← Dry Powder: The Private Equity Podcast
Dry Powder: The Private Equity Podcast
Full Speed Ahead w/ Hamilton Lane’s Erik Hirsch
00:19:28
In the second of our two-part series, we ask the Co-CEO of Hamilton Lane how they’re building an analytics engine that can serve both institutional and individual investors.
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- [00:04]
A
Previously on Dry Powder. Eric Hirsch, the co CEO of Hamilton Lane, took us inside the rapid build out of private market infrastructure.
- [00:12]
B
Good technology tends to flow broadly. It doesn't tend to stay constrained.
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A
Today on the show, we'll take a closer look at how Hamilton Lane is getting ahead of these trends.
- [00:21]
B
I think if you and I are right that the public equity world and the private markets will start looking more and more similar, then I expect that the tools will look very similar, the access to data will look very similar. That will be part of that whole experience.
- [00:36]
A
We'll see how Hamilton Lane is harnessing one of the world's largest private market databases and building an analytics engine that works for institutional and individual investors. We'll also explore how the influx of retail capital is rattling the industry's fee structures. I'm Hugh MacArthur, chairman of Bain's global private equity practice and this is Dry Powder. One thing that I think is hard to look at from a data perspective because there aren't a lot of standards and it's kind of opaque and privates meant private is what's gone on with pricing and fees and what you think might happen in the future as individuals get more involved. From my seat, if you talk about the old 2 and 20 model, not a lot has actually happened to that over the course of the 30 year history. There's been a little bit of scaling maybe on the fees coming down, but people still call it the 2 and 20 model for a reason. But that's actually masked a real price decrease certainly in private equity and a lot of private assets through co investment. Co investment has been much, much more ubiquitous over the course of the last 10 to 15 years. It's probably somewhere between 20 and 40% of all the invested dollars are not getting the same economics on them as they are committed to the LP commitment to the closed end fund. And that in of itself is is a price decrease. What do you think is going to happen in terms of rethinking pricing and fees if there is a rethinking of pricing and fees in the future as more individuals come on stream as private investors?
- [02:01]
B
While the headline may sort of sound the same, that it's 2 and 20, you're absolutely right that that's just not true that today fundraising is very difficult. And in a more difficult fundraising environment, GPs are quicker to offer guaranteed co investment at no fee. And so when you look at the total capital base that they're required to deploy and then you look at the actual portion that they're getting paid on, it's Very different. So I would say the management fee is not really too, because early discounts and then the co investment, et cetera, et cetera, et cetera. And so I think you're probably looking at a market that's really closer to kind of 1, 1.25% of what's happened on that. And then the carry impact, again, depending on how you want to calculate that, there's a lot of dollars that they are responsible for deploying that they're not going to get paid on.
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A
Right.
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B
So here comes the retail investor. And so today, on average, the retail investor is paying more than the institutional investor. And I would say that's not surprising. We're in the barely in the first inning of the game here and the retail investor is excited to be invited into the game. So today they are somewhat focused on fees, but that's not their exclusive focus. But we know exactly what's happened in another asset class. So we can again just turn our attention to the public equity side and look at what fee compression looked like there and how rapid and how severe it was. And I would expect that over time and we'll see how long this takes, but we're going to see fee compression. The idea that you're going to sort of open yourself up as an industry to the retail investor and you think that they're not going to be focused on fees, I think would be a gross miscalculation.
- [03:49]
A
Right. I mean, I think there's no doubt we're already seeing moves all the time in the media that traditional asset managers are coming into this space. Solution providers like yourself obviously are coming into this space. But the blackrocks, the vanguards, the fidelities of the world are going to be offering product and they come from a world in the mutual fund industry where pricing, as you pointed out, Eric, has gone down drastically over time. So it's hard to imagine that there's not going to be a nudge on providing the lowest possible fees and some competition to do that among the traditional asset managers. So from where you sit, do you see some of these traditional public equity providers being the big winners here as they kind of pivot toward the private markets? Or is it going to be some of the alternative firms themselves are going to thrive in this environment?
- [04:32]
B
I'm betting today, I'm betting on the latter. I think it's the large alternative firms. So why do I say that? I think there's part of this is sort of the DNA that if you've never really been in this asset class or if Your senior leadership is dominated by people who have never been in this side of the asset class, having the mindset, the relationships, the know how. Sure, you can buy some of it or you can rent some of it, but I think there's a fundamental piece to it. As you know, some of them are looking at this in very different ways. Some of those big crazy public equity oriented managers are now starting to acquire, right. So they're looking to acquire that skill set and bring it in house. Some of them are partnering and some of them are trying to just build organically themselves. So far the build organically I think hasn't gone great. And that's going to take a long time to do that and if speed is essential right now, Right. So I think this is going to be fascinating because the ripple effects are significant depending on who wins, who loses, what happens, who goes where. You can see that the large alternative firms are, are really all increasingly focusing on brand. That was something that we never had to really worry about in an institutional world where the LP universe was known and quantifiable. The retail universe is not known and frankly hard to quantify. I mean people are like 100 trillion, maybe it's 130 trillion. Well, that's a big difference between those two numbers. And so I think brand and distribution are obviously going to be crucial. And so you can see a start now on kind of the brand arms race as people are all trying to figure out how to position themselves and, and to have their brand identified with sort of success for this asset class.
