Mario Giannini & John Toomey – Private Equity Panel (Capital Allocators EP.309)

25:51How much risk are you taking on the falling knife? When you look at by number of companies, though, it's actually interesting. It's consumer, it's industrial. I think what we've seen is we see continued interest in healthcare writ large, anything kind of tangentially related to innovation. It really talks about innovation, but through the venture cycle and the venture market. And of course, that's where the bulk of it is. But innovation also reaches into the broader private equity markets and companies using innovation to enhance supply chain, to enhance the delivery of healthcare services. Those are where managers I've seen show some pretty interesting resolve and interest.

26:30Mario, thoughts? It's funny. I was thinking as John was answering that one of the curious things about at least this cycle right now is that there really isn't any predominant theme that says, oh, here's an incredible opportunity space like in tech. As John was describing, there are great characteristics behind these industries that will drive growth and profits forward. But I'm not really seeing places where people go, there's a pocket of opportunity because values are low or there's a capital shortage or whatever it is. This is not today, anyway, a particularly theme-driven market. As you look out a couple of years, Mario, you alluded to the denominator effect.

27:12What are you seeing in terms of the LP demand for funds as they're thinking about the next fundraising cycle? I think this is where the industry will have its biggest shift from the last 10 years. And I don't think this is driven because the market's gone down. I think this was something that was destined to happen. The industry has simply outgrown both in terms of its size and its desire for more size has outgrown the limited partner capacity to fund it for a period of time. There's just not enough money in the world to give GPs everything that they want, whether it's a much bigger fund. They've all raised their flagship fund, then their flagship fund that's a little smaller, than their flagship fund that's a little smaller than that, and then their flagship fund that doesn't cover anything the other funds did.

27:59They all have multiple products. I think LPs are sitting there going, now what do I do? Because I don't have enough money to do everything I want to do, given what I've been doing for the last 10 years. So I think this is really where the industry is going to have a pressure point over the next two, three, four years. This is not a, oh, the market goes up 20 % and everything's magically solved. LPs are sitting there going, if I have 100 to invest, I really wish I had 500. So what do I do? Do I cut back the number of managers? Do I give everyone a little bit? And I think those are the discussions that are going on.

28:35And GPs are frantic around it because they obviously want to be one of the ones and they don't want anyone else to get any money. This is one of the discussions that will dominate the industry for some period of time, I think. I agree with all that. I mean, it was first the numerator effect with the swell of values, then it was the denominator effect. Then we started to see a decline in distributions, and then we head back to the stress in the system. So I think we still see the stress. We'll see not a full unwind, but we'll see more calls being made really all the way throughout the system, more conservative capitalization.

29:09We've seen managers essentially fully equitize their companies today with the view that they're just going to refinance out in a better market instead of taking it as much or at the same level of debt that they've used. So Mario's right. I see it the same way. There was already headwinds within the market. But again, back to stress creates opportunities. I mean, just like in other periods of dislocation in the market, I do think you'll see a consolidation of the brand extensions that we've seen to Mario's point. I mean, everybody was raising a large fund and a medium fund and a small-ish fund and a micro fund and a tiny fund and industry funds.

29:45We've already actually begun to see that with some very strong managers within the market. But I actually think it will create a premium for investors with capital today. And I think if you have capital, you probably will have access points into managers or expand your positions in managers' funds in ways that are very difficult to do when capital is free-flowing within the industry. So the two of you are two of the largest players in the industry. And on the other side, are your investors have to be facing these same kind of questions. So I'd love to drop down on that a little more. Mario, we can start with you.

30:25Capital might not be as abundant. So you have to make effectively capital allocation decisions across your portfolio. And on the other hand, if you do have the capital, there could be some great opportunities. How are you going about making those hard decisions? I think that is, bluntly, it's kind of what you're paid to do. And so you try to select on the manager side, the best managers. And as John said, you have an opportunity here to either increase your allocations to managers that otherwise were closed off to whatever you wanted, or new ones that just didn't take new investors or you didn't have a relationship with.

30:58So you do that. That's part of what you do. I think the trickier question is a lot of our clients make some of those decisions themselves and then we help them with some of that. I mean, the range of outcomes is unbelievable. You literally have people that are making tiny investments in a hundred managers so that they, it's like you never say no to anyone. And so you just don't. And others that are severely cutting back the number of managers with whom they will commit. And then it has that whole ripple effect with the general partners who now realize, oh my gosh, now what am I going to do? I need to go find new capital or I need to just sit in someone's office till they finally say yes or shoot me.

