E209: $70B AUM: How Cresset Delivers Alpha at Scale

0:00Avy, I've been excited to chat. Welcome to the How to Invest podcast. Thank you. Thank you for having me. I'm excited to be here. Avy, you started Crescent, which today has$70 billion. And before you had a prolific career in private equity, let's start from the beginning. How did you get into private equity? It was a securitist route, to be sure, how I got into private equity. I started out as a lawyer at Kirkland & Ellis and was actually very excited to be a lawyer. Started out in litigation. And then because I was also a CPA and had a business background, one of the senior partners, a guy by the name of Jack Levin, tapped me to start doing deals.

0:39and Kirkland opened up a Denver office. I went out there and built a deal practice. Pretty soon into that, what I realized was that I liked the side of the doer of the deals versus the side of the person supporting the doer of the deals and began talking to certain of my clients about potential opportunities. One of my clients made me an offer I couldn't refuse to run his oil and gas exploration and production company and to do deals for the parent company. It was a company called Cook International. They own Terminix Pest Control, a grain trading business, an insurance business, and a real estate development business.

1:21So I got a very broad-based experience and got to operate and actually have my own P &L in the oil and gas exploration and production side. So it was an offer I couldn't refuse. I did that. And then I got the itch to be an entrepreneur, did a consolidation strategy in the security alarm and personal emergency space, sold that, and then went to work for another client. It all kind of ties back to my Kirkland and how it's roots, it seems, by the name of Harold Simmons, who today we would call an activist. In those days, he was called a corporate raider. Harold owned a number of businesses. I was running one of the businesses as well as helping him try to take over Lockheed.

2:03When that failed and I was newly married and spending my life on airplanes, I decided maybe I ought to reorient my career a little bit. And I was offered the job of co-head of private equity of the old Continental Banks of Illinois private equity business. I ran it with a guy by the name of John Willis. and that was 1989. 1994, Continental Bank was bought by Bank of America. So we spun out our private equity business into a series of funds called Willis Stein. And that's really how I got into private equity, a bit of a securities route. Back then, you were writing these massive, at the time,$100 million checks and private equity was still an emerging asset class for lack of a better word.

2:55What was different back then? How was private equity different at that time? Private equity in those days was a very entrepreneurial business. You had a lot of entrepreneurially driven folks who were out trying to raise successively larger funds and make strategic investments. But they didn't have the sector focus generally. They didn't have the staff generally. They weren't using consultants in the same way that they use consultants today. Today, everything in private equity is Q of E by the name your favorite accounting firm, hire McKinsey, hire Bain, hire BCG to do all the research, huge investment committees, lots of layers.

3:43In those days, it was a much more entrepreneurial business, and there weren't that many funds above$5 billion. So it was really a much scrappier business today. it is a far more institutional business. I interviewed a former partner at Carlisle who was recruited by David Rubenstein. And he talked about how Carlisle really revolutionized having multiple funds within a franchise. As somebody who was in the industry at that time, how did that affect how you were running your funds? Well, one of the biggest regrets I have in the private equity business. And by the way, I'd still be likely in the private equity business, except in 2010, I was very sick.

4:26And so I retired. That was before GP stakes and all these continuation things that you could do. So when I retired, John had already retired. So when I retired, he was pretty much winding the fund down doing one annex fund. But one of my biggest regrets was in right around 2001, actually right around 9-11, we were going to launch a credit vehicle, and 9-11 happened, and we kind of lost our nerve, thought we needed to be insular for a while. And obviously, what Carlisle pioneered and others have pioneered, including Apollo and Ares and others, is the multi-strategy private funds group. And that 59 % of all the capital raised last year was raised by six groups like that.

5:16And so that was the right idea. And it didn't affect us because we didn't let it affect us because it's 2001 and then we became very insular. But it was definitely the right idea. And one of my great regrets that I didn't follow through with that at the time. And the argument is that if you're in the investment as a private equity investor, you're going to have a better vantage point on whether that business could return capital from a credit perspective. So there's this synergy between the private equity and the private credit part of the business. Well, I think that's I think that's one argument and a very good one.

5:51I think what's happened more from a business perspective for these funds is distribution is incredibly expensive. and a big deal. So if you're creating a group of folks, I think Carlisle today has over 100 people that are on their distribution team. So it's a lot to pay to be distributing one private equity fund. It's a lot better if you have sector-specific funds, credit funds, you have other types of vehicles. So yes, there is similar expertise in credit and private equity, although I would argue there are some specific skill sets for each. But I think it's more about the business of being in the private markets and the fact that distribution is so important and yet so expensive.

