Raelan Lambert, John Jackson, and Erik Sebusch – Inside Mercer Consulting (EP.345)

26:13And we can always upgrade. We're going to constantly try to improve that list, even if nothing else changes. Even if it's a static number, which it's not, we're going to try to improve that list over time as best we can. It comes down to a balance of what our clients need, what makes sense to add to the list, what makes sense to remove from the list, and those are the elements that go into it. What are some of the things when you think about either hedge funds or your participation in hedge funds that are different from how others might perceive you or the asset class? We spend a lot of time in resources dedicated to sourcing new opportunities.

26:47I think maybe some of the bigger misconceptions are that Mercer is large. They have very large portfolios. They have large clients that write very big tickets. That's true, but the opposite is also true. We also have very small clients. So we will do smaller managers, and that may be a misconception out there in the market. We will do emerging managers. So I mentioned 240 on that buy list today. Again, some of those are closed. Roughly 80 of those are sub 2 billion in AUM today on that list. A little more than two dozen of those, I think, are below 500 million in AUM. Our objective is to be early and identify that talent again before the market.

27:29And hopefully if we've done our job, we will participate in that growth. So happy to see a small manager go from 50 million to 50 billion. If we've got it right and they've managed the capacity along the way in a good way, we've participated in that growth. And I would say equally on emerging managers, I think of the 240 today, a little more than 50 came onto our approved list within the first two years of their life. And then we have the opposite as well. We have funds that have been in business for 25, 30 years, which is a rarity in the hedge fund space and can have 30, 40, 50 billion in assets.

28:06We have the spectrum covered, hopefully, for our client base. 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. Professional shareholder representation, online M &A payments, digital stockholder solicitation, SRS Aquium pioneered each and continues to set the bar for game -changing innovation.

28:52So 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. With the incredible breadth that you do across number of clients, types of clients, curious what you're hearing in terms of relative change in interest in hedge funds and different types of hedge fund strategies within. One thing that comes to mind definitely is the growth of the pod shops. So the multi -strategy, multi -manager platforms, if you will, now, there's been significant growth in that space, really post -GFC.

29:41And these platforms have effectively replaced prop trading that used to be in the investment banks, which, frankly, they've been quite successful in doing so. But in that, they've created a bit of a talent war that's going on right now. We've seen the pass -through cost structure eat away at investor returns. So now I think on average, the end investor is keeping around maybe 45 % of the gross return. And I think frankly, we're seeing just maybe too much growth too fast at the moment. So there's a lot of people chasing this model, but we think maybe there's some overcrowding going on in the space.

30:22We're also a little concerned about the amount of leverage that is building up at individual shops, but collectively as a whole from the group. And these are, you could argue, maybe some of the strongest risk management frameworks out there. They have very low tolerance for drawdowns, very quick to sell and deleverage. We're worried about a potential snowball or waterfall of that. But I would say that a lot of investors view the multi -strategy pod shops as maybe the silver bullet or the rifle shot. So I don't need to build a diversified hedge fund program. I can just get it all in one basket with one manager here.

31:01And we think there's a little bit of danger to doing that way. Not that they can't serve as a core piece of the portfolio, but you need some diversity. At the very least, you need to diversify that business risk. On the margin, if you're less excited about that than you might have been a few years ago, what areas are you tilting capital towards? I wish I had something unique to say, but credit. I think credit and macro are the two areas that we are most excited about moving forward. I think everybody is well aware of the opportunity in credit. Global central bank policy has effectively removed the business cycle and the credit cycle for an extended period of time.

31:39With policy tightening, we're pretty sure that's going to reverse course in some way with rates at where they're at and the maturity wall is coming. So we haven't had a distress cycle. We really haven't had a stressed cycle in credit. And we think there's going to be some pretty exciting opportunities. I think the one difference about this maybe relative to past credit bust, if you will, is we don't think there'll be a big moment of bust and a deleveraging. To us, this might be a more long drawn out period where we can produce maybe more than equity -like returns with bond -like volatility being higher up in the capital structure.

32:16And then macro, we just think volatility really across everything is going to stay elevated. So across equity markets, across credit markets, across interest rates, across commodities. And we think macro, both systematic and discretionary, are probably the best place to manage through the ebbs and flows of that volatility and changes over time for maybe the next three to five years. I would say that on our sourcing front, I probably should have mentioned that we're completely bottoms up. So I have a view that macro and credit might be more interesting than it has been for the go forward, period.

