Hugh MacArthur – Private Equity’s Challenges and Opportunities (EP.453)

23:34And we had yet to really enter into that game. The first thing I did was I called up all of the senior people I could think of from around the world. I called in people from Singapore, from London, from New York. We descended on the Middle East in the GCC in mass. And we spent about three months prepping for this make-off in the industry against all of our competitors, because we really wanted to win the work. We stepped up on the day we were fortunate to carry the day and win the work. And that began a 15-year wonderful relationship with a large sovereign Wealth Fund that was really the anchor client in us building out the LP side of our business.

24:12We were fortunate that not many people start with the largest, most sophisticated investor in the world. So it wasn't like we started with a very small LP and moved up. We started with, in some ways, the biggest challenge possible first. And then that allowed us that experience over time to work with a variety of other investors in other spaces. The LP world is very diverse. We started out at the sovereign wealth fund level, but that's gone all way down to family offices and pension funds and insurance companies and banks, endowments, all the different types of institutions that invest in the private equity world we have now worked with.

24:46And the interesting way that we're organized that I think clients appreciate is that we use the same group of people to work for both GPs and LPs. So clients know that the team that's working for them can see both sides of the coin. They understand what's important to a certain set of LPs and they understand what's important to GPs. We're able to integrate those two sides of the coin to get a win-win. You can't have a win-lose transaction in the LP-GP relationship. It's a relationship that's supposed to last over time and stand the test of time in an industry where it takes a decade or two to know what the heck's going on and how things are going in terms of results and how we're really dealing with one another.

25:25When you think of it as a relationship, it behooves everyone to understand the motivations, the needs, and the strategy of the other parties so that you're able to actually try and fit what you're doing into that context. What is it that you do with the LPs? LP work is actually very similar to GP work. They need an overall strategy. Where do you want to be in five years? What's your ambition? Typically, there's obviously a level of financial return that's involved in that. There's an asset mix, a desire that's involved in that. There are organizational issues that are involved in that. Some of these organizations are quite different.

26:02LPs are quite different from one another. The question would be typically asked, they can see many and oftentimes their cash flows out into the future in terms of the cash that will be coming in, the checks that they need to write, if they need to write checks. And they'll say, well, we're a 200 billion AUM organization today in seven years, we'll be 500 billion. How do we organize for that? What does that mean? What do our departments look like? What does our decision-making structure look like? What do we need to do to manage risk better? There are organizational pieces of work that we do. There are operational pieces of work that we do.

26:31How do we think about one asset class versus another or within an asset class? What does investing excellence look like from the LP side of the coin? So how should I think about positions in different GPs? And how should I think about co-investment? And how should I think about strategic partnerships with GPs if I want to be doing that? What's the universe of things that are out there? And what does that imply I need to be doing as an LP to be a good partner for my GPs? There's two sides of the coin. Everybody thinks about the GPs go and they get money from the LPs, so they need to come and be good and give the LPs things that they want.

27:04Well, that's absolutely true. But on the flip side, if the LP is asking for co-investment and the GP is providing it and saying, I've just got this deal. Here's co-investment for you. I need an answer in a week. And you're an LP and you say, my investment committee meets once a month. It's next three weeks. That's not good partnership back to the GP. So we need to try to work with the LPs to say, This is how this is going to work from the other side of the coin on the GP side. And therefore, if you'd like to have co-invest, you need to be set up to be able to respond when it actually comes in the door and be able to do it in a way that makes sense to the GP.

27:39There are a lot of different things we do for the LP world. It starts with strategy, but definitely goes to operations and organizational work as well. So you are sitting on top of so many relationships on really every side of the industry. I know you try to bring it together in an annual report and then a mid-year update. How did that report first come about? That report, I think we've done it 16 years now or something like that, came about, I remember this very, very clearly because I was very irritated, which was part of why it came about. We used to read in the media that one of our competitors would potentially partner with some academic institution somewhere, and they would come out with some article that would be printed about private equity and what was going on in the world.

28:22and most of the time I thought it was wrong. We kept seeing it episodically again and again, and it just became like this little annoyance that there were things out there that were being put out into the public domain that were just incorrect about the private equity industry. And finally, a few of us said, we do more of this work than anyone. We know what's going on better than anyone. We need to correct this issue. And it wasn't, let's go do an article and put it in the Wall Street Journal or Financial Times, because that's forgotten in two days. So we wanted to create something that was more lasting.

28:51And we thought, what if we do an annual report? What if we try and get the actual facts of what's happening in the private equity industry? That's a very hard thing to do because there's no one source of information that will tell you everything when it takes years and years to really understand whether investments are paying out or not. You can spin things in many different ways. And it is hard to get to the truth. I used to say, tongue in cheek, there are lies, damn lies, statistics. And then there are facts about the private equity industry right over here on the edge. So step one was, let's see if we can correct some of the factual errors and say, this is what's going on in the industry.

