Animal Spirits Podcast - Talk Your Book: Expanding Access to Private Markets

Episode Date: June 27, 2022

On today's Talk Your Book, we spoke with Bob Long of Conversus about giving financial advisors access to investments in private markets.   Find complete shownotes on our blogs...  Ben Carlson’s A Wealth of Common Sense  Michael Batnick’s The Irrelevant Investor  Like us on Facebook  And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation.  Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is brought to you by Conversus. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holt's Wealth Management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritt Holt's Wealth Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Ritthold's wealth management may maintain positions in the securities discussed in this podcast.

On today's show, Ben and I spoke with Bob Long about their fund, C-prime, that invests in private markets. Ben, one of the themes that I am bullish on over the next decade is advisors granting access to private markets, whether it's private credit, real estate, private equity, whatever, to their clients. And C-Prime has, this fund already is, I think it's launched at the end of 2020, and it's already got $600 million or thereabouts in assets. High net worth individuals are interested in this kind of stuff. And I agree. I think that they're going to be, maybe not clamoring for it, but if it's available as an option, a lot of them are going to find this interesting. I think that people are really, with the idea of illiquidity, not seeing the prices on a daily basis, even if, I don't know

that anybody would say this out loud, even if it's certainly not guaranteed to outperform anything. But I wasn't kidding. I said, I might even take a discount to have some illiquidity. And we spoke about this idea of the illiquidity premium. And I think that there is some debate right now about whether or not that exists, where it comes from sources of returns, like that. At the end of the day, private markets are attached in some way to public markets. They have to value these things, but the valuation of them is more smooth. So like in 2020, after the corona crash and you had this huge spike up, you don't see that immediately in your private marks. So it kind of goes both ways where you don't see those huge upswings right away,

where the stock market doubled in, what, nine or 12 months or something? Like, you're not going to see that in your private marks. It'll slowly catch up. But the same thing on the way down, it's more of a smooth approach. And this is using a term you don't always like, like Schrodinger's portfolio where like is the fund down because you don't see the mark every day. It's one of these things where it should be tracking the public markets, but because it's so much more long term

and marked on a quarterly basis, you just don't see it. And I think for a lot of people, some people say that's a bad thing because I want that liquidity. Other people would say, that's a great thing. I'm a long-term investor.

I don't want to see it. And I don't care if it's fluctuating a lot. of if you are going to tie up your money and make it illiquid, then I agree, you should receive a premium for that. Counterpoint, if you are going to have the benefit of not getting marked to market on a daily basis and not seeing the fluctuations and experiencing smooth returns, then for that, you should take a discount. But I guess at the end of the day, all that matters really is what are you investing in,

what are you paying, and what are expected cash flow? going to be. And I will say, this was a podcast where you and I learned something. I'd never heard of a tender fund before. Tender fund? You never heard of it. Credit to us for not making a Reddit joke about Tendies because it was sitting there. It was just sitting there for us. And we didn't do it. Yeah, I never heard of this. Credit us. So, yeah, I think we learned something. I think this is an interesting structure. So without further ado, here's our talk with Bob Long from Conversus. We're joined today by Bob Long. Bob is the CEO of Conversus. Bob we're going to learn a little bit about today about what Conversus is and what you guys do, but welcome to the show. Thank you.

Glad to be here. All right. So we checked out the website a little bit. You guys offer high net worth individuals the ability to invest in private markets. How does this work? What's the fund structure like? How do you guys allow that to happen? Great questions. So first of all, what we do at Conversus is deliver the capabilities of Stepstone group to high net worth individuals. Stepstone is one of the world's largest allocators to the private markets, $570 billion of assets across private equity, infrastructure, real estate, private credit on a global basis, investing in new funds, so-called primary funds, buying funds on the secondary market, secondaries, and then co-investing in specific companies or projects. So that's what Stepstone does. We allocate $75 billion, that's with a B,

to the private markets annually 400 separate transactions, so almost to a business day. So we're really one of the axes in this market, if you will. Conversus is simply the retail arm of Stepstone. We were created to deliver those capabilities to high net worth individuals and smaller institutions. In terms of our first fund, which you ask about, is called Conversus Stepstone private markets or C prime. It's an invest across all the asset classes.

