Podcast: Fund Shack

Fund Shack

#29 Luke Johnson, entrepreneur, investor, philanthropist

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In his 20s, Luke Johnson led the acquisition of Pizza Express and as chairman, helped it become the UK’s leading pizza brand. He has since established and helped develop household names, Strada, Giraffe, the Ivy, Zoggs and Integrated Dental Holdings, as part of his family office vehicle, Risk Capital Partners.

He is a successful newspaper columnist, author, former chairman of the Royal Society of Arts, and current Chairman of The Institute of Cancer Research.

In our exclusive podcast, Luke provides a critique of private equity, a critique of public markets, a critique of lockdowns and some of the most sensible advice we’ve heard yet about how businesses should be run in this brave new world.

Uncorrected transcript\some inaudible parts

Ross Butler:

You’re listening to a Fund Shack, private chat number 29. Welcome to Fund Shack. I’m Ross Butler, and today I’m here with Luke Johnson, a well known entrepreneur, businessman, philanthropist, and private investor, Luke. Welcome. And I have to say thanks so much for coming to meet us physically, because this is the first time we’ve been back in the studio 18 months and personally I think it makes a real difference. Nice to see. I was looking over your bio in preparation for this. And I had to say, and I don’t say this just a flatter you, but I was amazed at the breadth of your undertakings and your achievements. So you’ve got obviously a varied portfolio. And within that I recognized about three quarters of the businesses. Now you do consumers, so maybe that’s not so surprising, but that leap out of me, then you’ve been a successful newspaper columnist over years, if not decades. And I know that that’s not easy to sustain and you’ve been very active on the philanthropic side. You’ve publish books. This is quite a productive repertoire. Now you only get one life, so it obviously doesn’t seem strange to you, but why do you think it is that you’ve managed to be so productive across so many relatively varied domains?

Luke Johnson:

Well, I think I’ve always liked to be busy and I have a father who has had an extremely long career and although he stuck to the one career of being a writer, a journalist and a historian, he, he was incredibly productive and wrote many, many millions of words and published 40 books and so forth. So I think he gave me a good example to follow as a role model. And you know, to a degree, I think life is what you make of it. And if you have the energy, there are always opportunities. I think given that most of us perhaps we’ll live to, you know, be in our eighties. That means we might well have a 50 year working career. And it seems to me, therefore that we should all plan to have at least two different careers and possibly more I’ve always been interested in people who’ve done a variety of things rather than just one profession and stuck to that their whole working life and then retired. None of that interests me in the slightest.

Ross Butler:

It rather goes against the grain these days, cause everyone wants to specialize to such a great degree. And if you’re seen to be your specialist in more than one area you’re seen as an amateur in at least one of those,

Luke Johnson:

Well, there may be some truth in there. And I think I could be accused of being a [INAUDIBLE] at some things in life. And you know, I don’t deny that if you diversify, then you may have less depth and you know, there are advantages to focus and specialization, particularly in the modern complicated world. However, the point you made at the beginning is we only have one life. It’s important to keep interested and lively. I think for example, take philanthropy. I’ve served on the boards of a number of different charities and nonprofits over the last few decades. And one of the great advantages of that is I think it teaches you things and you meet people that if you are only doing business, you wouldn’t. So I would actually encourage all successful people in sectors like private equity or venture capital to seriously consider whatever age, but say in their forties, the idea of becoming a trustee of a school or hospital or some other nonprofit, because I think it broadens your horizons. And that should be partly what life’s about. I think there is a risk if you only do one thing, you get dull and you repeat yourself and the needs to be more to it than that. I think.

Ross Butler:

Yeah. investing itself is very nature. Kind of it’s, you’ve gotta have a broad outlook on life because you know, you’re looking at different sectors. You are not the specialist, you’re not the, in most cases, the executive, the doer, you’ve gotta stand above that. So that will kind of make that, that probably adds to your ability to be a successful investor.

Luke Johnson:

Maybe I think one of the challenges for private equity is that although they pretend to themselves, they aren’t the specialist in terms of how to run a business or a particular industry. I’ve sat on boards with private executives who are there telling the managers how to run the business and making decisions that I think should be delegated to the executives who are full-time in that business. And the arrogance sometimes are private equity executives in thinking they know best let’s them down. I think there are some areas where private very good, you know, buying and selling for example, raising finance, they’re pretty good at that. Some of them are pretty good at picking talent but above and beyond that, you know, knowing markets, knowing competitors, you know, understanding the intricacies of the technologies that they’re working with, really being able to spot the best executives at the operational level to work with. Mm not so sure

Ross Butler:

I’m sure you’re right. And I actually, I think I do agree with you, but to play devil’s advocate slightly, if it didn’t work, would they, would they do it? It’s certainly the trend is for greater activism and certainly the institutional investment community buys the idea of interventionists private equity firms. So presumably they look at the data and think, well, those that are a bit more muscular in their approach with executives do better. There must be some cause in effect,

Luke Johnson:

There probably is if they’re the right private equity firm and as you well know, you know, it depends which quartile of a PE house you are talking about. I think we’re all humans and I think private equity investors have as much ego as anyone. And, you know, according to Maslow’s hierarchy of human needs, once they’ve developed a certain quantity of wealth what’s next, and obviously what’s next is some degree of status. And that would mean them adding value and making a difference and being important in the ownership so that the value accretion is partly thanks to them. Now, I would normally accept that the financial engineering aspects of deals are probably down to the PE house. I have they bought it on a low, multiple, can they sell it on a high, multiple, have they added the right amount of lever to goose the returns?

Luke Johnson:

Have they made a clever bet in the first place? All those things of course are down to them, but, above and beyond that, you know, quite often I think, you know, it’s debatable whether they really make a difference. Now, I think there are some very good private equity investors. And I, I would say on average, you know, successful private equity investors are clever people. And, you know, obviously if they succeed and they, you know, get backing from limited partners and, and show good returns, then they can’t be that thick. However, it’s amazing what lever in a rising market can do.

Luke Johnson:

And, you know, generally speaking over the last two decades, certainly, you know, it’s been a pretty good game to play. I would say private equity in terms of accumulating returns for investors and indeed enriching private equity investors. I think, and I’m not talking about myself so much, cause I’m not really an institutional private equity investor or executive, but I think it’s as good a career as one could pursue, if, you know, you want to get rich in a pretty safe way because you are playing with other people’s money to a very large degree and you know, you can write very big checks. And so if you get your bets right, then you do extremely well. And to a large degree you know heads say wind tails, other people lose. So, you know, private equity as a career has proved a pretty good bet. And I suspect it will continue some time because you know, there are a lot of organizations raising big funds and there’s a lot of parcelling which to a degree, you know, is self-fulfilling

Ross Butler:

So, you’ve packaged yourself up to some degree as one of those people, because yes, you are not an institutional, but you’ve got risk capital partners. You could have just been Luke Johnson, the big wealthy investor, but for some reason you see it as useful to be seen as part of that community.

Luke Johnson:

Well, I think probably a lot of people prefer to deal with a brand, an organization rather than an individual. I think an individual is more egotistical inevitably. I think when we set up risk capital partners over 20 years ago the sort of private office was much less common, I guess, if one were doing it now, you know, that’s what I would do. Also. I have more money now than I had 20 years ago. In the meantime, we also did raise a fund with limited partners. And you know, it’s say for one, an investment is now spent and we’re returning funds and it will show a good return to our LPs. And I think it’s been a success, but I didn’t wanna do another one. The point about a fund of course, is it’s a very, very long term commitment.

Luke Johnson:

It’s really a 10 year commitment from all the partners. And indeed obviously the limited partners. So it’s a very unusual structure in terms of most jobs, if you like. And, and it, it really is a partnership arrangement rather than employment arrangement and all the longevity and loyalty required that, that displays. And indeed, I think if you look at the history of most PE houses that have fallen apart more often than not, I would say it’s cause the partners fell out, you know, and that may have been because they made some bad investments, but quite often it’s literally personality clashes leading to the, you know, founding partners of the organization, not getting on etc. And that’s what leads the LPs to then dessert them. But I’m not in denial about the fact it’s a lucrative and on some levels successful structuring of buying assets, because I think there will always be the advantage they have over say, public companies in private equity are virtually, always willing to buy and sell.

Luke Johnson:

Every asset is for sale. And they are always willing to buy a new asset. Public companies are slaves to the cycles of the stock market. And very often in my experience, public companies are forced to sell at the bottom and buy at the top. And it astounds me how often I come across situations where there’s a public company in a particular sector that will know that industry very well and have huge synergistic advantages of making a strategic acquisition, but for a variety of reasons, they’re too slow or it’s at the bottom of the market or whatever. They can’t make the acquisition private equity, which doesn’t know the industry as well. And doesn’t have any synergistic benefits makes the acquisition and then flips it to the industrial buyer a few years later at a huge profit. And, you know, you wonder why does the public market always end up paying more? And I guess it’s because private equity are ultimately really M [INAUDIBLE] specialists, all they do is buy and sell in a sense. And that’s what they focus on. They’re small and flexible and they have this great timing advantage, which really plays to their strength.

Ross Butler:

I agree with you. I think it’s it’s one of those things and there isn’t a problem with it. As long as the, those rewards are accessible to as many people as possible. One of the problems is that anyone can invest in the public markets, but it’s, it’s increasingly easy to invest in private equity vehicles, but it’s still pretty difficult for your average job.

Luke Johnson:

Yeah. And of course, as we know, private equity still only represents a tiny proportion of the overall savings and pensions money out there. And as a proportion of overall institutional individual portfolios, it is growing, but it’s still, I would imagine worldwide, you know, under 10% across most diversified forms of savings. And it, it is gonna grow structurally more allocation is gonna be devoted towards private investments once or another, be it VC or PE. That’s probably a good thing. I’m not surprised even though, you know, two and 20 relative to public market management fees is I, the level of attention required investing in private companies is a great deal, more intense. So, you know, I would argue it’s, it’s justified to an extent and the returns are there. And another area where I think private markets have an advantage is they are more willing to put higher levels of debt into investments. Generally, my experience public company fund managers, don’t generally like to invest in companies that have 3, 4, 5 turns of [INAUDIBLE], senior debt. Whereas many PE houses are perfectly comfortable with that. Indeed. They would consider that a standard lever of leverage for a normal buyout. So, you know, that financial engineering in rising markets and growing businesses, compounds returns. Yeah. And  it’s an another advantage that PE has over public markets. So

Ross Butler:

Just at this point, can we step back to some of our international listeners might be wondering where have you come from, if you are not a mainstream private equity guy, could you give us a quick potted history, maybe looking, starting with, well, wherever you like, but particularly like Peter express as a signature deal.

Luke Johnson:

Sure. Okay. So in my late twenties I, and a, a group of partners took control of a private business called pizza express. We merged it with a a group of franchise restaurants, pizza expresses, arguably the leading pizza chain in the UK. It’s been going since 1965. We took control of that in 62, 63. We took it public.

Ross Butler:

Wasn’t it ’82?

Luke Johnson:

No, ’92, ‘93.

Ross Butler:

Sorry. Okay. Sorry,

Luke Johnson:

Go. I’d only just graduated from university in ‘82.

Ross Butler:

You said ‘62, so yeah, you’re Right.

Luke Johnson:

Yeah. ’65. It was founded. ’92, ’93 we took control of it. We took it public, and it was very successful. And I was chairman of that during the nineties and, the chairs rose from 40p to eight pounds more. And, off the back of that, I then started doing more deals. It initially mainly public company deals. And then through the later nineties and into the two thousands, many more private companies, and, you know, over the decades, I’ve probably invested as principle in 50 or more businesses with a strong bias, as you said, towards consumer and in particular areas like, hospitality and leisure, mainly UK. And you know, at the smaller end, I, I would characterize the classic investment I do as development capital. That’s my preference.

Luke Johnson:

So frequently backing a founder not always taking a majority stake, quite often, a minority stake. Yes, we do buyouts, but quite often, not and pretty flexible in terms of the types of deals we do in the structures. And I think that’s because to a fair degree, most of the time we’ve been using our own money, my money. And so we can do bigger and smaller deals. We can do longer deals. And clearly we don’t have to do any deals at all. I think one of the reasons I chose not to raise a fund when our last one was exhausted was, as I say, it’s a 10 year commitment. I’m 60 next year. And I didn’t wanna be marching into my sixties with a sort of, you know, seven, eight year commitment still to go of making, you know, a minimum number of investments and a minimum amount of capital deployed every year.

Luke Johnson:

And it’s been very interesting to me over the last 18 month, with the pandemic, a lot of private equity houses, particularly in 2020 sat on their hands grave mistake. I think they should have been out there doing deals. And you know, a lot of them were underinvested. Anyhow, they had a great deal of dry powder. They’re now even more under invested and they under are under huge you to invest. And, you know, ultimately a P house that doesn’t get money to work is no good to anyone. Mm. So they will get their money to work. Unfortunately they may well end up paying too much. Now, usually private act is pretty good at avoiding those sort of cycles, as I said earlier, and, you know, they’re astute people, private act invest. So they’re very reluctant to overpay, but I sense that quite a lot of houses have got their back slightly up against the wall in terms of the pace of investing. And that’s not a comfortable place to be. And I’d much rather be in a situation where you take a year off. Things are too pricey. Conditions are too difficult. I won’t be investing this year. And then do twice your usual number of investments when times are good for investing.

Ross Butler:

Yeah. So you have that flexibility, which is an advantage. We come back to maybe the structural advantages, but you mentioned you were active in 2020. I mean, what’s your view of the market and opportunities out there?

Luke Johnson:

Well, I’m very much to niche investor. So, you know, I’m not putting a hundred million to work a go or 200 million, whatever it might be, you know, I’m investing five, 10, 15 million pounds in each bet. And I think in the end of the market that I tend to operate in, there are opportunities two or three of the deals I’ve done in the recent past have been distress. And there’s obviously some of that going on, particularly in some of the sectors I’m familiar with. And those are deals that the vast majority of private equity houses are not geared up to do. Don’t feel comfortable doing for all sorts of probably good reasons.

