Year in Review 2025 (EP.478)

0:00The biggest topic this year driving everything is private markets. I would categorize that in two ways. The first is liquidity. And the second is the changing structure of the industry. So liquidity has been an issue for several years. And it all comes down to why aren't dollars coming out the back end the way they used to? It's a really tricky question because if you think about making a pizza, you need dough and cheese and sauce and toppings. And in private equity, you need equity capital. Well, there's tons of dry powder, trillion two of dry powder. You need debt capital, and there's almost an infinite amount of corporate private credit available.

0:45You need companies that are willing to transact, and there's tens of thousands of private companies. And now there's 10 ,000 private equity-owned businesses, a fair amount of which are later in the life of that investment chapter. So there's a lot of businesses that need to transact. You have all these ingredients in place. So how come there's no pizza? And the answer is, the oven's not on.

1:13I'm Ted Seides, and this is Capital Allocators. Today's episode is our annual year in review. Our CEO, Hank, and I cover investment trends across private and public markets, and top-of-mind issues for allocators. We then discuss highlights of the podcast and our efforts to improve discoverability of great episodes, outstanding asset management fintech products, and Capital Allocators University. With the year in review, we also kick off our countdown of the most popular episodes of 2025. We'll drop two this week and the top three next week. Coming in at number five is Adrian Mellie from Eagle Capital.

1:58It's a fun, nuanced exploration of applying the most sophisticated tools of hedge fund investing to long-only public equities. And at number four, it's Alex Sasserdote from Whale Rock Capital. Alex is a passionate TMT investor who describes how he finds companies ascending their S-curve of adoption. Next week, we'll drop the top three. Wishing you a relaxing, enjoyable, and very happy holiday. Before we get going, we have a holiday gift just for you. Discovering podcast episodes you want to listen to in a big library kind of sucks. When you find Capital Allocators or any other podcast, the natural rhythm is to listen to what comes next.

2:44After 550 episodes, it's been impossible to figure out what you'd most like to hear. We started the path to help this year with our summer series of the best CIO interviews, and we'll continue pushing out a best of summer series going forward. That brings us to your holiday gift. We've taken the next step and created eight playlists of the best episodes across the following categories. Most popular, legends, CIOs, fundraising, public equity, private equity, private allocators, and interdisciplinary knowledge. Each playlist has eight amazing episodes and we'll update them as new ones rise to the top.

3:27You can find the playlists on our website or on Spotify. On Spotify, search for capital allocators and the most popular and legends lists will pop up. If you click more, you can see the others as well. wishing you a very happy holidays and happy listening with easy discoverability. Thanks for spreading the word about the new playlists of the best episodes of Capital Allocators. Capital Allocators is brought to you by my friends at WCM Investment Management. WCM has the courage to back future histories not evident today, informed by their unrelenting focus on mode trajectory and elevated by insights on corporate culture.

4:11WCM's deep roots in public markets set the foundation for its approach to private investing. They didn't just want to enter the private markets, they wanted to improve the investing model itself, build something better aligned, more thoughtful, and truly long-term. As a firm owned by its people and grounded in Laguna Beach, WCM is built for alignment and independent thought. Rather than chasing a scoreboard, WCM invests with a partnership mentality to build meaningful relationships with founders reimagining their industries. They show up earlier, stick around later, and let value compound over years.

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5:26Past performance is not indicative of future results. Please visit WCMInvest.com for WCM's ADV and further information. Please enjoy. Capital Allocators is also brought to you by 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.

6:13So 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. Enjoy our year in review. So this is turning into a fun annual tradition. The genesis of this conversation was an annual letter that you used to write that outlined the business. What went on in the past year, what you're excited about for the following year. Last year, we spent a little bit of time talking about all that you're hearing in the institutional community. Even before we jump into what you're hearing, give us a sense of the interactions and the conversations you have with your peers in the institutional community.

7:02Well, a core part of it is the podcast. There's 60 episodes a year, and that's 60 podcast conversations, 60 prep calls, probably another 60 calls of people that I'm thinking about having in the future talking about what they're seeing, what's happening in markets. Then we have our summits that will be for next year, which brings together 120 senior level thought leaders, decision makers on the allocator side and the manager side. They're all small group discussions. So you're getting a sense of what's most important on people's minds. So hundreds of conversations with different people in and around the industry.

7:38What are you hearing? The biggest topic this year driving everything is private markets. I would categorize that in two ways. The first is liquidity, and the second is the changing structure of the industry. So liquidity has been an issue for several years, and it all comes down to why aren't dollars coming out the back end the way they used to? It's a really tricky question because if you think about making a pizza, you need dough and cheese and sauce and toppings. And in private equity, you need equity capital. Well, there's tons of dry powder, trillion two of dry powder. You need debt capital, and there's almost an infinite amount of corporate private credit available.