It does so on a global basis. And interestingly, it's structured as a tender fund. What we do is we take money in a monthly. We provide liquidity quarterly. And so we manage the cash for investors. It's registered under the Investment Company Act. And we do it this way to make it more convenient for individuals to invest into the private markets. So when you invest in C prime, you're not just.

allocated to a fund, you're invested immediately in a diverse pool of mature private market assets. Bob, I've never heard the term tender fund before. Does that refer to the liquidity profile, the entry and the exit, or is that something else? It does. Exactly. So the tenders are the quarterly liquidity process. Again, we take money in monthly, and then on a quarterly basis, we offer liquidity for up to 5% of the fund, not of your investment, but of the fund on 90 days notice. So the idea here, Michael, is that most investors can get liquidity most of the time when they need it. They get it at 100% of net asset value. And for those of you very familiar with the private markets, you know that secondary sales by individuals almost never come at 100% of net

asset value. That's typically a discount. So what we do, it's really a lot. It's really a hybrid. You gentlemen, advise high net worth individuals, you help arrange their investment allocations. What we do is we've created a tool for financial advisors to have access to the private markets that sits between the daily traded exposure, your public stocks and bonds, and your 15-year or more lock-up to private funds, feeder funds, fund of funds, and that sort of thing. And so this sits in between, and it delivers most of the illiquidity premium of the private market assets in a structure, we think is more convenient called a tender fund. So since you have that cap on, the amount of that can come out, that helps with that time horizon mismatch, where these are

longer term investments, but you can still kick out some of your investment in short time frame. Is that right? Yeah, we're exactly seven minutes into this, and you got to the hardest question, Ben, thank you. So we're not alchemist. We are buying private. market assets that have longer investment horizons. We're buying a mix of those. We're buying a portion of those that are closer to their liquidity date, where they have a shorter duration. Where does that liquidity come from? Is that coming from new investors or are these secondary market transactions? It's come primarily from realizations. So if you look at, for example, our results over our last fiscal year, which ended March 31, we had very substantial net asset value

growth. Of course, I'm required to say that, and it's true that actual results may vary from historical performance. We had good net asset value growth. About half of that came from selling companies or dividends or distributions. So this is the hard part. And I think what most individuals and small institutions just haven't had access to. It is buying a portfolio. We've assembled a portfolio. This is why I stressed that huge scale in the beginning. Our portfolio managers have to pick assets that generate our target returns, but also maintain, on average, a relatively near-term liquidity. So some of our assets are going to be held for four or five years. But we also are buying on the secondary market some assets that will realize earlier in one to two years.

And so the mixture of those is really the secret sauce of what we believe Stepstone is one of the few firms, not the only firm, but one of the few firms in the world that's able to do. Are those investments made through direct investments into the companies, or are you investing strictly through funds that Stepson manages? So we are doing all of those things. the portfolio will have a very substantial part co-investments, and in the case of private equity co-investments, we're able to do those on a no-fee, no-cary basis. So a very substantial portion of co-investments. Then second, we're buying funds on the secondary market or individual companies

on the secondary market. And we make a small amount of commitments to NUCON's so-called primary funds. So it's primarily, it's co-invested in secondaries with a little bit of primaries. And as your question demonstrates that you underlying, your question is, yes, individual companies tend to have a nearer term liquidity profile. Plus, it's easier to predict when, because you're close, you're talking to the management team, you're getting the financials, it's easier to predict when they're going to liquidate and create cash for our investors. I have a little experience in the secondary market for my endowments and foundation days, we invested in a few secondary funds like that. But it's been a while since I've been in that world. What is the market for that