29:26And then also in the annual report, talk about some of the major trends that we see or something that's hot. It could have been a geography. It could have been a subsector. It could have been a style of investing, something that's going on that we think people should know about because we see enough of it to know that it's a trend. And then we spend a little bit of time in the report talking about what we see is potentially happening in the future. So a little bit of cloudy crystal ball gazing about where things may be headed in the industry. It wound up being extremely successful, well beyond what we actually ever had thought it was going to be.

30:00That's the origin story. I'd love to dive into what you're seeing now. I think we are at an inflection point in the private equity industry. At a macro level, we see continued penetration of private assets. One of my friends said it very well, With the public markets, you've got 90 % of the world's money chasing 10 % of the world's investment opportunities. The private markets are the opposite. We have 10 % of the money chasing 90 % of the world's investment opportunities. There's going to be a rebalancing of that over time, which means that the private markets are going to be supersized. Against that backdrop, if you look at something like private equity, we do have some temporal things going on that are setting the stage for an inflection point that will really separate those that thrive in the future and those that are going to struggle or not be here in the future.

30:46The best context I can set, Ted, is that we went through this period of about a decade where we had a zero central bank interest rate structure in the US and Europe for most of that time. That was the anomaly. People kind of got used to it as normal because it lasted for over a decade, but we had a wonderful capital cycle of people investing and interest rates being low and GDP growth being positive and compounding and multiples just going up and up and up. So I could buy something and four years later, sell it for a higher multiple. And the world was great. And raising money was pretty good off the back of that.

31:19And the industry made great returns. In the last five years, we've seen the opposite of that. We've seen a whole bunch of 12 to 18 month periods of chaos, if you will, starting with COVID in 2020, then moving on to unprecedented inflation for the industry that led to unprecedented rapid rises in interest rates for the industry. And now we're dealing with tariffs and policy that are roiling the markets over time. There's been every year, practically since 2020, an industry freak out of, oh my gosh, let's look at the portfolio again. Here's something else we haven't seen. What do we do? How do we do it?

31:52And what that period of anomalous zero interest rates and then these periodic upheavals have massed is the continued maturation of the industry over time. Now we're pulling our heads up and looking at a world where we've got very high prices because things are expensive and there are lots of dollars chasing the same investment opportunities. We've got costs that are increasing for GPs because you need to find new sources of capital and compete harder for the capital that's out there with traditional institutions. Everybody has recognized now that half of the world's wealth is with individuals and those individuals have almost no exposure to private asset classes and private equity would like to go and get that, especially in an environment where institutional sources of capital are pretty tight right now.

32:40All of that upheaval has caused a great difficulty in the industry being able to exit the investments that they have. So the liquidity issues for traditional LPs are real and the competition for that money is extremely intense. So there's a big push into private wealth because folks like you and me are not necessarily investing in the industry the way that institutions are. And GPs have woken up to that. They're saying that's where the exposure is. That's where trillions of dollars are. I need to be better at that. Well, that costs money. I'm going to have to have more people on my payroll chasing small checks than I am chasing very large checks from large institutional investors.

33:16It's just a fact. Also, the cost of getting the subsector expertise that we're talking about is going up. I've got to be sharper at what I'm doing, my investment theses, my subsectors, how I'm doing it in a more competitive world. My cost for value creation is going up. I've got to continue to develop and maintain an ecosystem for adding value. I don't know any GPs that are saying my costs are going down. So prices are high. GP costs are going up. Also, fees per dollar of AUM have been going down. Folks will say, well, no, the numbers on the books that I see are pretty much the same as they were five or seven years ago.

33:47Yeah, that might be true. But this thing called co-invest. 15 years ago, co-invest was a hobby. Some people asked for it. Some people didn't. Some people didn't care. Now, co-investment is about 30 to 40 cents of every dollar that's invested in the industry. Depending upon the GP, there are some GPs whose dollar of fees per dollar of AUM have gone down by 50 % over the last decade because of co-invest. Then there's some folks that write very large checks, which they know are in short supply. They don't want to pay the number on the book, and they're not. You've got an industry that has got high prices, which means the margin for error is low in generating returns.

34:22You've got increasing costs. You've got pressure on fees. That implies to me, you better be ready to succeed and have a strategy going forward for the next five or 10 years because these forces aren't going away. The industry is maturing. The competition is intensifying for the people, the deals, the sources of capital. So what's your plan. Are you going to be an alpha generator? Do you have a differentiated way of doing things that you could build moats around that other people are not going to be able to penetrate? And do you feel confident about that? Great. Then you can build a plan going to try and do that.

34:53Are you going to be a scale player? Are you going to be a consolidator? Are you going to buy up other GPs because you're public and you realize that in the public world, your growth and fee bearing AUM is what the markets are looking at. And you need to do that organically and inorganically. So bigger is better. And you want to be the consolidator in the market? Or are you somewhere in the middle and you've realized that your highest and best strategy might be to be part of someone else's story? Should you consider selling to somebody else who's going to be bigger over time? I'm simplifying, but some mix of alpha generation, scale, et cetera, is becoming more and more important in the industry.