Ross Butler:

Um there’s not much experience of doing distress deals.

Luke Johnson:

No. I mean, there’re obviously a handful of specialists that only do them and some of them are very good and really I’m really impressed by the quality of some of those deal doers.

Luke Johnson:

But they tend to focus only on that. Again, they would tend to be doing slightly bigger deals than me. And some of the deals I’ve done over the recent past has been modest if any competition, which, you know, for most private equity players is very hard to achieve. You know, generally speaking, every single deal is got proper advisors and intermediaries and is well marketed. And you know, the, the assets touted widely around the market and there’s plenty of competition and you get a, not a perfect market, but a pretty good market price achieved for most assets of quality and, and size. Mm.

Ross Butler:

Would you say that so I’m just trying to get to grips with what the secret of your success is. Would obviously you can’t put on a, on a napkin, but I’m wondering if to what degree would you say you use your intuition when you are assessing whether something is a good opportunity versus bringing in the advisors and producing reports for, you know, like, so a typical investment executive would then have to go to an investment committee and it would be a group decision, but it would also be a real discipline in terms of dotting all the eyes and crossing the Ts and making sure that there is a really explainable, calculable case. You don’t have to do that. So you can rely more on your intuition, to what extent do you?

Luke Johnson:

Well, I think having the discipline and having group input is vital. And you know, there have been occasions in the past where I have not been as rigorous as I should have been, not within our fund, but with my own money. And sometimes it’s blown up in my face and I, you know, I’ve tended always to be at the sort of higher risk, higher reward end of investing. So, you know, I’m much less interested in steady investments that will, you know, gradually make me twice my money. I’d prefer to go for things that make me three or four times my money, but occasionally go wrong and you lose everything. And obviously that’s highly undesirable and never part of the plan, but it can happen in life. It, it normally it doesn’t actually happen with deals. I do because of leverage it’s because the business hasn’t worked.

Luke Johnson:

I do use intuition and inevitably we are, you know, social animals who you mentioned at the beginning of this meeting, how much better it was face to face than on zoom. I completely agree. That’s all about what you might call intuition and being a human being I think private equity investors who pretend to themselves that it’s all science and spreadsheets are under an illusion. Hmm. I suspect none of them do actually think that because otherwise they wouldn’t be successful. No, I think having checks and balances is essential and they come in all shapes and sizes, not just credit committee, but of course, lenders and others will have their own, you know, impositions, I think relying exclusively on, you know, the accountants and lawyers and other specialist advisors to tell you all about the business, rather than doing any of your own personal due diligence.

Luke Johnson:

And having at least some in-house capacity of taking a commercial view on a situation and the people running it and so forth is a mistake. And you know, I have to say having worked with some bigger PE houses, some of them are very good at all that both having in-house resource, but also getting incredible work from advisors. So I wouldn’t to cry any of that at all. I think it’s important not to bely obsessed about the reports. I think you have to look at the big picture. You, you almost certainly, at some point have to take a view. I think sometimes, you know, I’ve seen PE houses miss a deal because they let relatively small issues cloud the thing, and someone else is more willing to step back and say, you know what, nothing’s perfect, good enough. I like it, etc. And it’s the right price and so forth.

Ross Butler:

Um you mean, a bias towards optimism to some degree?

Luke Johnson:

I think anyone in capitalism does. Yes. You know, if you don’t believe in growth and you don’t believe in a positive future, and you don’t believe in the potential of the business, you are backing to deliver value, then you probably shouldn’t be taking money on it. So yes, and I think probably ultimately most PE houses have that frame of mind or the individuals working in them. And so they should and obviously, you know, as well as making a turn on the multiple and the magic of leverage, the other biggest element in any private equity successful investment is growth. That’s the thing that will ultimately deliver the really great return growth. And indeed, it’s also what the buyer at the other end looks for. You know, I have occasionally invested in businesses that have very little, if any growth and they’re quite hard to sell because, you know, people don’t want to really invest much in stagnant businesses. And why would they, you worry that if he’s not going forward, he’s probably going backwards.

Ross Butler:

Yeah. You alluded to the fact earlier that you invest in relatively small deals and so they can be the specific situations that you’re assessing, but particularly I’d say at the moment, is it not increasingly important to take a more of a macro view as well, given the interventionism, let’s say of the state in various sectors are you having to, are you trying to factor that in, when you look at new businesses in areas that could be locked down?

Luke Johnson:

Well, it’s a very serious point and pretty profound for anyone who’s involved in markets and free enterprise and so forth, you know, have the rules of the game change such that the government will force you to shut in a way that would never in modern history of happened before and, you know, destroy the value you are trying to create here. I’m sort of without being ostrich like about it, I’m of the view that these are things one cannot influence, and generally, therefore you can, you know, give yourself a hashtag stressing about them all night long. I think you have to try and focus on your own specifics of situations where you can make a difference both in your own life and your business. And I guess I’m taking a view generally that, you know, with regards to, for example, lockdowns, which have been impacted certain sectors, like travel very severely indeed, ultimately society can’t afford many of these more.

Luke Johnson:

They’re just too expensive, both economically, psychologically socially. And so you know, the harms, the undoubted damage of lockdowns are becoming ever more apparent as was obvious because they’re diverse and long term, whereas of course, daily hospitalizations of and deaths from COVID to, you know, on a daily basis. But you know, governments can’t keep printing money. I don’t think in the way they have done to pay the bills. And you know, some of the bills for both businesses and governments are starting to fool you we’ve got threats like inflation. So and so on. So big picture means I don’t think, you know, countries like the UK and many others can really afford to do many long lockdowns let alone the fact that I think proof will recently show they don’t make much difference. So they really aren’t worth it, both health wise and wellbeing as well as economically.

Luke Johnson:

And therefore I think, you know, it’s probably a pretty good time to take a view and say obviously to a large degree, thanks to vaccines, but also the, the terrible costs of the interventions are such that they cannot be repeated again and again. And so as people keep saying, we have to live with the endemic disease and get on with work and, you know, start earning some money to pay the bills, which means decent businesses that might be shut down. If there were another lockdown are probably a reasonable bet, but there’s gotta be a discount somewhere in there. And, you know, clearly if once constructing portfolio, you don’t want to bet exclusively on businesses that are vulnerable to being shut down. And I know one or two PE houses where, you know, big chunks of their portfolio have been closed for much the last 18 months. I’m very lucky and is absolutely luck that I’d sold a whole raft of businesses over the previous couple of years, which would’ve been smashed to pieces by lockdowns. And thank God I did, because it meant that although I did have certainly a couple of businesses that are, you know, in sort of recovery mode, we say having been severely battered if I’d had a half a dozen of them, it would’ve been significantly worse.

Ross Butler:

Yeah. I think you’ve gotta be right to just focus on what you can influence. And yeah, I do find it surprising that there’s so little commentary on the potential fallouts, like economists used to issue, press releases. If we had a public holiday telling us how much it costs the British economy, and yet we’ve been impartial lockdown for two years and well, they don’t issue, press releases about it generally. It’s like, it’ll be all right. We’ll just go along as, as if nothing ever happened. So I think, I think you’re right. You have to just focus on what you can, what you can influence, but there probably will be a reckoning.

Luke Johnson:

Well, I think there needs to be reckoning because I think overall it can be argued that, you know, in certain ways society slightly lost its marbles over the last 18 months. I think the toll across many aspects of communities in terms of, for example, children and education, young people, generally, the damage to them the irrationality and lack of evidence base for some of the interventions and so forth and so on. You know, we don’t want to get distracted into that black hole. I is such that you know, in hindsight, in the years to come, I do think we will realize that grave mistakes have been made and I’m not talking about, you know, locking down two weeks too late. I’m talking about the very essence of universal lockdowns and the harms of, you know, unemployment and you know, the, the divisions it creates in society between those who have to still go out to work.

Luke Johnson:

And those who think that everything now is working from home for forever speaking personally, one of the toughest aspects has been, people thinking in a rational way when they’re all isolated. Yes. And I think for myself, and I believe for many others that actually you get things more right if you are debating it with others in person. Mm. And I think the idea that we’re all thinking rationally because we’re on zoom calls is diluted. I think there are very profound differences. I know for myself, I’ve had hundreds of zoom board meetings and such like, and I can tell you now they are very, very dysfunction compared to a proper board meeting with people in the room. Definitely no question of it. And for example, if you’ve got a large board and most large organizations and institutions have large boards, there is a massive predisposition towards people, not dissenting of any kind, when there’s a certain number, people on a zoom call, they are much more likely to stick their hand up or nod to the chair or do whatever it is to say, yes.

Luke Johnson:

I just wanted to bring up this one point. Can I just question this it’s extraordinary, how often a non-executive argument will do that and then two or three others will say yes, yes. I was wondering about that does not happen on zoom calls. Yeah. And you look at our leadership and the key advisor groups, for example, you know, in public health and others that have been making these draconian and extraordinary decisions all on zoom, not good debate, not good vigorous discussion of what are the, you know cost benefits of this. Have we thought of the whole picture here? Mm. And I think that’s been going on a great deal. And I think because we’re all snug at home, particularly those better off powerful people who run society in industries like private equity. The fact that, for example, you said at the beginning of this meeting, this is the first time I’ve had one of these interviews for 18 months. I can’t tell you how many conversations I’ve had like that, because I’ve been in my office and meeting people if I possibly can since May last year. Right. But every banker, every accountant, virtually every institutional person I know of fund manager, PE executive has been at home the whole time. And I don’t think that’s conducive to critical thinking. And

Ross Butler:

It’s so easy to say, well, what’s more efficient, you know, everything

Luke Johnson:

It’s convenience. Yeah. Convenience. Yes. You’re right. Efficiency is the wrong word because efficiency suggests getting it right. It’s convenient. It’s a bit like getting home delivered food. It’s very convenient, but mostly eats. I’d rather eat in a restaurant or have proper cooked food at home after you’ve done some shopping, then a crappy meal that is probably more expensive home delivered.

Ross Butler:

And yet it’s harder to articulate the benefits cause they’re slightly intangible and they they’re harder to, to put hard quantification on. And you also kind of alluded to the, everyone talks about quality these days, but there is a real inequality element to this whereby white collar workers like you and I could choose just never leave our homes again.

Luke Johnson:

Ft and economist readers love it all. Yeah. Because they run the world and they’re very comfy. They’ve got gardens. Someone collects the rubbish. Someone delivers their food. They, you know, get stuff on Amazon. They might see more of their family. What’s not alike and they’re safe. Meantime every year, every day in Britain, 10 million people are having to go out to work, to keep the broadband going and to deliver the groceries and so forth. And that is a more pronounced inequality on many levels than I think ever in our lifetimes. And you know, there are so many serious issues arise from this such a for example, has furlough undermined a chunk of the portions of the nation’s work ethic, you know, and it’s peak 9 million people being paid to stay at home. Why wouldn’t they want that to continue? Is the real reason people are willing to accept low quality output from working from home because it’s saving the money on commuting. I think that’s a big factor as to why lockdowns have had such enormous support seemingly. It’s not the science it’s because people are saving money on their fairs.

Ross Butler:

What’s your policy preference with regards to the companies that you own?

Luke Johnson:

Well, I want them in the office now it’s obviously up individual bosses. I would say, you know, if they think they can run things efficiently and you know, it makes more sense for their particular shape of their workforce to do it at least partly from home a hybrid model, flexible. I get it. And I think workforces these days will increasingly demand that and companies that insist everyone is in the office every day may struggle to recruit or retain people.

Ross Butler:

Although young people might find it more attractive.

Luke Johnson:

Of course. And I know I do. And I think there are, it depends on the big and the industry and the people in the work. UI guess people in my generation are much more likely to say, we’ve all gotta be in the room. Those who are, you know, much more used to the flexibility, should we say video conferencing might argue, no, let’s stick to what we’re doing now. And of course there are lots of things that can be done perfectly competently online rather than in person, but when it comes to anything critical, a key pitch or, a key sale or, interviewing someone to hire them or whatever it might be that really matters, then I see there is no substitute for doing it in the room. And, h passionately believe that. And I think actually it has been a competitive advantage, I believe over the last year in doing stuff that I am in the room when people are willing to be. And, h think it’s helped clench deals and given me an insight that people who are relying exclusively on zoom, you know, I’ve missed.

Ross Butler:

So the Woody Allen quote, which I’m gonna get wrong, but two thirds of success is showing up

Luke Johnson:

90%.

Ross Butler:

We’ll go with that. Leave us with something optimistic, positive. Can you tell us about deal you’ve got in your portfolio, you like the look of, or something about the world that you are optimistic about?

Luke Johnson:

Well to use that bogus venture capital phrase pivot, I have slightly towards areas that are more digital inevitably because historically, you know, I’ve invested heavily in areas like retail and hospitality, which means, you know, shops and restaurants and cafes in pubs and hotels. And of course, all of those, you know, have struggled over the last 80 months and face challenges going forward. So I would still invest in all of those sectors, but I’ve also made an e-commerce investment last year into a gardening products business it’s called Primrose. And that has an October year end, but we think it’s gonna deliver for this year’s results because it’s had the principal season now and we’re happy with that purchase. We bought it almost a year ago now. And I think it’s a good sector. And I think eCommerce in that space is growing gardening itself has boomed during lockdowns. And I think some of that will stick. And we are looking at further eCommerce investment because obviously it’s gonna take an increasing part of the market in terms of people’s overall retail spend. So

Ross Butler:

What’s primroses model. Do, do you have to go onto their website to buy their stuff or do they start.