31:39And that's a lot of what's going on. These are real-time decisions. As I said, I think this is going to go on for quite a long time. So Mario, just on the capital where you have full discretion, what's the playbook that you're using in terms of the appropriate level of concentration with the ones you're trying to get into compared to continued diversification as you may have had it a year or two ago when it felt like there was more than ample capital to invest in everything you wanted to? We're cutting back. There's no question. I'm not a big believer in the amount of diversification that most of this industry says you gotta have.

32:14You have to cut back the number of relationships you have and concentrate them on those groups that right or wrong, you believe are gonna get you through this next part of the cycle and do it well. And those are hard decisions because people get angry and they yell and scream at you and that's what happens. But there's no question that you need to be cutting back the number of relationships, particularly because it then leaves you room to do newer things if that's what you wanna do. Because otherwise you're just stuck doing nothing but what you've been doing for 20 years, which I don't know, normally that's not a great recipe for success going forward.

32:48On the margin, so that last one manager, it's clearly subjective decisions. What do you go through with your team in deciding, okay, we're just cutting the line here, when you know in the back of your head, well, maybe this isn't the one we should be cutting. Maybe it should be the guy just before them, the woman just before them. How do you go about making that decision and keeping your conviction when it's so subjective on the margin? Well, first, they don't let me do it because they know I'll be wrong, which is usually the case. You have arguments and you have disagreements and you give it your best shot and you know you're going to be wrong.

33:26You know you're going to be wrong some of the times. There's no way to avoid that, but you do your best on it. And you have people in the organization that have been through cycles that have experience that are looking at it and going, I know I'm not infallible, but man, I've seen this before. This sort of rhymes with what I've seen and heard before. And here's how I think we ought to think about it. And if you have enough of those people around the table and enough people challenging it, you tend to come to enough right decisions that you don't go out of business. John, I want to bring the same question over to you.

33:56On your team, how are you guys making these active decisions about what to do in a more capital-constrained environment? Like Mario, I mean, a lot of our clients come to us for a particular solution. For some, it's just broadly diversified. We want you to do our private markets for them, or for some, it's point solutions. I do a lot on my own, but you know what I really need is venture or Asia or secondaries or co-investments. So we're building discrete portfolios. We have a saying here that it's very difficult to time private markets, but it's very easy for the markets to time you. So when managers raise capital on shorter and shorter time cycles, they raise bigger funds, your pro rata allocation is twice what it was before.

34:38If you think about the frenzy that occurs in the up market, it's very easy to get timed by the market. Our strategy, we are a big believer in diversification and a little bit of steady as we go as we build our portfolio. So we try to manage our, call them the portfolio elements that we build to be similarly sized for that part of the market that we're investing into and not get caught up in the, let's walk it up because we have the access or let's walk it down because we think it's a risk on part of the market. And the level of diversification, to Mario's point, it kind of depends upon what part of the market you're in.

35:15You probably should have more diversification in venture in Asia than you do in the North American buyout market because the dispersion of returns that our QIS team has shown over the 40 years of data that we have says, you do want to grab some of that right-hand tail that exists in markets where you just have those types of returns. So that's how we build our portfolios is to be steady. I do think what happens in this market though is we've got a forward pipeline and we're evaluating the opportunity cost with every investment decision that we make? What's the other manager that looks just like this and when are they coming into the market?

35:52What's the alternative? And in other strategies, we have a flexible approach. What's the other strategy or geography that we can invest in? What are the merits of that? So that opportunity cost argument is just fundamental to our investment selection process. And in a market like this, what can happen is you may say, look, if I have two managers that I believe are substantially equivalent, I'm going to take the bird in hand in a good market. I can make that investment. I can actually begin to invest the capital. But now that there's become a premium on capital availability, if we have two managers that we believe are substantially similar, we may actually say, you know what?

36:30Let's wait. Let's actually not make that investment today in that fund. And let's see how the market plays out because we think we still have an opportunity to invest in something that looks pretty similar to what we're foregoing today. 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.

37:08professional 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-U-M. P-Q-U-I-O-M.com. And now, back to the show. John, a question on managing your business and funds over time. So as you said, if the capital finds the market, you can imagine as capital is coming in as it did to tech and then late stage tech in the last couple of years before this contraction, more capital is getting raised.

38:04and at the same time, the performance of that area is good. If you're steady stating the pace so that you don't have to make the contractions, you can envision the cyclicality of returns not affecting you as much. So perhaps that strategy, think of it as more of an equally weighted strategy than a performance-driven strategy. If that's the case, I think it's illogical that it would. What have you seen and how have you managed the organization and the business? Because you imagine that that leads to a slightly different type of return path as what the market might be doing if it's chasing and therefore doing well in the good times.