and what is the reason that people would be wanting to get out of their private funds right now? Because a lot of times you buy those at a discount too. So what is the reason? Is it just someone decided they need to get out of it? There was some sort of change at a foundation or an endowment or something. They realized they want to rebalance. What is the reason for getting into those secondary funds and how do you get into those these days? It's primarily what you describe. Ben. It is portfolio rebalancing by the investment staffs of large institutions who have decided that for whatever reason, they no longer like their large cap private equity exposure, for example, and they sell those assets in the secondary market. We are a buyer of those assets along

with others, and we think that our commitment to data, which I'm sure we'll get to later, gives us an advantage. In that regard, you also noted that those are typically sold at discounts, and they are, and that is part of what's helped our returns, is buying good assets at a discount to fair market value and therefore experiencing net asset value growth. The other thing that's going on right now and went on during COVID, and we definitely benefited from some COVID tailwinds, We launched this fund in the middle of 2020, hard time to raise money, really good time to invest money. We launched this fund. We had our first closing on October 1st, and we benefited from buying some assets at very attractive prices during the COVID environment.

But we've also benefited as supply chain dislocations, of course, the war, and now public market volatility have driven large institutions to be willing to sell their assets or be interested in selling their assets. The other thing going on here is large institutions sometimes experience a denominator effect. So if they want to be allocated 20% to private equity, 80% to public stocks and bonds, if the value of that 80% declines, well, now they're out of balance and they're interested in selling. Bob, can we talk about before we get into some of the investments and the environment that we're experiencing today, can we talk about this idea of the illiquidity premium, which is one of the foundations for investments. investing in these type of instruments? Why do we think that exists? I'd like to get your take on that. Really good question. Our research and experience indicates there is a premium for illiquidity and that these markets are more opaque and those who bring an information advantage do have a true advantage. That can be expressed through actual premium returns. We believe that

exists. One statistic that might illuminate that distinction is, if you look at U.S. public equities, the distinction between a first quartile top 25 percent manager, they generate about 11 percent historically. A first quartile manager, bottom 25 percent, generates about an eight. So the distinction is about three percent, which is a lot. It's not insignificant. It's a lot in the public markets. But in the private markets, U.S. private equity, top quartile performers, 24 percent, Bottom quartile performance, 2%. So the dispersion of returns shows you that there's tremendous benefit to having the right information and access to the right deals.

And therefore, that's where I think the liquidity premium loss. Everybody says their top quartile, I guess is one of the things you never hear from. You never hear from a phone who says, yeah, we're bottom, but don't worry about it. To tug on that question a little bit more, and this is a leading question, the idea of the premium that you might receive an illiquidity, ostensibly comes from lower prices that you would pay for a comparable investment in the public markets, where you can buy and sell every day, but hasn't the valuations for private companies, whatever metric you're looking at, been rising over time? And I don't know if it's at par with public investments,

but I'd like to get your take on that. Yes. So first of all, evaluation practices have improved substantially, as your question indicated, over the 20 or 25 years that I've been doing this in an active way. In terms of the illiquidity premium, it comes from a couple of things. First, it is the ability of those managing these private companies to be less sensitive to near-term fluctuations in value, manage for the long term, not be influenced by a public stock price moving around, be able to invest in longer-term projects like capital expenditure or a business transformation. The second thing is private equity firms, particularly over the last 10 years, really coming out of the financial crisis, have made massive investments in operational

improvement to their portfolio companies. When I got into this business, a valid criticism might have been that the value was from buying low and selling hot. Well, that is just some of that still happens. And we're not embarrassed at Stephstone to say that we back people who are good at M&A. But so much more of the value today comes from digging into the companies, bringing expertise, creating alignment of interest between the management team and second, third, and fourth layer employees and the long-term interest of the private equity investors in order to generate lasting, durable operational benefits that then drive the returns. You mentioned the long-term nature of it. How much of private equity and private investments

in general is almost a psychological trick? Because a lot of the marks you get, I know, could be for what the companies are doing are on a quarterly basis, and they could be on a three, six, maybe nine-month lag depending on the manager. So a lot of times I think it's good for investors to just kind of have it out of sight, out of mind. They're not looking at tick-by-tick basis like they are with the stock market. How much of a psychological component is there to investing in privates, or do you think that most of these investors kind of understand that? I believe most financial advisors who we primarily deal with, I think they do understand it. But your point is really important, which is individual investors have rarely