32:49But I wouldn't say we're necessarily targeting that. We're looking, we've got our eyes peeled, but again, quality trumps everything and we're never going to force it. So if we don't find a compelling opportunity that we think makes sense for our clients in credit or macro, we won't add it to the list. Eric, I'd love to turn to your world of venture. Lots of differences structurally. As you're hearing John go through how you think about hedge fund research, what are some of the things that popped into your head as well? that's quite different from what we need to do in venture. Yeah, I think it's the thought of being able to just fire someone easily, right?

33:24These are blind pool assets that take a long time and it's the longest gate in the asset class. So that's a little different. We have managers and GPs we like, but once the fund is set, we have a lot of monitoring if we like it or not for long -term versus firing them and waiting for that gate process to discontinue that relationship. At the top of the funnel, how have you organized your team to canvas an area that's so commonly thought of as an access game and getting to the right GPs? One of the comments that John made about the asset classes having empowerment, we also have a global reach, which is fantastic.

34:06And that allows us to have our Asia team try to reach out to interesting managers in Asia. We get to understand who are the good investors from just being in the marketplace. Alternatives is a relationship industry. I would say venture is exponentially so. And as Mercer's name is out there and we're participating in conferences, we're doing good work as an LPAC member, doing good work for clients. We get recommended as well as we're talking to other LPs, we're talking to other GPs, we're talking to CEOs, asking them about their syndicate partners, who they like the best. And we start developing targeted managers to develop a relationship because it takes time, particularly with those access constrained managers.

34:56And you build that relationship, you show why you're valuable beyond just money, and you slowly start trying to find opportunities to partner together. How have you thought about where you want to play in venture from the earliest stages to the late stages? So that changes from whatever cycle we're in. A couple of years ago, we were not necessarily supporting your crossover late stage managers for your venture portfolio. Now, that being said, there's some good ones we backed and we would like to continue the relationship with, but we'll target certain areas. We actually have a heat map of areas that we're looking for.

35:40Early stage, let's put that aside. I think there's always a good time for early stage investing. You have to have a disbelief in the ability of the homo sapien to innovate if you're going to turn your back on early stage venture capital. But I think in the mid -stage late and growth, you have a high risk area because there's the technology risk still inherent in those businesses. Early stage, you know it is, they're going to ebb and flow. Mid -stage and late, you start wondering if that technology is going to work and companies are going to really adopt that product or service. And then in the growth, you're really paying for growth and expansion and sales if the technology is already baked.

36:27So sometimes that area, you can find the right manager, the right opportunity where you can have a little bit less of a risk appetite, but also get venture -like returns. At the moment, we're looking at more of a barbell strategy, that very early stage and true growth, which I believe is the growth that is using to fuel extra sales. Technology risk is out. The mid -stage, we're at a little bit of a risk area right now because we've fallen into a fundraising risk environment. Post this downturn, the valuations have been so high. We don't know if those mid and late stage companies that had very high valuations are truly going to grow into the investment banking metrics that justifies their existence.

37:14In the late area, there's a lot of unicorns that are going to be zombie corns, right? And that's part of our job of trying to ascertain and understand what those portfolio looks like. So at the moment, not saying all mid -stage and late -stage managers we don't like, but we're looking early and growth. How do you then dive in to assess which managers you want to partner with? Piecing together a whole bunch of things. There's understanding what references, may it be an LP reference or another GP or the CEO has said about those individuals. The ones that will be responsive to take a call, we're pretty lucky being Mercer and the clientele base that we have is so broad.

38:01We have a pretty good ability to access the most access constrained managers. And we will do a targeted approach. Again, just as John will see anybody just about that comes through, we'll look at their deck. doesn't mean we'll necessarily always take a call, but there's a very high percentage of them we will take a look at. And it's a combination of the targeted rifle shot approach, and then we're always an open door policy and happy to talk to managers. One element we do like is we do like to skew towards the smaller managers of each sector or asset class, smaller growth equity managers, smaller early -stage managers, smaller mid -stage, because we want to begin a relationship that we can grow over time with them, allowing the clientele base to also grow and expand with that manager.

