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This is an audio transcript of the FT News Briefing podcast episode: The risks of private capital

Marc Filippino
Good morning from the Financial Times. Today is Thursday, October 28th, and this is your FT News Briefing.

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An activist hedge fund has called on Royal Dutch Shell to break itself up, and Israel’s coalition government seems united for now. Plus, private markets have become massive, but their lack of transparency is causing concern in some quarters.

Robbin Wigglesworth
Some regulators are worried that bigger chunks of the economy are “going dark”, as they put it, as more and more economic activity migrates into private markets, that they get less visibility into what’s going on there.

Marc Filippino
I’m Marc Filippino, and here’s the news you need to start your day.

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Activist hedge fund Third Point came out swinging yesterday. It called on Royal Dutch Shell to break itself up and said the oil super major is bogged down by an incoherent strategy. A source told the FT that Third Point has built up a large stake in Royal Dutch Shell that’s worth about $750 million. Here’s the FT’s US energy editor, Derek Brower.

Derek Brower
This is a pretty big deal. I think after the Engine No 1 activist battle against ExxonMobil that we all heard about earlier this year. This is the next big effort by an activist shareholder to take on Big Oil, and after ExxonMobil, they don’t come bigger than Royal Dutch Shell.

Marc Filippino
So, Derek, why is Third Point doing this?

Derek Brower
Well, it argues, and I think lots of shareholders have made this point about Shell in the past, that its structure doesn’t really serve its purpose, to serve the purpose of investors. And what they mean by that is that it’s just too big. It’s got too many different arms. And now, the energy transition is something that Shell says it wants to be a participant in. Third Point is arguing that Shell needs a strategy to handle that and the strategy it says it should adopt to handle that is to break up and have one company handling the “legacy”, what it describes as legacy oil and gas assets, refining upstream and so on, and another one that can attract a lower cost of capital to finance clean energy projects.

Marc Filippino
And Derek, could this actually happen?

Derek Brower
Well, I don’t think Shell is going to say, hey, we’ve got a hedge fund that tells us to break up so we’re gonna break up. What it will do, I think, is try to reiterate that it has a strategy for the energy transition, and this strategy is about unwinding its oil and gas over time, reducing its emissions and focusing on renewable energy. The problem here for Big Oil in general is that activists are kind of calling the bluff. They’re saying the energy transition is actually a serious thing, folks. It’s not something that you can just tell us you’re gonna deal with through a bunch of press releases about what you can do with renewable energy in 10 years' time. This is actually a force that will reshape your entire business, and that’s what Engine No 1 told ExxonMobil. And that’s what Third Point is telling Royal Dutch Shell.

Marc Filippino
Derek Brower is the FT’s US energy editor. He’s based in New York.

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Israel’s coalition government, which was formed in June after two years of political gridlock, includes parties from across the political spectrum and, for the first time, an Arab-Israeli party. They came together to keep Benjamin Netanyahu out of office. The former prime minister is on trial for corruption, but hopes to return to power. Yohanan Plesner is with the Israel Democracy Institute and says the coalition may be stable for now.

Yohanan Plesner
As long as they look backwards they remember the political crisis, they remember Netanyahu that is looming out there, with the ultra-Orthodox allies ready to kick them out of power, and that brings them together. Once they become more comfortable in their ministerial seats and feel like the government is stabilised, I think some of the inherent fissures and discrepancies and differences within this coalition might begin to emerge.

Marc Filippino
That was Yohanan Plesner, president of the Israel Democracy Institute, talking to Gideon Rachman in the latest episode of the Rachman Review. You can listen wherever you get your podcasts.

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Investor money has poured into private markets in recent years. We’re talking venture capital, private equity, real estate and other investments that are not publicly listed. Morgan Stanley estimates that private markets are now worth $8tn. But the FT’s global finance correspondent Robin Wigglesworth says that the rush into private capital could leave investors disappointed or worse. He joins me to talk more. Hey, Robin.