benefited from having liquidity and assets designed to be long-term holds. So if you look at the financial crisis, for example, in the sales that were made by individuals or even smaller institutions or larger institutions that generally did not serve them well. So for a portion of your portfolio to have a long-term mindset, a long investment horizon, we do think it's helpful from a portfolio a construction perspective. And Ben, to your point, I think it's just ease of mind also for investors. I have 25 million of my friends and family invested in this fund. Our fund's now about $600 million. And in each case, I told them, yes, we offer this liquidity, but plan to be in this investment for two to three years, at least. I would almost take an illiquidity discount at this point.

I mean, oh my goodness, every day you open up the screens and the market's down four or five percent. I gladly lagged the public markets by a little bit in order to not see the marks. Michael, that's a great point. My wife and I were taking a walk on the beach this weekend, and she has her MBA. We were talking about corporate finance theory and all that we learned. And the idea of the meme stock phenomenon, the idea that stocks could be grossly overvalued, not for a day or a minute or for a week, but for months on end, her professors, my professors, would have said when we were in school, which a long time ago, we'll admit, would have said

that just couldn't happen. That just couldn't happen. It didn't. It actually brings me to a related point, not original to us, but you will hear this from many of the large allocators to the private markets. So they're a pretty radical statement. Over the last 10 years, the private markets and the public markets have in some ways changed places.

20 years ago, almost every company that went. public was profitable. Over recent periods, a shocking percentage of companies that go public are not even profit. Moreover, all the activity, excitement, market cap, and the public markets tend to be around the cool, sexy sectors, a handful of sectors. Whereas the private markets are dominated by the real economy, industrial's health care, consumer discretionary. It's It's a really interesting dynamic that's occurred, and therefore we think that the tender fund structure makes sense for individuals. So if we contrast to the public-private thing, right now in the public markets, investors

have finally decided in the last 18 months or so, all right, we're not just caring about growth anymore. We're caring about cash flows and stability. And I guess that would be a good way to contrast something like private equity, the venture capital right now, where you mentioned those private businesses and private equity, most of the time, they're kind of boring businesses that people are taking over and there may be more predictable. They just need to be more streamlined or made more efficient. Is that a good comparison where it's more about cash flows and that sort of thing there? It is. In general, here's how we think about

it. Venture capital, growth equity, leverage buyouts. That's sort of the continual. And so the line between venture capital and growth tends to be profitability in general. That tends to be the line. And our first fund, C prime, we have very little venture capital. We do have a meaningful amount of growth equity in that fund. Over the last couple of years, venture capital has gotten pretty much all of the limelight in private equity, but it's a much, much, much smaller piece of the overall private equity market compared to its LBO counterpart. Can you talk about that?

Yes, and it's absolutely true. I don't have those statistics in front of me. It is true that venture got a lot of the headlines, and meanwhile, regular way leveraged buyouts and growth equity were chugging along, generating very attractive returns for investors on average. And what we've seen recently is a repricing of the venture market, which we think is going to make venture very interesting in the near term, but we've seen a repricing of that. And it tracks what's happened in the public market. I mean, the public markets, you've seen the highest flying technology stocks see the largest declines in their values. Bob, you mentioned that you do a lot of work with financial advisors in this fund. Is that the main way to access this for individuals?

And then maybe you can talk about some sort of the minimums and whether you have to be an accredited investor, just kind of the behind the scenes stuff that us as financial advisors care about. Is there a minimum per financial advisor? Is it per client? How does that work and who can access this fund? Our first fund conversive steps on private markets or C prime is this fund. Actually, I don't think we cover this. I want to make sure that I do. C prime invest across private equity, real estate infrastructure, private debt globally by investing in assets on the secondary market co-investments directly into companies or projects and then some primary funds. It's designed to be convenient, efficient, transparent. So we work primarily with financial advisors. And that is the way investors.

generally access our fund. You can go directly to our website if investors, if your financial advisor doesn't offer us, but we encourage people to work through a financial advisor. We're available to accredited investors, $50,000 minimum. And importantly, with this fund, you don't have capital calls and distributions, which we touched on earlier. You invest all your capital up front in a monthly subscription. Closings are the first of the month. And then we take it and invest it, we manage the cash. At year end, you get from us, actually in January, you get from us a 1099, not a K-1. So you're not forced to delay your tax filings waiting for your tax form from Conversus from C-Pr. You're actually getting a 1099. So 1099, $50,000 minimum.