39:00What have you figured out in your due diligence process that allows you to tease out the differences between someone on the margin that you do want to invest with and someone on the margin that you take a pass? A lot of it is through that reference checking and the face -to -face due diligence process. Zoom is great. It makes things more efficient, but I still believe there's no replacement for face -to -face. The ability to break bread, get to understand that individual, see them in action, how they're working as a partnership, managing conflict, throwing a pro or con out there that could be a little controversial and see how they manage it.

39:41See how they even treat waitstaff and hostesses if you're having a meal with them. This is a long -term asset class, sometimes longer than many marriages in the United States. You want to be partnering with these people. So sometimes it is the human element. There's a lot of great managers out there and you don't need to be partnering with jerks. As you bring that all together, as we talked about with John, how do you think about your approved list for your clients? So we try to maintain the relationships with the best of the best managers, keep an eye on those that may not be performing as well, but we're always trying to upgrade.

40:19There's some managers that change strategy. They could go from growth to small buyout, and they move over to the buyout team. They could take their eye off the ball and create too many strategies, create too many platforms, and it suffers. Returns sometimes as the firm grows and creates other products, their returns diminish. So the very selective few that we are putting on an approved list has a mix of all. You have some of the new managers, and then you have your established managers, because I think there's lots of turnover that's going to be coming in the next few years, given where we are in the market and where valuations are.

41:03It's the old adage, we'll see who's wearing pants. What does your approved list portfolio look like today? It's a mix. Just as Hedge Fund tries to have different managers in each sector, we like to have one that has a sourcing advantage, one that has an operational expertise, one that has an expertise in a couple of core sectors, one that maybe utilizes university systems a little bit differently with student ambassadors. Just like a differentiation in the portfolio, we don't want to be hiring a bunch of venture capitalists that are going to invest in the exact same things. How many different managers or partnerships are your clients invested in?

41:46As a whole, that's hundreds. And we would have a portfolio of probably 25 to 35 private equity managers. And your venture portfolio could be anywhere between 10 % of that to 50%, depending upon the client. And it's hard to give an exact number, but in venture, you have to have a few more managers than you would in buyout, just because of the volatility and the risk that's inherent with them. And then sometimes it's difficult to put very large checks with many managers. How do you think about re -up decisions? Re -ups are interesting because we take a fresh look at every manager. Many managers, come to us and think it's a done deal.

42:30We have a relationship. We've kept in touch with them, but it is difficult to knock out an incumbent because we have a very good manager base, but it's not an automatic ticket that they're going to get a re -up. We like to build relationships. We like to keep relationships. We have some very long relationships. Being decade -long investors with many GPs. We prefer that, but it's not a given. And we'll put them through the gauntlet again when it comes time for due diligence. And I'm happy to say those have been persevering, but we also have a very good knowledge base on those managers because we have a much closer relationship, particularly through co -investments we might be doing with them and or secondary opportunities they may give us.

43:22How is your team organized to cover these managers, monitor them, and make decisions? We have a squad setup. So we have squad leaders that have relationships. We rate some of these relationships. We have our top relationships. We have the secondary, third, third are probably monitoring. The fourth, we're probably not necessarily very active, but we're trying to touch base with the highest priority ones quarterly. The next set we try to do biannually. And the squads manage that from a relationship perspective. So what we like is that a GP can come to Mercer and they have a one point contact for everything Mercer wide.

44:02We'll manage all the clients through that one individual, through the process. And so the squads manage everybody's outreach, relationships, and the inbounds that we need to segregate across the group to determine who's going to take a call, get an understanding, and move it to research. How do you work through parsing allocations in managers that have finite capacity for Mercer as a whole? So knock on wood, we've been incredibly lucky to get access that all our clients wanted. in my 10 years of being at Mercer, we've only had to take it to an allocation committee once. Typically, the GP is the one that is picking which LPs they want and would like.

44:56In the rare case, that one, they put it to us. We had to go through an allocation committee and we have our allocation requirement that we follow to be the most fair for all the LPs that want access. Yes. Raylan, as you're listening to John and Eric walk through these processes, what's popping into your head? A couple of things. One, I'm just extremely proud of the organization that we have. There's a story that actually popped into my head, and it was an individual that built a private equity program at a large U .S. public plan and decided to go become a placement agent. So now the dynamics are very different.

