AI, SaaS and the Next Private Markets Shakeout

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0:32Alexa Binns: Welcome to Swimming with Alligators, the VC podcast from the LP perspective. With your hosts, Alexa Benz and Ernest Slecht. You ready? Let's dive in. Chris, I'm so happy to have you back. Thanks for being on the show.

0:49Chris Schelling: Well, thanks for having me back. Being the first repeat guest is quite an honor. So pleasure.

0:54Alexa Binns: Yes, yes, that is correct. Chris is the first repeat guest. I was looking it up before we started recording. I believe your last episode was episode 22. People should go back to it. And it was released May 1st, two years ago, 2024. So as I was going back and looking, last episode that you were on, the market was very different. You talked a lot about behavioral finance, Caprock, multifamily offices, and manager selection. just curious now that you're in a new seat at um axia um you know what's changed in the market

1:37Chris Schelling: and you know why the move a lot has changed i mean two years goes by in a blink but um i'll just give kind of like the background for the move and sort of like what we do and what we kind of see and where you know i think a lot of this is evolving in wealth it's happening really rapidly like the level of sophistication and changes that are occurring in terms of like product structure and what's happening in wealth is just going so fast. So two years ago, when we last caught up, I was at Caprock in my family office, was looking at Axia's credit product. And so I've known Axia for, you know, 15, 20 years from the institutional world, really well regarded in terms of deep research across private markets.

2:18Chris Schelling: Anyway, I've looked at the product. We had a conversation where I've known a lot of people here. And, you know, I saw the roadmap that was coming in terms of other vehicles and products coming to market and just sort of this view of how actually it could be a great value-added partner to wealth. And so joined in sort of this strategist sort of content role here. And, you know, since that time, we've come to market with two other products. We've got a roadmap behind that. And I think well-positioned to sort of be that provider of value-added research content and asset management services across private markets to the Wealth Channel.

2:56Alexa Binns: To level set for our audience, could you just give the background on Axia?

3:02Chris Schelling: Yeah, happy to. I'll kind of spare the commercial, but Axia has been around for 20 years and our DNA would be as a institutional investment consultant slash advisory firm. I think there's sort of a pejorative around consultant. That's unfair. We can talk about sort of where I think we have, you know, big advantages and people like us have big advantages. But really today, we're$380 billion investment advisory specialists focused on four verticals of private markets. And that's all we do is private markets slash alternatives, private equity, private credit, real estate, real assets, and hedge funds.

3:37Chris Schelling: And historically, we have been a partner to big institutions. So we help them in sort of three different ways, research, advisory, discretionary, right? Real simple. We have a big research platform. You can access that, do it yourself. We help you as an advisor and outsource sort of extension of your staff, or we can be an asset manager. And so increasingly we've done more of that, managing just portfolios for clients across those verticals. And then that's the natural evolution of kind of that approach to wealth, to building portfolios in private equity, private credit, et cetera, and then making it accessible to wealth via those wrappers.

4:15Chris Schelling: So today that business is called about a billion and a half with three different products and it's growing really rapidly. I think we're very well positioned to take what our firm has really founded. It is deep, deep skeptical kind of research and thorough analytics. By 2007, we released a diligence report on Madoff. Obviously that was huge back then and it sort of landed our credentials as you know really being skeptical and thorough research so that's what we are today yeah and it's a great seat to be in so i can talk more about the products but i thought maybe we'd go wherever makes sense for for you

4:51Alexa Binns: can you share with us something we should be skeptical about today so if we want to just jump

4:58Chris Schelling: right into i think like you know where i would see skepticism or at least being concerned about some of the valuations is AI for sure. Like there's no question it is a big technology disruption that is occurring, but you can have, think about bubbles. Like what's a bubble? Like we can get into the big, you know, epistemology behind what a bubble is. It means inflated valuations. You can have a bubble without true technological disruption occurring. It's very rare that you have disruption occurring without a bubble, right? Because that's the whole kind of Gartner hype cycle. If you really have things that are changing the economy or changing the way things are built and made, it's going to get overinflated.

5:38Chris Schelling: So I think at the same time, you can have both expectations that are probably too optimistic and too pessimistic occurring at the same time, right? And that might be happening what's right now. We see pockets of excessive valuation in certain areas. And I think there's capital formation there that's going to lead to capital destruction in the long run. But at the same time, I don't think we fully appreciate like the diffuse impact that it's having across the economy, right? Like, I think it's really nuanced. It's not, we joked about this in the conversation before the call, but it's not legacy SaaS goes boom.