6:43And to be able to spread that distribution over a group of vehicles makes a lot more sense. Distribution being getting investors, getting endowments, pension funds, but also today retail. Well, yes, I might not use the word retail. I think what I would say more is that the wealth multifamily office channels today are about the same size, almost the same size, maybe a tiny bit smaller than the warehouse channel. So you have the warehouse channel, which is about 10 trillion dollars. You have the same thing on the RIA side is about$10 trillion. So there's$20 trillion between RIAs and wire houses.

7:28$20 trillion is a very big area and underpenetrated as compared to the institutional side, which would be pension funds, life insurance companies, endowments and foundations. That's one of the largest kind of non-wirehouse pools of capital in the country. You guys have grown from, I think, a couple billion assets to$70 billion. $70 billion. Yeah,$70 billion. And you now get the choice of whether you want to allocate to the Carlyle or the Blackstones, which has all these advantages, brands. There's an old saying, you don't get fired for hiring IBM versus maybe more of these entrepreneurial private equity funds or the smaller ones are focusing on the lower middle market.

8:16Talk to me about the trade-offs. Is there ever a reason to go with the large private equity funds? And if so, when? It's such a great question and such an interesting topic that we could talk about for the rest of this interview. But it doesn't make sense to me to say that we're going to be closed to some of the largest players. But it does make sense to me to say that we want to do things that are differentiated with them, whether it's the way in which we might co-invest with them for being a limited partner or the way in which we might seed new vehicles that they're putting together. But we don't want to be close to them.

8:55In general, I think that firms like ours believe three things are better. They believe that earlier funds are better than later funds. They believe that sector-specific funds perform better than generalist funds, and they believe that smaller funds in general perform better than larger funds. But those are general rules. So we do do a lot of middle market and lower middle market investing and fund investing. But like I said, we don't want to be closed to the megafunds. We want to find out ways to use our capital, like a sovereign wealth fund would, to create unique access points and differentiated investment opportunities for our clients.

9:41I often tell the story of when we were raising our third Willis-Stein Fund, and I got a call from a Middle Eastern sovereign wealth fund, and they said, we want to invest$100 million in your fund. $100 million is a lot of money at that time. I said, well, that's great. What do you need? And they said, well, we need a co-investment. I said, OK, well, of course you'll get co-investment rights with a, you know, with an investment of that size. And the person on the other end of the fund said, no, you don't understand. I need to co-invest in something you've already done. So, OK, what else do you need?

10:11And he said, well, I need you to come over here to the Middle East and present the co-investment and your fund over the next 60 days. And and then, you know, we'll we'll see if we're going to do this. But we're highly inclined to do it, given your reputation. I said, great. In 30 days, I was over there and I had convinced one of the entrepreneurs that we'd invested in to allow us to add some capital to it so I could create a co-invest. And I would have jumped through all the hoops I needed to jump through, including going to the Middle East at the drop of a hat, in order to get that$100 million investment.

10:43So today, the large RIAs like us, especially those that are focused on the ultra high net worth and family offices and allocate$100 billion capital are a target for large funds and small funds. What kind of terms are you able to get being such a large investor on the co-invest? Is this typically some guarantee for some number? Is it some first rights? And what's kind of the best in class terms that you're able to negotiate? There isn't there isn't one simple answer to that, because every every asset class, every manager is different. Just to give you some goalposts, for example, in venture capital, it's about access.

11:31It's about getting into those top decile performers that are largely closed to anything that isn't a foundation or an institution. And we've been able to crack that, you know, a lot of hard work and a lot of relationships, but also by showing them the consistency and who our clients are, are very desirable for them. Because a lot of our clients are wealth creators and people who are creating businesses that they want to invest in. So we've been able to crack that. So it's all about access there, and it's about co-invest access. And sometimes you get co-invest for free in venture capital, and sometimes you're still paying 1 in 10 or something that looks like 1 % fee and 10%, or sometimes just an access fee, and that's all over the place.

12:16With a larger private equity fund, what you're trying to do is to be a seed investor in something that they want to launch that might be differentiated for them, something that's a new vehicle. where we might get a little bit of GP economics and some co-investment rights. It's very unusual that you're negotiating fee breaks, but that does happen once in a while as well. More so in places like real estate, maybe credit. On the credit side, you can often get that. I had Professor Steve Kaplan from the University of Chicago, and he calculated just what co-invest rights mean on an IRR basis. So if a fund is returning 25 % gross IRR on net basis, that's 19%.

13:00Said another way that if you were to invest all of it on a zero and zero basis, you get kind of 600 extra basis points. Or if you do one-to-one, it's 300 extra basis points. So it is a pretty significant source of alpha if and when you can negotiate it. And also, big caveat, if and when you know how to not be adversely selected in your co-investments. That's a great point. Steve is very thoughtful and very good. I've known Steve since I was in the private equity business, and my son was recently a student of his, so that was kind of fun. Steve's great, and he's right about that. The adverse selection thing is really an important point, right?

