Animal Spirits Podcast - Talk Your Book: A $20 Trillion Dollar Market Opportunity

Starting point is 00:00:00 Today's Animal Spirits Talk Your Book is brought to you by Stepstone Group. Go to stepstonegroup.com to learn more about their brand new Stepstone Private Credit Income Fund, credits at stepstone group.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ridtholt's wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ridholt's wealth management may maintain positions in the securities discussed in this podcast.

Starting point is 00:00:44 Welcome to Animal Spirits with Michael and Ben. Michael, we're hitting on the fads. I guess not fads. Fads too strong over work, but the trends. And this is a trend that it just seems like it's been growing and growing and growing. You mean the soup de jour? Yes, we've had more conversations about. this with private credit. And it's certainly not going away this asset class or strategy

Starting point is 00:01:07 we're going to call it. Yeah. I think this was timely because there's a lot of articles in the media about private credit and what's going on there and being able to have a 40-minute conversation and really drill down and ask follow-ups. I think it's helpful to bring context to this. It's certainly, it's far from a new asset class, but it is certainly the one that is, is it is probably the balance between, like, popularity and familiarity is one-sided. So I think this conversation helps to level that. And I think it's more, it's important to have a nuanced discussion, especially for advisors between, like, look at the yield.

Starting point is 00:01:47 Oh, my gosh, this is amazing versus what happens when this calamity, it blows up or whatever. And those are the two sides that you're hearing now. It's good to have you have more nuanced, context-based, thinking through the risks, thinking through the returns, thinking through the structures, I think that's helpful. So we talked to Bob Long, who is a CEO at Stepzone Private Wealth. We've talked to Bob before about different alternative asset classes, although he did say he does not consider private credit an alternative asset class. I wish we double-clicked on that, as they say in the podcast business. Yes, he set us up and we didn't take it. But Bob gives a deep dive. We push back a little bit.

Starting point is 00:02:21 There's back and forth. I think this is a great conversation. So here's our talk with Bob Long from Stepstone. Bob, welcome back on Animal Spirits. Thanks for coming on. My pleasure. All right. Today we're going to be talking about the hottest topic on Wall Street. That is private credit.

Starting point is 00:02:38 For those who maybe are outside the industry that aren't seeing a flurry of emails hit their inbox like I am, introduce the concept. I think a lot of people are familiar with private equity, but what is this private credit that we keep hearing about? First of all, I got to start by thanking you guys for having me on for a fourth time. You know, this is the fourth, we can be brought by the number four, if you will. It's four years, four billion of a U.M and fourth fund. I'm keen to get a fifth fund because I assume you're like S&L and then I get a fifth fund jacket. But we'll see there when we get there. I think Steve Martin was the first one who got it.

Starting point is 00:03:14 He was. There's a long list of people that I'm generally compared to, you know, like Steve Martin, Scarlett Johansson, Tina Faye. But we'll go get to that. Private credit. So private credit is the least alternative of the alternative assets. In fact, I could argue you shouldn't even put it in the alternative assets bucket. But we're a private market specialist. We do private equity, private credit, private real estate, private credit. And it's grown dramatically recently as you envisioned. But what it really is is today's version of lending. So a direct and private credit's a big term. And within that, there's a smaller subset. that's most of private credit. And we'll talk about the other subsets, which is direct lending. And direct lending is simply a private equity company, private equity fund, buys a company,

Starting point is 00:04:04 puts down 50 or 60 percent equity and borrows the rest. Historically, they often borrowed that from banks who syndicated that loan. That market is smaller today because private credit funds or direct lending funds, like Credex, have filled that gap as banks have become more in the distribution business and less actual investors, or some people would say they're in the moving business, not the storage business. Private credit is filled that gap. These loans are generally floating rate loans with a five to seven year tenure. They generally have covenants. And they're today, I'd call it 50% loan to value. So it's just another source of income for investors

Starting point is 00:04:46 that we seek to provide in the way we provide access to other asset classes for individuals on the same terms as institutions. The way that people think about private credit, depending on which side of the value you stand, some people like, this is amazing. We can get higher yields and it's lovely. And other people on the other side are saying, no, no, no, wait, wait, when a recession hits, this is all going to blow up and just wait, it's going to happen. Where do you fall in the lines of this is the greatest thing in the world or no, this is going to be the next big subprime lending? He's asking the barber if he needs a haircut. True.