6:14Chris Schelling: Like that's way too simplistic. And in fact, there's areas where things are being disrupted that it's not SaaS, it's services, it's small businesses. And I don't think that's being appreciated. So it's nuanced, but I think understanding where there's opportunity, and frankly, it's probably, you know, the time to invest was a year ago or two years ago. And now a lot of those valuations are really stretched. So yeah, if I were to zoom out and just look at our team, like we're probably skeptical in all of our asset classes, as far as a lot of the big valuations that we're seeing. So we have, you know, yes, real assets.

6:50Chris Schelling: Do you want to own data centers or do you want to own and invest in maybe the power infrastructure behind those data centers? Do you want to be a lender to corporate credit risk? Because a lot of those offtakers, it's corporate credit risk. And maybe that's not priced adequately to other areas of the credit market. So that's where I would say, like right now, it's probably a time to be a little bit more skeptical when everybody else has sort of FOMO.

7:14Alexa Binns: Chris, you kind of got into what I was going to follow up with is how the bubble of AI is impacting your other asset classes. But you kind of mentioned it also with kind of the real assets and that next layer of figuring out, all right, what is undervalued that's going to be very needed in the next three to five, 10 years? When I think when people think of kind of venture and AI, they think of, oh, everything's just overvalued. Do you think there are some pockets that are being undervalued today? maybe it's in SaaS companies and certain types or growth equity companies today. Where are you seeing kind of the opportunity?

7:58Chris Schelling: So, yeah, if I would look at, let's stick with SaaS. So we've done a lot of research and we've invested in SaaS, both in the credit side as a lender and in private equity. But if you think of where there's risk in SaaS, maybe that leads into where there's opportunity. So over the last, call it, eight, nine years, roughly 20, 25 % of private equity has gone into software businesses. It's been very hot in the private equity side and venture capital aside. A lot of that was deployed in, call it, 2019, 20, and 21. So that sort of three-year vintage was, call it, maybe 30 % of total capital deployment.

8:36Chris Schelling: And it's maybe a third of what's total outstanding. So you've got this little pocket there. Why is that at greater risk? a couple of reasons. The three main ones being that was done when rates went to zero and they really bottomed out in like 20, you know, 2020, 2021. That leads to valuations, right? That were peak valuations kind of in that 21 peak. So those businesses were highly capitalized. Some of them were highly levered based on like, you know, ARR with rates at zero and then rates reset. And so So now they see their cost of capital. It's the 21-22 vintage that was expecting to be borrowing at like 6, and they wound up borrowing at 11.

9:16Chris Schelling: And then that's also the period where, you know, chat GPT kind of came out. I think it was November 22. So really that pre-22 stuff, it had a mix of economic conditions that sets that most at risk of being disrupted. Stuff since then has actually done very well, like a lot of 2024. we see pretty strong EBITDA growth in like our SaaS businesses and software businesses because those are AI native. And so it's benefiting from those things. Like even those earlier ones, like if we look at what business characteristics make them durable versus at risk, I think SaaS that has, you know, proprietary data, customer, installed customer base, maybe with sensitive customer data and it has this intersection of functional workflows with kind of horizontal workflows with functional industry specifics.

10:13Chris Schelling: Those are really like highly embedded. If you think about like Uber, no one uses Uber, right? Because like the UE is so cool. You use it because there's a real world network effect that's hard to just replicate. And so like, will they use AI? Probably already are. I don't know. But like, that's not the differentiation. So there's a bunch of stuff out there that's like that, but I think will be fine. There's more bland, you know, horizontal software that's like simple workflow stuff that probably doesn't have a right to exist anymore. And again, you're seeing that in one of the big sort of PE hand the keys back to the lender scenarios right now, like where AI lets you do it yourself pretty good or maybe better even more customized than what exists off the shelf those businesses are at risk and then like even the knock-on effects okay so it probably means sass has to get better sass has to get cheaper like if you can build it yourself versus

11:13Alexa Binns: buy it why wouldn't you no this is a very cool example of how the work you're doing at axia is so research driven. Very cool to hear how AI is reshaping the companies and the software. What about diligence and even investment committee behavior?

11:34Chris Schelling: It's very similar. You see the low hanging fruits are where it makes analysts more efficient. So maybe AI is going to replace junior analysts. That's where the lower value added information service roles are going to be competed away probably, but it makes senior analysts, portfolio managers way more efficient. So I mean, we have lots of different tools that we're using and investigating. I mean, we have subscriptions to, you know, enterprise stuff. And so it's helping in low hanging fruit, like, you know, memos and synthesizing and aggregating data. One of the challenges in private markets is there's a lack of data ubiquity compared to public markets, right?

12:18Chris Schelling: So everybody in public markets have a right to all of the data in real time. That's why we have Reg FD and things like that. That's not the case in private markets. Information is still highly, highly asymmetrical and you have to actually go out and get it. So a big part of the value add in private markets is going out and accessing all that information, which is still kind of manual. Like it sits behind data rooms and NDAs and confidentiality agreements and you have to pull it in and scrub it. So once you get that, you can use tools to then synthesize it and analyze it, be more efficient with that.