35:29And if you don't know how you play and how that's relevant, it's going to be really hard to raise the right amount of capital to do what you want to do, to get your deals that should be your deals, and to get talent excited about working for you. The interesting thing about those three things, Ted, is that if you fail at one of them, you fail at all. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past? Partner with a company that's been defining the future of dealmaking for nearly two decades instead. When it comes to M &A innovation, SRS Aquium has reshaped the way that deals get done, streamlining processes for maximum efficiency and minimum headaches.

36:15Professional shareholder representation, online M &A payments, digital stockholder solicitation, SRS Aquium pioneered each and continues to set the bar for game-changing innovation. So leave the days of disjointed deal management behind and define your future with SRS Aquium, the smartest way to run a deal. Learn more at srsaquium.com. That's S-R-S-A-C-Q-U-I-O-M.com. And now, back to the show. I'd love to dive into some of these topics. And the one, certainly in the institutional market, you hear the most about now is this liquidity bottleneck. What is the data telling you about where we are and where we might be going from here?

37:04It's scary. In sounding the alarm on this, I'm very surprised that there's not more discussion going on about how serious a situation this is. Last year, the distribution to the private equity LPs as a percentage of their net asset value was 11%. Historically, this number is between 20 to 30%, which matches up with a four-year cash recycling cycle. Well, 11 % is more like 10 years, and no LP has a model that says, I'm getting my money back in 10 years. The last time that number was 11 % was 2008. 2008, we're entering the worst recession for 75 years. We're not even in a recession, and yet we're hitting a number that is correlating to the worst recession in 75 years.

37:49To make matters more challenging, the number that I just threw out at you, 11 % for 2024, in 2023, that number was 12%. It wasn't much better in terms of liquidity a year earlier. The number the year before that in 2022 was 15%, which again, is not much better. And everybody was thinking, oh boy, 2025 is finally going to be the year of lots of liquidity coming back. Investment banks were telling us their pipelines were full, GPs were optimistic. We were at incredible levels of activity in January. And then this word tariff started to come out in February. And that caused a tremendous amount of uncertainty.

38:26And the deal markets have slowed and gotten slower and slower since then. And right now we're kind of at a pause and people are saying, oh my gosh, are we going to have four years in a row of horrible distribution? By the way, we've never seen four years of these types of returns per net asset value dollar for LP. So this is an unprecedented liquidity squeeze in the industry. And last year already, we saw a 25 % decline in fundraising for buyouts as a result. This year, we're seeing a continuation of that. There was no fund in the buyout world in the first quarter that closed that was above$5 billion.

38:59dollars, which is the first time I can remember that happening in quite a period of time. This liquidity issue is in many ways unprecedented. In many ways, it's not fully appreciated because we're not in some global recession. There aren't things that are fundamentally broken in the global economy. So it's shocking that we're in a situation that's as serious as this is. And to give you a sense of the magnitude of the situation and what it's going to take to solve it, there are about 30 ,000 companies right now that are being held globally and buy out portfolios worth about$3.6 trillion. And about half of those companies have been held for at least five years, five years of sell time in the private equity world.

39:38We're talking about 15 ,000 companies and$1.8 trillion worth of value that LPs are expecting to see back really, really soon. For comparison, the entire TEV of the global buyout world last year was$600 billion. So that's three years of pretty healthy dealmaking just to clear that if that was all that you ever did. And of course, that's not all of what we're going to do. So we're talking about a five plus year problem as the GFC was in order to process all of this liquidity. This is not going to go away in 2025 or 2026. It's going to be continued pressure on the institutional LPs for liquidity over the course of the next several years.

40:14And I have no doubt, having been in the industry for 30 years and having the calls that the private equity business is over again and again and again be wrong, that the resiliency of this industry is going to come through in the end and that life will be fine. But the magnitude of this challenge is underappreciated because we're not in some other larger crisis that causes you to focus on it. As you look at that from a GP lens and the different avenues they have to sell businesses, IPO, strategic, sponsor to sponsor, what's preventing this volume of the last few years from accelerating? We can take out the tariffs and uncertainty.

40:51There's a couple of things doing that. One of them is mindset. It's important to understand that. one thing that many GPs learned coming out of the GFC is that if you just held on to a business long enough, life would be fine and you'd be able to sell it for the number that you wanted to sell it for. And that was true. There was a lot of concern. Maybe we're not going to make money on these businesses and we should just give the keys to the banks. But the GPs that held on to the assets for as long as they needed to, five years, six years, seven years, found that when the economy ameliorated, when interest rates ameliorated, they could sell and earn a reasonable return.

41:24When you thought you were going to lose your money, if you get a 10 or 12 % IRR on it, that's actually a home run. So the mentality of the entire industry is, let's just hold it until we get it fixed and it's right. That can be great for any individual firm, but when the entire industry does it, it causes a massive liquidity crisis. And that's what we're seeing right now. The LP community is getting louder and louder with a voice saying, we don't care about maximum return. We don't want a fourth year of high illiquidity in this asset class. Because remember, there's still a trillion dollars of dry powder out there for buyouts, which means if the GP picks up the phone and says, I need your check, the LPs are writing the check.