Starting point is 00:05:18 He was asking. Michael doesn't need one. The title is Talk My Book. is our call, but I'm not going to do that because you guys know me. Every investment has risk. Plenty of capital has flowed to this sector. A couple of observations. Most of my career in private equity, private markets, which is pretty long here at age 62, the equity check put in, therefore the amount of equity that a private equity sponsor puts in a deal is quite high by historical standards now. It's 50, 60 percent of the deal. I very much

Starting point is 00:05:52 remember the days when it was 20 or 30 percent. So less leverage, de-risked? Much less leverage. And therefore, that is a margin of safety or protection for lenders, the industrial logic of which is frankly hard to argue. I think that underlying your point is that a lot of money is flowed to private credit. And that's true, but that's because a lot of bank money has left. So banks were historically 70 plus percent of this market.

Starting point is 00:06:20 Today, they're 20 plus percent of this market. Plus, private equity has grown dramatically as it has reached further corners of the private markets. And frankly, it's a whole other conversation. Being public is just not as necessary today. There's more need for private equity back. Companies create more need for private debt. We think the market is, call it $3 trillion for private debt. And there's about a billion, $1,000, $1,000,000 or $1,000,000, 50 or 60% of that market today.

Starting point is 00:06:52 is served by dedicated funds. So yes, a lot of capital has been raised, but we believe there's substantial space to grow, and the loan to values are a very strong protection. So more equity, less debt, less leverage. I know we're going to talk about the credit side, but on the equity side, while you're having less debt, which is theoretically a good thing, the valuations have also been floating higher over time. So part of the arguments for private equity success back in the 80s and 90s is that they were getting. getting much lower multiples for these deals. And as you mentioned, as capital has come flooding in, a natural byproduct of that is valuations rising with the infusion of capital. Can you talk about

Starting point is 00:07:34 that side of it? Well, we need charts and graphs in a whole conversation, I think, to go through that. But overall, multiple levels are not at highest today. They are not at all time highs today. And when you look at certain sectors in the technology sector, for example, that dominates the public markets. You will often see valuations in the public markets materially higher, materially higher than the private markets. And it's not just tech. I'm thinking about an insurance company that we own that happens to be based here in Charlotte, where I am. And it's key public insurance brokerage firm. It's key peer is a public company that is valued significantly differently. I like the private asset in that example. But we're getting into a broad macro. I think the big takeaway is

Starting point is 00:08:18 private credit has grown, but it has covenants. It has a reasonable loan to value. And it has, you know, a piece we haven't talked about. Private credit lenders are generally principles, not just agents. And investors see the benefit of investing along someone who's going to hold the loan through the maturity, someone who has expertise in the individual sector. So we've got team, we've got a team of 65 plus people. And within that, we've got sector specialists in technology, do industrials, pick your sector. So when the general partner comes to us with a loan, with a proposal to buy a company, we understand that space, we understand what can go wrong, we understand what can go right,

Starting point is 00:09:04 we understand the valuations, and we're going to hold that loan. So that's really beneficial, I think, to the whole ecosystem. So money coming in is not just from investors. that are attracted by the higher coupon payments, although that's certainly part of it. It's also to fill the need for capital. Ben, what was that staff from Tors and Slok? Was it 85% of companies that generate $100 million in revenue or private?

Starting point is 00:09:30 Am I getting that right? Close enough. Yeah, you're in the ballpark. It's in our deck. I can quote it for you. It's 87% and here's the number. 87% of companies of size and scale, 100 million of revenue. So we're cutting out all the mom and pop business.

Starting point is 00:09:46 says 100 million of revenue are private. Half the number, if you're only selecting from public stocks today, you have half the choices you had 10 or 15 years ago. And that trend is not going in your direction. So the private markets have just substituted for the public markets in ways that I think we've talked about before and direct lending as a follow-on trend of that. So why can't these companies just call JP Morgan and ask for a loan? They can. They're going to pay a very high price, and J.P. Morgan's not going to respond as a principle with committed terms quickly. So the bank market still exists. Those deals, and we'll get a little technical here, those deals will tend to have market flex. Trust you guys are familiar with that. We'll explain that to the audience. The bank. All right. I'm a stranger to the gym, Bob. I flex all the time.