38:40And then there's a contraction and it's doing a little less well in those areas. I mean, in our business, probably similar to Mario's, we've got a forward pipeline of the managers. We have a sense of what our firm-wide allocation would be. So when we take on a new client mandate, we've got some insight of like, okay, well, what's the hypothetical portfolio? What would that look like? And in certain parts of the market, how deep would we go in order to complete that portfolio over the timeframe that the mandate prescribes? To the extent that we believe that we're going into a part of the market or a depth of the market because of the allocations available to us, because of the managers that we're selecting, we could get into a different part of the market where we don't think the returns are equivalent to the ones that we do invest in today, we won't take on that mandate.

39:30And that's painful. That's painful. But that is the guardian, the protection of, for us, the brand that we've built over 40 years, that if you drift astray from that, if you go too quickly, there's a pacing element in here. As long as we have a sense of what's coming online, what's happening in the market in front of us, what's the duration. We've got some levers, as Mario said, if we too need to elongate by a year, four years instead of three years, as long as we have all those levers at our control, then we can continue to grow the business and give our clients the same type of experiences they've enjoyed from us for a long time.

40:09I do want to say one thing, because I think what you're hearing from John and I is fairly unique in this industry. You're hearing portfolio construction, which is not what this industry he talks about. This industry is nothing if not the chaser of the shiniest ball that comes in the room. And that is part of what leads to some of the issues that the industry periodically has. Because, Ted, your question is right. There are periods of time when someone who's doing portfolio construction, the way you're hearing here, will underperform because you're not 80 % in venture. And venture is having a great time and everyone goes, how come my portfolio is not up 800%.

40:49It's only up 50. And I hate that. Those are real discussions. And that's part of why portfolio construction actually works over a longer period of time. So Mario, when we're going through this period of time where folks like you will make these harder decisions about where to allocate capital in the next funds, who are you seeing ends up as winners and losers from the GP side? I think as you enter this world where it's not like it was five years ago, I suspect the winners will be those general partners, those groups that have had a pretty good strategy of how they're going to grow. They haven't just chased, you know, I'm going to have 17 funds because my competitors have 17 funds.

41:31I think people with longer track records will be winners. Unfortunately, that means that a lot of newer managers are going to struggle. I don't think being a newer manager in the next two or three years, unless you have some incredibly great area you're in or have something unique, are going to do very well. It just seems like the more conservative, I'll call them, organizations are probably going to be winners over the next two or three years. And as general partners position themselves, I suspect that's part of what you will now begin to hear. Because three years ago, you heard, I am cutting edge.

42:05I am new. I am unbelievable. In the Marvel universe, you've just never seen me before. Now it's going to be, hey, I'm Superman. I'm Batman. You know me. You know what I've done. You know how I am. And I'm tried and true. I've been through all these villains and I can get you through this one. That to me is probably going to be the characteristics of the winners. Mario, what are some of the key signposts of what conservative means? Because some of the ones who have been around as long as Batman are the same organizations that have expanded into multiple products and every way across the landscape.

42:39Yeah, I think one of the things that investors are gonna have to do is spend a little more time understanding the governance at some of these general partners, because I think you're right. Some of the general partners that have been around a long time, what you realize now is what they have become is a collection of deal people. And it's not an organization anymore. It is Mario and Ted and John outdoing their own deals. and the gray hair that you thought was overseeing it all isn't really overseeing it all. We're going to have to begin to understand how some of these firms have operated internally if we haven't already.

43:12That's going to be a sea change for a lot of limited partners as they begin to do this analysis. They're simply going to have to understand what has been happening internally because you're right. What has happened at a lot of these firms is that the governance structure has shifted and what you thought you were investing in is not the same firm. That's just part of, I think, a diligence process that we as an industry are going to have to spend a little more time on. John, winners and losers? Yeah, I had the same view as Mario. I think there'll be a consolidation of capital in the market in particular.

43:43There'll be a contraction of brand extensions. I think it'd be hard to be a new manager here. And one of the things I've loved about this industry in the three decades I've been a part of it is there's something that is rejuvenating about it. There's a bunch of managers today that we would consider to be brand names that didn't exist 15 years ago. So the opportunity to create those relationships, to invest in them, to be founding investors in a lot of those funds, that's an exciting part of the industry overall. I heard when Mario said conservative, where my mind went was conservative, but from a, what type of risk do you as an investor want to take?

44:18We take market risk with every investment that we make ultimately. But do I want to take the risk of three people who've never worked together when I have an alternative to invest in another part of the market? And even if you're an established manager, to Mario's point on governance, you can have a manager that is the same eight people driving and leading and executing on exactly the same strategy. And now you're just assessing of, has the market evolved? And how do I underwrite that new investment opportunity in light of what this manager has done historically? Or are they in the midst of a governance transition.