42:00And yet they haven't seen much money back in the last four or five years. That's a real crisis. The LP community is saying, we'd like to see the cash come back, even if it's at a lower return than you know you can get in three to four years. There's a fascinating dialogue going on right now. And we're starting to see for the first time things being sold at numbers that are probably below the targets where the GPs wanted to sell the asset at because they know at some point in time, they're going to be back out on the road, raising their flagship buyout fund. And if they haven't returned capital in a whole bunch of years, it's going to be tough to do that from the same LPs.

42:33And you've got another effect that makes it difficult to raise money, which is that if I haven't been writing you lots of checks for the last three or four years, and we've been through the COVID bump and the inflation thing and all these other things, if I'm an LP and I'm looking at your marks. How do I know those marks are accurate? How do I know you can sell that business for that? We've been through a whole bunch of things and I know you think it's worth X and I know you think you'll make it right and you'll sell it for that in the future, but I don't really know what that's worth. So if you're out raising a new fund and you haven't been returning a lot of capital to your LPs, there are a lot of challenges out there.

43:07When you look at the different exit avenues or the IPO market hasn't been around for a long time in mass, strategics have tremendous uncertainty in the economic environment. You're left with this sponsor to sponsor activity. If you're a GP looking to buy a business, you're a GP looking to sell a business, there's this feeling of a gap in the bid-ask spread. How is that playing out in the deals that are getting done? It's playing out in a lot of different ways. The sponsor to sponsor activity was up in 2024. I take that as a good sign. The bid-ask spread problems are getting a little better, meaning interest rates have come down a bit.

43:45We've had two years of non-recessionary GDP growth, that means EBITDA has gone up a little bit. And the more of those things kind of happen, the less the spread is an issue. We've also seen that deals that are faster growing companies where debt has been less of a percentage of the capital structure. So a lot of fast growing businesses may only have 30 % debt on the capital structure and 70 % equity. So the bid ask spread issue is less of an issue. Some of those software businesses that are doing really well are able to trade at good amounts. Some things in healthcare that are growing really rapidly are able to trade.

44:15So If you have less debt in your capital structure, it's easier to get a deal done two years down the road from when interest rates really spiked up over those 18 months by 500 basis points. But it's in those kinds of industries where people have comfort that we're not going to see a recession that will impact it, or we're not going to see macro issues that will be a problem. And we're seeing the kind of balance sheet EBITDA growth movement that will allow us to refinance a deal and make the numbers work for the seller and the buyer. Now, we're also seeing all other kinds of creative activity.

44:47We're seeing continuation vehicles in the secondary markets. We're seeing partial stake sales, which LPs like very much because it means the original GP is keeping substantial skin in the game while monetizing part of the investment, but not all of the investment over time. So if I can't exit fully because I don't have the right balance sheet EBITDA growth mix, then I'm trying to figure out, can I exit partially or in a different way that will actually make LPs happy? I've spoken to a lot of LP groups over the course of the year. If I'm in person, I do show hands polls. And if I do webinars, I'm doing digital polls.

45:21And two thirds of the hands that go up in the air or votes that get clicked are always we want to see more 100 % cash outs. So the LP world says, I love all the creative stuff you're doing, but just give me the check back with the return because that provides certainty for the LP. To the extent that the thread through that is businesses that are doing well are the ones that get sold or have a partial sale. What does that leave behind in the portfolios of both GPs and ultimately the LPs? That's the big question everybody's asking. What we know is that the average GP has twice as many businesses in their portfolio than they had 10 years ago.

45:57That's a lot of companies to look after. GPs are not house flippers. Companies are organic things that need to actually be tended and they need to be pivoted, reprogrammed, or some other ways improved in order to get on an exit path. That can take 12 months to 24 months. If you need to really re-pivot something or rapidly accelerate performance, that takes planning. That can take investment. That can take time. There are lots and lots of companies out there that are doing buildups. Buildups are, I started with a platform and I added one or two companies to it, or I added 22 companies to it. I added some number of companies to it over time, and then I'm going to sell it.

46:32Imagine you were a GP that was halfway done with your buildup when 2022 and 2023 happened and interest rates went up 500 basis points over 18 months. Well, I'll bet there's a lot of stalled buildups out there with those kind of doubling of the interest rates. Now I don't have 5 % debt, I have 10 % debt that I'm trying to put on it. My buildup doesn't work at 10 % debt, that wasn't the model. So what does one do with a halfway done leverage buildup in order to create value if I can't do the rest of the buildup part of it. There's questions like that that are the big ones where you have to think, okay, I have a valuable asset here.

47:07I can't go with plan A, but I need a plan B or a plan C. And so what is plan B and what is plan C, which may be completely different than plan A, and then have time to execute on that, show traction, show real results, and give people confidence that it's worth a certain multiple upon exit. With some of these assets, it will take time if they require a substantial re-pivot in order to get them into a position where they can be liquidated at an attractive rate of return. When you look retrospectively at this environment of low interest rates, increasing multiples, and good returns for all private equity, without the likelihood of multiple expansion, you've got higher cost of debt.