- [06:12]
A
It makes a lot of sense to me, Eric. I mean we, we run surveys of ultra high net worth individuals every single year, hundreds and hundreds of people. And we ask them, can you name a quality private asset manager? And the number one answer year after year is I don't know. So the branding work is still, there's a lot to be done, a lot has been done, but there's a lot to be done to educate these investors. Eric Hamilton Lane is known as having one of the largest private market databases in the world. Can you tell us how you use this data to actually help clients?
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B
It's back to the portfolio construction piece and again also just trying to make ourselves better investors. So you're right, we have a massive database that's not only fund manager performance, but also underlying company performance. So I can tell you in the healthcare sector what normal revenue growth or average debt levels are because I can see across tons and tons and tons of private companies where we're getting financials and operating metrics so data to me is important, but we've built technology to really analyze and to use the data, and I think that's more important. So our sort of flagship technology is something called Cobalt, and that is really a tool that is empowering investors to be better investors themselves and to sort of be better portfolio constructors. And you can assess risk and you can benchmark and you can do all those things that we would think of as what a normal portfolio manager would want to do. So I think it's got to be the tech and the tool combined with really great data and then that I think just informs better decision making.
- [07:47]
A
So can you talk us through an example of how that type of analytics that COBOL can provide could help a client make a better investment decision and how that that engine serves or could serve the retail market?
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B
So I go back to asset allocation. So if you and I were sitting here talking about the stock market, we would spend very little time talking about what one stock we liked, and we would spend even less time talking about what one asset manager that's buying stocks that we like.
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A
Right.
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B
We would be spending a lot of time talking about where your portfolio is underweight, overweight, whether by sector, by geography, by size, by type, etc. And again, in our industry, in the private markets, we spend virtually no time talking about that. You go to a conference of LPs and you're going around the cocktail party and you're right back to this co investment that we did, that was great. And this fund manager that we like, that's amazing. And if you said so are you underweight by 5% this sector? It's like you don't really talk about that. So for us it is very different. We spend a lot of time talking about that because as we've read in the sort of the public markets, you know, asset allocation can kind of account for 70/ percent of performance. In our industry, it's probably not quite that high, but it's really far from zero. I bet asset allocation is accounting for half of the performance.
- [09:08]
A
So just so I understand you, Eric, so you're saying obviously mean variance, public market thinking does not completely work in a world where everyone's actively managing their assets and they actually have control of those assets. You cannot apply that. But you believe that there absolutely is enough, what I'll call beta, for lack of a better word, that portfolio construction is not thought of nearly enough when putting together private portfolios. So it's a combination of making sure you've got the right portfolio construction weightings as well, as obviously I'm trying to go for top quartile managers wherever I possibly can because waiting at the expense of investing in a third or fourth quartile manager is not going to help me. Is that fair?
- [09:48]
B
I totally agree with that. So, case in point, you and I are both running our own respective portfolios and we're sitting in the pandemic and you decide that you're going to tilt your portfolio massively overweight venture and growth. And I decide I'm going to tilt my portfolio to traditional manufacturing and I'm going to kind of retrench into industrials and more basics. So the year or so after the pandemic you look like a genius because your portfolio is going through the roof and mine is definitely not. Fast forward to today and it's changed again. If that huge overweight to venture and growth is not looking so great today, regardless of how good the managers were, that sector in general has gotten sort of hit on valuations and coming off of peak values and whereas a lot of the basics are now sort of rebounding in a much more substantial way. And we can look at that over lots of different cycles of were you heavy credit or not? Were you in secondaries or not? Were you overweight Europe or not?
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A
Right.
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I think it matters immensely and there's a lot of data to sort of back that up. But it's got to be an. And we got to get good portfolio construction and we need to actually pick good deals and pick good managers.
- [11:04]
A
Right. And that makes a lot of sense to me. And we've talked a little bit about branding, we've talked about the need for education around private markets, particularly for individual investors. Can you share an example of how you're actually translating some of these insights you're talking about into educational materials that analysts or investment advisors or anyone can use to actually help people understand what we're talking about.
- [11:24]
B
We do a bunch of things around this one. I love to do myth busting. So we publish a lot of pieces that are literally myth busting of taking kind of a commonly held view that is just lever the S and P and you can mirror returns.
- [11:37]
A
Right.