44:50And if they're in the midst of the governance transition, whether I know it or not, because it's not always necessarily transparent on the face, I'm underwriting different risks and that wouldn't necessarily be labeled conservative in my view. So I think it's a choice of what risk do you want to take. And I think we will see investors in a scarce capital environment gravitate to that. For me, the winners as well, if I think less on the manager side, but really on the investor side. Again, back to my belief that we're entering a window where there is a premium available for capital availability.

45:22So if you are a newer investor in the asset class, if you are sitting on an allocation of 5%, 6%, 7 % and you're trying to get to 10%, I think it's actually a pretty interesting time to create investable opportunities and to create exposures and managers that might not have been available to you four or five years ago. So one of the things we hear about capital coming into that space on the margin who may be able to access that opportunity is really two buckets that seem to come up a lot, retail and the Middle East. And we'd love to hear, Mario, why don't you kick it off, your perspectives of where we are on that money actually coming into the space.

45:59What I can say about the Middle East is if you want to meet general partners, just go to the Middle East and sit in the lobby for a day. You'll meet them all. It's the most efficient way to sit down with all of them. What John was describing about where some limited partners are best describes most of the Middle Eastern investors, not all, but most of them. So there is probably more capital available in the Middle East today than there are in other parts of the world, just in terms of concentration. So yes, there is more. Is it unlimited? Is it enough to fund all the general partners? Absolutely not.

46:33And then the retail is an interesting one because over a period of time, retail will continue to be a larger. And by retail, I probably mean high net worth because when I hear retail, it's not my sister through her account at Fidelity. I don't know that that's really what we're talking about as much as the high net worth, the mass affluent channel. That will continue to be a growing part of the market. It will have hiccups. We saw the ones at the end of last year on some of the name products. And so I think people need to be careful in terms of how they're selling into that market, the investor base that they're willing to accept in that market.

47:11If it's a lot of people that want to do a trading strategy, is that really where you want to be? And I think we will have some real ups and downs in terms of both investor and manager experience in that market. But it's a trend that will continue over the next 10 years, whether it's bigger than the institutional market or equal or somewhat smaller, I'm not sure. But it will be an increasingly important part. And to the winners and losers, it is not an equally accessible part. there are a lot of managers everywhere who will not get access into that market. So I think it will create some distortions, if you will, in terms of who is accessing that market in scale and who simply has no ability to get at that market.

47:58John, maybe we click in there. I know when we first met, it was not too long after the beginning of your relationship with Vanguard. We'd love to hear your experience and what you're seeing from that channel. Yeah. So can used to be super positive. They've been wonderful partners. We're in our fourth year, fourth of vintage, if you will, on our relationship. And what we've seen in the small institutional side and the non-institutional side is maybe the way that I would describe it. So not quite all the way to retail, as Mario described. The packaging needs to be different. Those clients have different needs, different reporting timelines, sometimes different access points.

48:39The Vanguard relationship in particular is what I think of as institutional packaging for the small and non-institutional market. That's what we decided together with them as the most logical foray. What I've seen to the small institutional, non-institutional market is channel partners say, we don't actually want a retail offering. There's almost like a, well, no, no, no. I want to invest like Harvard and Yale and CalPERS. I want to invest in the same way all these large institutions do. But I need help. I need an access point. I need an intermediary to be able to do that. So that's where Hamilton Land and HarborVest are putting those types of solutions together.

49:15And that's what we're doing with Vanguard. Are there other pockets of capital that you see coming into the space? I think we've touched the surface of the non-institutional market. Today, a lot of it is institutional packaging, mass affluent, ultra high net worth, high net worth. We're not even further down the triangle, if you will, if you've seen those. That's possible, but that market has even more unique needs than we call it mortal money. So when an individual actually is investing capital, they don't have the requirement of a 7 % actuarial return on the duration of the liabilities and the visibility that pensions have on the duration of their liabilities.

49:55Individuals have often much less visibility on their liabilities. So it comes with different packaging needs, that ultimately, if you think about the total wealth market, that's in many ways the next biggest realm for not every manager, as Mario states, but for managers with scale and the ability to actually do everything that's required. Earn the trust, invest the capital wisely as a good fiduciary, and equally as important, service that capital because that part is just as important. You've both alluded to the potential for excellent opportunities in the current market, whether that's shifting your portfolio so you have available capital, the whole idea of the dynamism of the industry itself, and then of course, new capital coming into the space.

50:38So I'd love to turn, Mario, and ask you, of these new opportunities that you see, what gets you most excited? I don't know how this cycle will play out, but I think we all have a pretty good feel of how other cycles have played out. And this one will be no different. I think you will have credit as the more interesting place today, then secondary, and then equity. and there will be things that kind of blur through it all. But the way most of these things happen is credit comes in first because people don't know how to price the equity and they have different views on how they, but companies need money.