47:47How does the historical experience inform what might need to happen on operational improvements so that private equity can drive returns in the future? The data is really, really clear on this. If you look at the last 14 years of realized returns, roughly speaking, 50 % of the returns of buyouts have been due to revenue growth. 50 % has been due to multiple expansion, largely owing to the low interest rate structure that we were talking about. And zero has been from margin improvement. For a dinosaur like me that's been kicking around this industry for over 30 years, having 0 % of the value creation on average come from margin expansion is unthinkable.

48:26This entire industry was founded on buying unloved industrial businesses, fixing them up, getting them to run more effectively, and then selling a better business for a better price. That's the history and the DNA of the buyout industry. We had this anomalous 10-year span where I really didn't have to do that because I had this zero central bank interest rate, constant GDP growth environment that was creating multiple expansion, along with the fact that the industry fell in love with underwriting growthier assets, fast-growing software businesses, fast-growing healthcare businesses, and multiples went up and up and up over time.

49:02As you pointed out, I don't think we're in that environment anymore. There are certainly, in some cases, opportunities for multiples to go up with certain assets, but I don't think the industry can bet that the amount of value that was due to multiple expansion in the next 10 years is going to look like it did the last 14 years. Therefore, what do I do about that? Well, I still need my revenue growth, that's good. But that margin expansion on average cannot be zero going forward if we want to have attractive returns. I mean, margin expansion in both senses. One is, yes, there's still value investing and there's room to take out cost for businesses that are bloated and that need to be streamlined and made more efficient.

49:39But with all of these fast growing businesses, whether we're talking about software or healthcare IT or fintech, whatever you're betting on that's growing fast, we need to get real operating leverage. All the cashflow can't go into customer acquisition and customer success or wherever it's been going that's caused a lot of these businesses that have grown real fast to not grow margins or even have margin shrink over time. So getting back to and learning how to make margin expansion really a part of the value addition equation is going to be the critical asset test, I think, for this industry to continue to generate really attractive returns going forward because you only got two controllable levers, one's revenue and one's margin expansion.

50:18The multiple is going to be what it's going to be over time. And most firms that I know don't model in big multiple expansion as a way to success because you just can't control that. If you look at some of the types of deals that you would think would lend themselves to that operational improvement, more value buys than growth buys, carve outs, things like that. What's the history shown of the success of those types of deals over the last decade? Over the last decade, the data is not as good as it was in the decades before. Part of that is the competition for a lot of these deals has gone up over time.

50:51So carve-outs is a good example. Our average carve-out prior to about 2012 was a 2x deal because the industry had figured out that unloved businesses that weren't part of somebody else's core, but were good businesses in and of themselves could be invested in and you could get revenue growth, margin expansion, and multiple expansion on the back end of the deal. The problem is when everybody figures that out and everybody starts looking for carve-outs, then the prices go up. And a lot of that you have to pay for before you even get the asset. Now, in the last decade or so, the average carve-out is earning more like one and a half times and trailing the rest of the industry.

51:27It used to be the best source of deals in terms of value. Now, it's one of the more challenging sources simply because it's known as a source and you have to pay for some of that. I also think that this question of really generating operating leverage for growing assets is a big challenge as well. You can see that the asset's going to grow. You can see that you need to invest for that growth, but how to really create operating leverage while you're doing that is not something that a large part of the industry is familiar with as an investment thesis. And it's relatively new. In the 1990s, if you said, hey, let's go get some software businesses and lever them up, and that'll be a great way to do a buyout, people would have laughed at you.

52:04That was not the buyout industry. And now it's the single biggest sector in all the buyouts. And some investors, of course, have figured this out. The rule of 40 is now the rule of 50, 60, or 70 for some folks that do it every day. But a lot of other folks have noticed these are attractive areas, but they haven't figured out how we actually do that and make sure that EBITDA goes up at a rate that is equal to or greater than revenue growth. So much of what we're talking about are real challenges going forward. And then there's this fundraising trend of all this money of wealth that's going to come in.

52:37How is that balanced between the institutions that are not piling money back into private authority there? And then you have this interest in wealth. How do you see that playing out? I think the answer, Ted, is yes, we do see that money coming at speed because individuals would like to have access to private markets. And why is that? We've learned over the last 15 or 17 years, taking the United States as an example, that the number of public issuances is less than half of what it was in the early 2000s. And a few tech stocks tend to dominate how the market performs. That can be a wonderful thing because those tech stocks have done great.

53:16But at some point, individuals say, well, I have enough of that exposure to NVIDIA. What else have you got? And their advisors are telling them, you need to diversify. You need to diversify away from these few stocks in these few areas that are actually providing a lot of fuel for your portfolio growth, but you need other things in there to be more diversified and safe in case something happens, that's private assets. So advisors are recommending it. Individuals want it. It is the great whiteboard of capital that's out there. So GPs want it because others are liquidity constrained right now. Traditional asset managers want it.

