Capital Decanted: Episode Summary – Top Episode Rewind: Fan-Favorite #5

Release Date: July 23, 2024
Hosts: John Bowman and Christy Hamilton
Guests: Sean Ward (Blue Owl) and Sean Urie (USAA)
Transcript Timestamp Range: 00:00 – 98:14

Introduction to GP Stakes

In the milestone tenth episode of Capital Decanted’s inaugural season, hosts John Bowman and Christy Hamilton delve deep into the evolving landscape of GP Stakes— a progressive and trending area in investment. The episode examines whether GP Stakes offer pure incentive alignment between Limited Partners (LPs) and General Partners (GPs) or serve as a potential distraction.

John Bowman [00:00]: "In this episode, which is a fascinating overview of this burgeoning, progressive and very trendy area of investment, GP Stakes, we assess whether this is a pure incentive alignment between LPs and GPs, or whether it's a distraction."

Understanding GP Stakes

GP Stakes involve LPs acquiring minority equity positions in GP firms themselves, rather than simply investing as traditional LPs in their funds. This structure introduces complex return drivers and cash flows that differ significantly from conventional private equity investments.

Historical Evolution of GP Stakes

John Bowman outlines the development of GP Stakes over the past 25 years, highlighting two primary phases:

1. Proto Permanent Capital Phase:

   • Investment Banking Track: Early 2000s saw investment banks like Credit Suisse and Morgan Stanley taking balance sheet equity stakes in hedge funds.
   • Investor-Led Track: Major asset owners such as CalPERS and ADIA began acquiring stakes in firms like Carlyle and Apollo, seeking diversified investments.

2. Modern GP Stakes Business Phase:

   • Key Players: Goldman Sachs’ Peters Hill Partners and Blackstone Alternative Asset Management emerged as dominant forces.
   • Market Consolidation: Blue Owl, formed from Dial Capital’s merger with Alrock, stands as the largest player with $55 billion in assets under management (AUM).

John Bowman [06:50]: "The first phase is what I'll call the proto permanent capital phase... The other track that was molding its own future at the same time was what I'll call investor led."

Return Streams in GP Stakes

The episode dissects four primary return streams for GP Stakes investors:

1. Management Fees:

   • Nature: Stable, fixed income-like returns.
   • Yield: Typically 7-10% annually.
   • Quote:

     John Bowman [22:23]: "These management fees can actually be fairly extensive and it's the first taste of the return stream."

2. Performance Fees (Carry):

   • Nature: Performance-based upside similar to traditional carry.
   • Alignment: LPs participate in the carry across all funds managed by the GP.
   • Quote:

     Sean Ward [58:00]: "There's an upside alignment if the collection of the GP's funds successfully return more than the hurdle rate."

3. Participation in GP Fund Value:

   • Nature: Growth in the GP’s own fund commitments and balance sheet.
   • Comparative to Traditional LPs: Similar to unrealized marks in private equity funds.

4. Exit Opportunities:

   • Nature: Potential gains from selling the GP stake, going public, or other liquidity events.
   • Disclaimer: Not the primary return source; GP Stakes are typically long-term investments.

Sean Ward [58:00]: "We've had individual exits at managers' positions that have gotten us back 5, 10, 15, even 20% or more of our purchase price just on the carry from one realized investment."

Myth Busting GP Stakes

John Bowman and Christy Hamilton address three prevalent myths surrounding GP Stakes:

1. Myth 1: Founders Have No Incentive to Sell Equity Stakes

   • Reality: Modern GP Stakes are primarily for balance sheet capital and growth, not merely liquidity events.
   • Fiction:

     John Bowman [14:00]: "The large majority of these stakes and infusions of cash are for... supporting their own GP commitments to future funds."