Starting point is 00:10:41 Yeah, we're in S&L world so we could have some Hans and Franz. I go. That jokes here. The, my two favorite characters from S&L. All right, market flex. Bank writes you a commitment letter and says, yes, I'll provide this loan to you at X terms. But if the market isn't there for me to lay it off, well, I need this flexibility to do X and Y. And of course, it's subject to credit committee, et cetera, et cetera.

Starting point is 00:11:07 So direct lenders, like ourselves, benefit from speed, certainty, certainty, expertise, and deep relationships, and what we've seen is, even in a competitive market, and I don't want to pretend it's not, or that the general partners don't have very sharp pencils when pricing this debt. They do. They value speed, certainty, relationships, expertise, being able to deal with one or two parties, not a syndicate who will have to approve any covenant waiver or any amendment earning tweak. They value those things. And thus today, they're paying base rates, which today is so far as opposed to live board. These are floating rate loans, if I wasn't clear on that, base rate plus five to 700 basis points. And they are submitting themselves to covenants

Starting point is 00:11:55 and sometimes prepayment fees and that sort of thing, too. So these are very attractively priced, we believe, in terms of the risk. And that, of course, is an attractive investor. The yields look amazing to investors. So you said plus five to 700 basis points. We're talking, I guess, I don't know, eight to 12 percent yields or something like this. So my question is that yield for the investor is also the debt burden for the company. So how these companies managing to pay double-digit interest rates on their debt? How do they survive that? Importantly, higher cost of debt has flushed out marginal private equity deals. That's the first thing to understand. So that higher hurdle rate has made it so they're a little

Starting point is 00:12:35 more selective is what you're saying? They have been much more selective. And I think net net for the industry, that's a very good thing. But clearly the deals have to pencil out, right? Companies have to, private equity firms are still seeking to hit their historical rates of return. And they can do it with this cost of debt if they achieve the operational improvements they seek to with those companies. Do you think that, so Jamie Diamond was talking last week, and there was a quality about something going to hell that was severely, severely taken out of context and made it appear much worse than it actually was. That's really not what he was saying. But what I gather from his comments, and I don't know if you heard them or not, was it sounds like he's a little bit

Starting point is 00:13:17 jealous that J.P. Morgan is not in this business in the way that they might want to be given the capital requirements of these giant financial institutions. They just can't move as quickly. They don't have the flexibility. Do you think that's some of what's going on from the bank's point of view? Absolutely. The Dodd-Frank and the other capital regulations that have been imposed on banks make it harder for them to do, more leverage transactions. Also, just think about the way banks are staffed, right? It is an agent mentality, not a principal mentality. And this is an asset class that's better suited to a principal mentality, to buy and hold to be accountable and responsible for the outcome of that loan, whether it pays back on time and in full. And so banks are just not in

Starting point is 00:13:59 that position today, they don't have five and six and seven year compensation plans the way we do and private equity firms do. So it's just different. What we're talking about here is a minor part of the shift that I've seen over 30 or 40 years away from banks as principals to banks as agents. This is just a part of it. How much of this, too, was just the regulations after 2008 crisis that banks got pushed out of this? How big of a part of it is that? Very meaningful, Ben. very meaningful. Older news, if you will, so not something people talk about as much. But sort of the base bump that sort of came in that 12, 13, 14 tight of time frame was largely driven by that. And many of these firms got into the direct lending business at that time or since then.

Starting point is 00:14:49 One of the things I'm proud to say about us is we've been in the direct lending business much longer for more than 15 years and have a very deep track record with people who have been investing together for that and have actually seen a cycle. So I would encourage your listeners, whether it's our fund, any fund, any credit fund, make sure you're looking at the tenure of the senior leaders, the decision makers, had they invested through a cycle. You know, we're living in a world today. It's not brand new, you know, two or three years ago when rates, or two years ago, when rates started increasing. You had many, many investment professionals, certainly most, maybe not most senior, but most by bodies who've never seen rising rates.