13:42So many foundations and institutions don't have the kind of experienced staff to make decisions on these co-invest. We have a huge investment staff, people who have been in the private equity business for years. So we hope to avoid the headfirst selection issue. The more powerful thing, even than the co-invest, is when you can be lucky enough to help seed something for a manager, a new fund, a differentiated fund, something that they really want to do and really want to get off the ground quickly. And you can get some GP economics as well so that you're not only getting some co-invest rights, but you're also participating a little bit in the carry is really where the unique opportunity comes.

14:33Maybe you could double click on the seeding opportunities, maybe without giving the exact name of a manager. What do some of these opportunities look like when they come on your desk and you decide to pull the trigger?

14:48Pick one that would be interesting. You've got GP stakes. The issue with GP stakes today is that most of those investments were done without a liquidity provision. In other words, you have a perpetual fee stream, which is very nice, but there's no way to monetize that fee stream. And different things have been tried. Secondary sales typically are at a discount, so that's not a great event, although it may be better than not having a liquidity event. So if someone was looking to launch a perpetual GP stakes vehicle that would have in it its own internal liquidity, like an interval fund, a tender offer fund, that's something that maybe we would seed and we would be part of the GP.

15:37Something like that. Something new that's differentiated. I just use that one because it's something we are looking at and thinking about. It kind of goes back to a Procter & Gamble model. You keep one pivot foot. So you either do new product with the same customer or new customer with the same product. So you like to seed not a new relationship, but you like to seed an existing relationship with a new product. You can do that. That is true. or one of the things that's important and most important is team. So we're okay seeding a fund, a first fund, for a team that's spun out and has a track record as a team as long as it's the team, right, or largely the team.

16:28What we're not okay is people are just coming together for the first time and from different places, we usually aren't excited about doing those. But, you know, there are always exceptions to every rule. And as you mentioned, your$70 billion AUM, your$100 billion, including assets under advisement, you're starting to approach this very large pool of capital, which comes with its own challenges. How do you retain Alpha with going around with$100 billion? And how do you practically operationalize that in a way that keeps your clients kind of getting alpha in the market? Yeah. You know, there's$12 trillion.

17:07If we're just talking private markets, there's$12 trillion between now and 2030. It's going to be private investments by individual investors, in other words, non-institutional investors. There's a lot of places to put capital. We are not yet at a point where it's constrained. Now, people often say, well, what about the smaller ones? What about the ones where you can only write 20, 30, 50 million dollar checks? Well, the answer is those have to be in a pooled vehicle. So you're not going to do direct co-investments very often in, you know, venture capital opportunities where you only have a 20 or 30 million dollar allocation.

17:49That's going to have to be part of a co-investment vehicle. So you can still create the alpha. The only thing that you're not getting is people who like to kick the tires and do things by the each. They're not getting that opportunity in those smaller vehicles. I personally don't think that's an issue. There are some financial advisors and investors who think it is, but it's just the nature of it. There really isn't a choice. So the larger co-investments, the larger fund investments can be done direct as a one by one. the smaller ones have to be in pool vehicles. When I think about co-investments, I think about it as all about incentive alignment.

18:30So there's two aspects to it. They're like, where are the incentives for the manager? And also is the manager good at their craft? So if you think of kind of a two by two matrix, you could have somebody that's very good at their craft that has bad incentives, probably even worse than somebody's that's not good at their craft and as good incentives. We can argue that. But what I really want to double click is when you create these pooled capital and when you negotiate with GPs, how do you make sure that your incentives are aligned and how much thought goes into that very question? So when we're creating a co-invest vehicle, we are not charging our clients anything for that co-invest vehicle.

19:09So our incentives and our clients' incentives are 100 % one. What we're trying to do is to get the best returns for our clients. So what we're looking at is making arrangements with GPs who we believe are going to create interesting opportunities for us to invest and making sure that we are, to use your vernacular, double-clicking on the diligence to see that we agree with them in where these investments make sense. Their incentives are twofold, right? Raising more capital and the need to create co-investment. They want to raise more capital that they get fee and carry on. So they know that it's a necessary evil to create some co-investment.

19:55So large capital sources will invest with them because that's what they require. But they also have incentives sometimes to do larger deals than perhaps their fund size would dictate. And in those situations, they need the co-investors. So they have two sets of incentives. And we obviously want to be part of both and be there for them when they need us, as well as creating a better return, as Professor Kaplan tells us, through the co-invest vehicle. By the way, there was an interesting article. I can't remember exactly where it was, but it was about David Swenson. And it was about that everybody believes that David's brilliance in the Yale model was because he was first into private markets in a very large way.

20:44And that is true. That is a big part of his brilliance. But what also was part of his brilliance, and was pointed out in this article, was his ability to get to know GPs early on and to be a great partner to these GPs. So having been a GP, I understand their side of the equation. And what we try to do is to be great partners to them from the beginning so that there is a series of opportunities that when they think of launching things or doing something differentiated, or when somebody spins out of those GPs, they think of us because they know that we are there for them to advise them, to tell them what will work and to be there if they need additional capital for something or they need to seed something that they want to start.