53:49If you're a Vanguard or a Fidelity or a BlackRock and you're selling ETFs at 10 basis points, that's what you're charging for them. How'd you like to sell some private product at 100 basis points or 200 basis points or 300 basis points or pick your price. They're pretty interested in that as well. Everybody in the industry wants this to happen. In my experience, when everybody wants something to happen, it's going to happen. The question is just how rapidly is it going to happen and what kind of an impact is it going to have? I mentioned half the world's wealth is in private capital. If you just assume five or 10 % on average of somebody's portfolio is in private assets, that's trillions of dollars.

54:23That's doubling the private asset industry. So you don't have to believe that you and I as individuals are going to have half of our net worth into the private markets to believe it's going to have a huge effect. It's just a question of how rapidly are the right products going to be made available and distributed and how rapidly are people going to be educated about these types of opportunities. We run surveys every single year of ultra high net worth individuals and we ask them, can you name three respected private asset managers for us? And the number one answer every single year is I don't know.

54:57As long as that is true, we do have an educational hurdle to get over before people are going to be piling into a lot of private assets. But I think like everything else, the industry will get over this issue. There are some institutions that are big enough to build their own brands and they are building brands right now. There are other institutions where the brand is already well known. I mentioned the Black Rocks, the Fidelities, the Vanguards of the world. A lot of people know those brands. And if they start selling private product and start educating people that for your 401k, you should have a little bit of an allocation into private equity, then that's going to work.

55:30That's going to be their task to do. But the brand is known, at least, of the intermediary that's providing the access. And so it'll happen. And it's happening much faster than I would have predicted two or three years ago. So I do think that we're going to see private wealth at scale in private markets very, very quickly. As you look at the industry landscape as a whole, who do you see as the winners and losers going forward? That is one of the hardest questions to answer. My friend, Jim Colter, over at TPG said that the private equity industry is like a Rube Goldberg machine. And for those of you that didn't waste your childhood watching Three Stooges shorts like I did, a Rube Goldberg machine, it's a massively complicated machine that actually does something very simple.

56:12So it could go through three rooms of different mechanical things that all happen and bump against one another, and then it puts the lever on the toaster down and the toast goes down at the end. And he said, the private equity industry is a Rube Goldberg machine, because what we do is incredibly simple. We buy companies, we make them more valuable, we sell companies at a profit. And yet all these subscription documents and K-1s and reporting and all of the hoopla around it is incredibly complicated to work through. And that was all fine when it was a cottage industry in the 1990s. And it was a few folks with LLC agreements buying a few companies.

56:44Now that private equity is a$5 trillion global industry, it's not fine anymore. And this is part of the change that's going to have to happen for individuals to invest, for the industry to continue to grow, is that we need to streamline the machine, use technology, get it into the 21st century. And that is happening. So who's going to win in that environment, to me, really comes down to a couple of things. It's number one, you got to recognize this is what's happening, whether you like it or not. Number two, you're going to have to have the scale in order to participate in this, because it means as a GP, you're going to have to invest in technology.

57:19You're going to have to invest in private wealth and retail capital. You're going to have to invest in new processes that are going to be different than they were in the past. Or you need to be specialized enough that you're an alpha generator that people feel like they have to have because you know how to do things that other people don't know how to do as well as you and you can repeatedly do them and you've proven it and therefore you're the shiny thing in the window and there's always going to be appetite for that to juice alpha and juice returns over time. The challenge is going to come for folks that are trapped in the middle.

57:47If you've done really well, but you don't quite have that size to make the investments required to be part of the dismantling of the Rube Goldberg machine, and you don't have the alpha generation capability to be able to deliver outsized returns going forward, are you going to be able to find enough support and access to things like the private wealth channel or other channels where the bar is going up? The other correlation to this is that institutional investors that are part of this liquidity squeeze that we've been discussing, they're going to continue to write checks and invest in private equity, but it's going to be much more of a zero-sum game.

58:19If I'm going to get an allocation from a certain LP, somebody else is probably going to lose their allocation from that LP. So the bar on commercial excellence and relationships and making sure customer success actually happens is going to go up for those institutional investors, and that adds more cost. So if you're not quite big enough to be able to do that and do it well, and you're not quite differentiated enough to create alpha reliably in an LP's mind, it's going to be hard to see how those folks win. There are only a few firms today that are large enough to be the likely scale players. What are the elements of strategy that you tell someone who may not clearly know exactly where they fit in and are worried that they might not be one of the winners?

59:03It really starts with your DNA. hey, how have you been so successful over time? What is it when you're at your best that you do that has uniquely driven your success? Coming out of a world where we had these very attractive structural economics for the industry where everybody could earn a lot of money as long as you were doing smart deals over time and getting into a much more intensely competitive world, you need to sharply distinguish and specifically articulate what it is that you do well. There needs to be a there there, which for most firms that have been around for a while, there's a there there.

59:38That's why they've been for a while. But what is it? Can you write it down on a piece of paper? Because you're going to need to explain it with a much higher degree of specificity than you have in the past. And you're probably going to have to invest your resources even more in making sure you continue to do that well at a very, very high level and that you don't do certain other things that you may not be as good at, that you may have sort of diverged into over time. It's not that a lot of these firms that are good, that they can't reach areas like private wealth unless they have hundreds of people out there.