What's the fee structure for this? We believe we're the low-cost provider in our market. So we charge 1.4% asset management fee, no promote or carried interest. So that's our entire fee. There are no acquisition fees, disposition fees, administrative. It's 1.4%. And importantly, we believe that our fees are right on top of what the large foundations, endowments, institutions that Stepstone serves with the same product, if you will, the same content, the same investments that we invest in. and C-prime are going into the portfolios of these large institutions. If Stepstone were investing for the benefit of Grand Valley State Endowment, we charge about the same thing, a little more. We charge a little more for retail, obviously, but not a meaningful premium.

Bob, you did your homework. I was a former Laker for my MBA there. I am aware of that. So I'm curious, how do you determine the mix between private equity and private real estate and private infrastructure? How does that work? Because there is no S&P 500 or total stock market index fund to private equity. So how do you determine that allocation mix? It's the hardest thing we do, Ben. So we're solving for three goals. Hit our target returns, provide the 20% liquidity and minimize risk, which is generally expressed as volatility. So those are our three screens. And we work among those asset classes and among secondaries, co-invested primaries to get the mix right on those three dimensions.

And so while the fund is primarily private equity, and I believe will in most instances be primarily private equity, if we see an infrastructure investment that meets the right criteria to get our overall investment portfolio. And remember, this is like a stew. That's the analogy I like to you. We bring in money monthly. We're having realizations almost on a daily basis. This is a continuous process.

So we're constantly investing in new transactions. We've done about two a month to date, and that's accelerating. And a transaction would be we buy a fund or a group of bonds. We make a co-investment. We're over a thousand companies today. So each time we make a decision to make the next investment, we're doing it with the lens. of those three criteria. Let's hit our target returns, make sure we have the liquidity,

and do so in the way that minimizes risk. And do you ever close these funds? This tender fund structure, is it open-ended? Or are you up to come up with another fund? How does that work? It is a continuous offering. It's certainly possible at some day in the future. We would close the fund, but it's intended to be a continuous offering. And we do think this fund, which is already $600 million after about 20 months of operations, we've frankly been thrilled with the reception we've received and from financial advisors, we think this fund could be very large and take advantage of those opportunities on a global basis. Given that retail is now coming into private markets and the markets are so much bigger,

deeper, more transparent than they are, it stands to reason that markets will get reasonably more efficient and that the low-hanging fruit was already plucked. It's not to say that returns can't be good going forward, but do you think it's fair to say that the wild excess returns of private markets from, I know the 80s is a long time ago, but it's a different world today. Even though you could still do quite well, it's not as easy as it used to be. Is that fair? It's totally true. It's not as easy as it used to be. And therefore, we believe, and our investment proposition is that the investment in data and scale are really, really important. So one of the reasons I brought our team to Stepstone was, I think we have the biggest commitment to data and analytics

of any firm like ours in the world. We have 60 people devoted to data science and engineering. We have a PhD in mathematics that works directly with our two portfolio managers on our fund C prime. We have proprietary technology designed in-house at Stepstone that allow us to evaluate opportunities on those metrics I mentioned and determine not only is it a good deal that we think it's going to hit the return characteristics that we're looking for, But also, when is it going to generate liquidity?