Luke Johnson:

Yeah. I mean, you know, they have an app and so forth too, but mostly people are on the website and, you know, it’s, it’s exclusively, it’s not an omnichannel, so it doesn’t have any retail outlets at all. It only it’s, you know, only digital, and it’s quite long established business. And, it’s quite a fragmented sector. Actually. There are quite a number of digital players in, the overall gardening space. You know, it’s a sector that we stumbled across, but we like, and, I think there’s more to go for. So, yeah, I would say that was, a deal that we’re excited about and we think has, has lots of potential. And, and so inevitably, you know, if you look at e-commerce generally, you know, you are up against Amazon, but there are some sectors that they are perhaps less focused on. And I think gardening, you know, has some logistical challenges, gardening, for example, that Amazon seem less interested in. Right. And they’re such dominant player, ideally, you know, you don’t wanna be directly competing with them. Mm. We do work them actually as most people do in e-commerce, but, ideally you get people on your own website. Yes. And so yeah, that’s one business we’ve bought recently that, we think is interesting.

Ross Butler:

Great Luke. Well, it’s been great catching up with you in person. Thanks very much for sparing your time.

Luke Johnson:

Thank you.

Ross Butler:

You’ve been listening to the fund shack podcast, make sure you subscribe and visit our website@fundshack.com for many more video interviews. It’s the private capital channel for alternative investment professionals. Thanks for listening.

Fund Shack

#28 Fabian Chrobog, North Wall Capital on European special situations

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Fabian Chrobog is founder and CIO of North Wall Capital.

Fund Shack

Alistair Lester, CEO of Aon M&A on protecting and enhancing returns

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Alistair Lester is CEO of Aon’s M&A and transactions services business in EMEA. This is not the conversation you think. Aon has spent recent years building out its capabilities across the risk spectrum.

Transcript

Ross Butler:

Alistair, you are the CEO of Aon’s M&A business in EMEA, but it’s not your first bout there. You started in the graduate scheme some 25 years ago, and in the mid 90s working for private equity clients. And I wanted to start by asking you to what extent has the insurance services industry over that quite long timeframe responded to the pace of change in the world and the risks that businesses and private equity firms face today?

Alistair Lester:

There’s been a huge amount of change of course, in the world. The insurance industry is not renowned for being particularly speedy in terms of pace of change, but actually there’s been a pretty significant amount of change within the insurance industry and particularly within the part of the insurance industry and the broader professional services aspects of our world that faces off to the M&A and private equity ecosystem. When I think back to being told that what we did for private equity firms was a niche part of our industry and a niche part of a firm that I previously worked for.

Alistair Lester:

I think we, as an industry, are really only just starting to embrace the scale of that relationship opportunity in the same way in the last three, four, five years, a couple of good examples of what’s really driven that Ross. If you go back two, three years, if I said to a PE firm, what do you think of Aon, Aon could do to help you? They might say, I know you, we talked to you on the limited partner side, you’ve got a big investment management arm of your business, and we talked to them about LP investments, or you are an LP in our fund or, or they might likely have said insurance due diligence. And they might’ve said something more recently, this warranty and indemnity insurance, or as we call it in the US, reps and warranties insurance product,  which has genuinely exploded in the last four to five years in utilization in PE.

Alistair Lester:

And yes,  we do all of those things, but what’s really exciting for us is our ability over the last few years as our industries evolve, and as Aon has evolved to bring multiple advisory capabilities, multiple advisory work streams to life on the one hand and multiple or an increased number of financially motivated insurance instruments to bear on the other hand and much more sophistication and science around how we really do develop, deliver value in the portfolio. So when you have that conversation now with clients who’ve been on that journey over the last three, four years, they would absolutely recognize our industry. And particularly our firm, I think, has been leading the charge in areas like cyber consulting, in intellectual property consulting and advisory and valuation, of course, in risk and assurance in the broad set of human capital from retirement benefits, but also talent reward and compensation aspects of deals.

Alistair Lester:

Then on the instrument side, looking at the adjacencies to warranty, and indemnity insurance like loan contingent risk insurance, be that tax insurance be that litigation insurance we’ve pioneered a product called judgment preservation insurance. We’ve pioneered the ability to wrap insurance around your intangible assets or intellectual property. You can potentially use those instruments as collateral, which enable you then to access different forms of financing. So really the big change has been this institutional-industrial realization there is an opportunity to marry up what has traditionally been seen as a relatively lazy, perhaps enormous pool of insurance capital with all the parts of the capital markets and bridge the two in a way that drives value into private equity deals, because as you and I both know, private equity are just so hungry for what they call new technology and new ideas, and that’s been a fantastic accelerator for what we do.

Ross Butler:

Why is AON providing the services that it is providing? What’s the journey from your insurance services capabilities to the services that you’ve currently  just outlined?

Alistair Lester:

The world lives in a world of risk, and Aon as a firm is all about risk. We are a risk business. Insurance is an instrument that can help clients manage their risk. But what we don’t do is just deliver insurance products. We also deliver a range of advisory capabilities that help clients understand, identify and mitigate risk insurance instruments are just one part of the mitigation aspects of how you deal with risk. Every deal that any client does, they price risk into their deal, and they deal with risk in a deal in different ways. Maybe they priced chips. Price chips are a result of people identifying risks they’re not comfortable with. Maybe they seek contractual recourse against the seller against the counterparty, and maybe that contractual recourse is somehow secured through escrows. Maybe, as a buyer, if I identify risk in a deal, I defer an element of the consideration to see if that risk crystallizes, and if it does, I’ve protected myself because I’m not having to pay my deferred element of the consideration. All of those things are well-established approaches to dealing with risk in a deal. Those risks need to be identified for people to be able to understand them and then come up with solutions for them. So, the exciting point is we think those three buckets of price-chipping contractual recourse, and deferred consideration, they’re all perfectly valid ways of dealing with it, but none of them are actually optimal ways of dealing with risk in a transaction. By contrast, optimal approaches can include solving them through more insight into those issues, so you get more comfort with them. We can provide that in a range of ways across people, risk and cyber risk and intellectual property risk, et cetera, et cetera. But secondly, by introducing an insurance instrument, which can take that risk away in a far more attractive way and deal with those potential risks in a far more attractive way, potentially than price chipping or deferring, or getting contractual recourse against the counterparty.

Ross Butler:

And all of this kind of moves you further towards, I suppose, insurance being a purely defensive product. You’ve got a clear line of sight to enhancing returns through all of this.

Alistair Lester:

You’ve teed it up beautifully. So, we talk about what we do is securing investments and enhancing returns. That is our little strapline. We think with our advisory capabilities, we can give you much more insight into what you’re getting into. We think with some of the core traditional insurance solutions that are out there, very plain vanilla, traditional insurance solutions, you can secure that investment. But actually going to your point on enhancing returns, we think that we are able to deliver these structured insurance instruments across a wide range of areas, including structured credit and tax and litigation, et cetera, whereby spending a pound, a dollar or a Euro on that instrument you are realizing or recognizing multiples of that either in the enterprise value or somewhere in the capital structure of the transaction.

Alistair Lester:

That is a very different way to think about insurance, where for most of us, including people who live and breathe it, you know, renewing our car insurance or home insurance, or even our business insurance every year, what you’re really looking for is a way of reducing the cost of insurance, because you see it as a sunk cost. You don’t see it as a return generating instrument, whereas with a lot of what we’re doing, it’s spend a dollar or Euro pound on that instrument, and you will see a multiple of that somewhere in your enterprise value or capital structure.

Ross Butler:

It seems to me that risks over the, say, that 25 year period, have gone from being relatively tangible, relatively geographically, constrained to being much more intangible, much more distributed across the world, less physical and therefore just much more complex. And I suppose, as a result of that, harder to quantify and I guess where there’s complexity there is opportunity, which is why it’s logical for insurance providers to have expanded in this way. Is that a reasonable reading?

Alistair Lester:

I think that’s, that’s a very astute reading Ross. I think this is why Aon has diversified its capability set, for exactly those reasons, And if you double-click on intellectual property, as an example, and intangible assets, as an example, you only have to look at the huge rotation of the S&P500 over the last 40 years, which has gone from being, completely dominated by hard assets, tangible asset values, and companies who operated in those areas to companies, which are absolutely intangible asset rich and intellectual property based. And as a result, by the way, the insurance industry, some argue, has struggled to stay relevant as it could have done growth of global insurance premiums has lagged global GDP growth for that reason, because the insurance products are not as relevant as they need to be to what’s going on in the world traditionally. So, Aon made a move into intellectual property – and this is what Aon has done brilliantly – we have purchased capability and talent in adjacent areas to us. So, we bought a business, which was one of the leading intellectual property consulting businesses. And then what we’ve done is we have worked with that business to deploy that capability into a private equity context. We’ve worked with that business to build insurance instruments that can deal with intangible risk and intangible assets in a way that wasn’t previously being addressed. And we’ve gone one step further by helping to use both of those things, the insights and the capability we have on the advisory side, the risk modeling, the quants capability we have on the valuation side to then build product, which is enabling and opening the door to IP, rich companies, to access financing, using insurance as a collateral around their intellectual property in a way that’s never been possible before.

Alistair Lester:

So that’s an absolutely spot on. What Aon has done over the last five to ten years is it’s added inorganically areas of talent and capability, whether it’s in cyber, whether it’s in intellectual property, the talent world, we’ve added businesses and people who have bought different skill sets to our firm. Many of whom have had zero exposure to the insurance industry before. But actually by bringing these people into our industry, they are giving us perspectives on different emerging risks, which we’re able to support clients from an advisory point of view with, but also match those risks into the huge pool of insurance capital and start to build some new and evolved and developing insurance solutions that, that provide answers.

Ross Butler:

Tell me a little bit more about the, the IP services, in the specific context of venture capital and private equity. What type of business is it most useful for?

Alistair Lester:

So we think that one of the things we’re most excited about is we’ve always had a relatively limited story for the VC end of the private equity and financial sponsor community that is truly value added. We have an ability to identify, map and value the unique intellectual property, particularly the patents, but not just the patents, it can be data. It can be trade secrets, et cetera of individual companies. By doing so, we place a value on that, on that intellectual property, through a proprietary valuation methodology. We have the former head of intellectual property at Phillips in the Netherlands, global head of IP at Phillips. We have the former general accountants of general counsel for patents from Microsoft, right. People who honestly, if you ask them, ‘Would you ever, five years ago, can you ever see yourself working at Aon?’ They would have said, ‘absolutely not. Why would I?’ So we have some unbelievably deep talent in the IP space. I think we have more of the top 300 recognized global IP strategists working for Aon than there are at any other company in the world. And no one would know that right.

Alistair Lester:

We then spent a long time persuading the insurance industry of the efficacy of that valuation methodology, and there are many other parts of the capital market’s ecosystem, which rely on the underlying security of insurance to enable financing. We look in the aircraft, leasing space, residual value insurance on aircraft hall is, is a critical requirement for aircraft leasing. You know, finance use of aircraft leasing require certainty over what the, the aircraft may be worth at the end of the 10 year lease. And the way they’ve got that in the past is through residual value insurance that provides the underlying security, really what we’re doing and intellectual property is a similar thesis. We are valuing the intellectual property for a proprietary methodology. We then were demonstrating the efficacy of that valuation to the insurance market who are then wrapping an insurance policy around that value, not at a hundred cents on the dollar at a discount to the value, maybe 50 cents on the dollar by wrapping insurance security around what were previously intangible assets.

Alistair Lester:

You are turning them into tangible collateral. And what can you do with tangible collateral is you could raise finance against it. So, now we think we’re inventing or pioneering at least a new potential way for firms who are in the maybe series B series C stage to raise working capital and runway capital. Because up until today, the primary way for those firms to raise money has been to raise equity founders that owners don’t like raising equity, it’s diluted, it’s expensive, it’s painful all of those things and actually being able to, or they go and raise venture debt. And venture debt performs an essential service, but also it’s not, it’s got a lot of complexity to it. We think we have an instrument now, which can enable you to access pretty straightforward, not cheap, but pretty straightforward debt secured against an insurance wrapper, which is wrapping your intangible assets. And we think by doing that, we are potentially reinventing how you finance early stage companies. The British Business Bank wrote a paper probably two years ago saying why can’t banks recognize intangible assets more as collateral for financing? We think we are leading the answer to that question, which is- what can you do if you do it in this particular way?

Ross Butler:

I assume that larger businesses with large IP people folio, they’ve got other financing options.

Alistair Lester:

A hundred percent. That’s a great question. But, and yet, we also have clients who are approaching us and asking whether we can collateralize their IP portfolio for the purposes of satisfying pension trustees. Right. For example. So, you know, we need to provide collateral to our pension trustees. Maybe this is a product that we could use to satisfy our pension trustees over pension liabilities and future pension contributions. We’ve got financial institutions who are approaching us and asking whether this is a product that they could use to satisfy some regulatory capital requirements, right. So, you know, is this a product that could satisfy the banking regulators to a certain level that intellectual previously unrecognized intellectual property that they held in their business is now something they can collateralize and use to enhance their financing of, of whatever obligations they have. So it isn’t just the venture answer, but we’re seeing particular appetite and interest in the venture backed community in the early stage businesses area at the moment.

Ross Butler:

That’s a great example of allowing people to focus on the upside and enhance their returns. I don’t want to spend the whole time talking about COVID, but obviously it’s completely changed the nature of, and scale of risk. That touches on so many parts of business, so I’m thinking particularly like cyber, for example. I was speaking to a CEO the other day, he’s based in London, 90% of his employees are in India. Geographically remote. Can’t get out to them very easily. All of these risks seem to be not really thought of, just a couple of years ago.