45:33And this individual calls me one day and says, Raylan, you guys actually respond. You actually respond to my emails and you hear the amount of channels that we're sourcing deals from and looking at new opportunities. Being responsive and actually showing that professional courtesy to all stakeholders in this ecosystem, I think, really jumps out at me. There's an element, I don't want to say Eric said the word, I want to do business with jerks. But I'd say that's one of the things when coming to Mercer and having worked at prior organization, yeah, there's a very low jerk tolerance within our culture, within our institution.

46:10There's a tremendous amount of integrity. And I think that's one of the things that jumps out is the team's on top of things, but they also have that element of professional integrity. We're all mirrors, right? What you reflect is what you get back. And I think that's one of the things that we've been extremely fortunate to have people that aren't just viewing this as their job or just a means to an end. They're doing it as something that you're getting joy out of what we're doing. And I think that could sound kind of cheesy, but to me, it's coming through in the kinds of opportunities and the teams and the structures that we've built and the success that we've had.

46:43We've had managers do reference calls on us. Are we good partners? Do we do good work? In more than one case, we've gotten good feedback there. So I think, as Eric said earlier, it's very much a partnership relationship business. And we take that very seriously and value those key partnerships on behalf of our clients. reputation matters. And when managers call on us, oftentimes what they hear back is these are good guys and they're good partners and they do it the right way. And I would say the other thing that Raylan mentioned was we have to prioritize our time, right? That's the one thing we don't have more of.

47:14And we will be pretty candid and say, we're not interested now. We're not interested ever. It's not a good fit. Or we'll follow up with you as soon as we can. So we might not take every meeting, but the email is going to get open and we're going to look at the materials and make sure we're not passing something up. We're going to be open and honest and get back to you and give you our honest feedback, which I think is valued in the industry. I'd love to ask each of you one last question, which is what initiatives in your respective areas are most top of mind? And Eric, maybe start with venture.

47:44I've got a pet peeve right now. I've been looking at vesting schedules. There's this influx of investment bankers, mutual funds, hedge funds coming into the venture space. and this is a 10 -year vehicle. Most of those funds don't end in 10 years. There's always the plus, plus, plus. I've seen an explosion of short vesting schedules of two to four to five years. And it's just not great alignment. I don't want a GP to be able to leave after two years, get 100 % of their carry, sit on the beach, and now the team or the LP base have to dilute the carry to bring in another partner, and then somebody reaps those benefits.

48:31I think that is proliferated. I don't know why some of the law firms have allowed this. I think it's bad for the GP as well as the LP, and I've seen some of the best funds fall apart because of that. John? I would say for me, it's really top of mind is the opportunity set. We think we're at the very early stages of a significant shift in the opportunity set, particularly for hedge funds. With interest rates at zero, it becomes very challenging. You just don't have volatility. You don't have as much dispersion. There's a lot of crowd mentality and risk assets. And that worked for a very long period.

49:07And we think you need maybe stronger risk management. You need more alternative exposures, alternative meaning not equity, not fixed income, not necessarily all private, but you need something in the middle and hedge funds serve that role. I think the challenge that is top of mind for me is we're seeing a bifurcation, maybe one of the best forward -looking opportunities we've seen for hedge funds in a long time, a really robust kind of new launch environment. There's a lot on our list right now that we're taking a look at and prioritize and we'll move forward with some on relative to maybe the demand in the market, which is a little bit weaker for hedge funds right now, mainly because hedge funds outperformed last year on a relative basis.

49:50And now everyone is reevaluating what I do with my equity allocation, what do I do with my equity and alternatives allocation relative to fixed income now, given where rates have reset. And I think there's a lot of perception that we could get easier returns in traditional asset classes. And obviously I'm biased, but we think you still need that alternative exposure. So we're trying to reconcile or rectify that disparity between the opportunity set, the new launches, and maybe client demand at the moment. Really? My role is quite multifaceted and layered. You think about the responsibility I have for our team.

50:26But a lot of that also is advocating and innovating and looking at where the market's going and how do I ensure that within a broader enterprise, a fantastic large enterprise that Alts is a top priority. So I spent a lot of my time on that. I think about the things that we've accomplished in securing the commitment for Marsh McClendon to grow our business. That's a first, to be that level of priority, to look at where we're at in terms of our data, tools and technology and have the ability to say, this is a high priority and this is why. So a lot of, I'd say what's top of mind for me is where I'm seeing the client need around the world, across various segments.