12:54So I think there's a longer

12:56Chris Schelling: runway, frankly, where still just a data advantage will accrue in private markets versus public markets. Public markets, you see hedge funds using AI to come up with trading rules and to actually implement stuff as an agent. We don't see that in private markets, but I can give an example of a big private equity firm that has an AI agent on their committee. So this is a firm that has, you know, 10 or 11 people on the committee, but this entity has a vote that counts like everyone else, obviously won't swing it, but it's fed the entire memo. It's fed the data room, all the information, and it comes to the committee vote with questions.

13:36Chris Schelling: It's like, that's really cool. And what they have indicated is that it's always asking things that humans have not thought to ask. So it makes you smarter and brings a different perspective. So like we're seeing all these areas where, like I said, it is disrupting things. It is really impactful.

13:54Alexa Binns: I love that. And it's because I think we're in this transitionary period where a lot of fund managers across different asset classes are tinkering with the tools, which I think is really important. And you should look for individuals who are constantly tinkering. But within that, you have to have parameters that allow you to, one, not tinker too much. You can literally create everything and anything that you think you need for an internal tool. And two, that are congruent with helping you become a better investor for whatever you're really good at. And so from that point, has like the incorporation of AI as like another kind of table stake tool in the toolkit, has it changed things that you look for in the criteria of a fund manager or for your team?

14:52Chris Schelling: I don't think it's fundamentally changed things to that extent. It just makes you more efficient in how you're prosecuting the process and accessing some of the information. I mean, it's good at pattern recognition. I mean, maybe one area that it has changed is you are now asking GPs and asset managers about how they're implementing AI and how they use it. So examples like the one I just gave on the investment committee, those are now things that people in due diligence are asking about. I think it'll only continue to evolve. We touched briefly on this, too, about the use case of behavioral coaching and an analyst in an intro meeting with a GP.

15:37Chris Schelling: There can be tools that can be created that already have. Historically, that was more of an apprenticeship process. You sat through lots of meetings. You learned how to ask the questions based upon pattern recognition of those meetings or what the GP does and what you should be asking similar GPs. Well, now you can create a tool that can actually coach somebody in real time. You know, you ask this, follow up with this, et cetera. And so I think there's lots of ways where it theoretically could make the whole process better. And we'll probably, I mean, we are starting to see things like that. There's AI-based behavioral coaching tools in other areas, like Minerva is doing things for senior executives at portfolio companies, et cetera.

16:17Chris Schelling: So I think we'll see some of these applications. It's still early days.

16:21Alexa Binns: I had a question that that I just kind of came to my mind when you first were introducing and talking about your new seat and use the word called like not only research, but like content. And content is something that's becoming bigger for even for allocators as they discern for net new relationships. what are you doing? I was talking to an LP yesterday that was saying, hey, we look at also what are you doing outside of being an investor in VC to help you become more of a founder magnet, to help you get those insights? Because as you mentioned before, Chris, data is something that can still be proprietary.

17:03Alexa Binns: Sourcing can't really, but knowing about a company, but actually the specific information you know about companies and industries can be helpful. um what's the role that content plays for an allocator um an advisory firm that's so important now i think well so from my seat like part of my job is to leverage the research that we have and

17:31Chris Schelling: all the data across our teams i mean we have you know 200 250 people that are engaged in investment functions like day to day. That's what they do. They're meeting all the GPs. They're taking the notes. They're digging through the data rooms. And so that provides, you know, with an incredible view and sort of going through that and having some insights and observations, like taking that and creating value added content for clients and investors. An example would just be like some recent research on credit risk. We talked a little bit about like, you know, private credit. Is there an apocalypse happening there.

18:07Chris Schelling: We think that that's wildly overdone, but we have some great research that we've distilled and provided to our clients to say, here's how to think about risk in your portfolios and here's some sort of baselines that you can use. So I think, you know, really good value-added content has something that's an applied takeaway, but increasingly, like one, just this is a thought that's occurred to me, I think GPs and asset managers need to be creating content in various media, right? That is what their LPs want to consume it. So it's less and less about a PDF or a white paper that you can just shoot over to them in an email and more about interactive data, whether that's data visualization, charts that are sort of live in real time and people can, you know, move things around and sort of look at stuff.

19:00Chris Schelling: I think that is becoming much, much more important. And that's still also early days.

19:06Alexa Binns: Another very hot topic that you've been observing from this cool seat of getting getting to pull from everybody's observations is around SPVs and like layering SPVs. Can you tell us what you're seeing there?