8:24You need companies that are willing to transact, and there's tens of thousands of private companies, and now there's 10 ,000 private equity-owned businesses, a fair amount of which are later in the life of that investment chapter. So there's a lot of businesses that need to transact. You have all these ingredients in place. So how come there's no pizza? And the answer is the oven's not on. All investment either happens or doesn't happen because of greed and fear. That's basic behavior. You could say that private equity is frozen because of fear. It's fear on the GP side of if they sell, returns aren't what their LPs would have thought.

9:03They're afraid they're not going to be able to raise their next fund. So rather than say, we'll just transact and move on, if we hold it longer and the business continues to grow, we'll get to our MOIC target. We'll get to 1.8. We'll get to 2.0. It's just going to take a couple more years. On the LP side, you still have the aftermath of 2008 where you got too skewed to privates and there were liquidity challenges. There aren't real liquidity challenges on the institutional LP side now, but they don't want to go there. So they say, well, you're holding for longer. We're going to commit less. There's fear on both sides.

9:34Private equity firms only want to buy if they get a great deal and they only want to sell if they're getting full value. There's a few turns of multiples in the middle and you haven't seen that thought quite yet. What's interesting about that is you mentioned the same dynamic last year. Why hasn't anything changed? I was in AGM where I spoke a couple of weeks ago and they had done a poll the previous year of, do you think exits are going to be more than 10 % higher, zero to 10 % more, zero to 10 % less and worse than 10 % down? 90 % were in the zero to up 10 % and the answer was minus 40. At the beginning of this year, I wrote a blog post that effectively said, this is going to take a lot longer than people think.

10:19And then Liberation Day hit. So Liberation Day had an impact on strategics. That's a significant part of exits. Economic uncertainty slows down strategics interest. I continue to think this takes several years. Maybe it's two, three, four years away. It's a question of how long does it take for that bid-ask spread to narrow? Do you get the sense that GPs feel the pressure? Do they know that LPs are sitting there with their foot tapping saying, when are these exits going to happen? When are these distributions going to happen? But yeah, this isn't a secret. They feel the pressure, but it's a different kind of a pressure because it's a pressure on the GP business.

10:55The GP needs to raise their next fund. They need to keep their talent. They need to keep growing. The LP actually doesn't care that much. If I want 20 % privates and I have 20, I'm good. I'm just not going to commit as much because there's not coming out as much at the back end, but I'm okay. The LPs are not over their skis. The other is the structure of the industry. You went from 25 years ago, institutions had 0 % in private equity to today, they're anywhere from 10 to 50. The institutions are where they want to be. So the market share in terms of asset allocation is not changing. If anything, almost every CIU you talk to, if their target is 30, they probably have 35 or 40 % in privates today.

11:34It doesn't scare them, but over the next five years, they want to bring that down to 30. That's the institutional market, which is what's fueled private equity for 25 years. What the GPs then look for is what are the next areas of growth? There are two. There's sovereign wealth funds and private wealth. If you're sovereigns, you have huge pots of money to put to work and you don't want to have 500 small relationships. so you concentrate on larger firms. The private wealth channel is a whole different distribution mechanism. What those two things have in common is they benefit the largest firms.

12:07They don't benefit the middle market player. So the middle market, you have contraction, and then you have expansion of the already large managers. That's the landscape for what's happening with fund flows, particularly in private equity. What does that mean for the middle market? There's two things it could mean. One, it probably means there's a contraction. There are a lot of private equity firms out there today who don't realize they've already raised their last fund. But there's another side to that, which is in theory, if the largest funds are raising more and more money, they need things to buy.

12:38What are they going to buy? Well, the business from the mid-market sponsor that's been growing is now ready to be purchased by a larger asset manager. So there should be an opportunity for returns. You have this joke about hedge funds. You ask a room of LPs, do you like hedge funds? They all say no. But then you ask them, do you like your hedge fund managers? They all say yes. Is that what the middle market has become? Well, not yet. That's a classic exercise in base rates. The base rate of a hedge fund return, nobody likes that, but of course we like ours. Private equity still has shown returns that meet investor expectations on On average, middle market's been better than large.

13:19Small has been better than middle market. Median has outperformed the S &P. Bottom quartile, definitely not. Top quartile, buy a lot. The question becomes, as prices go up, as exits aren't there, if the returns compress to the point where you can only pencil out the magic 8%, if you get below 8 % net, then you're going to be in a situation where people don't like the market. They still will love their managers. I've asked at every AGM I've spoken to this year, please raise your hand if you think your private equity portfolio is median or below. And there isn't a single hand that's ever gone up.