Robin Wigglesworth
Hi, how are things?

Marc Filippino
Things are great. Good to have you back. Robin, how did private markets get so big in the first place?

Robin Wigglesworth
Well, private markets have been around for as long as, you know, ownership has been around. But we can see the private equity industry really started gaining prominence in the 80s. Venture capital around the same time. But it’s in the last decade that things have really exploded. Now private equity has gone from, you know, an industry of, you know, daring buccaneers to being a huge institutional industry in its own right. These are giant firms that invest in thousands of companies and employ millions of people around the world. And I think the attraction has been increased by the fact that bond yields are so low. So if you’re a pension plan or an insurance company or a private bank or a sovereign wealth fund in the Gulf, you want to have a certain return target. You might want to make seven or eight per cent a year, and you’re not going to get that from the bond market. And you might not get that from the stock market as much in the future, either. So that’s why private capital, with its quite often double-digit returns, becomes not just a nice-to-have, but a must-have in any sort of broader allocation for you to hit those targets.

Marc Filippino
Sure. But you know, you know, we’re hearing concerns and not just from you, right? Like this week, Moody’s warned of the systemic risks created by the growing private credit industry, and that’s part of private equity. You mention in the piece that you wrote for FT.com that the high returns of private capital could be misleading or skewed. And you also point to the lack of transparency in private capital. What’s the risk there?

Robin Wigglesworth
Well, exactly. Now, investors in private markets typically do get quite a lot of information, but it is not widely available. And that’s why some regulators, including the SEC, are worried that bigger chunks of the economy are “going dark”, as they put it. As more and more economic activity migrates into private markets, private markets become bigger and more important that they get less visibility into what’s going on there. And that is something that is worrying a few people I know.

Marc Filippino
Now Robin, not to put you on the spot here [laughs], but would you, in all seriousness, would you be happy if your pension fund invested in private markets?

Robin Wigglesworth
That’s a great but tricky question to answer. Yes, I think unavoidably private markets is and has to be a major component of any pension plan purely because there is so much economic activity in private markets. Think about real estate. In many ways, you know, real estate, private companies, that’s where a lot of the economic action is these days and that pension plans have exposure that makes perfect sense. My concern is that a lot of these funds that do invest in these areas are very expensive and their net returns, basically how much money they make for an investor after they subtract their own fees, is pretty poor. So I understand the attraction, and in principle, I think it’s a good thing, including for my own pension plan to invest in private markets. But I worry about the nitty-gritty detail that at the moment, there is such a frenzy in some corners of the private capital ecosystem that a lot of investors are going to end up rueing how much money they chucked at it.

Marc Filippino
Robin, worst-case scenario, if there were a crisis in private markets, you know, could it ripple out to the broader economy?

Robin Wigglesworth
Completely. I mean, the private market is still part of the economy. You know, what is the difference between a major company listed on the stock market and a major company that is private, it’s still a major employer. And if that company goes bust for all sorts of reasons, then that is something that can ripple. I think that a lot of regulators are starting to ask is, is there so much money now in private markets and the other interlinkages, they’re so big, and the whole ecosystem so large as a whole that problems there, are they obscured from the sights of regulators? And can a major setback ripple into, let’s say, the mainstream bond markets or equity markets? And I think the worrying thing is that we just don’t know. And I think that is what’s giving, you know, some regulators and some investors, I know the heebie jeebies.

Marc Filippino
Excellent use of the phrase ‘heebie jeebies’ there, Robin. Robin Wigglesworth is the FT’s global finance correspondent. Thanks, as always.

Robin Wigglesworth
Thanks for having me.

Marc Filippino
You can read more on all of these stories at FT.com. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.

This transcript has been automatically generated. If by any chance there is an error please send the details for a correction to: typo@ft.com. We will do our best to make the amendment as soon as possible.

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