19:20Chris Schelling: This has been a trend for several years. is it's not new. I mean, when I was in my prior role, we saw it, you know, we were sold on this. And then SPV technology, those of you guys know, is like nothing new. It's perfectly fine when it's used. One of the problems is when we see what we call SPV sandwiches, where it's just layer upon layer upon layer, and you don't know, number one, what the underlying assets may actually be, but you certainly don't have great transparency into the layers of fees upon fees upon fees. And so...

19:52Alexa Binns: Chris, it reminds me of something that happened maybe in 2007, 2008, when we just kept layering things and nobody knew what they had.

20:02Chris Schelling: Yeah, exactly. And then you package it and sell it and repackage it and resell it. So it's very similar to the risk of what's happening with some of these smaller subscale, subinstitutional kind of SPVs that are out there. and I think they're selling into a desire to participate into this AI. And before that, it was, you know, whatever was the hot opportunity set there. But I think there's a difference between, you know, subscale has access to an SPV that they can repackage and sell and is going to go out and sell it versus somebody that is actually driven by an investment thesis and is investing in that thesis and then providing access.

20:46Chris Schelling: Like, it sounds like a fine kind of distinction, but it's actually really important. Like, one is I'm going to sell whatever sells and I'm going to package it in a way that is easy to sell. And I think people have had a hard time kind of distinguishing between the two because of those layers of complexity. So to me, it's about ensuring that your partner or provider or whoever you're working with has the ability to assess what's in there. I mean, in the worst case scenario, like there's been fraud. It's not even what you think you're getting. But even if it's not, it could be some sort of a restricted stock or something that's not the common in what the underlying company, you know, you hope it is or it's an option or something like that.

21:26So, yeah, that's one area where also we've talked about being skeptical.

21:31Chris Schelling: I would be skeptical if somebody, you know, comes to your room and says, I've got this great access because of my great network. And it's, you know, one or two people that have only been doing this for two years.

21:44Alexa Binns: Now we're going to take a quick break to speak with our sponsor. All right. Today, as our special guest, we have Nick Kasson, who heads up Sidley's secondary practice. Nick has a ton of experience with fund liquidity transactions. He's focused on venture, but also PE, real estate. So any questions you have around continuation vehicles and LP and GP-led secondaries or tender offers, those are the things that his clients are coming for him to ask about. Welcome, Nick.

22:11Earnest Sweat: Thank you. Thank you, Alexis. It's great to be here with you.

22:13Alexa Binns: So Nick, you are known for secondaries in general, not just venture. Can you give us a picture of the full universe of secondaries that you're dealing with?

22:23Earnest Sweat: Sure. And that is really one of the aspects of my role here at Sidley that I enjoy most. And that is the breadth of asset classes that we deal with. I mean, as I mentioned, the transaction structure, whether it's the GP-led structure, the strip sale or the LP trades really can apply to all asset classes. And so currently I'm working on deals that involve data centers, deals that involve private credit portfolios, single asset GP leads that involve credit rating agencies, multi-asset GP leads involving real estate joint venture recapitalizations. And so it's really a huge breadth and then constantly interesting new and novel issues that we have to deal with depending on the underlying asset class and the specific regulatory concerns that those engender.

23:25Alexa Binns: Well, in that case, I think our VC audience are quite lucky because a lot of these sort of liquidity options didn't originate in venture. They've come from PE. They've come from other asset classes. Are there any trends you're seeing where more venture GPs are implementing different strategies? Yes.

23:48Earnest Sweat: So it's definitely one of the upticks I've noticed in recent years, and that is venture participation in these transactions. I have on my desk right now transactions involving three different venture funds. One is an LP trade. The other is a GP led where I am representing the new money. And the third is a GP led where I'm representing the venture sponsor. And that in itself has raised some interesting conversations in particular around economics.

24:24Alexa Binns: And for our allocators who are listening, I'd love to hear your perspective on why choose to work with Sidley? Sure.

24:33Earnest Sweat: So I think what Sidley offers and what is a differentiator is really the breadth and expertise that we have across not just secondaries, but private funds as a whole. I mean, I believe you know my colleague Shane, who leads our venture practice. We have a practice that focuses on GP stake transactions, which is obviously fits into the broader remit. We've got excellent fund finance capabilities, including anything relating to NAV loans, which are also a topic of high interest in the market. And so really, I would say it's the breadth of our expertise, but also the fact that we're very commercial.

25:20Earnest Sweat: I mean, I've been doing these types of transactions for 15-20 years now and so I've seen the touch points. I know what clients should care about whether that be on the buy side or the sell side and so what I pride myself in is being commercial and coming to an efficient and sensible and reasonable middle ground probably faster than And so what's some of my competitors are able to achieve?

25:50Alexa Binns: A lot of real world experience. Right. Is there an example of something you're helping a client with right now that you could share with us?