Alistair Lester:

We launched our cyber- M&A private equity focused business, getting on for two years ago now. We did it for a couple of reasons. Outside of private equity and M&A, Aon had made an inorganic acquisition in a company called Strauss Frieberg, which was one of the leading global cyber risk consultancies that grew up in the US and again, I I’d imagine if you spoke to many of the people inside the original business, they had not had anything to do with the cyber insurance worlds. They were deep cyber risk consulting people. Then we built a client facing delivery of some of the capabilities within that business, and we did that by, we actually bought across people from the big four who were providing private equity, cyber due diligence, which was just emerging two or three years ago. We bought some of those people across. And the exciting thing is, we were able to persuade them of a couple of things, which I think we’ve proven out, which is one. We have the in-house technical cyber capability that we just bought this business with deep technical cyber risk capability. But two, we also have in our industry, a huge amount of data insight from cyber insurance. So we know what is happening in the cyber risk world, because cyber insurers are paying claims for our clients. So we know what’s, what’s creating those claims and we know how much is being paid for those claims and how those claims are being managed and how the risk of being mitigated to avoid them happening.

Alistair Lester:

Again, you put together deep cyber technical expertise with quant data, true deep, rich data over what is actually going on in the cyber world, which is causing financial loss. And you’ve got a unique skillset. So, our cyber team, actually very specific to private equity, have built something called Portfolio Scanner, a piece of proprietary tech, which blends in automated threat analysis with a quant model. We’ve done this for a number of PE firms. You can run it at relatively low cost, to come and run a six month cyber review across your portfolio. You can run it in very quick time, automatically across your entire portfolio, and it gives you a traffic light outfits of which firms in your portfolio need a closer, deeper dive from a cyber risk point of view.

Alistair Lester:

It’s no guarantee that there’s no problems in the ones that are green or amber, but it will tell you from an outside-in point of view, an unobtrusive outside-in points of view, where we think based on outside threat and industry sector knowledge and claims statistics from cyber insurance, you should be going to look Mr. GP to double-check that firm is doing what it should be around cyber risk. We actually ran that for a GP last year. And one of the firms that came out on the red of the traffic lights, we literally just reported to the sponsor. And just 10 days later, as we were going through the action plan, they had a ransomware attack. And that led into a huge recovery exercise. Again, no guarantee that if we ran that exercise six months earlier, the ransomware attack wouldn’t have happened, but certainly there would have been more awareness within that firm of the risks and, and hopefully some, some mitigating actions would have been taken.

New Speaker:

What’s really powerful areas that is all consulting work, but we’re delivering technical and rich data insight in an, in an automated manner, in a highly efficient manner, real time. We are launching and delivering within three to four weeks, not let’s run a long cyber risk consulting project, which takes many months because by the time the speed of the world’s changing so much that, you know, six, nine months’ time, it’s a different threat. It’s a different group of people. It’s a different type of ransomware, whatever it is, you know, you need to be keeping on top of this on a regular basis.

Alistair Lester:

So a lot of our PE funds now are actually running Portfolio Scanner on a regular basis, but at six months or 12 monthly, and they run it, it’s just a, it’s a health check across their portfolio. And it just helps them stay in touch with, with exactly what’s going on. And, you know, we were quite excited. We ran it for Cinven, which reported that in their ESG report.

Ross Butler:

That makes perfect sense to me, marrying the qualitative in the quantitative. I’ve long felt that you have the cyber professionals who are focused on best practice and process, but you’ve also got the kind of the unknown quantitative part, which is the elephant in the room. And you know, companies that pay ransoms, they don’t publicize it, of course. And one suspects that it is a much, much bigger problem than most people realize had they had to send a press release out and it was in the media. And so there’s something of a disconnect between the scale of the problem and what to do about it. And it sounds like you’re able to contextualize the problem and then find the solution, which feels to me like where I’d want to be.

Alistair Lester:

Yeah. Yeah. Look, I think just one thing I’d add is, is I’ve just talked about that in a portfolio context, which is critical. The other thing we’re learning is fascinating is our clients who go through that exercise, looking inside the portfolio, across the portfolio, they almost without fail, ensure they implement pre-investment cyber due diligence as a specific work stream going forward. A lot of firms haven’t been. Or they felt that their IT DD covers cyber. They’re close cousins, but they are distinctly different things. By the way, we’ve also got to make sure we’re okay as we’re going into new deals and this whole workstream of cyber due diligence, which we think where that evolving further into what we call digital and tech DD, where you’re looking at yes, the cyber risks.

We had a client say to us not long ago, every deal is now a tech deal, right. So let’s look at the tech in that business and understand how risk-exposed it is. We just brought a guy in from Turner & Townsend, a well-respected property consultants. Again, not an insurance guy, he’s a risk consulting person, but he’s able now to deliver his risk advice in a much more informed and contextual way because of the data and the insights we can provide from inside the industry. And that’s why we’re bridging the advisory and the risk transfer together.

Ross Butler:

So just so I’ve got the lexicon straight, you’ve got it, diligence, which is like you, your internal systems, and processes, and making sure that they’re efficient and functioning. You’ve got cyber, which is like security and stopping attacks. And you’ve got digital and tech, which is

Alistair Lester:

It’s performance risk. We ran a deal for a PE fund who was buying a, a reasonably well-known real estate platform. Right. And actually what we helped them understand was how many of the hits on the platform were from bots and how many were genuinely from independent consumers, right. And that goes to value. You want to pay for the consumer. So it starts to become not just a risk issue, but also evaluation issue, which is exciting.

Ross Butler:

What about people risk? Do you do anything in that domain? Obviously there’s a link with, with cyber and behavioral behaviors.

Alistair Lester:

We do it very broadly. And I think traditionally again, when people thought, well, what would Aon do in the human capital space to help us? It would be, well, we’ll do some actuarial work on the pension plan, or we’ll do some look at life and medical insurance and make sure that we’re meeting employee benefit risk. But again, Aon bought a business not long ago called QT, now rebranded Aon Assessment Solutions, they are a bunch of psychiatrists and psychologists. We had an infrastructure client who was funds, who was buying a, a bus business. I mean, lots of infrastructure funds by bus businesses. I think EQT had just bought a big one in the US.

New Speaker:

Interesting little story: we were arranging motor insurance for the bus company and they have to have it. And one of the things that drives motor insurance is, is driver’s safety. The price of motor insurance is driven by how safely, how well do you train your drivers. We brought in our Aon assessment colleagues to create a framework for the type of personality that they wanted to hire and to maintain as bus drivers and to put it very crudely, you are looking for people who are less aggressive on the accelerator, on the gas pedal. There are characteristics which are going to lend you to be more heavy or less heavy on the gas pedal. So that had two incredible benefits.

Alistair Lester:

One: By doing that, and by demonstrating to the insurance company that they were hiring that sort of person that puts the risk in a better light, it enables Aon to secure a better price for the core old-fashioned motor insurance for the buses. But here’s the other thing you could also demonstrate: how the fuel consumption of the fleet would reduce and the environmental positive environmental impacts. And of course, the economic positive impact in terms of reduced gas fields and fuel bills for the bus fleet. You’re going to value in way more ways than just one, which is we can help you reduce your insurance premium. We could also help you reduce your operating costs through reduction of fuel consumption, and we can demonstrate that you’re thinking about that through an ESG lens in a world where those things are increasingly important. It’s a really good example of how we’ve gone from being an insurance broker to adding these other elements to a value.

Ross Butler:

And that comes from presumably the psychological profiling of the people

Alistair Lester:

Right. So when you go and hire now bus company, you need to hire people with these characteristics, which we have defined for you, and it’s now built into your, your recruitment processes.

Ross Butler:

There’s a huge change that’s, that’s happening in terms of the work environment. Are you’re doing some thinking on this area.

Alistair Lester:

So again, we have an enormous human capital practice who stretch right across, you know, governance, board consulting, compensation, talent, et cetera. And, and we have, we’re one of the firms we sponsored in various countries, something called the Work Travel convene. So we brought together in Australia, in the US and the UK in different countries, large employers. And we’ve done that over the last 12 months. And this isn’t, you know, the private equity and M&A world, but this is more broadly as Aon. And what we tried to do in the private equity community is then bring the conclusions and the insights that, that are being created from those sort of exercises into P funds into their portfolio. But the work travel convene is really trying to look in that crystal ball about where this is going, what are the implications for the workforce?

Alistair Lester:

One of our big areas of course, is terms and conditions of employment and benefit packages, and how do you construct compensation packages to reflect different working environments and all of those sorts of things. So a huge amount of work in progress on that. And I think a lot of clients are increasingly looking for help in that area, because as you say, there’s so much uncertainty.

Ross Butler:

Yeah. I think also private equity firms are increasingly focusing on people and talent and talent retention is their core asset. And you’ve got private equity firms hiring HR, internal HR people to just think about that within the portfolio.

Alistair Lester:

Again, one thing that people won’t know probably is Aon has two businesses, one called Radford, and one called McLagan. They are two leading compensation consulting and compensation data businesses. In fact, McLagan is probably recognized in the general partner and the, in the PE community as being the leading private equity compensation consultant in the world. We know we build many of the, many of the maps, many of the GP carry plans, they come through McLagan insight, but again, Aon in the past culturally McLagan would have been run as a very independent business, delivering his value to its clients in a, in a slightly isolated way.

Alistair Lester:

The way that the firm has been reorganized in the last few years is, is around what we call Aon United which is really about bringing the whole of the firms and the clients, and the fact that we have people who are delivering compensation and talent advice to a large number of PE funds, you then think about how can you maximize compensation particularly through carry of your general partner practitioners through the ever-increasing adoption of innovative solutions and innovative financing structures, right? So those things are linked as well. We can help you maximize returns in your portfolio companies, which then drive your compensation structure that we’ve helped you put in place by the way, through these ideas over here. So, these things are not all individually separate from each other. They are all intertwined.

Ross Butler:

I’ve got a couple of other COVID things on my list. Supply chains, which I assume is bread and butter for insurance services, but global supply chains, given international relations and protectionism, is, it’s not in a good place.

Alistair Lester:

That’s a critical factor. One of the most important parts of the insurance world, which is probably overlooked is two areas, but one is business interruption insurance. That’s come under the real spotlight as a result of COVID. I mean, let’s be honest and, and not necessarily the most positive spotlights, and we’ll see how that all plays out, hopefully positively for policy holders who have valid claims. People in our industry have been talking about supply chain risk for a long time. I think what COVID has done is accelerate that and now there really are needs for firms to really, truly understand their supply chain, but not just because of the, the revenue and the, and the financial risks, but also increasingly through an ESG lens as well, you know, modern slavery background checking, all of these sorts of things are really important in the supply chain.

Ross Butler:

I’ve written a couple of things down from your preamble, but I can’t quite read my writing. Judgment preservation insurance. Is that right? Yeah.

Alistair Lester:

So that’s a, that’s a new area we’ve developed over the last year or so. So we’ve invested heavily in, in our litigation risk group. So there again, there is a theory, a thesis that we would like clients to see litigation as a potential asset, rather than just something they unfortunately have to go through. If you’re bringing a claim against somebody and you believe you’re going to win. And more than that, perhaps you’ve won at the first quarter or the second court. We developed a product which will enable you to ensure as much of that judgment as you can. And in the event that it progresses to the next layer and you lose, then the insurance, it provides you that, that capital. And here’s the thing that that’s really exciting. So we just closed the deal for a client who had won a significant judgment against the large US firm. And we were able to secure several hundred million dollars of insurance, which by the way, it was not the total amount of the judgment award. It was a substantial tranche of it, but by no means a majority, we were able to secure some, several hundred million dollars in judgment preservation insurance, which very simply said in the event that this is overturned, you are going to be indemnified by the insurance company, and that’s nice to have, right. But here’s the really positive and interesting thing: that firm was then able to use the judgment preservation insurance to access third party financing. So the insurance became collateral to access financing. Litigation funding has become a big thing, right? Litigation financing has been around a long time. It’s absolutely got a place. It provides a very essential service. But we are introducing new ideas, which potentially are alternatives to that, arguably again at a lower cost of capital. And that’s super exciting. We’ve hired people in our firm from litigation, funders and litigators who understand that world. And what we’re really doing is using their knowledge and insight with our capability of building insurance, structured insurance instruments and structured products to, to redefine how, how clients can, can see, find value in those sort of situations and see them as assets.

Ross Butler:

In a private equity context, every moment counts, it’s the distraction, I would imagine more than anything, you don’t want it as a standing board item, when you’re trying to grow a business fast.

Alistair Lester:

This is exactly right. And certainly when you come into exit, right, what you do not want is uncertainty over litigation and exit. So we do a significant amount of wrapping up litigation like we do within the tax world. What insurance is very good at Ross is, is rapping, is bridging low probability, but high financial risk situations into certainty, right? And of course that costs money, which is the premium. But that’s what insurance can be very good at. And if you can, you can do that increasingly with tax. Some brilliant advisors around the world will tell clients, this should be fine. What you get from the big four, what you get from the lawyers is we’ve done this before. This should be fine. What you don’t know is whether someone on the other side of the deal table to you has the same view.

Alistair Lester:

Maybe they are a large conservative, strategic, maybe it’s the first time they’ve done a deal in that jurisdiction, whatever their motivations are for feeding the risk, the perception of the risk is different to your perception of a risk. And those are the sorts of things that can derail deals, right? They can get, they can, they, you know, they, they become distractions from actually, this is fundamentally a good business. We want to buy here, but we’re getting distracted by negotiating and arguing over whether we think this one piece of litigation is more or less likely to happen or more or less likely to cost this amount of money, right, and insurance can deal with those situations by giving you a well, we can sell you, it will cost you this to take this issue away. Now, all of that cost makes sense in the context of the data.

Alistair Lester:

It doesn’t, but at least it gives you something, a point of certainty, which you can get a resolution on and that’s becoming much more understood and that’s relevant in tax too. And you can push further by the way, without getting too off piece into further adjacencies around structured credit. So the same broad thesis Ross applies in receivables financing. So one of the things COVID has done is really drive a real increase in the amount of receivables financing that go on in the market. What many don’t appreciate is if you can wrap insurance around those receivables in an appropriate manner, you can de-risk that portfolio receivables. If you’re de-risking that portfolio of receivables, you can arguably lengthen the tenor and reduce the coupon on the financing terms you’ve got. So it’s the same thesis. And just in a slightly different situation.

Ross Butler:

So do you have a classic CEO 3 or 5 year vision for Aon in M&A?