1:00:07Yes, it does cost more money. But if I have relationships with private wealth managers, with traditional asset managers, with investment advisors, there are ways to go to market that are actually not all that expensive, that don't require hundreds of people. But what I tell clients is if you're a mid-sized firm and you're not thinking about this now, then a lot of the choices may be taken away from you in three to five years because you're not planning out where you proactively want to go. On the other side, if you're an institutional LP that is down the middle, meaning they have a relatively mature portfolio, they have some of the similar liquidity issues than others, how do you advise LPs to think about their strategy going forward?

1:00:46LPs are on the other side of the coin, obviously, and they need to think about having more structured conversations with their GP partners. It's a relationship. Many of these relationships between GPs and LPs have been around for decades. It's a different type of conversation. The conversation begins with, talk to me about your portfolio. Talk to me about your liquidity plan for the next three years. Typically, many GPs, they sell something when the MD that led the deal said, we're ready to sell, let's go. I don't want to have that conversation. I want to have the conversation around, show me your whole portfolio.

1:01:20Let's talk about the next three years. When do you expect things to go? Why? And at what sort of level of return? So I can help with my cashflow planning. Let's have a structured conversation about the entire plan for that. That's something that happened in 2008, 2009, when too many people were thinking that the private equity portfolios were all going to go bust. I don't think anybody's worried about that, but people are worried about when am I going to get my money back? So let's talk about a three-year window and you take me through the whole portfolio is discussion one. Discussion two is how prepared are you for the future?

1:01:50On the LP side, the world is changing. We've talked about a lot of those elements that are going to change in the future. So you, Mr. GP, I want to have a conversation with you about your strategy and why you're going to be a winner five to seven years from now. Tell me about how you anticipate your fee income changing over time, given these things like co-invest in the market and where you're sourcing capital and tell me your plan for sourcing retail capital. Because as an institution, I want to know that I'm still important to you over time. How much retail capital are you going to raise? What are your costs doing?

1:02:20What are your fee-related earnings going to be? How many LPs have ever asked a GP what their P &L looks like? Yeah, the public ones have to report it every quarter. 99 % of the industry never has to report it. That's a conversation that never happens. And LPs need to start having this conversation. So the work we're doing with LPs right now is helping them prepare for the next five years and figure out what their liquidity issues are going to be by talking to their GP partners and just having conversations they haven't had before. As you look out at your business in the practice area, how are you thinking about how that will evolve over the next several years?

1:02:55As I mentioned earlier, Ted, we think there is almost an inexorable movement toward more money pouring into private asset classes. So we will continue to broaden our business when we first started. we literally just looked at buyouts and private equity. And now there is venture capital, growth capital, all different kinds of flavors of ice cream and private equity that didn't exist back in the 1990s. We have private credit that's 6x the size it was 15 years ago that we now work in, infrastructure, real estate. There are many, many different private asset classes that we now spend our time working in with GPs and LPs that are growing and getting supersized that were just not as growthy when we first started the business.

1:03:37So for our practice, it's doing a lot more things with a lot more people, which drives a lot more questions around strategy. And for our own business and how to do that, we're in the physician heal by self mode, which is AI is changing the world. We know that's going to happen. That's going to happen in consulting too. So what do our set of solutions need to look like for our clients to make sure that we get them speed to insight on the front end as fast as humanly possible or machine aided humanly possible? and how fast do we get speed to value once they actually own something? This whole discussion of AI, it does remind me of the personal computer industry.

1:04:14I think that the full impact of AI is going to take a lot longer than most people think from just reading the newspaper or consuming media. But I do think that ultimately it will be much more deeply transformative to every business in the future than now. And what I think back to is my days as a college sophomore. When the Macintosh computer was invented, which is 1984, every student was required to buy a Macintosh. And so the computer revolution was here. We're all going to have a personal computer. We're all sitting in our dorm rooms, which were wired into the computer center. And we played games on it most of the time.

1:04:48We wrote papers on it and we played games on it because there weren't many apps for the computer back then. There were not even hard drives back then for the computer. And so for about 10 years, there was a huge hype over PCs in everybody's house. But if it's a glorified typewriter, there's not that much that people were going to do with it at home because there was no app for that. And in the 1980s and even 1994, 10 years in, there was still a question of, I thought this was going to transform the world. And it really hasn't. Then, of course, the Internet came along and became popularized two to three years after that.

1:05:19And things really started to take off. But my point is, we're now at the iPhone. and the iPhone has changed everybody's life in incredibly dramatic ways that no one would ever have thought of in 1984, looking at that Macintosh computer. The Mac took a long period of time on the PC to actually do what it was supposed to do because it lacked apps, but the Mac has kind of morphed into the iPhone in most people's lives. And I think AI is on the same kind of trajectory. It's gonna take a while to get going. We're in the experimental phase, whether it's consulting or some other business, but boy, when it gets going, I don't know what the iPhone equivalent is going to be in every industry, but it's coming.