26:01Earnest Sweat: Sure. So on the venture side, I mentioned I'm working on a GPU ad representing the sponsor. And one of the items that comes up as part of these GPO ads is the expectation by the new money coming in that the GP will continue to retain significant exposure to the continuation vehicle. The primary reason for that is to ensure alignment of interests. And so what the new money will usually require is that any existing investment that is being made through the fund with respect to the portfolio company at hand be rolled into the CV for that same portfolio company. But in addition, any carried interest that's generated and that's crystallized as part of the CV sale also be rolled into the CV as an investment by the GP or GP affiliates.

27:05Earnest Sweat: And so the discussion I'm having now is essentially working to have an exception made to that general rule so as to allow the GP sponsor to quote unquote clean up shop as part of this transaction and perhaps give certain senior investment professionals that are approaching retirement an exit opportunity and an ability to take money off the table. Or to recut the economics as it relates to the CV carry waterfall, because there's no default that entitles the carry holders in the existing fund to those economics as it relates to the CV, unless they have that specifically negotiated in there in that GP docs.

27:59Earnest Sweat: such that that often does become a topic of conversation when on the sponsor side and considering these transactions.

28:07Alexa Binns: Well, it sounds like something that should almost be expected given that these transactions, you know, these funds are stretching out to so many years that this would end up being a commonplace opportunity to put the new leadership at the helm.

28:26Earnest Sweat: Indeed, generational shift going on. And now back to our LP interview. Do you have any kind of like checklist or major questions people should be asking?

28:40Alexa Binns: Because I've been surprised by one, the activity and individuals who have claimed to be able to put together these SPVs. I think they've put together, but again, I don't know if they have access. there's a side note there's one person who I was like this is the dumbest thing you could do that posted on x where she says she made more in her in one anthropic spv than she's ever made in her life or something like that not smart but anyway so you have people doing that but do you have any kind of like questions that people could ask if they're a family office I've even heard like pretty significant or sophisticated allocators looking for access in these kind of four or five names.

29:26Chris Schelling: And I mean, it does make sense to want to get access to a category winner, like at an attractive valuation when you see evidence of a liquidity or an IPO coming up. Like, to be clear, like that makes sense. We have we have exposure to some of these companies in different ways. I think it's how you go about getting that and making sure you're working with, you know, a reputable partner, I mean, one of the simplest ways is just ensuring that that person actually has that capacity and you have the ability to look through to the underlying portfolio. And you've got to read, you know, the LPA. I've seen opportunities where people don't even look at the LPA or the PPM or understand what's in there.

30:04Chris Schelling: So understanding what you own is super, super critical. And if you or your advisor doesn't, then that's probably not the approach that you should be utilizing to get access to private markets, right? It's not going direct. It's maybe working with somebody to build that exposure for you. So we have a, yeah, I mean, we have a checklist, like we have a DDQ, how to do DDQ. It's, you know, 20 pages or whatever with all kinds of questions that people should ask, but just ensuring that it makes sense. I mean, and you can discard some of this pretty quickly. Like a tool that I just use is I look at my LinkedIn network.

30:38Chris Schelling: At this point, I've got, 10 ,000, 11 ,000 connections. If the person touting their access has no connections in common, that's probably a pretty good sign that that's made up. When I see somebody that's got 500 connections and I look at those connections really quickly and it's all credible VCs or LPs or PEGPs, that looks a lot more reasonable.

31:03Alexa Binns: This is a very tangible example of something I know you are an expert at, this just general trend of private markets moving into the wealth channel, apart from, you know, best practices in how to vet these SPVs, any other sort of trends you're seeing or advice you would have for people who are new to allocating in this asset class?

31:31Chris Schelling: Yeah, I mean, you know, broadly, the democratization of alternatives, I think it's a very good thing. When you think about in feudal Europe, you couldn't own land unless you came from landed gentry, which was a heritable right. It didn't matter how much money you had, it had to be passed down. And for the longest time, private markets in the United States have had an asset test where you were prohibited from owning private equity unless you were a QP or accredited investor. And while there's reasons why that's meant to protect people, it also just limits what they could participate in. So to me, that's always felt, you know, and there was times when I was not an accredited investor myself and had been doing this for a long time.

32:13Chris Schelling: And so I couldn't invest, but somebody that inherited a ton of money and might not have known was able to. So I think like a level of sophistication is probably more important than a pure asset test, but like democratization done right, it's intended to open up the aperture of investors who can participate in, you know, historically what have been very strong performing asset classes, private equity, venture capital, et cetera. Whether you agree with it or not, if you just look at the top 100 pensions in the United States, the best performing asset for 99 % of them who've invested in has been private equity.

32:48Chris Schelling: So making sure people can participate. Done poorly is just opening the aperture for more sales. And certainly everyone wants to grow their business. You need to grow their business. There's benefits of scale. But I think done right, the whole goal is to take really skillful allocation and make that available to retail investors. So I think there's wrappers that we can talk about that are important and that broaden that ease of use. If you look at, this is maybe not the greatest analogy or maybe everyone doesn't agree with it, but I think if you look at indexation, there's some interesting characteristics that are relevant for private markets.