Alistair Lester:

I do. We’re living in the middle of the hottest market we’ve seen in, in a long time. We’ll see how long that lasts. But I think, I still think we’re scratching the surface in terms of the value we can bring to our clients. If I’m really harsh on ourselves, we still are delivering one or two of our core traditional value propositions into a deal. And actually if we just paused and, and delved a little deeper into the deal or had the right conversation in the right way at the right time, there are multiple live opportunities that we have allowed our clients to leave value on the table because we haven’t been either able to identify or able to articulate how we could find a way to help them to, to find that value and bring that value off the table. So that’s really the key thing. I think we’ve grown enormously in the last three to four years. There is still huge white space for us, we think because there’s just, we’re very fortunate. We’ve got an incredible breadth of services and we’re backed up by this incredible ability to bring capital, to bear in a way which hasn’t happened before. And honestly, we’re scratching the surface.

Ross Butler:

Alistair, thanks so much for your thoughts and for coming on to Fund Shack. 

Alistair Lester:

Listen, thank you so much for having us Ross. It’s been great.

Fund Shack

Dan Aylott, Cambridge Associates

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Dan Aylott is Head of European Private Investments at Cambridge Associates.

This is a Fund Shack ‘private chat’ about the large opportunity set in the European private equity market, from buyouts through to venture capital, with a focus on growth strategies in all these markets.

Transcript:

Ross Butler:

You’re listening to fund Shack. I’m Ross Butler. And today I’m speaking with Dan Aylott managing director and head of European private investments at Cambridge Associates, where he’s responsible for EMEA private equity and venture capital research. Dan works with clients to help them build, manage, and monitor their private market allocations. So he has fantastic insight into the industry and some unique perspectives on the market, which he was good enough to share with me. Enjoy!

Ross Butler:

Welcome to Fund Shack. You’ve been at Cambridge associates for a fair while now, but I believe you’ve just undertaken it a new role. Can you tell us a little bit about that?

Dan Aylott:

Yeah. Hi Ross. And I’m very happy to very actively speaking to you today. I’ve been at Cambridge just over nine years. I’ve been in the industry now for a whopping 20 years. I started with a private equity team in year 2000. I joined Cambridge nine years ago to work with clients on their private markets portfolios. So for the first sort of eight and a half years at Cambridge, that’s been my primary focus. And then last year, my role changed slightly. So I now I’m head of European private investments, which entails me having a mix of responsibilities.

Dan Aylott:

My primary responsibility going forward is to cover the European private equity and venture capital research function here, which means that, were tasked with finding best ideas and high conviction managers. But for our clients, I’ve brought some client relationships with me. I continue to work with some of our key clients at the firm. And yeah, excited by the change. Even when I was working predominantly with clients, I was often, doing manager due diligence and looking and scouring for ideas for, for those clients’ portfolios. So this is just a, really an extension to, to that role. But I’m excited. We’ve got a, a large opportunity set, I think, in, in European private equity and venture where we’re adding resources to the team so that we can we can cover all of those opportunities. And I’m very excited by what lies ahead.

Ross Butler:

What’s particularly exciting. You, what parts of the market do you really like the look over at the moment?

Dan Aylott:

I’m passionate about all parts of the market really, but I think for us at the moment, there’s a real desire and hunger to look for growth strategies, and that can be anything from very early stage venture through to growth, equity and buyouts that have a growth slant to them. We’ve long been talking about the benefits of growth and how growth is the predominant factor in achieving outsize returns in private markets portfolios. That’s where a lot of very interesting ideas are coming from right now. Certainly, in the venture space the ecosystem there has really been growing and expanding in Europe in particular, there’s always been a very sort of well-established U S venture market as everyone obviously knows.

Dan Aylott:

I think Europe has often been thought about as being in the shadows of the US and even potentially China and Asia to some extent, but I think recently we’ve seen some strong performance coming out of Europe and some the manager universe, if you like, sort of expanding in all directions with many interesting strategies for us to, to look at and to answer, consider for our clients.

Ross Butler:

Tell us a little bit about that if you would that. Can you quantify the, the growth of European venture in the last half a decade or so?

Dan Aylott:

In the last year alone, there was $20 billion raised by European VCs, but there was 40 billion invested in Europe. So that gives you a sense that the market is very attractive and is attracting investment from all over the world. In fact, and that’s really feeding into a very buoyant and a flourishing ecosystem. So it’s definitely an area of growth and, and definitely an area where we’re seeing lots of very interesting opportunities There’s always been well-established firms in, in the venture space in Europe for a long time. We’re seeing a lot of managers spinning out. Operators, people who’ve run or worked in senior positions in technology companies and have done very well made a lot of money, want to continue to invest in the space. Joining forces with investors to create new firms that I think are particularly interesting.

Ross Butler:

Then what underlies this growth? Was it just a question of time in the market, because for a long time, European venture capital it underperformed and it was, and it was subscale and perhaps to a degree, it is still subscale, but, but what underlies it’s, it’s, it’s recent growth?

Dan Aylott:

There’s a number of things that you might want to point to. When I started in the industry 20 years ago, roster the European venture landscape was really not on the map. I was joking with a colleague this morning about how, diligence used to be done. Data rooms came in the form of a, of, of envelopes packages in envelopes that were sent to you via the post. So that, that age has me somewhat, but the venture capital market obviously had been impacted by the.com crash. There were very few European venture firms last minute.com perhaps was, was the most famous impacted obviously when, when the crash happened. So really nowhere on the map where performance really wasn’t, wasn’t there either.

Dan Aylott:

And it takes a long time in venture for performance to come through. I think since the financial crisis, there’s several things that have happened. We’ve been in a very low-rate environment for a long time. So people have been seeking growth and seeking alpha from different areas of their portfolio. And I think that, venture and growth has been an area that has if that, that, that growth and that innovation that can’t be sort of captured anywhere else in, in portfolios. I also think it became a little bit uncalled to be a banker or or go into financial services after the last financial crisis. And there was an impetus perhaps, but for young people coming out of universities, strong tech universities to think about doing something different.

Dan Aylott:

So there’s a number of factors I think that has fed into it. And I think as, as we’ve seen performance improve in Europe and we have some statistics that show over recent horizons one year, three year, five year European venture growth has actually performed strongly versus the U S and Asia. And I think as that performance has started to come through its European venture has caught the attention if you like of investors. And from that, and the more capital that flows into the, into the industry, the more opportunities that it creates.

Ross Butler:

That’s all directionally very positive. But the venture managers that I speak still tend to complain about a relative lack of capital in Europe compared to their us counterparts. Would you, would you agree with that?

Dan Aylott:

I mean, I would. I don’t know how, what the best way of saying it… It is… Underserved relative to other markets. Something like10% of jobs in the US are currently within companies that are VC backed and the equivalent number in Europe is 1% that is still quite concentrated around markets like the UK and Europe. But what happens with LPs generally is that there’s a lag. So the PE investors see performance coming through and then think, well, okay, this looks interested. I’m now going to start committing capital to these types of strategies. And so that’s what I think we’re seeing here is that we were convinced Cambridge that European venture and growth is an interesting space for our clients to commit capital finding great ideas for them to do so. There’s some convincing to be done around European venture capital and growth for certain investors, because historically performance in Europe has been difficult.

Dan Aylott:

The exit environment has been a little more challenging, and that’s being addressed. I think in some ways, here in here in Europe, there are changes to the regulations around listings, for example, that might make it easier for technology companies to go public. But that’s just one example, but there are, there are changing in a positive direction in Europe. And so, I think it’s just a matter of time for people to continue for investors to continue to see that positive momentum coming through. And I think that the capital will continue to flow into it. Abut I think it’s today, or you’re right. I think there’s still, more to go for. I think the overhang of capital in Europe is much less than it is in Europe. sorry, then it is in the U S apologies. Yeah. so, there’s some interesting dynamics in, in Europe that were, that we’re keeping our eyes on.

Ross Butler:

I’ve heard one hypothesis, which is that in fact, if more capital accrues to European venture and growth capital, you might see returns increase relatively counter-intuitively because of that sub scale element to the industry. Is that something that you would agree with, or do you think that the more capital that flows in will, will eventually kind of push returns down?

Dan Aylott:

Yeah, it’s an interesting thought. I mean, the fundraising market at the moment is really, really frothy. And boy, there’s lots of capital being raised everywhere, not just in Europe. I think the general perception is that the more, that more capital that gets raised, the more likely it is that returns will tail off. So it depends, I think you still have to keep disciplined. I think the key is for the managers that raise the capital that are successful at raising the capital stick to their strategies and, and remain disciplined in, in the areas that they’re good at and the areas that they can, they can produce, the attractive returns for their clients. And I think if managers can do that then, then, then returns will still be maintained. I think, as I’ve said, I think the, the universe of opportunities continues to grow for some of the reasons we mentioned earlier, more entrepreneurs, more, data scientists coming out of, of universities, more, more M&A from corporates looking to improve and acquire additive technologies.

Dan Aylott:

So as the universe continues to expand, I think that there is enough opportunity for more, more firms, more managers, more funds to be raised, but there probably will come an inflection point, right. Where, where potentially there becomes too much money and the overhang becomes too great. The managers either become ill, disciplined, or valuations get so high that it can then impact returns. And that’s always the concern and something that we’re focused on a lot,

Ross Butler:

But we’re not, we’re not close to that point though. Would you say….

Dan Aylott:

I don’t think we are in Europe yet. No, absolutely. I think there’s probably quite a way to go. We still like to see our managers remain disciplined, as it relates to fund size and strategy. But there does seem to be, an increasing opportunity set. And back to that stat, I mentioned earlier about 20 billion raised by European VCs, 40 billion invested, that tells you that even managers outside of Europe are looking at Europe as a potentially fertile place to invest. And I think that will continue and we’re seeing more and more, for example, U S firms setting up offices in Europe that haven’t previously had boots on the ground here. And so I do think there’s a way to go on that.

Ross Butler:

So if I’m a European venture manager or growth manager, it’s a good time to hit the road and start fundraising, but I’ve got to be disciplined. I’ve got to stick to my knitting as they used to say to what degree do I have latitude with regards to kind of think about different fund structures or sub sectors. Do you think there’s, there’s investor appetite to see firms explore those kinds of innovations?

Dan Aylott:

Yes I think so Ross. We are seeing, in terms of funds raised, ‘opportunities’ funds or, or ‘overage’ funds so that they can continue to back the winners in their portfolio. And this has been a phenomenon that we’ve seen for a few years now and that can work really well. Managers want to continue to invest with their best companies and if they can select the winners in their portfolio, then the benefits to their investors are all great. And obviously, investors must be comfortable for the longer hold periods that that entails. But we’ve seen, we’ve seen a lot of that happening in terms of fundraising and that’s one way for managers to expand their offering if you, like.

Dan Aylott:

I think the other side is that increasingly we’ve been seeing specialization across the, across the market and this applies to the buyout space. It applies to growth, and also it applies to venture where we’re seeing managers really sort of focus on what they understand what they know best. And it might be areas of things like FinTech. It might be AI, it might be SAS or consumer. And, and we’re seeing an increasing level of specialization with, with some firms. This can, this can be interesting. It allows LPs and investors to really kind of construct their own portfolios in the way that they want to, if they have a, a belief, for example, that FinTech is where the greatest opportunities are going to be. They can add some FinTech opportunities, maybe some crypto, that’s another area where managers are really specializing. And so we’re seeing an increasing amount of that. Again, we still like to see managers remain disciplined, raise the right amount of capital to prosecute that strategy. And that’s always the key consideration for us, but we’re definitely seeing more of that in the venture space and frankly, elsewhere in private markets. There’ this theory that as, as a market evolves there becomes more specialization and more deeper domain expertise within the managers.

Ross Butler:

And is that a firm or fund or both phenomenon? So, I’m thinking if I’m a generalist venture capital manager, is it the right strategy to start raising very siloed funds,

Dan Aylott:

Different strategies, work for different managers, right? There are definitely, there are definitely examples where people have been successful at doing just that as you described. So, they raise different vehicles within, under the same firm umbrella and have dedicated teams prosecuting on those strategies. They raise a, a one fund, one pool of capital, and they have teams within their firm that specialize in certain areas, but ultimately investors get a diversified portfolio across those, across those themes. And then the other thing is the other way of doing it is to be a single strategy firm with a very clear specialization in what you’re doing, whether that’s crypto, whether it’s digital health or, whatever the sub strategy is. And so there’s different ways to play at Ross. And there will be different ways it will work for different firms. I don’t think there’s a one size fits all answer to that really.

Ross Butler:

Does Europe have any particular sub sector advantage advantages in either of those kind of very broad spaces? I mean, you mentioned a couple already FinTech and

Dan Aylott:

Yeah, it’s interesting. I, and I think these, these sub strategies are still emerging, really Ross. I think we’re watching closely areas like FinTech, and I think the fragmented European sort of financial services markets are helpful to that. And the, the different currencies in, in Europe can be helpful to spawn interesting opportunities across FinTech. So that’s one area. I think Europe is a leader in yeah, environment, environmental issues. And so climate tech could be an area that Europe excels at. And, and there are some, some managers that we’ve seen that are focused on, on those types of strategies, agritech, climate tech energy, that kind of thing. But yes, I think there are certain areas that that Europe has a unique kind of positioning for areas such as, SAS and enterprise of enterprise software, SAS digital health, I think are probably a little more global in their, in their sort of their reach if you like, or applicability. So I think we’re seeing as much innovation there in Europe as perhaps we have in the U S although probably, a few years behind in terms of the development of the market, as we’ve talked about already. So

Ross Butler:

In the UK versus the rest of Europe, because obviously the UK is still in Europe given the events of the last year, rather than put Brexit on the back burner. But, but how are things looking from a vendor perspective there,

Dan Aylott:

That’s a good question because Brexit, like you say, we’ve been talking about Brexit now for, for, for more than four years, right? It’s well, when you’re coming up for five years and I think when then the referendum result happened I talk about this as well in the context of bias, but I think just the uncertainty around Brexit was the key thing. Now that we have some certainty, I think people can adapt and they can, adjust their, their, their business models to deal with, the additional admin that’s related to Brexit. I think the key thing we were concerned about were, was talent and movement of talent. So I think we still got a way to go really Ross before we can answer that. And no one has a crystal ball. I, what I would say is that particularly in the venture space in Europe, there have been, hubs that have, have, have grown up in Europe, places like Berlin cities in central and Eastern Europe in the Nordics, there are the French ecosystem is flourishing for venture.