51:11Secondaries we've talked about. So I suspect that will either concurrently or as the credit continues to go. And then equity will be the last one. And where that's most interesting in six, nine, 12 months, wherever it is, I'm not sure. But I think that, to me, is how this will play out because it's always played out that way. And I don't think we have changed the fundamental rules of how people invest and how economies go through these kinds of things enough to say, oh, this time it'll be really different and the order will shift. So I'd be looking at it from that lens. And again, it's not to say there's no equity opportunity today, but it is to say that there's more of a wave behind you going credit secondary than equity.

51:52As we've had this explosion of private credit, capital raising and lending in this shift, really since the GFC from the banks, what's your sense of the underwriting that's happened all the way through? Usually these things start well when things get ebullient. Sometimes the standards just to put so much capital to work isn't as strong. So as you're looking at those private credit opportunities, Mario, how are you looking at the underwriting that's happened and whether that's going to hold up? I think it will hold up pretty well. There are a lot of really lousy credit groups that have formed. People feel like, hey, I've been a good equity manager.

52:30I'll go get Mario and I'll be a great credit manager because he borrowed money for a mortgage. He must know what he's doing. That is something you have to watch out for. But I would argue that the trend behind you is so strong that you're probably still going to be okay in that. I mean, a few things. The movement away from traditional sources of credit is only going to continue. Banks are getting out of that business. And what's happened in the U.S. with Silicon Valley and Signature, I mean, there's just going to be more need for private credit. The amount of capital moving into that, I think, is going to be helpful.

53:03It's not too much. And as you think about the dynamics of that market, we have had more equity in companies than we've had in prior cycles. So if we think about the risk to the credit compared to what it was in 07, 08, where you had much less equity, the risk going forward of deals that have been done is more on the equity, I believe, than on the credit. The credit is fairly well protected, not everywhere, but generally. I don't think that dynamic is going to change. So I would say as much as I tend to be more bearish on stuff today, I'm embarrassed at all, really. I'm far more bullish on private credit than a lot of the people I hear tell me it's got to go down because it's been up.

53:45John, perspectives on private credit? Yeah, look, I see all those trends too, and it's only going in one direction. I think in many ways, because it is predominantly a floating rate market, both in sources of capital to the extent you're in the CLO world or you're making those investments. So you avoid, I mean, the real blowouts that are happening now are happening in the high yield market where there's fixed rate debt underwritten somewhere in the middle of the capital structure and the large buyouts. And banks are holding that. And that's actually just shutting those avenues for new financing down even further.

54:17So there's a lot of pain that's happening. And we're seeing our managers, they don't play in the fixed rate market quite as readily. So that's been a positive. As I said before, I think cov light or no financial covenant debt is a beautiful thing for the equity. And I actually think it's good for the lenders too. and allows you to ride out any period of volatility. And I think in addition to what Mario said around how things are capitalized, I look at the types of things that our managers do today. And I think people in the industry, they're just better than 20 and 30 and 40 years ago. Take nothing away from the founders of this industry who created something out of nothing, which is always special to be able to do that.

55:00But when I look at the playbooks that managers deploy the resources that they bring to bear. I see it just the way Mario does in terms of the private credit being a pretty interesting place if you're just looking for yield relative to other parts of the market. What are the implications of all of that cov-light, all of that flexibility for the private credit and private equity managers on the potential for distressed investing and default cycles? I mean, the default cycles have been non-existent. It's probably the only asset class within private markets that I know of that had to give back capital over the last 10 years.

55:37Like we raised a distressed debt fund and then the distress didn't show up and we're going to have to give it back. That doesn't happen in other parts of the market. I think that the overall size of the distressed market, it's really become a traded market as opposed to, hey, let's find the fulcrum security. Let's buy a toehold position. Let's actually see once it gets put into play. Things get put into play. There are managers that have that strategy, but the relative size of that is nowhere near certainly the way every other parts of private market grew because of this structural evolution within the financing markets.

56:13Yeah, when they come into your office and they do, whenever there's periods like this, just put a do not disturb or close for business sign. There's not going to be a distress cycle. Sorry, there'll be some distress deals that are interesting, I'm sure. But you sort of had this period where, oh, my gosh, things are going bad. let's raise a distressed debt fund. And they still are trying, but just tell them to go away. John, I want to circle back and ask that question I'd asked of Mario, which is, as you are harvesting capital for new dynamic opportunities that aren't in your portfolio today, what are the areas you're most excited about?

56:48Maybe building on Mario's answer around the sequence of opportunities, the one addition that I would insert, I agree with the direction, is if you think about, again, this lens of premium for capital availability, we've seen already an uptick in the deal flow on the co-investment side. So although overall private equity deals are down, managers, because they're either overcapitalizing from the equity standpoint, or they're reserving more than they once did, or they now won't achieve the exit that they're looking for. And they don't want to take on a leverage recap and they're taking on an equity recap.

