of the world, including sovereign funds that are providing for entire countries. George and I know where we came from and how we got there. As a firm, we never forget who we work for.
Today, almost every single public pension fund has some investment in private equity funds. We are not the sole investment a pension fund may make but alternatives have an important role to play. Pensions need to be able to meet their long-term obligations. Shortfalls can lead to reduced state or municipal services or increased taxes to raise revenues. Sovereign funds have their obligations too and are long-term investors who have grown to appreciate the private equity model and its importance in a portfolio.