Dan Aylott:

And so I think, I think venture capital really i, a pan European phenomenon, although, as I mentioned, earlier in terms of venture backed employment predominantly, it still resides within the UK as a, as a percentage of the overall market. But I think perhaps what we’ll see is a more even distribution of that across Europe.

Ross Butler:

Can we talk a little bit about the exit market you’ve already touched on the fact that there’ve been some easing with regards to IPO restrictions, what’s your general view on gone on, on the exit world?

Dan Aylott:

I mean, I, I don’t know if the regular, I haven’t seen the regulations around listing. I think we’re still being debated, but I think it’s been recognized that in Europe there needs to be an easier path to listing companies, venture backed companies. And so that is, that is I think, still under review. I don’t, I haven’t seen the results of that of that review yet. But as I said earlier, I think large corporates have become more acquisitive. So there’s probably more opportunity for M and a, and there’s also the U S market. So European companies can still can still go to the U S for, for their access. I think it’s still something that’s improving. And for example, there’s been some very successful life sciences exits the, they don’t necessarily hit the Heights of some of the U S listings that we’ve seen, but that they are happening and, and producing some very attractive returns for investors. And I think that that will continue to be an improving picture as time goes on and will help again adding to the to the attractiveness of the European market.

Ross Butler:

I guess one of the things that the venture industry has struggled with is, is a lack of natural institutional investors that are venture capital minded. But I assume that that’s something also that will develop and, and grow over time as investors gain experience in the asset class.

Dan Aylott:

I think so Ross, yeah. And it comes down to risk really, and the perception of risk. Right. And we work with clients of all shapes and sizes, right? With all different types of programs. We’ve, we’ve Cambridge, Cambridge associates. We have been advocates for venture for many decades and our clients have done extremely well from their venture allocations. And so, I think, I think overall, we have an easier time of convincing clients of the benefit of venture, but look, it’s a, it’s a re it’s a riskier asset class when you look at the loss ratios, for example, in funds they’re still very high. So that doesn’t mean that, as I’ve said, performance has continued to improve in Europe and has been, for mthe right managers in the U S have been extremely strong.

Dan Aylott:

And the point there is that the winners, far outweigh the losses, right? You, you need to pick funds who can find those breakout deals that are going to produce the returns that investors are looking for. But I think there’s still this perception that venture overall is a riskier part of the market. And so, I do think that as a, as I mentioned earlier, as the returns continue to solidify and be strong more and more investors will take note more and more investors will take a closer look at venture and find us a place for it, an allocation for it in their portfolios. Particularly as the traditional. And, if you look back at the buyout opportunity in Europe, the early two thousands, there was a lot of low hanging fruit, white space returns were very strong. People could generate great returns. Second decade returns have moderated. It’s been harder to differentiate yourself. The market has become more efficient. And I think as those parts of LPs portfolios start to see that there’ll be looking for other ways to generate outsized returns

Ross Butler:

That you also cover private, private equity buy outs, but from a growth perspective. So what, what are you seeing there are there? I mean, it’s easy to call yourself a growth-oriented buyout specialists, but how do you determine that that’s actually the case?

Dan Aylott:

Growth is a strong determinant of returns. And so, when we’re looking at managers, we’re looking at, what type of businesses they’re buying what are the growth rates in those business in terms of, of revenue and, and how are they helping to maintain and even grow that revenue over there, over their whole periods? That’s not to say that we, we don’t look at any managers with a different strategy. But I think increasingly over time, we’ve seen that just, buying, buying companies, applying a bit of leverage, making a few operational changes to increase margins. Doesn’t really, doesn’t really cut it in terms of achieving the sorts of returns that investors would, should, should expect from this asset class. And you really need to have an element of growth. Now that growth can be, it can be a quiet, it can be organic, there’s different ways of, of looking for growth in buyouts. But that’s what we’re focused on. We’re always looking to see where that growth is coming from. And I think, as I said, it’s an important determinant of returns.

Ross Butler:

We’ve also seen buyout firms move into the venture space as well, which I suppose with some buyout firms has a cultural effect, because there was once a very clear division between the VC and buyouts for a long time, and perhaps that’s not so clear anymore.

Dan Aylott:

I’m not sure that’s true. There have been some examples of some buyout firms establishing venture teams. There are some buyout firms that feel that having a venture program or a small venture fund alongside their private equity business is additive because they get to get, they get to see innovation and it’s kind of earliest form and that can inform where they want to look in that buyout strategies. I don’t, I haven’t seen a lot of that actually, Ross there’s some definitely some examples. And I think you’re right. I think the, probably the issue is that it’s a very different skillset, a different mindset. You need dedicated resources for it clearly. And so it’s difficult, it’s difficult to integrate. And a private equity mindset is different from a venture mindset in many ways, private equity is all about preserving capital, not losing any capital.

I mean, venture in venture capital it’s, it’s, it’s almost expected that money will be lost. As I said earlier, loss ratios are still somewhere in the 30 to 40 range. I think it might even be higher. I don’t have the numbers in front of me, but it’s almost expected that a part of your portfolio will fail and, and as entrepreneurs that’s okay. You’ve got to focus on your winners in, in venture. So it’s a very different mindset, and I think it’s hard for a private equity firm to have that sort of similar approach. But no doubt, as you mentioned, there’s been a few firms that are doing it and some doing it successfully,

Ross Butler:

Going back to the sector idea, does that also apply in terms of specialization? Does that also apply to the buyout world in the same way?

Dan Aylott:

Yeah, definitely. And it’s probably a little more advanced, I would say, in, in, in buyouts potentially where we’ve Cambridge associates long been investing in managers that have sector specialisms. So again, predominantly, or I would say the US has been ahead of the head of Europe in that. So, in, in sectors like healthcare and sectors like technology, there’s actually a few opportunities in Europe for those types of, of investments, but we still believe that sector specialization and deep domain expertise, is a positive for, for investors. And we’ve, we’ve got the performance numbers to show that actually the, , if you’re a specialist, you, you outperform your generalist counterparts. And I think in areas, for example, like healthcare in, in Europe, where again a fairly underserved space for specialists, it’s an, it’s a sector that has long been invested in by generalist managers.

But we, as I said, we believe in that sector specialism, and that’s an additional domain expertise such that, managers that have that focus should have an advantage. And so we’re definitely watching that. There’s a, there’s a handful of managers where we’re interested in, in Europe for our clients and looking to invest the capital on their behalf in, in those strategies across the size range, by outsize ranges. Yeah, not so much, actually. So I would say that specialization tends to start in the smallest end of the market. And there’s a number of factors there. So probably related to spin out so often, we’ve seen sector teams or sector heads spin out of generalist firms to set up a dedicated sector fund. Those funds naturally being first-time funds being more focused and more specialized will be smaller.

Now over time, we fully expect some of those, those funds and those managers to grow and expand and, and become larger. But there are very few large specialists in the European market, unlike in the US where we’ve seen the emergence of some very large say technology players and increasingly healthcare specialists, certainly some consumer specialists in the U S that are now multi-billion dollar funds. I think we’ve got some way to go in Europe before we have that level of opportunities at the larger end, but we’re seeing several interesting things at the smaller end of the market where, arguably markets are more efficient. I think they’re more efficient, they’re more reasonably priced from a valuation perspective. And where investors and managers with real domain expertise have an advantage. So I think it’s interesting for the low middle market and the middle market at this point.

Ross Butler:

Dan it’s mid-April, and I understand this is your first day back in the office for the best, best part of a year. How’s it, how’s it going to affect ’em and how has it been affecting kind of day-to-day business where you are?

Dan Aylott:

It feels very strange to be back in the office today. It feels like my first day at work again, but having been on calls like this on zoom for the last year I think we’ve all got quite used to it. So it’s been very interesting to see how managers have dealt with, with this pandemic how they’ve dealt with deal origination sourcing of new transactions, which largely has been done virtually on calls like this and the fundraising process. So, I’ve been involved in a number of DDS over the last year where everything has been done virtually. I have personally find I’m looking forward to being able to get back to meeting managers in their offices. But actually I’m always amazed at how well this industry adapts and, and in particular for this crisis and the specifics around the pandemic, I think the industry has moved incredibly to adapt to this new environment.

It will be interesting to see how things unfold as easing unlocks. I think that the preference for meeting face to face and that sort of real interaction with, with, with managers will still prevail. And I think we’ll have definitely be meeting in person again, hopefully soon. I think the industry is probably more aware of the carbon footprint it has now in terms of travel. So I fully expect, and I know here at Cambridge Associates, we’re definitely thinking that through in terms of what makes, what makes sense and, and going forward in terms of our travel policy. But I think it will, I think it will have to come back in many ways. I had a manager asked me the other day, we’re planning our annual meeting in November.

Ross Butler:

What format would you prefer for AGMs etc? In-Person or virtual?

Dan Aylott:

Actually both. Please! I think investors will want the option. I think going forward they’ll will demand to have different ways of doing things. So it will be very interesting. I it’s been, it’s been really surprising to me how quickly the market rebounded from a fundraising perspective. So, Q1, and I think through the majority of Q2 last year, everyone was focused on their portfolios, trying to understand what COVID meant for their portfolio companies shoring up those portfolios. Making sure that, their companies can survive this period. And then I think beyond Q2 as, as it emerged that certain sectors strategies where we’re going to be fine and resilient through this, I think the fundraising market really came back and, technology, healthcare, all the things that we’ve talked about, very resilient through this.

And I think that will continue. I think that’s an acceleration in innovation if you like that, we’ll just, just continue. So it will be interesting. I think this is going to be a fascinating period for everyone in the industry to see how this unfolds. But I’m expecting to continue to do some of this, some of this sort of virtual meetings and discussions and conversations with managers, with colleagues but I’m also expecting to have some more interaction face-to-face as things ease and as, as, as prospects live writer globally,

Ross Butler:

I do hope so, Dan, and thanks so much for sparing your time and your insights.

Dan Aylott:

Pleasure. I really enjoyed it. Thanks Ross. Appreciate it.

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#24 Bob Long, Conversus, on making private equity accessible

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Today I’m speaking with Bob Long CEO of Conversus. Bob originally listed Conversus Capital in Europe in 2007, and it was the largest listed private equity vehicle of its day. He recently relaunched the Conversus brand within the private markets, giant StepStone, and together they’ve recently launched the new liquid evergreen private equity vehicle that appears to solve the discount problem that plagues listed private equity, and that’s a tough problem to solve. So here we go….

It’s some years since I first came across, Conversus. And since then it’s had something of a rebirth and you’ve launched a novel vehicle, which is opening up access to private equity for a large potential investor base. I was wondering if you could start by giving us the little potted history of the Conversus brand.

Bob Long:

Sure. Happy to do that and good to see you again. So Conversus as you may know, comes from the Latin for conversion, and we think of Conversus as converting the advantages in private markets historically enjoyed by institutions into opportunities for individual investors. And that was the theme of converses capital. The publicly traded trust that we launched in 2007 on the European stock exchange and what led you and I to get connected back in those days. So we ran that business for five years and we learned that that publicly listed investment trust. And I should say we weren’t actually a trust, but that’s, that’s the term used for those vehicles, the listed private equity vehicles, that structure really didn’t work very well. And there are great names and great firms who’ve run listed trusts on the London stock exchange for decades. Those trusts have generated net asset value wildly in excess of the footsie index over that period of time.

Bob Long:

But nonetheless, the stocks trade at a deep discount to net asset value. And so as, as one of my investors said versus capital, you come to work every day trying to generate growth net asset value. And we did frankly, a job we’re very proud of in that regard, but I eat stock price. And so the stock price of Conversus Capital did not keep up with the net asset value performance. So we did the right thing for investors and we sold the portfolio at a premium to the stock price and a result in a transaction that worked out very well for investors. Now, today, those other names that I mentioned again, great names run by great people. They continue to trade at a material discount in most cases to net asset value. And so we simply think Tim Smith, my partner in Conversus Capital, my partner in Conversus, StepStone, we simply think we have a better mouse trap in the form of a tender fund.

Bob Long:

So that’s sort of the deep background on how we got there. Maybe I’ll move from there into how we all came together as a team. So we sold Conversus capital Tim Smith and I did in 2012, and then I went to run a listed business development company in the United States. That’s the closest thing to a listed alternatives vehicle available in the us markets. I did that and Tim started a distribution business in the UK, and we learned various things along that way, but we’ve been dreaming this dream that there was a better way to provide for individual investors in smaller institutions access to top tier private markets. Fortunately, I reconnected with Tom cinema. Who’d been a colleague at bank of America, along with Tim for 15 years, Tom had left BoA to go run a business called CNL, which was one of the leaders and the retail alternative space in the United States and Tom and his number two Neil Menard head of distribution were in the process and had left CNL.

Bob Long:

And we’re also sort of dreaming the same dream we had. And Tom and I had old friends reconnected and the four of us banded together. I happen to own the Conversus brand. So we came together as converse us, and we knew we had expertise in structuring. We knew we understood what retail investors really needed and wanted. But we also knew that in this day and age, the investment management capabilities necessary to create a world class best in breed, truly institutional caliber investment team process sourcing execution well is a really high bar, a really high bar. I grew up in a small town and they have a saying, don’t bring a knife to a gunfight and for us to go and build our own investment team seemed like bringing a knife to a gunfight. So we came together under the Conversus brand and then went through a process of meeting and interviewing numerous firms who were prominent and successful in the private markets and had a goal of expanding their capabilities into retail, to offering individual investors in small institutions. And we were thrilled to a form of partnership with StepStone who is has been a great partner for us. And we are a wholly owned subsidiaries converse. This is simply a brand that is used to convey the institutional capabilities of StepStone to the retail audience. We stop there and see what questions that raises for you.