Starting point is 00:15:32 I had only seen a declining rate in Burma. And it's very important when you're evaluating a credit fund. Because remember with credit, your upside is you get your money back. Therefore, you get your money back plus interest. Minimizing downside, evaluating risk, and therefore, we believe being extremely diversified are critically important to any credit product and particularly a direct lending product. So who is higher rates hurting? Because it's benefiting the private credit lenders. Is it hurting the private equity borrowers? Let's talk about who it benefits. I think it benefits

Starting point is 00:16:09 savers. I mean, anyone who's saving, if you, we lived in a world, I graduated college in 1984 and basically rates more or less trended down for most of my working career. And that hurts savers. You know, it hurt retirees. It hurt people in those categories and while equities benefit from very, very low rates for a long period of time. So we're in a reset world. Credit is important. You can earn attractive returns with credit. I believe attractive risk adjusted returns in credit. And so it's getting a lot more attention to that. Another area that's getting attention is the structure of these funds, which if listeners take anything away from this conversation, it should be that these are long duration, for the most part, relatively illiquid assets.

Starting point is 00:17:00 This is not a cash equivalent. This is not something that you can get your money back tomorrow. And there's been stories popping up in the media lately about investors wanted their money back and not being able to do so. So talk about the structure of this fund and what can potential investors or what should they know before they even think about looking at something like this. It's a really important question. Thank you for asking.

Starting point is 00:17:22 first and foremost, we focus on educating investors, and I believe our quality peers do so. I believe the mainstream press has misrepresented the understanding level of the average investor in a semi-liquid fund, and that's what we offer, our four funds, S-Prime, Spring, structure that we've talked about on the show, and out credits. These are semi-liquid funds. They sit between your daily traded exposure that you can sell every day, and there are publicly traded credit funds, you can sell them every day, but you may not like the price, because they will sell at less than net asset value frequently. With a semi-liquid fund, it's a compromise. It's a hybrid.

Starting point is 00:18:06 You get most of the benefits of illiquidity, and you get quarterly liquidity, generally for 5% of the fund, not of your investment, but of the fund. And I believe, despite the press as reports, including this weekend, that the vast, vast majority of investors fully understand that. I would agree with that, by the way. They price, they size their position accordingly. They understand that to get these sorts of returns, historical returns, you do have to suffer some or deal with some illiquidity. We're not magicians.

Starting point is 00:18:40 We're not alchemists. Neither are our peers. These are hybrid solutions that a vast, vast number of very sophisticated financial advisors and clients are flocking to. You can look at the numbers. We're $4 billion of AUM today. We're raising $200, $300 million a month across our four funds because investors see value in getting most of the illiquidity premium and diversification benefits of private assets, getting daily and monthly valuation so they know what they have. They avoid capital calls and distributions. Talk about that some more. Put that to the side for now. And they can get out quarterly at a

Starting point is 00:19:19 100% of NAF. So 5% of the fund means most of the time, not forever, not every single quarter for the next 20 years, most of the time, most investors will be able to get out at 100% of net asset value. And the other thing that's misrepresented by the press is that if Michael and Ben, you guys are in our private equity fund, which offers 5% per quarter redemptions, by the way, the high has been 1% to date in that fund, and it's several-year track record. If for whatever reason, there's a war, there's an event, and we have 10% redemptions, 10% of our investors seek full liquidity. You would each get 50% of your investment back at 100% of NAV on a few days' notice.

Starting point is 00:20:09 Okay, 50%. And then presumably the next quarter, you'd come back, presumably, and you'd come back, presumably, and you would tender or seek to redeem again. So I think investors understand that. I think there's a high degree of industrial logic. And when you contrast semi-liquid funds with the other ways to gain exposure to these return streams

Starting point is 00:20:32 and these diversification benefits, which are the traditional drawdown funds, that in the case of private equity are a 15-year experience. And in the case of private credit are somewhat shorter, probably a 10-year experience from first cash flow to last cash flow. They see value. They see value in semi-liquid, and they see value in the other piece, which is being