57:28So the single asset secondary deals, right, where it starts to blend into the co-investment market. That kind of bifurcation, if you will, or fracture in the market, which creates a brand new access point of scale. The olden days, it was you invest in a 10-year limited partnership fund. You hope to be invested in the manager who invested in a private company, and that's how you got access. And now there are many more ways and many more points of entry into that. And so our view is creating and capitalizing on those access points, given the scale that we have, is what we see as the most interesting.

58:03So it's not thematic from an industry. It's not thematic from a kind of where you are in the capital structure. It's thematic around the changing shape of the overall private markets and the cracks that are opening up that we're kind of jumping into to feed the capital where there's a premium to be had. I'm curious on the co-invest activity, maybe less so for your organizations where you have the resources to canvas, co-invest, and fund investment. As you're advising, say, one of your clients that maybe uses you for a pocket and they're thinking about time allocation. So yes, there are more opportunities to do co-invest, but there are also more opportunities to chase down desired funds you didn't have access to before.

58:45Mario, what are you hearing from the community in terms of how they're choosing to prioritize that time? Most investors want to do co-invest. It's sexier. It's fun. You're doing deals with general partners, so you're kind of a general partner in your own mind. But the reality is for most institutions, not all, but for most institutions, they're simply not resourced enough to do co-investments. And so our view is they either ought to do every co-investment that walks in the door and just make sure you do enough of them, you're diversified, or have someone else do it because there are so few investors, one, that have the resources to do it, and two, that are willing to take that risk because your bad deals tend to go bad sooner than your good deals become good deals.

59:28And so someone goes, wait, I can lose as much in that as I put in a fund? What the hell am I doing? So to me, the real question should be, what should you be doing? And by and large, I think most institutions should be doing funds and thinking very hard about how they're going to do co-investments and whether they're going to farm it out. Just how are they going to do it? And in fact, in today's market, three years ago, on any deal, there were 150 people that said they wanted to do a co-invest on that deal. Maybe 50 of them actually ended up answering the phone and doing it. And now it's down to 10, 8, 12.

1:00:03It has very, very significantly shrunk the universe of people that are willing to do or able to do co-invest today. Well, I'm pleasantly surprised we've gotten this far without discussing the magical phrase ESG. Mario, it's one of your very, very favorite subjects. Maybe talk about your perspective on how the ESG movement is coming through the industry at a time where it's less obvious that everyone's a winner. Well, yeah. Thank you for letting me talk about it. Although my compliance area will probably delete everything I'm about to say. It's an area filled with BS and on both sides. So on the political side, particularly in the United States, where you cannot talk about ESG in many places because it's a bad thing.

1:00:45Think about this. Let's take FTX. Everyone agrees that was a terrible investment by a lot of people and fraud. How could you avoid fraud? It wasn't a fraud issue. it was a pure governance issue. If people had an ESG filter, they'd have never done that deal, ever. Having an ESG filter that keeps you away from FTX, I'd argue, is a pretty good thing. So there's that aspect of it. But the other aspect of it is so many limited partners, and general partners also, but more limited partners, yak about ESG. Oh, ESG is very important to me. And then when you say to them, what does it mean to you? They have no idea.

1:01:20They have no idea what it means. ESG means different things to different people. in Europe is the big deal and the USS is the big deal. Nobody knows what they're measuring. No one knows how to measure it. And no one really does anything, even if they do measure it. So to me, what I think we need to get to is a place where we have some understanding of what we mean by the term, how we're applying it, and what are the metrics. And then until we get there, I just think ESG will be either a bunch of happy talk on one side or a bunch of political tools, essentially on the other side. And that's not a very healthy place for anybody.

1:01:56John, starting there, thoughts on ESG? From where we sit, we actually do believe in the principles and how we run our business. So if you think about some of the choices that we've made with respect to how we run our management company, we actually align reasonably well with a lot of the principles. And for us, it's ultimately an economic decision. I actually think a lot of the principles of ESG, as Mario had articulated in the FTX example, actually align quite well with economic benefit, and managing risk. So that's how we run our company. At the same time, we have a pretty strong view that our clients should have their capital invested in the way that they want it to be invested.

1:02:35And for some, we want it to be considered as a determinant factor, specific criteria. For many others, they want it to be considered, but not a determinant factor. And for other of our clients, they say, we don't want you to consider it at all. And we have the capability to include or not include on the basis of that fundamental principle of investing our client's capital in the way that they want to. I do think both sides have grabbed onto those letters and pulled them apart and twisted them and extrapolated in many cases, places where there's a lot in the core that just makes a lot of sense in terms of investing.