Ross Butler:

Well, that’s a great introduction. Thank you, Bob. I mean, the first question is StepStone, I understand is a very large asset manager, but actually I don’t think it’s that all that well known. So could you just give us a little bit of insight into, into them?

Bob Long:

I will. And I have to say Ross you’re in the majority. The StepStone is, is the largest asset manager. Well, not well-known even among financial services professionals. It’s just, it is what it is. And they recognize that, or the firm recently went public on the United States stock exchange. So it’s it’s, it’s changing, but StepStone is a fascinating firm. They were formed in 2007 by a group of people who believe that the fund to funds model was not the way forward. And I believe they were right about that. And they believed that more customized solutions built around a highly data driven investment process was the way forward. Now they started in 2007 and I’ve heard some of the stories tough time to start. Heck I, IPO to listed investment vehicle on the Amsterdam stock exchange in 2007. So I know what it’s like to start a business in 2007, but they started in 2007.

Bob Long:

They built a tremendous firm that today has $330 billion of assets. They are one of the five largest allocators of capital to the private markets globally. Our firm allocated $53 billion to the private markets last year. And so that, that breadth and scale has been extremely helpful to Conversus, but I’ll come back to that. So that StepStone bothered 50 people, 13 countries, 19 offices, primarily serving a hundred of the world’s largest and most sophisticated institutions, primarily doing that through bespoke separate account or fund of fund type structures where they meet the needs of those large institutions.

Ross Butler:

So an organization of that size can do whatever it wants. So what did Bob long and Conversus 2.0, bring to their party?

Bob Long:

Yeah, that’s a good question. And here’s the candid answer we met with a lot of people and had had frankly, a fair amount of interest in our team. Stepstone in some ways needed us less and wanted us more StepStone had been around the retail business. They had a few relationships they’d studied it carefully and they recognized unlike some other larger organizations that do a great job with w with liquid structuring, investing, distributing, liquid securities, mutual funds and whatnot. Stepstone understood that there were unique structuring and distribution capabilities necessary. They wanted a team focused on it. They knew enough to know that there’s frankly not been a lot of success in I won’t name names, but many very large liquid asset managers. That the names that you all know have dabbled in offering private markets or alternative assets to individual investors using the same sales teams in the same concepts, the same messages they use for mutual funds and liquid security stocks and bonds. And frankly, there aren’t many good examples of that working out. And there are numerous of examples of large well-known firms, great firms, not succeeding and steps on saw that and share the same perspective we have, which is you need a dedicated team. You need to sell this differently and you need to structure it in a way that’s genuinely investor centric for individuals. So that’s why we came together with them and they have been fantastic partners.

Ross Butler:

Yeah, the retail that the kind of the mass market has proven a really tough nut to crack for, for private markets. It’s a real shame in my view that they all the listed vehicles trade on a discount, but have you, do you think you have cracked it? And if you have cracked it, you know, what have you got? Tell us what you got.

Bob Long:

What we’re trying to do is in our first fund, Conversus, StepStone, private markets, which we call CPRIM. Our goal is to deliver the illiquidity premium and diversification benefits of private markets, private assets in a form with quarterly liquidity at a hundred percent of nav for 5% of the fund, not 5% of your investment, but 5% of the fund. So the idea is that most investors should be able to get liquid in their investment. Most quarters, not every quarter, if we have another March, 2020 you may not, we may not be able to honor all investor requests. And we’re very upfront about that in a given quarter, we may have to so-called gate in a given quarter, but most investors should be able to get their money out most of the time and experience private market asset returns. And so that’s frankly hard to do, because to do it, you have to minimize cash drag. You can’t just have a bunch of liquid securities or cash on the balance sheet. You have to be able to predict capital calls and distributions. If you’re gonna have a diversified portfolio that includes funds and is open architecture, and you have to be able to source off those investments.

Ross Butler:

So in normal times, investors can take out they can redeem their offering, but at any one time only 5% of the whole fund can be redeemed. Correct?

Bob Long:

Correct.

Ross Butler:

And so let’s take an extreme situation, say there’s another, credit crisis, but whatever reason everyone wants out, it’s going to take many quarters to start winding it down, and everyone will be locked in to some degree.

Bob Long:

This is an evergreen vehicle. So we take money in monthly and we offer the liquidity quarterly. So the idea is when you invest in CPRIM, your money’s actually invested. It’s not just committed the way it would be to a regular draw-down fund. So it’s similar to the listed investment trusts in that way. And there’s your money is invested. So getting to your liquidity question, it’s a very good question. Here’s why I think we think that’s extremely unlikely to happen. First of all, we will have thousands and thousands of individual investors globally. So the probability that all the investors want out at a given point in time seems to me are frankly, basically impossible. You’ll have investors who learned the lessons of the financial crisis and, and frankly, the lessons of 2020. And that if there is a market dislocation, when, when there’s a market dislocation, because they will happen again, yes, there will be investors who seek liquidity, but they’ll also be investors who think this is a great time to invest more capital. So, and you may have, we have a significant investment coming in from Latin America right now, for example 15, 20% of the capital over the last couple of months, but that will grow over time and we’ll have capital coming in from Europe. We have some coming in from Europe, we’ll have some information. You can imagine a regional crisis where those investors decided that they need their money out, but the probability global dislocations in all markets that calls all of our investors to want to liquidate at one time, it seems almost impossible to me that said the same phenomenon would occurred at the same pressures would occur if we had another global finance. And in that event, we certainly have the ability to redeem more than 5% in a given quarter.

Bob Long:

And if you look at the backgrounds and history of the four principles of Conversus and what we’ve done during times of stress and pressure with investment vehicles, I think we’ve shown a track record of being willing to do the right thing, including selling Conversus capital, which was a permanent capital vehicle, the largest in the world with $2 billion of assets generating quite a bit of revenue, frankly, but we sold the portfolio because that was the right thing for investors. So I don’t think that will happen here, but we do have the ability to sell assets if we need to. And importantly, we’re ultimately governed by an independent board. This vehicle is structured like that mutual it’s listed under the 40 act, which is sort of technical, but it’s, it’s, it’s governed like a mutual fund in the United States. We have a majority independent board proud to say that independent board has invested about a million and a half dollars of their own money in this fund. You don’t see that very often, that that is real, that’s a substantial commitment. So they are reputationally and financially and ethically bound to do and that could of course take all kinds of actions as as controlling the, as controlling the board to make sure we did the right thing in an circumstance. So we feel like we have the governance in place to protect investors in a deep downside case.

Ross Butler:

I can get access to private markets and I can get out on a quarterly basis in normal times asset value. And that’s the key difference, isn’t it, to the investment trust world

Bob Long:

I ran a publicly traded business development company in the US and I ran one of these listed investment trusts in Europe. So I’m think I, maybe the only person that’s ever been CEO of two of those things, plus the, a Tinder fund here in the U S which is the structure, what we call the list of trust in the public paid of business development companies in the U S you can sell those every day, but you may not like the price because they historically traded less than now with CPRIM. You cannot sell it every day. We require 90 days notice, and it’s quarterly, but you will like the price. It is a hybrid, and we are very proud to be very upfront about that. We are not alchemists, you know, we can’t instantly turn it liquid assets into liquidity, but we think we’ve got the right balance of monthly subscriptions, evergreen capital, quarterly liquidity with notice. It is interesting and useful to arrange the people in them. I’m happy to say that today we’ve gotten really strong market reception. People see that. I mean, people say investors and, and portfolio managers see, I have a place in my portfolio for private market returns, with a high likelihood of quarterly liquidity and a real strong likelihood that over a couple of quarters, I’ll be able to get my investment out there. There’s a place in my portfolio for private market returns without sort of liquidity profile. And that’s that’s what we’re offering.

Ross Butler:

So it sounds like the Holy grail of liquid access to private markets that are more or less invested in those underlying license most of the time. So let’s go back to where you were before I cut you off. How do you, how do you pull it off then?

Bob Long:

Yeah, this is this is something that I’ve been thinking about since 2006, when we were putting together converses capital. And it is difficult. It’s quite challenging. The reason we’re able to do it in Conversus StepStone is first and foremost, we designed an investment strategy. That’s not private equity only so included real estate infrastructure and private debt assets that naturally produce some liquidity, organically produce some liquid. Second. We focused primarily on secondaries and later stage secondaries. So assets that are expected and have generally do generate liquidity realizations, a relatively short period of time. And by that, I mean, sort of expected liquidity profile of a couple of years. Whereas, you know, the typical private investment fund is 15 years. And if you get an individual co-investment it’s five years, so structuring the portfolio right, having the right mix of assets is critical. Secondly, it’s about data.

Bob Long:

Stepstone is built as good a data system as is available in the world today. It’s called StepStone private intelligence, spy, cool name. It’s actually really cool to demo also. And I can give you stats tens of thousands of portfolio companies, thousands of meetings every year that are recorded with general partners, giving us an idea of when individual companies are going to be sold tens of thousands of phones tracks. So they built what we think of as the Bloomberg machine for the private markets. So they have extraordinary data that’s been collected. And then when you commit as much as anybody in the world to the private markets, these general partners have an incentive to share a lot of information with you and they are they’re also incented for you to buy their secondary assets. So the data that allows us to predict when assets, when a capital calls going to occur, when a liquidity event is going to occur is really, really important.

Bob Long:

We think StepStone has, has the best data.

Ross Butler:

So that’s your gun in the gunfight.

Bob Long:

That it is. And lastly, it’s the opportunity. It’s the, it’s the scale and breadth. So as we select individual assets and we have about 40, 40 transactions 40 funds, and co-invest in the fund today, as we select each individual asset, the portfolio manager needs to be able to choose among a variety of assets with different liquidity profiles. I think of it as a stew. And you know, when you add an onion, onions, never come in exactly the 1.2, five ounces that you were looking for, right. It’s always a little more low. Okay. So once you add something to the stew that has a certain liquidity profile, that changes what you need next. So you need a vast back to get it exactly right. You need a vast, vast array and StepStone invest in over 300 separate transactions in a year.

Bob Long:

We’re closing more than a deal every business day. So just think about that. So the variety of things that our portfolio managers have to choose from to create that just right liquidity profile, that limits cash drags, you can’t have a lot of unfunded allows you to hit your returns and also gives you visibility into liquidity for up to 5% of the fund on a quarterly basis. The ability to do that, to do that, they have to be have great insights into the cashflow dynamics of each asset plus the existing assets. So the one you’re about to choose, or that pool you’re choosing from the pool of assets you already have, and then a series of data models. Stepstone has made an extraordinary investment in data and analytics. Dr. Lisa Larson runs that team for us. We have 30 people in data science and engineering. So we’ve made an extraordinary commitment to that. Unlike some of our competitors, we’ve built proprietary tools. We built tools specifically for this that we built in house. And that allows us to predict capital calls and distributions. This is an open architecture. This is not a proprietary StepStone product. So this is private equity, private debt, real estate and infrastructure. It is across what we believe to be the best managers globally. We access that by making commitments to new funds, primaries find funds on the secondary market, and co-investing alongside leading general partners. Now in the near term, we can do all those things. So think about it as s a three by four matrix, each of the asset classes and all the ways that institutions access those asset classes.

Bob Long:

So we can do that now today to build out the right cashflow profile. We’ve been focused mostly on private equity and mostly on secondaries because secondaries and private equity are the deepest secondary market available. COVID gave us some specific opportunities. That was probably a one-time thing, but that was helpful. And so we started building up with private equity secondaries, but over time, we’ll diversify and eventually be about 60% private equity, another third real assets combination of real estate and infrastructure and a little bit of private debt. And we expect to have little to no cash to be able to run this portfolio with little to no cash drag in it and make it essentially self-funding over long term.

Ross Butler:

And over the longterm, depending on what the profile looks like, you can then invest in a bit more primary, private equity and less secondary as time goes on.

Bob Long:

So of course the advantage of secondaries is the cashflow profile, the disadvantage is you’ve got to take what’s on offer. If you have a high conviction in a given manager and believe they’re the best and their funds may not be for sale and certainly may not be for sale at a price that you like. So primaries are an important part of the strategy. You don’t see those kicking in a material way until year three or four.

Ross Butler:

How many underlying funds do you expect to have

Bob Long:

Well, today we have about 40, but we’re building up, we’ll be well, North of a hundred and maybe well, in excess of that, although we’ll be well, North of a hundred in the near term maybe said differently, your real investment or the most important metric is at the portfolio company level manager does matter, but we seek to have no individual portfolio company greater than 1% of the portfolio. So this will be very diversified. We believe retail investors in small institutions are not primarily looking for a swing for the fences. If that analogy translates, you know, the highest octane strategy we think we can give them the beta of top tier private markets now not the beta of the whole asset class, but the beta of the top half. We believe we can do that in a package with liquidity and reasonable fees, sort of like an ETF, if you’re familiar with that, that concept. So like an ETF for private markets, a core holding low fee simple, easy to use, very diversified, unlikely to produce the extraordinary and a 25% returns you may get. And I hope you do get in an individual private markets fund, but also with considerably less risk. So that’s what we’re trying to do. It’s not a swing for the Vincent strategy. It’s a core steady, get you the diversification benefits of private markets and get you the return premium. The illiquidity premium of private markets do that in a structure with bare fees and liquidity. We think the world needs that.

Ross Butler:

What do you mean by fair fees?