2. Myth 2: GP Stakes Are Chronically Undervalued by Public Markets

   • Reality: Evidence from Goldman Sachs’ Peters Hill Partners IPO shows significant undervaluation.
   • True:

     John Bowman [21:00]: "GP Stakes are definitely true; the Goldman IPO assigned a market cap that promptly cratered to two-thirds its original valuation."

3. Myth 3: GP Stakes Create Conflicts Among LPs

   • Reality: While potential for misalignment exists, minority stakes and supportive roles mitigate conflicts.
   • Half-True:

     Sean Urie [69:48]: "I would probably be more comfortable when they come in because... they are there to support, not to meddle."

Insights from Guest Speakers

Sean Ward (Blue Owl)

Sean Ward provides an in-depth perspective on the structure and benefits of GP Stakes:

• History and Strategy:

  • Blue Owl has been active since early 2000s, initially focusing on hedge funds before shifting exclusively to private markets.
  • Focuses on minority stakes to support GP growth without taking control.

• Economic Benefits:

  • Diversification across numerous GPs and funds.
  • Stable management fee income with upside potential from performance fees.

• Sourcing Deals:

  • Emphasizes relationship-building and long-term engagement with GPs.
  • Deals often involve strategic alliances beyond mere financial investment, including operational support.

Sean Ward [66:01]: "These are relationships. One of the big advantages we have is just that we've been doing it forever."

Sean Urie (USAA)

Sean Urie discusses USAA’s entry into GP Stakes:

• Motivation:

  • Sought diversification within private equity without increasing fund-to-fund layers.
  • GP Stakes offered vintage year diversification and broad exposure with fewer fees.

• Portfolio Integration:

  • Views GP Stakes as cash-generating diversification within a broader private equity portfolio.
  • Complements direct private equity investments by providing stable returns alongside growth-oriented assets.

Sean Urie [63:43]: "It's a great piece of the portfolio and complements other things... upside on GP stakes is probably a little more limited than direct private equity investment."

Portfolio Implications and Allocation

Christy Hamilton analyzes how GP Stakes fit into investment portfolios:

• Hybrid Nature:

  • Combines fixed income-like stability with private equity-like upside.
  • Not easily categorized, often placed in opportunistic or tactical allocation buckets.

• Risk and Return:

  • Offers downside protection through management fees.
  • Provides diversified exposure to multiple GPs and funds, reducing single-fund risk.

Christy Hamilton [22:23]: "If you have a diversified pool of all of them, just go ahead and create another bucket in your portfolio and call it a diversifier."

Conclusion and Final Thoughts

The episode concludes with hosts reflecting on the nuanced benefits and challenges of GP Stakes. They acknowledge the unique position GP Stakes hold in offering steady income while providing diversified exposure to private markets. The discussion emphasizes the importance of understanding the complex return mechanisms and carefully considering portfolio fit.

John Bowman [96:03]: "GP stakes offer immediate vintage and GP diversification in building out a private capital book... it's a really interesting point."

Christy underscores the value of using GP Stakes as part of a broader investment strategy, highlighting their role in enhancing portfolio diversification and providing unique insights into fund performance and strategies.

Notable Quotes:

• John Bowman [00:00]: "Say goodbye to tired market takes and superficial sound bites... we dive into the heart of capital allocation."

• Sean Ward [66:01]: "These are relationships. One of the big advantages we have is just that we've been doing it forever."

• Sean Urie [63:43]: "It's a great piece of the portfolio and complements other things... upside on GP stakes is probably a little more limited than direct private equity investment."

• John Bowman [21:00]: "GP Stakes are definitely true; the Goldman IPO assigned a market cap that promptly cratered to two-thirds its original valuation."

• Rob Christian [54:15]: "Our first GP stakes deal was part of a spin out of a hedge fund firm from Lehman... we've scaled to focus exclusively on private markets."

This comprehensive summary encapsulates the core discussions, insights, and conclusions of the "Capital Decanted" episode on GP Stakes, providing a clear and engaging overview for those who haven't listened to the full episode.