21:28I'm always fascinated double clicking on these long-term games with long-term people. This Naval quote of how do you play these recurring games with the same actors and how do you build relationships over years and sometimes decades. Unpack a relationship like what you're talking about where you're investing with them early and then you continue to invest. How does that start and is it always quote pro quo or is they're just this reputational relationship capital that builds and you're kind of always giving to each other. So double click on that a little bit. I, you know, I hesitate to, uh, uh, do you say any names?

22:05Cause there's confidential provisions. So, um, there is one very well known name, uh, that is one of the top six that I mentioned that raised 59 % of the capital that we as a firm and some of our predecessors have been investing with over a very long period of time. And we have invested in many of their vehicles that span credit, GP stakes, and other related investment vehicles. And the idea is that we have the kind of relationship where when they're launching something or thinking about something, we're talking to them early, and they're gauging what our appetite might be for that, and we're gauging how we see it and whether it fits or not.

22:59Just double-click on kind of how those relationships build out. Businesses people, and this is no different, while it can become very transactional, and that's unfortunate, it should always have that element of relationship and culture. And when you can be consistent in the way that you approach things and they're consistent in the way they approach things, you do build up a cadence and trust that I think makes it much easier to get to yes on an investment. It's not unlike a co-investment opportunity where in the beginning, you're diligencing the manager, and then you're only diligencing the actual underlying company.

23:48So there's almost like this two-step diligence. And we're all human. We all have things that we do better than other things. And we all have mistakes that we make consistently and we try to learn from, and we all have our own frailties. So you learn. You learn what is the sweet spot for someone and why it makes sense to invest with them in those kinds of things, and maybe not in other things that are not perfect for what you're trying to accomplish. In that vein, has there ever been a situation where a GP has given you back the money because the strategy no longer made sense or made a mistake and communicated well that you backed that GP in another fund?

24:31And in what cases did that happen? There has been a case where we backed a GP and the strategy got overpriced very quickly. And we went to the GP and said, look, we have given you a commitment. We don't think it's in your interest or in our interest to continue down this road. Why don't we work something out? We've made one investment. growing up i thought managing money meant paying bills and balancing a checkbook but as you know that is only a small piece of the financial puzzle managing your money takes more than just checking your bank account every once in a while and great financial decisions come from having a complete picture and proactive management of your income expenses and investments take control of your finances with monarch it brings together all of your accounts investments saving goals and spending into one place making it much easier to understand where your money is going and whether you're actually on track to achieve your financial goals.

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26:10You release us from our commitment. We'll make sure that we deal with you fairly. And that was the right thing to do at the time, and it did work out. We've not done another thing with that particular GP, but we would because it worked out well. Taking a step back, when it comes to picking private equity firms in your first commitment into them, what's the criteria that you look for and how has that evolved over your career? When I started in the private equity business, people would ask me what was important in private equity and how do you make decisions about investments? And I would say, oh, you know, it's about industry dynamics, competitive positioning in people.

26:52And if you'd asked me 10 years into it, what would I say? I would say it's about people, culture, people, culture, and that the industry dynamics and the competitive positioning are table stakes. You have to have it, but you really need the right people and the right culture. And today, depending on the asset class, some of it's about sourcing, some of it's about what happens when things go bump in the night, but in the end it's always about having the right people with the right reps and the right backgrounds and perhaps it's painstakingly obvious but maybe you could double click why it's people and culture and how that plays out within a manager look everybody makes mistakes and and everybody makes hiring mistakes everybody makes strategic mistakes uh investment mistakes um you know you miss things, right?

27:52You know, I look back on the, there were two investments that I made that, you know, I wish I had mulligans on and I look back and say, well, how did I do that? How did I make those mistakes? It was always somebody in the daisy chain that you should not have trusted in the way that you did, that gave you information that turned out not to be what you, what you learned it to be ultimately. Now, that's not to say people can't be great and still make mistakes. They can't. The best investor is still not going to bat a thousand. Ted Williams didn't bat a thousand. Nobody bats a thousand. But it is to say that you can usually pinpoint, if you do a post-mortem, where you went wrong, what you missed.

28:38And without getting into tremendous detail, It's usually something that was, in hindsight, painfully obvious. And if it was the right person doing the right digging, might have been a little bit more of a factor in your investment decision. As you build out Crescent, you're also building out a pretty sizable organization. And how do you set the culture and the policies in a way to make it succeed? When we started Crescent, the first thing we did, there were, I think, 10 of us at the time, we went off-site with a woman by the name of Laura Desmond, who had just retired as the CEO of Starcom Media, whose specialty was brand, blueprint, and culture.