1:05:55It's probably going to be a lot deeper impact than we see. Hugh, I want to make sure I get a chance to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family? Boy, there are a lot of hobbies and activities that I have. I'll pick out one. I am a longtime frustrated gardener. I relocated years ago from Massachusetts, where it's very easy to be incredibly frustrated as a gardener, to Florida. And so instead of just failing at tomatoes, cucumbers, and zucchini, I can now fail at mangoes and avocados and grapefruits and bananas as well. I do enjoy getting out and getting my hands dirty and doing something just completely different and digging in the dirt and trying to grow things.

1:06:34And sometimes it works and sometimes it doesn't. But as gardeners, we try to hide our mistakes and then celebrate our victories. So I try to cover up the mistakes as quickly as possible. What was your first paid job and what'd you learn from it? My first paid job was back in 1981 as I was sophomore in high school. And I worked after school for a few hours a day at a women's clothing store after it closed. I vacuumed things and I cleaned the bathroom and I painted the bathroom and I cleaned things up. The most important thing I learned from it was I got fired from that job. I got fired because I didn't turn up one day.

1:07:08And I don't remember why I had something else to do that sophomores have in their mind. And I was thinking, oh, a couple of hours, I'll vacuum the floors tomorrow. It'll be fine. And I went in the next day and guess what? There was somebody else standing there that had my job. And I was fired after when I learned the value of you had better turn up because jobs are important to people and you'd better do them well. And you'd better get your mind in a different place because you think you're just cleaning up for$3 an hour. And that's a critical activity for someone who's trying to make their store attractive and trying to make their business attractive to their customers.

1:07:41It's a little bit of a painful lesson. It was a required kick in the pants for a 16-year-old, but I never forgot that. How's your life turned out differently from how you expected it to? My life in many ways has been way better than I would have expected it to. I was a daydreamer in college, so I kind of hoped it was going to be a good life. But the advice that I give a lot of young people as I reflect on my own life is that pretty much 90 % of the specific things that have happened in my life, I could never have planned for. I kind of had a macro journey in place. I wanted to go to college, get a job, thought I wanted to go to business school, get married, have kids.

1:08:16That's a very generic description of my life. I did all of those things, but all the specifics around those, I had absolutely no idea. So I had no idea I was going to go to the schools I went to. I had no idea I was going to work at a place like Bain. I had no idea I was going to be at the same company for 30 years. I had no idea I was going to meet my wife. I had no idea. I tell people, be open to opportunity because there's more opportunity in your life that's going to come your way for specific decisions than you can possibly plan. No matter how stressed out you are and you think you're a planner, there is no way you're going to be able to predict the specifics of what's going to happen and where.

1:08:51And you might miss some of the best opportunities if you try to organize your life that way. So I try to be open to possibility because I've learned that whether I'm open to it or not, things are going to probably turn out a little bit differently specifically than I had planned in the beginning. What's a mystery that you wonder about? A mystery that I wonder about a lot is the origins of the universe. I'm kind of a faith family and football guy, but I do a lot of reading about faith, about the origins of the universe, about the origins of us as a species. I'm interested in how man came to be, how faith plays into that, what it should mean for me every single day.

1:09:31And I try to learn about that. I read about it. I study it. I try to model my life after what I think I should be doing. And I find that that's a journey that I picked up when my kids were born. I'm trying to really understand the world that I'm in and what I'm supposed to do in a way that I hadn't spent a lot of time doing earlier in my life. And I find it challenging, intimidating, and rewarding all at the same time. What have you discovered from that exploration? I've discovered that it's a much deeper pool than I ever thought it was. And once you jump in with both feet, there are more and more things to learn than I had ever imagined.

1:10:05The cartoons of how things have come to be that I learned as a child are actually not cartoons. They're very deep ideas and very deep philosophies that very smart people have studied and learned a lot more about than I ever will. And so I'm trying to play catch up and pay attention and figure out what that means that I'm supposed to do in my own life going forward. Last one, if the next five years are a chapter in your life, what's that chapter about? I hope it's about successful transition. I am a dad of four kids. I have one that's in college. I have two more that will be going to college during the next five years.

1:10:41I have one that will shortly go to college after five years. And so we will become empty nesters during that point. I am not sure how my work life is going to evolve during that point in time. These markets are so different. And I'm trying to think about, well, what do I want to spend my time doing over the course of the next five years? And I'm 60 years old. I still have a lot of appetite to be busy and doing work. But exactly what I do in my day to day life is sort of a question mark with trying to successfully marshal kids off to schools and make sure that they're launching their own lives, which will be 90 percent uncertain, which I'm telling them to plan everything else in advance.

1:11:16I think the next five years, if I had the chapter, would be entitled Open to Possibility Amidst Transition. That's too long, but we'll call it that anyway. Hugh, thanks so much for sharing your keen and deep insights on this space. Ted, I really appreciate the opportunity to be on your show. It's a great show. Long time listener. And thank you.

1:11:53a good one and see you next time.