1:03:18The example I'll give you is for years, when we looked at a co-investment into an industrial company, we would look at the safety track record of that business. And why? Well, it actually was a pretty good indicator of a lot of things. How well was it managed? How does it think about its people? How does it manage risk? Are there any future liabilities we need to think about. Now, we've been doing that for 40 years. Nobody ever called that ESG, but I could make a pretty easy argument that that lens in terms of thinking about safety track record and risk and how they treat their employees might actually fall reasonably well within some of the principles within ESG.

1:03:56It just was never labeled that way. It was just a risk factor and a consideration when we decided to make an investment. I'll turn to another interesting area, maybe risk, maybe opportunity, which is China. How are you guys thinking on a go-forward basis about the investments you make in China? That's a very, very hard one. I think that one of the things that we are all going to have to deal with as a change in this world is that it's going to be an increasingly bipolar world. And I'm not in the deglobalization camp, so I'm not going down that road. But I think I use the example of Apple. If you wanted to make money in smartphones 20 years ago, whenever it was, you invested in Apple and you had a global industry leader.

1:04:36That's not going to happen anymore. You will have Apple US, Apple China. And as investors, we have to recognize that, particularly as US, this is going to be the first time, at least in my career, that where you are geographically will make a difference on how you're investing geographically. So a US investor investing in China is going to have to be very careful, both because of US restrictions that may or may not occur, and Chinese restrictions on US investors that may or may not occur. Europe, probably the same way. If you're a Middle Eastern an investor, it doesn't matter to you because you're probably not going to be affected by that.

1:05:08So it is not this global pattern you used to have for basically our entire industry's lifetime. And that will continue to be part of how we are going to evolve and have to deal with. That is not going to go away in any reasonable time frame. All right. Just one follow-up on that. As a representative of different types of pools of capital around the world. What does that imply for if you have a client in the Middle East and a separate client in, say, the U.S. in terms of how you'll think about investing in China? They will probably have different portfolio construction characteristics. The Middle Eastern investor will likely have a higher allocation to China, for example, than the U.S.

1:05:51investor. It's not a blanket thing, but that is part of, as I said, where we will have to begin looking at portfolio construction in a much more geographically used to care a lot about it from a currency perspective. Now, I believe there's geopolitical issues that are equally, if not more important. John, how are you thinking about China? Yeah, kind of a similar way. In many ways, I'm probably more in the deglobalization camp, or at least an unwind of what we have all benefited from in the last couple of decades. In some ways, it's too large to be totally delinked from the global economy. There's enough mutual benefits that come from the East and the West that I think we'd still continue to see that.

1:06:34I think from an investable universe, half of the private equity in Asia had really ultimately been within China. And a lot of that was actually USD offshore. What's been interesting to watch is the size of the China private equity and venture market from a fundraising standpoint, because a lot of the capital from the West that had flowed to those managers has slowed dramatically in the last 12 months. And we do have investors who are in the, I'd want returns anywhere you can get them in the world, to the do not invest in these regions. And we're seeing, frankly, more and more of that rear its head, which is requiring an additional degree of complexity in terms of managing pools from lots of different types of investors that have their own specialized needs.

1:07:21I would love to just hear your thoughts on other risks that you're concerned about cross-share investing? Mario, why don't you go ahead? I'd say generically the political risk is more of a concern than I really recall dealing with in my career. And by that, I mean, across all of the different, we obviously talking about China, the China-US risk in terms of that. As this industry grows and becomes a much bigger part of everyday capital markets life, which it is and will continue to be larger, I suspect that the political interference in the industry will increase. And I've said private equity outperforms because it's a better form of governance, period.

1:08:00I mean, I get the leverage and I get all that other crap, but it is a better form of governance. You'd much rather be private than public in terms of your ability to do things. If that edge begins to deteriorate because it becomes politically more challenging and more regulatory, more restrictions are put on the way you do private things, that's hard. But even in terms of, you saw in China, they regulated certain industries and basically wiped out all your equity in various companies. I don't think we've really been in a period where the politics so changed the way you invest. In the U.S., the movement between the Democrat and Republican changes the way people invest in a way that I don't remember really.

1:08:40Yeah, at the margin, you tax more, you tax less. But this sort of wholesale change in the way basic things operate here in the US, you see it in Europe, you see it everywhere. It seems to me that the risk factor of political involvement on the micro and macro level is more than I've ever seen. John? I'm a big believer of this asset class, as you and I have discussed before, and Mario points out as well. I think this industry could be two, three times the size than it is today and still be healthy and functioning and lots of flows of capital. and I do think it has to do with the superior form of alignment and governance.