Bob Long:

We’re charging 140 basis points management fee at the CPRIM level and no carried interest. We chose to make this a simple flat management fee structure. So 140 basis points is what we’re charging. If we invest in a five one on the secondary market, they’re charging fees too. So there’s no way to get diversity without some layer of double fees that doesn’t exist because StepStone has the scale that it has. And has it gets the volume discounts that it does has the ability to select those underlying fund fees or acquired fund fees to use the technical term there about, we think there were about 90 basis points in the near term, going down to 60 basis points. So if you think about it this way

Bob Long:

You get the best of StepStone. The same thing, stepsone would get the largest institutions for 200 basis points. And we think we think that’s square. I frankly think that’s very fair. And I’m also proud to say that the 140 basis points that we charge at the CPRIM level is pretty similar. Not exactly, but it’s right on top of what steps would charge your university endowment. If they were asked to put together a portfolio of all these asset classes, you know, all the broad market asset classes that includes secondaries and co-invest, which frankly typically carry a higher fee than a simple fund to funds primary, primary commitment. Now, piece of this that I may have left out that might puzzle our listeners. How do you get there? How do you do that? What, well, the answer is StepStone is doing the co-investments, which it typically gets at no fee and no carry for the 140 basis points. There’s no separate. So we’re not investing in the StepStone co-invest fund, which exists, or the StepStone secondaries fund, which also exists. Those are small compared to their, their bespoke sec separate accounts, but they, they do that. They offer that for small institutions, we are getting the same deals, but you’re 140 basis points covers that. So StepStone has made a real commitment to, to this vehicle by by giving us a very fair fee fee deal on those secondaries in Coleman.

Ross Butler:

How large can this vehicle get before it’s structured? He doesn’t work or, or return start to be eroded

Bob Long:

Ross. I think it can be very, very large, certainly 10 billion or more. And here’s how I get there. First of all, scale, frankly helps us on the cashflow predictions, just simple law of large numbers, right? If you have more funds you will be wrong when you project an individual fund is going to liquidate an individual portfolio company next year, it’ll happen this year, or it’ll happen the year after that. It’s absolutely. But if you have more and more funds, you will you’ll benefit from that. Also, you know, there are fixed expenses, SCC expenses, and whatnot in a vehicle like this legal fees. So a larger fund does bring those down. So you get some economies of scale. So at the margin scale benefits us. But let me answer your harder question. Like when did, when do you have to go down the risk reward profile, but I think 10 billion at a minimum for the following reason, a portfolio like this, you’ll see the assets turnover every three to four years, we need to commit to new or close on new investments of about three to 4 billion per year. Well, StepStone committed $53 billion last year. So I think it’s, it’s a question we don’t begin asking until we’re certainly North of 5 billion cutting in half the, I just used and probably North of 10 billion. And then we’d have to ask ourselves and our independent board who would make this decision by the way. And that’s critical. It was StepStone, still able to do this, you know, should we continue raising capital? So I think we can be quite large. And frankly, if you look at our fee structure, we are the cheapest, we’re the low-cost provider in our market. We designed this because we believe at that fee level, because we believe this can be very, very, very large, many, many billions of dollars.

Ross Butler:

The potential investor base is high net worth individuals, correct?

Bob Long:

And smaller institutions, according to your research, they’d say hat, what’s the appetite among let’s start with high net worth or private markets.

Ross Butler:

How do you think about high net worth and how do you access them?

Bob Long:

We’re available to the so-called accredited investor in the U S which is our individuals with a million dollars of net worth the studies we’ve seen. And there are no great perfect studies, but the studies we’ve seen the most recent one I saw was done by Morgan Stanley. The average investor has 1% or less lavish high net worth investor as 1% or less. Meanwhile, your college endowments have 20, 30%. Your pension funds have a similar percentage in a world where it’s straight to zero. Most of the leading lights believe public equities from here which have had a great run are likely to generate four, five, 6% returns on a go-forward basis. I think, I think the appetite of pro of individual investors is substantial for private assets, the hold backs. And it’s been that way by the way, it’s gotten worse or the problem for financial advisors who typically the way we enter interject directly or interact directly with individual investors.

Bob Long:

It’s gotten worse. As interest rates have gone down as prospects for global growth have flattened or, or said differently as the stock. I’m not a public market stock pro prognosticator, but certainly hard to see how the current slope of a line remains the same. Let’s put it that way. So as public markets are certainly fully priced, I won’t say over price because I’m not an expert, but fully priced bonds are yielding zero, the traditional 60 40 portfolio for individuals just, just doesn’t work. And so that but that’s been the case for a while. So why have an individual deal? This was the case in 2007, we formed converses capital because we saw this huge opportunity, right? Well, Conversus capital was listed. It was only available to qualified purchasers. it traded at a discount despite good investment performance, great investment performance may be so immodest.

Bob Long:

The challenge is you’ve got to make easy. You know, we say we’re investor centric and everybody says they’re investor central, but let me, let me break that down. We, we, our taglines are convenient, easy to do business, simple documents, short, sweet, clear, efficient. That’s a nice word for cheap. You know, we’re the lowest fee provider in our market space, and we want to be that, and then transparent. And this retail alternatives world, there’s been a history of hidden fees or less full disclosure or miss complex structures. In fact, they’re structures that have come on the market in the U S from great firms recently that have very complex carry arrangements that only those of us that are recovered lawyers like myself, not only, but, but they’re very complex carry arrangement. So we we’ve tried to avoid all that. So you’ve got to make it easy for individuals.

Bob Long:

Why do individuals not want to commit to funds? Well, first of all, the minimums are high. If you go to a typical private bank, it’s $250,000 or more, if you commit to a fund to funds to get the diversity, while you have capital calls and distribution. So you don’t know when the money’s going to be called, you don’t know when it’s going to come back. There’s typically complex tax reporting for U S investors that comes through the form of the dreaded K one partnership, a tax filing where a 10 99 vehicles. So very simple tax reporting that comes in January of every year. So it’s really about making it easy for individuals to do what they want to do, which is to have the diversification and return premium benefits of probable.

Ross Butler:

And just remind me again, what your minimum is.

Bob Long:

Our minimum is $50,000 us. I think the demand is extraordinary and certainly the reception we’ve received for what we have to do is really stay focused on making it easy and frankly easier. We need to constantly be focused on making it even easier for people to do business with us and being incredibly transparent about what’s in our portfolio, how it’s performing, where are the risks are those the things we need to focus on? And I, and we are as a management team.

Ross Butler:

Yeah. Well, when I think of the size of the potential, cause this all sounds like it makes perfect sense, but when I think of the size of the opportunity, I just think, well, why hasn’t BlackRock just jumped in here and done this. And I suppose he binds to that to some degree, but it still seems surprising to me that there’s this big opportunity out there. And you’re kind of relatively small team jumping in with StepStone is managing to access that

Bob Long:

Well, I’m glad you BlackRock just made a filing for a fund that’s quite competitive with ours. I don’t know that they started raising capital. So that’s certainly the brand name in our space, but I’ll say this, whether it be BlackRock or any of the other names that people bring them on as the largest investment and asset managers in the world to create a fund that starts and stays on the upswing of the private equity J curve or the private markets J curve, which is what we’re seeking to do, right? You don’t have that dip in the beginning. People would, who would invest in that when people can come in later to do that those large firms have to be able to access secondaries and to be able to buy secondaries, you need the favor of the general partners and they are commercial.

Bob Long:

And they favor those who commit primary capital to them in 10 in billion dollar chunks. And so StepStone and being one of the few firms is committing tens of billions of dollars globally, to all types of private market funds. We feel like that’s our competitive advantage. We don’t have yet the brand advantage of the firm you mentioned, and there are other firms that I’m sure you and our listeners have in the back of their minds and the front of their minds. But what we do have is the size scale data to be able to execute on this investment strategy, which requires you to be able to do secondaries and no coat, no fee co-invest to keep your overall fee load down and match institutional pricing and be able to do it from a, the ability to picks some, so many different choices to assemble a portfolio that hits just that right balance of returns and liquidity and diversity. So that’s why StepStone is well presented, presented, and we look forward to competing with the others.

Ross Butler:

Well, it all makes perfect sense on paper, Bob, but the proof of the pudding is in the eating. I think you’ve been running for six months or so. How’s it going

Bob Long:

If only the next six months would be as good as the last six months Ross. We are up in our net asset value 31% over the first six months. So, and we’ve been positive every month. We report our net asset value every month. So we have that transparency. We’ve been up every month since inception. And we’re thrilled with that performance that performance will not continue and not do the scent in a six month period consistently. The fund was not designed to do that. It’s do diversify them. So I should, as you explain, how do we do that? Well, we call it some COVID tailwinds. We invested in funds in the fall of last year and some that were priced off of a March 31 net asset value. When you do a secondary you’re buying off the last quarter, the net asset value as reported by that general partner.

Bob Long:

And so we were able to buy some deals at very attractive prices, as limited partners in those funds needed liquidity or wanted to rebalance their portfolio. We committed to those in the middle of last year, the way secondaries work, they didn’t close. They tend to close on quarter end. So the way that works is the convention. A number of those closed as September 30 slash October one, a number of more closed at more a December 31. And you saw in January a big bump in our main asset value. So we’ve benefited from that. So we’ve benefited from discounts, but we also bought some assets that we feel really good about. We’ve already had a number of IPO’s in the portfolio, which generally come in a mark up to where the investments were held.

Bob Long:

We’ve had a number of liquidity events in the portfolio. So we’ve frankly COVID was a terrible time to raise money, but was a really good time to be investing. So we benefited from that and we’re really pleased to be at about a hundred million dollars of net asset value today after six months and have a 31% now to increase or return for our initial investors so far. So that feels good. We’re continuing to invest in secondaries as we’ve grown larger, we’re buying more co-investments you don’t want to be really concentrated. So on a a hundred million dollar portfolio, you know, you, you don’t want to take on a $10 million co-invest, but you can certainly take on three, $5 million co-invest. Cause we expect to be a billion dollars within the next couple of years. So co-invest are more available to us now from a portfolio construction perspective, and we’re doing more of those and those again, they generally come with no feet and no carry we’ll continue to do some primaries. We were mostly private equity in the beginning, cause that’s what we could buy. And the pricing was good. We’ve started to add some real assets and we’ll eventually add some private debt. Although while you know, our, our five-year expectation is we’ll be five to 10% private debt given where interest rates are today. We may not do private debt over the next year, or certainly not in a material component.

Ross Butler:

Great. Well, thank you for sharing the structure of it. I just find it fascinating and it is novel. I think. So it was worth going through in, in detail. But I mean, I think you might’ve coined the term democratizing private equity and something that’s that I’m particularly interested in because I think private equity should be democratized. And this seems like an important contribution to that.

Bob Long:

I believe so, Ross, you know, we I may not have coined the term, but in Oh six and Oh eight, I was one of the more prominent people using it. I’ll, I’ll say that the we think individual investors over value liquidity in their PR and their portfolios. So we haven’t even talked about the 401k or defined retirement market here. Maybe that’s a separate conversation, but individual investors and C prime is designed to eventually be available. We want it to be available into 401k plans. It is available for the individual retirement accounts today, but individual investors tend to hold too much liquidity and not get paid for illiquidity family offices, institutions, pension funds long ago realized they needed to capitalize on the ability on it, the illiquidity premium. And I think we are seeing a secular trend of individual investors realizing that they don’t need to be able to sell everything they have today.

Bob Long:

They’re just not a reasonable set of facts where they need a hundred percent of their money today and they need to put some, it would benefit from putting some. And so this democratizing, it’s just, it’s just an expression of that. Individuals get more sophisticated information about investing about risk and returns is so much more available today, even than it was 15 years ago. When I started down this path, individuals are recognizing as our smaller institutions that they should and can afford to have some money in less liquid we’re, quarterly liquidity. But there are of course, other and I, they should have certain individuals should have some money in the longer lockup structures to the 10 and 15 year lockup structure, but individuals should have the benefit of that and get paid for it. So to the extent we have a retirement crisis, or to the extent we have an equity in we certainly have a problem with inequity and wealth creation. This is a tool, you know, the private markets are a tool and an option that shouldn’t and are available to a broader range of investors than they have been historically. And I believe that that serves both a financial goal, but also a a broader set of civic and civic goals for the certainly the developed economies.

Ross Butler:

I personally, I don’t think the word commitment is used enough. People talk a lot about liquidity or illiquidity and illiquidity somehow seems like a bad thing and you therefore need to be compensated with higher returns and you therefore need to take on more risk. And I’m not sure that that narrative is correct. I think you you are being rewarded because you are committing your capital, therefore giving the people who manage it more flexibility to make more money. I mean, it’s as simple as that. And so I think if the public narrative could change a little bit towards, this is just about commitment that could help them,

Bob Long:

You know the private equity industry in particular has not done a good job of managing PR and maybe we should have called ourselves the patient capital industry, but in, in life we often get paid for our patients and investors should get paid should get paid for their patients and typically do in the private markets.

Ross Butler:

Well, that seems like a good place to, to end Bob, thanks so much for, but it’s a pleasure.

Bob Long:

Good to see you. And thank you for the time. And thanks for those who are listening.

Ross Butler:

You’ve been listening to the fund shack podcast, make sure you subscribe and visit our website@fund-shack.com for many more video interviews. It’s the private capital channel for alternative investment professionals. Thanks for listening.

Fund Shack

#23 Simon Witney on sustainability rules and corporate governance

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Simon Witney on sustainability and corporate governance.

In this episode, I’m speaking with Simon Witney, who’s probably the best known private equity lawyer in Europe. He’s currently a senior consultant at Travis Smith where he spends much of his time advising clients on sustainability. He’s been chairman of the BVCA’s Legal and accounting committee and Invest Europe’s Tax legal and regulatory committee. He is a visiting professor in practice in the law department of the London School of Economics, where he teaches.

And he has a new book out published by Cambridge university, press called Corporate Governance and Responsible Investment in Private Equity. Our conversation is in two parts. Firstly, we look at the new sustainability regulations and what they mean for companies and investors. And then we go on to look at corporate governance itself.

Enjoy!