Capital Allocators – Inside the Institutional Investment Industry
Episode: Ian Charles - Private Equity's New Rules (EP.431)
Release Date: February 10, 2025
Host: Ted Seides

Introduction

In this insightful episode of Capital Allocators, host Ted Seides welcomes Ian Charles, founding partner at Arctos Partners, a prominent $14 billion private equity firm. The conversation delves into the evolving landscape of private equity, exploring new rules and strategies that are reshaping the industry for both General Partners (GPs) and Limited Partners (LPs).

Ian Charles and Arctos Partners

[06:10] Doc O'Connor: "Ian, thanks so much for joining me."
[06:12] Ian Charles: "Appreciate the opportunity to be here."

Ian Charles shares his journey from starting as a limited partner at a fund of funds platform to co-founding Cogent Partners, the first intermediary assisting limited partners in selling in the secondary market. This experience laid the foundation for his commitment to serving the private equity ecosystem through Arctos Partners, which has rapidly become a leading institutional investor across North American sports leagues and a strategic partner for private market sponsors.

The Changing Competitive Landscape of Private Equity

[07:46] Ian Charles: "The management company, the GP, that is a complex business and as the firms grow and mature, that complexity increases in nonlinear ways."

Ian emphasizes that many market participants underestimate the intricate nature of GP businesses. As firms expand, their operational complexities grow exponentially, presenting unique challenges. Arctos Partners addresses these challenges by providing data-driven tools that dissect the market and competitive landscape, enabling GPs to gain a broader market perspective often lacking due to their intense focus on internal strategies.

ARCT Taxonomy of Private Equity Firms

[12:55] Ian Charles: "It's designed to look like a pyramid, where at the very top are the most complex, the largest, the most sophisticated firms."

Ian introduces Arctos Partners' ARCT taxonomy, a comprehensive framework categorizing private equity firms into ten levels based on size, product mix, asset classes served, global presence, and other factors. This pyramid structure reveals a stark concentration of capital, with the top levels (Level 9 and 10) controlling approximately 20% of Assets Under Management (AUM) despite comprising only 0.2% of the tracked firms. As one descends the pyramid, a significant power law of capital concentration becomes evident.

Addressing GP Goals and Firm Positioning

[16:20] Ian Charles: "The organizational complexity is nonlinear. The capital that is required to grow is significant."

Discussing the ambitions of GPs within the ARCT taxonomy, Ian explains that firms must decide whether their goal is to ascend the pyramid or maintain their current level. For Level 5 firms, which are typically single-strategy and best-in-class, maintaining their position requires substantial effort due to market and competitive shifts. Arctos Partners assists these firms in evaluating their capabilities and strategic positioning to ensure sustainable growth or stability.

Tools for LPs and GPs: Diagnosing 'Right to Win'

[19:16] Ian Charles: "We have what we believe is one of the most sophisticated software platforms for isolating and estimating alpha generation for the manager."

Ian details Arctos Partners' proprietary tools that analyze performance data to distinguish skill from luck in alpha generation. By disaggregating performance across various strata such as industry, deal size, and geography, Arctos helps GPs identify their strengths and areas for improvement. This analytical approach enables firms to make informed strategic and talent decisions, enhancing their competitive edge.

Current Market Narratives

[09:30] Ian Charles: "The now narratives for Q1, which we're about to publish, are the election's impact on M&A and animal spirits."

Ian outlines the prevailing themes in the private equity market, including the impact of elections on mergers and acquisitions (M&A), manager consolidation, fundraising challenges, and a renewed focus on value-added capabilities. These narratives reflect broader economic sentiments and influence strategic decisions within the industry.

Impact on Limited Partners (LPs)

[25:34] Ian Charles: "When we ask GPs, what is your vision and what is your right to win, we ask the same thing to the LP."

From the LP perspective, dominant narratives revolve around liquidity constraints, changes in market dynamics eroding traditional LP control, and the growth of wealth and permanent capital. Ian advises LPs to align their investment strategies with alpha generators rather than mere capital aggregators, emphasizing the importance of active portfolio management and leveraging data-driven insights to navigate the current environment.

Recommendations for LPs in the New Market Environment

[36:38] Ian Charles: "You have to be able to pitch those GPs on why you're the right partner for them."

Ian recommends that LPs focus on scaling with managers who demonstrate consistent alpha generation. This involves articulating unique capabilities that make LPs attractive partners to GPs. Additionally, LPs should develop real-time active portfolio management capabilities to capitalize on market inefficiencies and optimize their investment returns in an overvalued asset class.

Private Wealth and Capital Aggregation

[38:45] Ian Charles: "There are really big firms that generate tremendous alpha."

Discussing the influx of private wealth into the private equity space, Ian highlights the distinction between alpha-generating firms and capital aggregators. He warns that while some large firms effectively package alpha for broader investment communities, others may offer expensive beta, diluting investment returns. The future impact of private wealth capital hinges on the ability of firms to maintain low-cost, high-alpha investment offerings.

Arctos’ Keystone Strategy and Initiatives

[40:58] Ian Charles: "The keystone strategy is all about locking arms with the entrepreneur along that journey."

Ian explains Arctos Partners' keystone strategy, which focuses on partnering closely with GPs to address their most critical challenges. Whether it's navigating consolidation, enhancing balance sheets, or innovating product offerings, Arctos provides flexible, capital-backed solutions tailored to each firm's unique needs. This collaborative approach positions Arctos as a pivotal support system within the private equity ecosystem.

Personal Insights and Closing Remarks

[51:16] Ian Charles: "Arctos is what I call a skinny level seven. We're hanging on by our fingernails."

In concluding the episode, Ian shares personal reflections on Arctos Partners' journey, emphasizing their commitment to disrupting and innovating within the markets they serve. He highlights the importance of aligning with a firm's core values and maintaining a demonstrable alpha generation capability as they navigate the complex private equity landscape.

[54:44] Ian Charles: "I spend more time than I probably want to admit trying to understand the most complex parts of cutting edge physics today."

Ian also touches on his personal interests, revealing a fascination with advanced physics and the mysteries of black holes, showcasing the human side behind his professional expertise.

Key Takeaways

• Complexity of GP Businesses: As private equity firms grow, their operational complexities increase non-linearly, necessitating sophisticated tools and strategies to manage effectively.

• ARCT Taxonomy: A pyramid framework categorizing private equity firms into ten levels reveals significant capital concentration at higher levels, highlighting a power law distribution within the industry.

• Data-Driven Insights: Arctos Partners leverages advanced analytical tools to help GPs and LPs navigate market dynamics, assess strategic positioning, and optimize investment decisions.

• Evolving Market Narratives: Key themes such as election impacts on M&A, manager consolidation, and fundraising challenges are shaping the current private equity landscape.

• Strategic Alignment for LPs: Limited Partners should focus on partnering with alpha-generating GPs, employing active portfolio management, and utilizing data-driven strategies to enhance investment outcomes.

• Keystone Strategy: Arctos Partners' collaborative approach in addressing GPs' critical challenges fosters a supportive ecosystem that promotes sustainable growth and innovation.

• Personal Commitment: Ian Charles underscores the importance of aligning professional endeavors with personal values and interests, illustrating a holistic approach to leadership within the private equity sector.

This episode of Capital Allocators provides a comprehensive exploration of the shifting paradigms in private equity, offering valuable insights for both GPs and LPs aiming to excel in an increasingly complex and competitive investment environment.