1:09:20I think there's a durable source of excess returns. It isn't just lack of competition. This has been a competitive market for a very long time. So I think there's something durable about the excess returns. So I'm not quite as worried about what I think of as existential risk to the whole asset class, but I do think there are exogenous factors that will slow the rate of growth. I think the geopolitical events around us are probably what I worry about the most, to think about something that could just cause capital flows to stop or investment activities to slow dramatically. I do think the political environment has been around us for a long time.

1:10:01I can't really don't think the industry has done a good job writ large around articulating the benefits that private equity brings to companies, to industries, to pension beneficiaries. I think we're getting better at that. But I think there's actually a lot of alignment between millions of individual beneficiaries who have a small slice of their pension and have benefited from these returns than people think. And that story is getting better and better told. But whether it's changes in taxation, changes in capitalization rules, changes in tax deductibility, changes in regulatory environment that make certain industries restrictive, I just am such a firm believer in the long-term resiliency of this business, that might slow growth for a window of time or put certain parts of the market up.

1:10:49And that'll affect certain firms, certain places within the market. But I think the industry at large, we are witnessing the creation of a private capital markets, kind of not dissimilar to what we saw 150 years ago underneath the old oak tree or whatever tree it was down at the corner of Wall and Broad. I think we're seeing the same thing. It's just, we're kind of in it. So you don't see it quite as clearly. And to me, that's what's super exciting about the opportunities. Okay. I want to ask you both one closing question, which is, and we'll start with you, John, what's been the most challenging aspect for you and the firm of this change in the environment for private equity?

1:11:26Rubbernecking. What I mean by that is, if you think about if you've ever been on a roadway or the highway and there's an accident, right? And I think what we've just experienced in the last 30 days is an accident. You know, it was a collision. There's damage. But I think the traffic that's been created isn't from the accident itself. It's from the rubbernecking as people are driving by and they're looking at it and they're thinking through, how does that affect me? And well, maybe I should be risk off. And I think about the car that is HarborVest. Like, of course, we're watching. We're like pattern recognition.

1:11:59We're absorbing that. But we're also focused ahead and we're looking through the windshield at the opportunities that in front of us. So for me, like the biggest sea change has been the rubbernecking, which has kind of gummed up the investable opportunities or the capital that would otherwise flow to what I think of as a pretty expansive universe of opportunities. Mario? I like that one, actually. I may end up stealing it, John. To me, one of the big challenges has been the relative inexperience of a huge, huge segment of the private markets universe, whether it's at Hamilton Lane, whether it's at our clients, whether it's in the general partner community.

1:12:35When you think about people that they've only been in the industry for 15 years, they've not seen a cycle. And I get everyone says that they saw the cycle when COVID hit, but that was like 32 hours or 30 hours, wherever it was. That has been a challenge in the sense of you have a number of people, and in many organizations, it's almost a majority of the people that have no frame of reference. It really struck me the weekend that Silicon Valley was falling apart and we were working through some stuff when one of our more junior people said to me, oh, walk me through how a bank failure works. What happens?

1:13:12Because you just haven't had one unless you were here in 08. And I think he told me he was in high school. And I thought, one, I'm really jealous. But two, that's striking. And you see it play out in a lot of different ways in terms of it. I think part of it lends to John's thing of people freeze up because they just have not seen it. And so they imagine it either much worse or irrelevant, and you end up with some very, very odd conversations about what's going on and what it could or couldn't mean. Well, we started with some opening thoughts. Maybe I'll give you a chance to give any parting thoughts.

1:13:46John, why don't you go ahead? That we didn't already cover. Well, first, I want to thank you, Ted, for the opportunity to enjoy the hour here with Mario as well as Mario. It's good to see you as well in this format rather than in a conference room before a finalist opportunity for a client, we're each trying to win. Look, I think there's no question there's stress in the market, as I've said. I think stress creates areas where you want to be careful. And I think stress creates areas where there's actually investable opportunity. It's really to be able to identify where those are in moments in time and to marshal all the resources that we have available to us to invest in those opportunities on behalf of our clients all around the world.

1:14:31Mario? I don't have much closing. I will say, I want to echo what John said about what an extraordinary industry this is, having come out from nowhere in a very brief period of time and created, I mean, when you think about the scale of some of the companies that have been created and you think about the scale of what the industry touches, it's extraordinary. But at the end of the day, if the goal is to be making money for retirees, to be making money for people that really need the money, it's just done an incredible job. It needs to learn how to now be socially acceptable, if you will. It's kind of like an awkward teenager that goes, oh, I didn't know how to behave that way.

1:15:08We'll get there. And I'm just amazed sometimes at what the industry has become. Mario, John, thanks so much for sharing your insights in this really interesting time, private equity. Thank you. Thank you, Ted. Thanks for listening to the show. If you like what you heard, hop on our website at CapitalAllocators.com, where you can access past shows, join our mailing list, and sign up for premium content. Have a good one, and see you next time.