13:57Everyone playing is playing for the top quartile. Earlier this year, you posed another bet, similar to the one you made with Warren Buffett back in 2007. This one was private equity returns versus the S &P 500. What happened with that bet? There was a lot of interest when that paper came out. And for several months, it looked like another charitable wager would come to formation. I had everything from several private equity firms coming out, including Carvervest and Hamilton Lane that have fantastic databases where you could get at an average realistic private equity return. I had a conversation with Todd Simkin from Susquehanna.

14:34They own Calci, so there was the potential for taking the bet and putting it on a prediction market. So a lot of things that looked interesting. At the end of the day, there wasn't anyone to take the public equity side of the bet. I reached out to some friends at Vanguard, but Vanguard isn't just a public equity index fund manager. They are a low-cost provider of solutions, including an early adopter of adding privates to 401ks through a partnership with Harborvest. So there just wasn't any natural person to do it. Warren might have been a natural person to do it, but unfortunately at his age and his retirement, I don't think he had an interest in doing it in the public eye.

15:12So we'll track the bet, but I thought it was interesting that on the margin, given all of the challenges in private equity, it's the private equity managers that were more than willing to step up and take that bet. Maybe someone will hear this and want to support the index side of the bet and we can do something for charity, but for now, it's just a concept. Where does private credit fit into this dynamic with this market structure and private equity? Most of the move to alternatives in the wealth channel has been in private credit. There's a bunch of reasons for that. One is it's a great vehicle for wealth.

15:49It's really hard to lose money in a year. So you make a portfolio of loans, and let's say they're yielding 8 % to 10 % unlevered. Let's call it 10 % to make the math easy. For you to lose money, you need a 20 % default rate at 50 % severity. Almost never happens. So the returns might not be great, but you're never going to scare them out because you're just going to be making money. The other piece of it is that the wealth channels used to liquidity. And by design, all of these alternative assets are less liquid than stocks and bonds. Well, private credit creates its own liquidity through coupons.

16:27So all that has led to the design of structures like interval funds and all this money is going in. The funny part about that is that private credit's never been all that interesting to the institutional market. And the reason is, if you have a known illiquidity budget, you want to make sure you get compensated for that with return, not just risk-adjusted return, but return. Now, if you're compressing your allocations, you're going to focus more on early-stage venture, growth venture, and some buyout. You're certainly not going to do it in something that has a lower expected return. So it's this really interesting setup where the move of all the wealth has almost all been private credit.

17:09And the large alternative asset managers are trying to figure out, can you create a structure that works in private equity, but it's much smaller than private credit's been today. So with all that said, what happens with returns in private credit? So you have the beginning of some defaults. No surprise. There's lots of businesses. Businesses do default. And Jamie Dimon says something about cockroaches and people freak out. I do not think there's going to be some calamity. The structure that the asset managers are using is just much better than what the banks used to use. You know, borrow short, lend long.

17:42So these are very long dated structures, which is great. You can work through problems. Where I think there is a challenge is when all this money comes in, the one thing it does for sure is compress spreads. I don't think the people buying in the wealth channel have the right understanding of what returns they should expect. There was a pocket of time coming out of 2022 where these corporate unlevered loans could yield 12 or 13%. I think people are anchored to that when the actual return is probably half that. That's just what happens when all this money comes into the space. So you previously mentioned venture.

18:16How has institutional interest in venture changed in the last year? To some extent, very little. Venture itself went from only early stage 20 years ago to all the way to growth. The one interesting aspect of venture structurally is to the extent private equity is private for longer, venture feels like it's private forever. It's a power law business. You invest in all these early stage companies and very few become stripe. Those companies now are wildly profitable and private. And if they need any funding, they can get it in the private markets. If they need any liquidity, they can do secondaries in the private markets.

18:52So what's happened is a lot of the institutional allocation portfolios who never used to invest in growth equity, their most successful venture investments have created a very meaningful bucket of growth equity that they can't exit. They can in a secondary market, but they can't if that position is still being held by the venture capitalists. So there's a different skew in the portfolios that used to be early stage venture, exit to the public markets, rinse and repeat. And now you have this big growing allocation to illiquid growth equity that may never have an exit. They're great businesses. You might want to own them for a long time, but people are changing the way they have to think about those exposures.

19:29How has that new pop in this now growth equity allocation, because these companies are staying private longer, affected the rest of the portfolio? The first thing it's done is increase the illiquid allocation, which means that when it comes to how much are you going to put in of new funds on the other end, there's less to go around. Nobody knows when that part of the private landscape will get liquidity. That's the biggest impact. But in terms of allocation to great managers on the early stage side of venture, that is still highly sought after and allocations haven't changed at all. How about public markets?