Starting point is 00:20:54 immediately invested. In a drawdown fund, you are committed, but you are not invested. Now, you commit $250,000 to a private credit fund through your favorite private bank, and they draw that over three or four years. They invest it, and you get it back. With Credix, we manage the cash list. It is difficult, by the way. We do it well. And all our other evergreen funds. Michael, if you commit today, which you can do this as a daily fund, buy it with a click through your RIA, then we take responsibility to deliver you the returns. We blend your money in with the existing money. You buy into the existing assets. And when you seek liquidity, you're exiting at a net asset value that represents all the assets. Can you see

Starting point is 00:21:40 during the next financial crisis other private credit structures if there's something bad happens and there's a rush for the excess for whatever reason that one of these funds is going to be gated and the financial media is going to lose your mind? That's probably going to happen, correct? First and foremost, the word gated is inappropriate. It's proration. It's what we talked about. A gait is when Michael runs a hedge fund and he tells people that they can get all their money back in a given quarter. And then when they all seek to, he says, ah, but look at the footnote where I said I could do a side pocket, right? Our funds and our peers, including those that have been written up in the press extensively pro-rate.

Starting point is 00:22:19 You do get your money back in proration. So certainly, in the event of a severe crisis, and we've seen this with some real estate funds, but let's remember a big difference between real estate and the other asset classes that we deal with within steps on private wealth, real estate has publicly traded comparables, or at least the investors believe, that they can buy apartments and warehouses in a publicly traded format.

Starting point is 00:22:50 They see a certain price, a certain cap rate, and they read across to a private fund, and they believe those are out of sync. So they see a carry trade. They sell one and buy the other. In the case of venture capital, in the case of private equity, in the case of private infrastructure, that does not exist. In the case of private credit, there are publicly traded funds, but I would point you to the frequency with which they trade at less than net asset value,

Starting point is 00:23:17 their fee structures, and others, other features where we believe a private fund makes the most sense or makes sense. I wouldn't say there's no place for the others, but we believe and we're seeing demand for the semi-liquid fund in private credit. I just want to comment that I would agree with you that the way that is portrayed in the media is obviously hyperbolic, and it's not to say that the issues that they're talking about are not real issues. But I would agree that most investors, not all, but the vast majority understand what they're signing up for. What they're signing up for is semi-liquidity.

Starting point is 00:23:52 And so with that, I'm just curious. Let's just assume that in the example you gave, there's 5% liquidity in any given quarter and 10% does want the money back. Where does the actual liquidity come from? Because if there's more demand for funds than exists, well, then you have to sell. ostensibly, if there's a high demand for liquidity, it's probably because something isn't great going on in the economy or specific to your fund, and in which case, you would have to sell at a discount to the prior nav. Can you walk through some of those dynamics? So in the case of a private credit fund, all your assets are generating yield, and they have a maturity date, unlike a private equity asset, which in the case of a tough market just gets

Starting point is 00:24:36 hell longer. So a private credit fund, and specifically one that focuses primarily on direct loans, which is what we're doing, the average repayment on those loans is three years. So you're generating organic liquidity in a private credit fund. You also have a credit facility in a private credit fund. So you have liquidity from repayments, liquidity from quarterly coupon, and you have a credit facility, all of which make managing liquidity in a private credit fund much, much easier. And to that point, contrast with our venture capital fund, where we only offer two and a half percent per quarter liquidity because that's what makes sense. Right. So forgive me for focusing so much on the risk side of it, but I think that the returns, the rewards are well

Starting point is 00:25:23 known, right? Everybody understands the coupon, the benefits of private credit are very apparent. So So in the event, listen, the economy is doing very well by almost any measure. Companies are healthy. Things are going well. If there were to be a downturn, how would those risks manifest themselves potentially in a private credit type of structure? You would see loans go on watch lists and eventually loans become nonperforming. One benefit of a semi-liquid fund that quotes a price daily is that you would see those

Starting point is 00:25:59 marks flow through immediately on a daily basis into our net asset value, which also affects our fees, by the way, as it should. And so those adjustments to valuations are where that starts. Over time, in your example, covenants get tripped, deals get restructure, but particularly in a world where the private equity sponsor is put 50 or 60 percent equity in a deal, the private equity sponsor is much less likely to walk away. So, Bob, this is the part that I think is really important because this is where some of the arguments happen is that, is that private credit funds would say we have a much lower default than our publicly traded counterparts. And the public investors would say, come on. What really is happening is the deals are getting restructured.