51:12There's increasingly demand for certain capabilities. How do we continue to grow those capabilities? And how do I make sure that those capabilities are higher on the list of priorities versus everything else that leaders are focused on? And so I spend a lot of my time on that. And of course, I really care a lot about our team and our culture and really ensuring that folks are rising to their highest potentially. Eric mentioned the squad system. I think that's been tremendously successful. I think there's ways that we can continue to evolve to maintain that specialism, but also provide all of our teams with as much exposure and empowerment, which John used, which I love that.

51:50I think we're always going to have bosses in the world, but I think empowering our teams is something I spend a lot of time on. There's a lot of new things we'd like to develop, but then we have to tailor that to our strategy globally, to each region. And what's going to be important in certain regions is not going to be as important in others. But I think that balance across the continuum of research, advice, and solutions, those bring themselves their own set of priorities. I think it's just picking those top things that we can deliver that will continue our success and our growth and keeping our teams engaged isn't always easy, but I think we've done a good job.

52:26And right now. Those are data tools and technology, new product innovation that clients see and demand. And I think continue to see how we fit into that total portfolio and can be a solution to clients that have different needs. I want to ask each of you two closing questions. Which person has had the biggest impact on your professional life? And Raelynn, why don't we start with you? Picking one person is very difficult. I would say the person that's probably had the most impact on my professional career has probably been my husband. I call him my conseiller. He often, especially in COVID, he would hear my conversation like, who are you talking to just now?

53:06And he'd give me uninvited criticism or input. But I'd say actually, he's probably been one of the biggest influences. I think he knows my strengths. He knows where I can be pushed. And so I think my risk -taking ability, my confidence, combining that with my just innate perseverance, I think he's been a great advocate and developer of my talent. John? Yeah, I think I have to go with my mother. She owned her own business for more than 20 years, so an entrepreneur and probably taught me the hardest work ethic of anyone I know, honestly. And really a passion and competitiveness to really succeed and win rubbed off on me a little bit.

53:46She's going to turn 70 next week. She's still working. She's still at it. I often say I might not be the smartest or brightest guy in the room, but one thing for sure, you're not going to outwork me. And I think that has served me well so far, at least. Sounds like we have the same mother, John. That hard work ethic was something my mother was oldest of 19. She raised four kids on her own, was a valedictorian, but chose to raise four kids and taught me no matter what job I had when I worked landscaping or concrete construction or when I first started Merrill Lynch in mid -80s, she said, find the hardest working person and do circles around that person.

54:28And I just think that hard work ethic was something she instilled in me. All right. One more for each of you, Eric. We'll start with you. What's the best advice you've ever received? I would say never say never. I learned to say to GPs, not now. I don't say never, unless if they've done something ethically and they've reached something terrible, it's easy. But never say never because you could look at something one day and it could be the worst thing. Comes back a few years later and you see the progression and your mind gets changed. John? Yeah, I think mine would be over -prepare. There's been times where I've gotten out of my comfort zone and maybe out on my skis a little bit and thrown into situations maybe that were a little bit nerve -wracking for me.

55:14And the one piece of advice that's always stuck with me is over -prepare. You'll never regret over -preparing, but if you under -prepare, you might not get a second chance. So that one kind of sticks with me a little bit. Yeah, for me, it's actually in my 20s after Aleph Goldman and I was at Amex, my boss at the time. So to be successful in business, you have to learn how to play chess and play it well. If you want to succeed, you have to think five moves ahead. And that's been a huge part of, I think, my success at Mercer is thinking through what I knew was so important to us with an ALTS, but how I call it pushing it through Congress.

55:52How do you get it done? And how do you do it in a way that taking feedback from others where you could view it as it being a door closing? I view it as more information. That's actually helpful. I got more information as to that person isn't supportive. Why? Let me spend more time. So I think that really impacted me early on in my career. Raelynn, John, Eric, thanks so much for sharing this look inside Mercer. Thank you. Ed, thank you very much. Yeah, thank you. Been a pleasure. Thanks for listening to the show. To learn more, hop on our website at CapitalAllocators .com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more.

56:39Have a good one and see you next time.