33:31what has indexing done for public stocks?

33:36Chris Schelling: Well, it's made it cheap. It's made it scalable. It's given you broad, diversified access, kind of a one-stop solution. And when done right, I think private credit, certainly private equity, provides some of the same things. And so structures where you get broad access to drivers of return that continue to perform, hopefully, ideally, and you do it in a way where it's relatively cheap. I mean, private markets are still going to be more expensive than public markets, but where scale can accrue and fees can, discounts can accrue to the end clients. That's a good thing. And then making minimums relatively low.

34:19Chris Schelling: So like very low minimums, low accreditation requirement. That, to me, is like the whole basis for why democratization should happen. So I think that's not one tool. That's not one solution. That's not one wrapper. But that's an evolution of a bunch of things.

34:36Alexa Binns: It's so fascinating that you are not seeing, like, flames and fire in private credit. Can we just ask you a little bit about that finding?

34:45Chris Schelling: So private credit has raised a ton of money in the last decade, but everything has. If you look at private credit compared to the size of private equity or other private credit markets, it doesn't appear to be massively overcapitalized. It's$2 trillion. High yields, call it$2 trillion. Bank loans are right around$2 trillion. Private equity is$6 or$7 trillion. So it doesn't seem to be hugely overcapitalized. It's grown. Now, I like to say private markets are not one thing. Private credit is certainly not one thing. There's direct lending. There's all sorts of other stuff. That addressable market is multiple times probably of the corporate lending market.

35:23Chris Schelling: And even within the corporate lending market, there's mega deals, there's large deals, there's mid-market deals, there's small market deals. It's not all impacted the same. And so when we look through, we have seen evidence of spread tightening. We have. We've seen evidence of credit underwriting status eroding a little bit. So weaker documentation, weaker credit protections. but we also track 60 ,000 credits in real time and we just haven't seen massive defaults. We haven't seen EBITDA falling off a cliff. We haven't seen coverage ratios completely dry up. In fact, in the last three years, we've seen interest coverage ratios pretty broadly improved.

36:05Chris Schelling: So yes, there are going to be defaults. This is not a zero default asset class. You should think of it more like high yield or bank loans but we don't see this impending, you know, 20 % of the market is going to default. Like some of the headlines have been wondering how absurd. I mean, what we've seen has been lots less than that. So again, just being data-driven and empirical and saying, yes, there's going to be pockets of risk.

36:28Alexa Binns: Yeah, I think over the last five years, each asset class has done kind of the Spider-Man meme and pointed at the other saying like you're the cause of everything or you're more um we're more well off than than you and it's kind of jumped from you know venture being the the red-headed stepchild to then like you know credit to then even private equity having some some real challenges i think what we can all agree on is that the zero interest rate period had real impact on all of the different private market asset classes.

37:04Chris Schelling: I mean, it had it created capital misallocation. I mean, that's what happens when you fiddle with the price of money, you're going to create capital misallocation. So that takes time to correct. I wouldn't say it's like perfectly corrected. I mean, I think one of the results we're seeing in private credit is that, like, as a result of some of these outflows and the stress in the market, we've seen underwriting standards improve. And so, you know, the market has been adjusting. It takes a little bit longer in venture. It takes a little bit longer in private equity. But we've definitely seen the impacts of that.

37:36Chris Schelling: Valuations have, you know, reset. Buyer-seller expectations are closer. Capital structures have rationalized a bit. So, yeah, it feels like things are healthier than the most, you know, ardent critics of the space sort of want you to believe. Yeah. I think the other thing, just in private markets, and this is something that I want to convey to new allocators to the space, RIAs, is you can be a little opportunistic, but I really cringe when people want to be tactical. Venture capital, private equity, private credit, private real assets, these are strategic decisions, and you are investing in them for, I mean, decades, but certainly five to 10 years minimum.

38:25Chris Schelling: So you shouldn't be really like quarterly thing. Like you set a plan, right? You find managers and partners and advisors to work with. You commit those allocations and you have to give it time to work.

38:38Alexa Binns: I love that. That's the great advice. Is there a private markets product or structure that you are seeing out there that makes sense, that you're sort of bullish on?

38:52Chris Schelling: I'm going to talk my own book, so you have to discount this by that. But I think interval funds make a lot of sense. And for some of the reasons that we already talked about, like index funds. But just from an ease of client use perspective, putting my advisor hat on, what I realized is the difference between anything that requires a subscription and like a tender offer fund being one, an interval fund that looks and feels like a mutual fund, for an advisor, that's the difference between what we would call advisory and discretionary. One, you're giving a recommendation. The other, you can execute on it.