Starting point is 00:26:44 So yeah, they technically might not be a default, but the terms of the original deal are getting extended, which I'm not saying that's a bad thing. It just might not be fully, it just might not be the whole truth and nothing but the truth. So can you talk about what that part of it looks like? Yes. So recognize today that I am not the portfolio manager and in the weeds on doing an individual private credit deal. So I'm going to have to be somewhat general and also rely on some prior experience, which might be a little data to this point, but I'll try to answer as best I can. Loss rates. So another thing anyone evaluated a credit fund should really focus on. There are lots of published statistics about loss rates. And you're right. They're relatively low in this sector. You must focus on what is the denominator? When a sector is growing very quickly, loans don't default in the first year, Michael, unless you really screwed up, the underwrite.

Starting point is 00:27:38 So first and foremost is to ask, what is the length of the track record upon which you are hearing from the private credit manager that is defaults or total of six basis points to pick one of our peers whose pitch I heard recently? And by the way, ours are about 10 basis points. Of course, past is not prologue, can't count on that, read the prospectus, et cetera. Hours are about 10, but they are over a very long cycle.

Starting point is 00:28:06 So put default rates in the context of what's your default rate for loans that are, you know, more than two years old or more than three years old? Not what's your, what's your loss rate over your current denominator? You guys are following me on that? That's the first thing. The second thing is, I believe the industrial logic that more, efficient outcomes occur when you have an agent, sorry, when you have a principal lender negotiating with a principal equity sponsor. The deadweight loss that comes from the inefficiency of a bank

Starting point is 00:28:40 syndicated loan market where you might have mutual funds in a deal, you might have insurance companies in a deal, you might have pension funds in a deal, and the lead bank is hurting cats to try to reach a consensus and come up with a compromise with the private equity fund sponsor the general partner in order to save the company, provide a lifeline, a restructure, amend, extend. And so there's a very strong argument that default rates, loss rates, should be lower in direct lending because it's a principal to principal transaction and because there are fewer parties, very fewer cooks in the kitchen, all of whom have a direct long-term economic interest, not just bankers with a near-term bonus on the line.

Starting point is 00:29:29 So I think we all understand incentives and how the principal transaction might be better than the agent. Is there any evidence to corroborate the fact that private equity companies might be better lenders than banks? I believe the loss rates, even if you subjected it to the sort of scrutiny that I just described, and I haven't done the works. I'm not going to quote, I don't follow what the public loss default rates are. I think in high yield, they're measured in percent, not basis points.

Starting point is 00:29:58 But you guys might know. But I am, look, I'm convinced it's true. I've been doing this for 40 years. And I've been in all parts of it. And I'm absolutely convinced it's true for the reasons we described. With all the money coming into this space, there's obviously other funds being set up to vacuum up all the money, right? Someone needs to invest it. So what do you do to stand out and what do you do to differentiate yourself from all these other funds?

Starting point is 00:30:22 because there's a lot of options for investors these days, as Michael mentioned in our inbox. Right. There are. CredX are fund for individual investors. Looks a lot like our other funds. And then it's an evergreen fund. It's 40 Act registered. It's 33 Act registered. It provides a 1099. It's available for your IRA. It has a low minimum of $25,000. What's different about our fund, this fund, is it's available to all investors. It's structured as an interval fund as opposed to most credit funds are business development companies, and they have some eligibility requirements that we are able to not have in the case of credits. You can also buy with a click through your broker or investment advisor. So it's on the NSC system, the mutual fund system. You're

Starting point is 00:31:09 able to buy it with a click. So ease of use is critically important. In general, and I can go more specific, fees are lower in our fund as compared to the most credit funds, which are BDCs, business development companies, and leverage is also lower at the fund level. Those can lever $2 of debt to $1 of equity, whereas our fund is limited to $1 of debt to $2 of equity, and we will run with significantly less. Can you compare and contrast those fees, too? I'd be curious to hear what the difference is. Sure. The typical BDC is a 1.25% management fee and a 12.5% incentive fee. Our fund Credix is a 1.15% management fee and a 10% incentive fee. Is there any hurdle?