And so imagine we're buying a portfolio, and we did this, a portfolio of funds from a Sarvan wealth fund that decided they could do it better than general partners themselves and they should sell their funds and go into direct co-investing. We were there to buy some of those funds, a couple of hundred companies in 10 or 12 funds that we bought in one project, one transaction. our ability to underwrite each of those companies, hundreds of companies in those 12 funds, and predict when they are going to reach liquidity, when those funds we bought might call capital from us, because you remember we're responsible for that, and then look for correlations

in results and what-ifs across that portfolio. It requires a massive investment in technology, and frankly, I think it is one of our competitive advantages. The other one is scale. So when you invest as much as we do in the private markets, we are certainly one of the largest. I'm not aware of anyone who invest more than stepstone in the private markets on a global basis. Then the general partners who are closest to these deals, closest to these funds, we have very good lines of communication with them given the support we provide to their new funds. Let me put it that way. If we see a turn in some of these markets, we've obviously seen an adventure, but if we see it in private equity and maybe

some credit, because we haven't really seen too much destruction there yet, and if the economy turns, which maybe it will, maybe it won't, I assume that you guys are well positioned for that given the amount of money that you have coming in, that you can use it as an opportunity to be buyers at more attractive valuations? We really do. One of the great advantages of this evergreen structure or continuous fund structure is you're basically dollar cost averaging. So we've been raising $40 to $45 million a month. I think that will go up over the next several months, given some of the platforms that have joined on. Let's put that aside.

So that new capital, we enjoy the benefit of investing on a monthly basis, allows us to take advantage of the dislocations that occur. So historically, dislocation uncertainty have been great times for private market investments. And back to your earlier question, that's the time when you can generate. excess return beyond the illiquidity premium. So we believe we're well positioned to do that, and we're well positioned again because of our commitment to data and our scale. I've heard a lot of people say the private equity industry really came up starting in the 80s, and interest rates have been falling ever since then. Is there any credence to the argument that higher interest rates are going to make it harder for private equity or does it just make it

harder for everyone? I'm not sure it affects private equity more than other asset class. It's certainly true that some of the debt in LBOs is floating rate. Now, the managers of these funds, these general partners are excellent financiers, and so they certainly know how to price hedges and caps and that sort of thing, and they know how to manage interest rate risk. But they also manage companies that have the ability to pass through price increases and their products, which with the benefit of leverage could actually generate positive results. Bob, is there anything that we didn't get to that you wanted to cover? Yes. One topic we haven't really mentioned on is how we invest, how we're allocated. So a great

strength of C-prime is we're investing alongside in a pro rata way, Stepstone's 120 large, sophisticated institutional clients. So when a secondary opportunity comes available, I mentioned the sovereign wealth fund that decided to get out of fund investing and be a direct investor, we get our pro rata allocation of that transaction, the one I'm mentioning is called Project Treefrog. We got our pro rata allocation of Project Tree Frog based on our size and our budget for the next year in terms of what we're going to invest in secondaries. And we're not only getting that in the same transaction, we're getting the same terms. I believe that transaction was about a 12% discount in that asset value.

So if the very large state pension plans that we represent, the large sovereign wealth funds, they got those assets, let's say, I think it was a $300 million transaction, give or take. We got about $25 million of that. If they bought it a 12% discount, we bought a 12% discount. So this is very different than crowdfunding, do it yourself. This is truly institutional caliber. institutional pricing and a wrapper that we believe is investor-centric. We think we're the lowest fee provider. We make it as easy as we can, convenient to do business with us with a $1099 and a $50,000 minimum, and then transparent. No surprises, no hidden fees. We put on our website exactly where our returns are coming from. We've talked about realized gains, markups, discounts, our quarterly report. You can see exactly where we're getting our results. I think we're the market leader and transparency. So I think those are the things that distinguish us from most of the other private market opportunities. Bob, where can we send some advisors to learn more about conversus?

conversus.com is the best source for information about us. And of course, we do have a sales team that covers the country and the map for that and the names of the individuals are also available on our website. Conversus.com is your best source. All right. Great. Thank you, Bob. We'll put a link to everything that we spoke about in the show notes. We appreciate you coming on today. This is great. Thanks for the good questions, guys. This was fun for me. Thank you to Bob. Thank you, Conversus. If you want to learn more, go toconversus.com. Thank you.