39:32Chris Schelling: So if you've got a mutual fund, you can just go buy it in a client's account. If you have to send them a subscription, that's a whole nother step. and it's not just like the advisors trying to be lazy like clients hate signing things and so like if you get a new custodian or you got to change accounts open a new account fill out a subscription document most clients are like what am i signing now we got to talk about this like why why can't you just do this for me so anything that has ticker symbols that trades and looks and and by the way, ETFs can do this, but like feels like a mutual fund is, is I think going to get more adoption from the wealth community because it just is easier to use.

40:17Chris Schelling: It meets their needs, whereas other things don't quite as much. So now not everything fits in that. Like I'd be first to raise my hand and say like venture is tough to do in that. If you've got 10 year, 12 year, 15 year sort of whole period things coming up with quarterly or semi-annual liquidity probably doesn't work. I think PE can, and we have things in place that I think works. But just the structure itself, to me, and I think that's why you're seeing more adoption. If you look at evergreen vehicles, where's the growth the fastest? It's in the tender, I mean, it's in the interval fund segment of the evergreen universe.

40:51Chris Schelling: But there's not going to be one answer because the diversity of individual clients and the advisors that serve them is far greater than what you see in the institutional community. And so because of that, there's a lot more different tools in the toolkit needed to build out those platforms.

41:08Alexa Binns: And is that something you think was going to continue as the kind of RIA landscape matures in the private asset classes and there's more consolidation? You think they're going to be looking for products like that?

41:22Chris Schelling: I think the need for different tools is a permanent feature of wealth. And whether it's broker dealers, massive independence, small independence. There's a very broad, diverse universe there. And part of it is just driven by what the end clients want. Not every client wants to be serviced by a massive bank or a$400 billion wealth management platform. To be clear, some legitimately prefer a billion dollar,$2 billion boutique sort of local advisor that they can work with directly. So that market, yes, consolidation is happening. I don't think it stops. There's benefits from scale, like I said, but that segment of the market will also always be there.

42:06So tools

42:07Chris Schelling: and products and wrappers and access points to accommodate everything. And even like if you consider one big advisor, right, they're going to have different types of clients. Like you may focus on mass affluent and have a million dollar average client, you're inevitably going to have a 10 or a$20 million client. Vice versa, if you're ultra high net worth focused, like it makes sense to take, you know, the kids or Gen 3 or Gen 4 of a family who don't have the same liquidity as the bigger clients, and then you need tools to support their portfolio construction. So again, And I harp on this a lot, but I think it's so true.

42:49Chris Schelling: You need so many different tools available to build alts across the wealth ecosystem. That just isn't the case in the institutional world.

42:58Alexa Binns: How do you recommend structuring venture to fit into that universe?

43:02Chris Schelling: Well, if I had the perfect answer, I'd be building a product. Ernest said I can help you sell it, Chris. I don't know. I mean, I think it's tough. You want, you know, it depends if you want early stage or later stage, how proximal you are to sort of a liquidity event. But I think truthfully, like it doesn't work inside of a lot of the fund wrappers. So you've seen a few tender offer funds which have less liquidity and they can kind of gate with broader discretion. And you've also seen some traded products that kind of look and feel like ETFs are closed end funds. Maybe that works. I think time will tell.

43:41Chris Schelling: but yeah that's a good question that's the one that I don't think has been solved conclusively yet.

43:46Alexa Binns: Chris something you mentioned a few questions ago was about how when you were talking about credit not every credit deal is created equal right and there's different levels and different types right we're seeing that in all kind of asset classes and private markets as they mature do you believe venture is really being seen in that light when there are distinct different products but it seems like everything from my perspective is just is is kind of judged in a monoculture of criteria

44:21Chris Schelling: yeah i i mean i would say it's it is the same in the sense that it's not the same like if you put one lens on vc and think of it all the same that's that's very silly if you look like what's happening right now, I think actually seed stage is probably one of the most attractive points. Maybe early A, pre-seed looks like it's a little bit competitive again, and the late stage stuff has been very aggressively priced. And so you see valuations there have kind of exceeded what you saw in the 21 peak. And so it zigs and zags at different points in time, but certainly even even the hold periods. You know, a seed stage deal is not going to work inside of a five or 10-year sort of drawdown if you're doing pre-IPO or late-stage stuff.

45:09Chris Schelling: That is very different. And so, yeah, it feels like, if anything, the one area where you need to discriminate the most is probably VC. I mean, credit, closer, private equity, there's still differences between large deals, small deals, kind of what stage, you know, the hold is, but venture is probably the most differentiated. So again, it feels to me like we've seen more of the product development occur at the later stage stuff because that's, again, a closer pathway to sort of exit. There's more liquidity available on the buy as well. So, but yeah, figuring out a way to get earlier stage primary capital formation into the hands of wealth investors, if you could crack that nut, I think you've got a good product.