Starting point is 00:31:57 Yes, we have a 5% hurdle on that fund. And that means what exactly? That means if we don't achieve a 5% annualized return, we will not get our incentive fee. If we do, we will get our incentive fee. So that's pretty typical across these funds. And is the incentive fee, I'm sorry, over that 5% or no? It has a full catch-up. So in today's base rate environment, we will get the incentive fee most of the time.

Starting point is 00:32:23 To be very clear, we will. The investment strategies, I think, where we really stand out. So three things. First, stepstone, as you guys know, and the audience may not know, as an allocator. We believe we are the world's, if not the one of, the world's largest allocators to the private markets. We invest across the private market, $70 billion a year in over 500 separate transactions, we close. That's not our funnel. That's we closed. There are 1,000 of us operating from 27 offices in 15 countries. Most things in the private markets that move, we see it. In private credit alone,

Starting point is 00:33:01 we allocate $11 billion a year, pretty confident we're the largest allocated to private credit in the world. And as a measure of number of deals done, not overall investment, but number of deals done, we believe we are the most active. We close the most number of loans in comparison to the household names that you know. And so the point of that is our fund is very, very diversified. We do seek to have no loan over a percent and a half in our fund. We allocate and we source from 100 plus different sources, lending sources. They might be other general partners. They might be banks. they might be credit funds. We are a multi-lender, open architecture,

Starting point is 00:33:48 source of exposure to the credit markets. So that's first and foremost. We're very diversified. Secondly, we are able today to buy some assets on the secondary market. I think we've talked about in the past. There is an active secondary market in all private assets, private equities ahead of private credit and private infrastructure, but you can go and buy with expertise and knowledge,

Starting point is 00:34:12 and relationships that we have, we can buy assets, be them individual loans or funds on the secondary market, typically at discounts to net asset value. So that's a way by which we enhance the returns and also get vintage diversification going backward into the fund. The third might be most interesting to you. We're going to have a sleeve of 20 or 30 percent specialty credit in this fund. So direct lending, 70, 80% of the fund, specialty credit, 20 or 30% of the fund. Direct lending we've talked about, loaning to private equity companies, 50% loan to value, floating rate loans, etc. Specialty credit is more nuanced. This is where the banks have pulled back not just from lending to companies, but they're doing less lending to lenders, less lending to operating assets. And so the

Starting point is 00:35:06 opportunity to today to invest in leasing assets, transportation assets, consumer loans, venture lending is quite interesting. And so we're going to have 20 or 30 percent exposure to that. And if I could go back to the comparison to the other funds, the typical private credit BDC has incremental leverage. And we believe we can achieve similar returns. And of course, I can't quote returns, but they're well known and in the public eye. We believe we can achieve similar returns while using less leverage at our fund level by adding the secondaries, which enhance return and specialty credit. So that's our special sauce, very diversified, include some secondaries, include a meaningful

Starting point is 00:35:55 allocation to specialty credit. I have a question on the diversification part of it. You said you won't invest more than one and a half percent to any deal. is there a cap on the company that you will lend to? In other words, I understand that it might be 1.5% per buyout company, but would you cap it at say 10% per lender or something like that? Or I'm sorry, per borrower? Like GP? Yeah, so let's, I'm going to make up, but I don't need anything to name, me. Private equity company, XYZ. Would you allow them to be 10% of your portfolio, even if it's with different companies that they, that they sponsor? A little bit of

Starting point is 00:36:31 nomenclature here. So if a general partner had multiple private equity companies, we seek to be very diversified by general partner. When the fund is mature, we would unlikely, very unlikely be 10% a single general partner. Got it. So we want to be different. Again, with credit, your upside is you get your money back. These are glass-half-full gentlemen and ladies that run this fund, the PNs. And so we are just huge believers in diversification. We think that is the risk mitigate we bring that distinguishes us. Take a minute to describe the specialty lending part of it. Obviously, that's going to be higher yield, more esoteric, probably smaller pools of capital. Give us an example of what that might look like. Right. So back to sort of the big theme in my working career, as banks have

