Brookfield PE head: ‘We’ve never been financial engineers’

This week, I put on my allocator hat and visited Brookfield Asset Management‘s downtown Manhattan office to talk with one of the largest asset managers on the block.

David Nowak, president of Brookfield’s private equity group, sat down with me in a conference room overlooking the Hudson River for a wide-ranging discussion on the firm’s ultra-specific investment thesis, nuclear power, distributions to LPs and investing with integrity. Nowak, who commutes to New York from his hometown of Toronto, is responsible for the group’s North American business. With approximately $147 billion in global AUM, Brookfield’s PE shop invests across business and infrastructure services and industrials.

The following interview has been edited for length and clarity.

PitchBook: You joined Brookfield in 2011, arguably at the height of PE’s “free money” era. How has the business changed over the past decade and a half to meet the challenges of today?

Nowak: There’s two ways to answer your question: One is to talk about PE in general, and the other is to talk about us. It’s harder to earn your returns now than it has been over the past 15 years because there was this period where rates were low, debt was readily available, and a lot of financial engineering went into people earning their returns. Now, you have to work a little harder to find the value in order to drive the returns. Some people are saying PE is on the decline, and I don’t think it’s on the decline. It’s still the highest-returning asset class strategy that there is.

And what about Brookfield?

The good news is we’ve never been financial engineers. We’ve never been people who leveraged a balance sheet and counted on multiple expansions and a rising tide to earn our returns. Our strategy is very simple. There are three parts to it. The first part is that we have to buy businesses that we understand better than most people, and how generally we understand better than most people is by finding businesses where we have an information advantage. We stick to buying in business services and industrials, and they tend to be essential in nature. If you think about the supply chain of an industry, we want to buy that one component that, if you didn’t have that service or product, the supply chain would fall apart.

Part two is that we have an operations-led approach. Our team has the makeup that most private equity people have, like of investment bankers, accountants, management consultants and lawyers. But in addition to that, we have men and women who’ve actually been in operating roles that have run businesses.

The third piece is to try not to overpay. If you overpay for something, it’s very, very hard to dig your way out of it. So, how do you buy high-quality businesses without overpaying? It’s generally having insights that are misunderstood, or finding a business that is not operated effectively. For example, we bought a business that serviced nuclear power facilities, Westinghouse, when everybody was predicting the end of the nuclear industry. But because we had all this knowledge base of power markets around the world, we understood the importance of nuclear power to meet the world’s energy demands.

How do you go about sourcing these “misunderstood” businesses? You bought Westinghouse out of bankruptcy in 2017, so are you typically sourcing from distressed situations?

It runs the range. We proactively map the businesses we’d like to own, so we have a pretty good understanding of the top 50 businesses in the services and industrials sectors, and then we have subsectors below them. We have people who cover each of the subsectors, and each of them has a sort of list of five businesses that they think they’d want to own.

But to your Westinghouse question, even though we’re proactive, we do get calls on everything that’s in the market. Once in a while, you get a call out of nowhere, and you just sort of go, “Huh, that’s kind of interesting.” The real story on Westinghouse was, I got the call first, and I said no, because it was in bankruptcy, as you pointed out, and it was nuclear.

At the time, nuclear was in disarray. Everybody, every politician around the world, was saying, “This is the end of nuclear. We’re going to shutter our plants.”

But then my partner, Ron Bloom, (managing partner and vice chair of Brookfield’s PE practice), got the call. Ron was like, “This is kind of interesting.” So he takes the meeting, and I’m like, “Ron, what are you doing?” And he said to me, “What if the theory of the case"—that’s what he says, like Columbo—"What if the theory of the case is that if you took the nukes out, you couldn’t meet the power demands in the market, and therefore this is just political rhetoric, and so the politicians would have to revert?”

The thesis was that the nukes never come out of production. So we spot-checked it in 10 markets. We asked our colleagues, “If you take the nuke out of this market, can you meet the energy demand?” In 10 out of 10 cases, you couldn’t. So it got interesting from that point.

Earlier this month, Brookfield Business Partners sold interests in three of its portfolio companies to seed a new evergreen PE strategy targeting the high-net-worth channel managed by Brookfield Asset Management, called BPE. How should more traditional LPs, like endowments, foundations and pensions, be thinking about large asset managers pushing into the private wealth channel? Some people tell me it’s just a fee-gathering exercise, that there’s a move away from the underlying investment thesis and more toward this kind of AUM grab. How do you respond to those concerns?

Look, I think it’s a trap you don’t want to fall into. What we’ve said to people is, if we have trouble placing the capital into deals that fit our strategy, then we’ll slow down on the fundraising. The biggest risk in the strategy is that you raise a lot of capital and you become undisciplined in how you deploy it. In our infrastructure bucket, a similar strategy called BII, they’ve actually slowed down on the fundraising to make sure that they’re not compromising their investment objectives. So I tell investors when we meet them and they ask this question, I say, “My commitment to you is, when we come back to you in 24 months, the biggest compliment that you can give me is not just that we hit our returns, but we did it the way we said we would do it.”

What kinds of questions have you been getting from your LPs, either current or prospective, over the last six months? I imagine they’re concerned about distributions from Brookfield and across the PE landscape more broadly.

Yeah, there’s a tremendous amount of focus on DPI. I understand the recycling of capital. That’s the business we’re in. People give us money. We invest it, we sell it during the return, so we send it back. And then hopefully, if we do our job right, they recycle it back through into another vintage of the fund. But what you don’t want to let happen is that focus on DPI to take you away from doing what’s in the best interest of the investment.

We have a lot of internal discussions. Our fundraising people will say, “Well, we should distribute the cash. We need DPI.” And the portfolio management investment team that oversees it will think about it and say, “But if we took that capital and we reinvested it back in the business, we can earn an incrementally better return of whatever your metric is.” So that’s the healthy debate that goes on.