20:06How do all of the dynamics that you've just described ultimately impact public markets for both the allocators and GPs? Public markets have been quiet for a couple of years other than big move to passive, a lot of activity in pod shops. But it's been a sneaky year because active performance is back. MAG7 hasn't really rolled over. S &P's done well. And yet you've got active performance. You have really good long short equity performance. So people are starting to pay attention. But there's still no dollars flowing because of the bottleneck in the private markets. The biggest impact of that over the next couple of years is that when private markets unlock for liquidity, the first wave of that money from the institutional market is going to go back to the public markets.

20:47It's not going to get recycled in the private markets. Do the GPs know that? I think the public GPs are hoping that's the case. The private GPs don't know it at all. So that hasn't happened yet. You see trickles of it, but I think we'll start to see that this coming year. Then there's all the questions about the Mag7 and the valuation of companies facing AI. Is that a bubble in price? Probably. It's probably not a bubble in the underlying economic activity of the businesses. But Mag7 went from these dominant cash flow machines to taking all the cash flow and spending it in something that has an unknown ROI.

21:25That's what a lot of people are thinking about in the public markets. With all those structural challenges in deploying capital, where are allocators putting new money to work? When capital is scarce, you need to have a really high bar for the opportunities that you do pursue. That still happens every year. On the margin, there's a lot of intrigue about Japan, particularly in the public markets. It's very much a self-help corporate governance story. There's more interest in Europe as the value play. And then you could think about what Josh Wolf calls directional arrows of progress, things like defense and defense tech, certainly AI investments, particularly in infrastructure and data centers.

22:04There's always opportunities that people will look at that meet a high bar. And of course, everyone's always looking for the next great manager in any area across all asset classes. So we just covered a lot of ground related to different asset classes. is separate from market dynamics, what are LPs and GPs caring about? Certainly first half of the year, there was a lot of geopolitical uncertainty, starting with Liberation Day. The interesting thing about that in this community is it doesn't affect much of anything that people do. And that's because these allocator pools are like tanker boats, they're not fleet boats.

22:38So unless it's an allocator who's outside the US, domiciled in a non-US currency, and they have to make that currency call, you don't see a lot of activity. In fact, our CIO summit took place the Monday, Tuesday, and Wednesday after Liberation Day. And there was a feeling of panic on people not even sure they should come. Once they were all there, there was this catharsis that, oh, you also know the right thing to do is not much. The only thing that's been interesting to watch has been China. Because two, three years ago, China was going to be out of portfolios. Then you have a year where Chinese stocks perform really well.

23:12And now these things are cyclical. The US-China relationships, isn't that thawing a little bit? Maybe it's okay to invest in China. Even something that got so extreme is starting to come back. The other big one, of course, is AI. A lot of people are looking at it for operational efficiencies. There are some pockets where it's being used pretty meaningfully in investment strategies, but mostly people are just looking at this disbelief at the size of these valuations, how that's going to play out. Curious if there's anything else of note that you heard throughout the year from LPs and GPs. We've been talking about total portfolio approach for several years and in the press, it's deeply misunderstood.

23:49The idea is supposed to be strategic asset allocation. You have a bunch of asset classes, total portfolio approach. You're going to be more nimble. The reality is total portfolio approach is using data to have a better understanding of what you own. It starts with a very simple reference portfolio. If you're a 70-30 investor stocks, bonds, you can go on that passively. Anytime you invest in a manager, you're going to fund it from the same exact risk as 70-30. But that doesn't tie you to my 70 % has to be broken down, 20 % US equities, 25%. International equity is 20 hedge funds. If you like a hedge fund, you can do it, figure out what the risk is and fund it.

24:24There's been a bunch of things written in the press. Has TPA done better than? That's kind of ridiculous. It depends a lot on how you implement it. But that's something that more and more people are talking about because you have more data, you can refine risk better, and you can have more flexibility, particularly if you're looking at environments where you don't think the asset class betas get you to your spending needs. What will be top of mind for allocators and managers at the end of 2026? I'm very reluctant to make a market call because I deeply don't believe in market timing. So I will say whether it's next year or the year after the year after, I would be shocked if there isn't a significant compression.

25:03Maybe starts with the valuations of private AI companies and significant down rounds. And maybe that has downstream effects because of data center spending. I don't know how that all plays out, but I'd be shocked if there isn't some correction at a period of time. And people will be talking about that. I think people will be talking about the continued lack of distributions from private markets, at least for another year. It's just not going to unlock in any significant way. You're not going to see the IPO markets all of a sudden go ballistic because private CEOs don't want to be public. And I don't think strategics are going to immediately come back in spades.