Starting point is 00:37:25 pulled back from number of markets, other pools of capital have filled in. It starts with institutional capital, and then now that evergreen funds and other technologies have evolved, so individual investors can efficiently access this risk-reward exposure, you see evergreen funds like ours, although I think we're relatively early to this, moving in, but it's the same theme. It's the same trend. We talked about it with infrastructure where governments used to provide most of the capital, and now you see institutions provide some of the capital, and now individuals. So it's the same big thing. What do the deals look like? Well, we think, especially credits,

Starting point is 00:38:08 a $20 trillion market. So six, seven times the direct lending market. And we believe that only about half a trillion is dedicated to that today. So we think there's a real opportunity for growth. And we believe for a similar risk reward profile, of course, this is our opinion. Results will prove us out or not. We think you can pick up two or three hundred basis points by doing the work and taking on the complexity of specialty credit. So that might be lending on hard assets. And direct lending is lending to a company. Lending on hard assets would be infrastructure lending, asset-based lending, leasing, consumer pools, student loans, mortgages, auto loan receivables, then wholesale lending. There are as profitable lending to lenders that can be done is complicated.

Starting point is 00:39:00 We think you can extract a really great type of return. And what the consequences of that are, you've got massive diversification within these loan pulls. And if you think about just where we started, right, assume we were only a direct lending fund, we'd seek to have no more than a percent percent and a half in any one company. Now we're adding diversification by a whole set of assets that aren't, you know, aren't tied to the private equity cycle. They aren't tied to M&A.

Starting point is 00:39:25 Then we're getting diversification within them. These generally tend to be shorter duration. back to your liquidity question, right? The turnover on these pools of loans will be shorter than the three-year average turnover on a direct loan. And then we think enhances risk. We think it makes a lot of sense. It does require us to tell the story, which is why it's important to have not, you know, sound like conversations, the conversations like this to explain how we're different. What's the biggest reason you're getting that two to 300 basis points that yield bump there in the specialty lending? Less competition and lots of complaints.

Starting point is 00:40:00 complexity. Bob, what did we not cover today that we wanted to get to? I thought this is a pretty meeting conversation, but anything else on your mind that you wanted to hit on? I think the big news around Credex is our fourth fund, that it is the first time we've been able to bring the institutional capability to the stepstone. And this is a point I like to emphasize. If you're evaluating our funds or anyone's funds as an individual, any alternative assets, the first question you need to ask is, are you getting access to the same? deals that the institutions get. We have a pro rata policy. I think we talked about it, but I'll use my food analogy again. It's the same ice cream. If you want the ice cream in a

Starting point is 00:40:43 drawdown fund, if you can manage the drips, the ins and outs, then get it in a cone. You're an institution. If you want it in a cup where we manage the liquidity for you, then you buy it an evergreen fund. So CredX is just like that. It's the same deals that the world's largest and most sophisticated institutions who are 98% of stepstones in a assets, right? 98%. We're a small part at steps into private wealth. So it's the same deals. But our other three funds for regulatory reasons are only offered to accredited investors

Starting point is 00:41:18 in the case of prime and structure or qualified clients. And the case of credits, I'm just thrilled to say we can offer it to all investors at a $25,000 minimum. So we're really pleased to be democratizing this access in a way that we've not been able to before. That's the single most important thing. For people that want to learn more, where do they find you guys? So stepstone.com or stepstone pw.com is a great place. You can also follow us on LinkedIn. We post a lot of information there. It typically takes you back to the website, but it's a great way to keep up with us. And of course, first and foremost, ask your financial advisor about Stepstone private wealth. That's the highest compliment we can receive. We are on about 300

Starting point is 00:42:01 platforms already today in the United States and many, many offshore. So working through your financial advisor asking about our products and how they might be right for you is the best place to start. Bob Long, thank you very much for joining us. My pleasure. Okay, thank you again to Bob, remember stepstone group.com. If you want to learn more, email us, all your private credit questions. Michael will be answering those, animal spirits, at the compound news.com.

Animal Spirits Podcast - Talk Your Book: A $20 Trillion Dollar Market Opportunity

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