45:53Alexa Binns: At Axia, you have so much cool data and research, backward looking. where what's in your crystal ball what would chris see in the future uh as related to venture

46:08Chris Schelling: related to venture specifically i don't know i don't know i think i yeah i i think that you have to have you know earnest thinks that sourcing is commoditized and to an extent it is but i think you still need an advantage there and i think one of the ways you can get an advantage is by deep technical expertise and domain expertise. So, I mean, you've seen it in private equity too, where sector specialism is leading to excess returns. I think right now, like technical team who likes to focus on technical founders, obviously you got to commercialize it, but at the earlier stage, more and more important.

46:47Chris Schelling: So I've sort of gravitated just personally to that. I'm an advisor to a firm that looks at a lot of stuff like that and has some good success there. So I find that just personally super interesting. You see stuff like, you know, quantum computing coming. And ultimately, I think quantum will be more totally transformational than AI is. I think like actually to fulfill the promise of AI, you probably need quantum computing. Wouldn't pretend to understand it, but kind of. And so like, I think I'm bullish on that. We might not be at a point yet where it's totally commercializable. And so investments today might not.

47:25Chris Schelling: But I think we're getting closer and closer. So that's an area that I would spend time.

47:30Alexa Binns: A less of a kind of like future, future crystal ball. What do you believe is going to happen after kind of the IPOs happen in the foreseeable future 18 months and how that's going to impact the private markets?

47:47Chris Schelling: I honestly have no idea. I'm not going to pretend to have a crypto ball for that. I think you just look at the size of it. It's staggering. Right. I mean, I think these three IPOs that are slated to go out are the size of the entire dot com IPO market. And there's something like half of all IPO volumes since like 1940 or 1950. That's an enormous, enormous amount of capital formation and really, really high valuation. So I don't know. I think one thing that I am curious about is for some of the businesses, like let's focus on like enterprise AI type stuff. the cost to compute for that is something like 10x what the revenue is for it.

48:36Chris Schelling: That doesn't work forever. I know the Amazon model, grab market share. You can give up profits while you're growing and building. That works. I don't want to be skeptical of it, but again, I think that what you'll see is that those prices are a very good exit for a lot of people that had owned it in the private markets. And I think that's kind of what IPOs are increasingly, right? They're more of an exit and more of the growth and the capital formation has already occurred in private markets. So back to our earlier conversation, like on the SPV sales, like, right, it makes sense to try to get it where you can before that actually happens, because that's going to be the exit.

49:19You want to be on, it's like you want to be on the early side of the SPAC.

49:24Chris Schelling: I mean, you reach a stage in your career where things kind of look and feel like the greater fool argument, and you don't ever want to necessarily knowingly just participate in that, but you certainly don't want to be on the wrong side of it.

49:39Alexa Binns: Yeah, arguably, even the people buying the SPVs, they may have cusped onto the foolish end.

49:47Chris Schelling: If you hear a lot of the rationale for why they want that, I mean, yes, some are sophisticated. There's family offices that know what they're doing. They're building portfolios. But a lot of them are just like, well, we know it's going to IPO at X. And you don't know that. I mean, it probably will, but you don't actually know that. So I think there's expectations that aren't always fulfilled. And if even the later people to the game are betting on that happening, like, well, that really needs to happen. So it doesn't feel like the best bet.

50:19Alexa Binns: I think as a last question, it would be helpful. I always get great insights from you, not only as like from your allocator seat, but then just as an investor and somebody who's constantly thinking about what's next and how that impacts you as a business professional. for any people that are new to the asset class or even young investment professionals, what skills would you suggest that they start to really build and compound on?

50:52Chris Schelling: I'm not the only one that says this. I mean, I've heard it from a lot of people. But I think one thing that AI will make more important is the importance of relationships and building relationships and building networks. I have two teenagers, one in college, one not. So I'm thinking about what should they be doing and what advice should I give them. And they're going to do what they're going to do, regardless of what the ad suggests.

51:17Alexa Binns: Speaking of getting in touch, what's the best place to read what you're writing, find what you're publishing?

51:24Chris Schelling: Sure. Well, I have a blog on LinkedIn that's called Alternatively Speaking. So you can subscribe to that and get my monthly insights. and we have a website called AC Private Markets where all of our research is posted on the research page so you can access that as well.

51:42Alexa Binns: Fantastic. I highly recommend it. Following Chris is a must.

51:47Chris Schelling: Oh, thank you. I appreciate that.

51:49Alexa Binns: Thanks for being here, Chris.

51:51Chris Schelling: Well, thanks for having me, guys. It's good to be back.

51:53Alexa Binns: See you later, Allocator. After Portfolio Tile, investing with a smile.