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B
We do an annual market overview. And I think one of the things we're finding with the retail investor is that they need a lot of education. This is just all new to them. So the institutional world has had decades of experience and conferences and meeting with managers and reading white papers, et cetera, et cetera, et cetera. But if you look at the average retail investor today, their exposure to the Asset class is zero, right. And so they haven't had any of that exposure, but they have been exposed to the myths because they read the Wall Street Journal or they read a financial magazine. So they've had plenty of sort of negative overlay. They've also had plenty of positive overlay. They've heard about that venture backed business that was some huge home run is nice and it's kind of has them intrigued, but there's a lot of negative sentiment that has them concerned. So bundling this in ways and frankly partnering. So one of the things that we also have done successfully is we've invested off of Hamilton Lane's balance sheet into a variety of technology partners where we feel like it drives us closer to them, we're aligned with them and we're helping them be successful. So whether that's somebody like an I capital who is servicing into the wealth or case who's servicing there, or whether that's a business that we helped create like Nevada, which is now the biggest collector of private market ESG data in the world. And these are all important pieces and relationships around how do you kind of get education, how do you get better data? And I think all of that just helps make the asset class better and more successful.
- [13:09]
A
So while we see this change coming, I certainly see the change from my perspective in the individual investor becoming much more important in private markets and private equity in particular. And you see the change coming in your everyday life on the technology side to make that happen at speed. Why is it that the media seems to be more skeptical about private equity's role in private wealth and in retail capital?
- [13:32]
B
I think unfortunately the media has just been perpetually skeptical about our asset class. And I think on some level we only have ourselves to blame. I think again, long history of us taking the private and private equity a little too seriously. And so because data is not readily available, because there's not sort of a central knowledge base or a central source of truth, we're an industry that despite having a, you know, a long, a long tenure still exists in kind of rumor and gossip and myths. And so I don't know about you, but I'm still routinely in meetings where the skeptic is saying to me, well, if I just levered the s and P500, I'm exactly going to mimic what private equity does, right? And there's just these very strongly held beliefs about things that are just not true. But because that data is more controlled by private sources, it's not generally available. People don't know how to Interpret it or study it or analyze it. And so we still exist in a world with a lot of myths and misunderstandings.
- [14:35]
A
Right.
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B
And some big personalities that it's easy to sort of hate on and all of the other fun things that come with it. So I think the media skepticism today to me is more driven by this asset class is very risky. That's not great for retirees. Well, it's actually not that risky when you break down the numbers or, hey, it's illiquid, it's long duration, or we get into the question of the marks are bogus. So you have all these kind of in theory, analytical items that have never actually been analyzed by the person who's reporting them. And I think all of that kind of comes back to these sort of crafty private equity folks are really just about kind of a big money grab. And grandma and grandpa could be in real trouble here.
- [15:20]
A
Right, right.
- [15:20]
B
And I think nothing could be further from the truth. I mean, sure, there's always bad actors and sure, there's always people with bad agendas, but at its core, I think what's been happening to kind of the American Saver has been incredibly unfair. We go back 50 years, and essentially our society was oriented around the fact that you put in the time, you stay with one company, you retire at 65, you get the, you get the watch and, and you get the pension. And you knew exactly what that pension was going to be. You had budgeted for it, you built your life around it, and you did it, and that was good. Today we've got this huge retirement crisis that's here now and getting worse because we've basically said, hey, you go do it yourself. And at the same time, we said that what we've really done is we've excluded from all of those individuals the one asset class that has been the biggest driver of performance for all of the institutional investors. You go ask our institutional investors, hey, over the last 20 years, what has been the single biggest driver of your pension fund performance? And their answer is, my private market allocation. Well, all these individuals over here with their 401ks or their individual savings haven't been able to do that. And so I said a big macro. Yes, we should be concerned about risk, and yes, we should talk about liquidity, and yes, there needs to be regulation, but from an equality standpoint, they should all have access to kind of the same tools to accomplish their retirement goals.
- [16:46]
A
That makes a lot of sense to me, Eric, and some do, because there obviously are pension funds, public and private, that invest in private equity, but certainly there are whole swaths of workers that do not have access to that, and they're dependent upon their 401ks, which don't have access to private assets, and they're dependent upon other sources of income. And to your point, figure it out yourself. And I've certainly been looking for 30 years at systematic ways to kind of prove that private equity in particular is riskier than the public markets. And I haven't been able to do it. So you and I are in violent agreement on that point. So overall, given everything that you've just described, Eric, how do you see data analytics shaping the future of private equity investing? And what role are you hoping Hamilton Lane is actually going to play as we see the industry transform?
- [17:30]
B
I think if you and I are right that these worlds are getting closer and closer, meaning the public equity world and the private markets will start looking more and more similar, then I expect that the tools will look very similar, the access to data will look very similar. That will be part of that whole experience. That will be part of pulling out your smart device and looking up stock prices and a private market manager performance and putting them all together and being able to kind of manage your portfolio. So I think our involvement there is, I hope, to be very significant. Again, we already own pieces of tech firms that are beginning to do this. We're feeding and licensing data into various channels that we think will be empowering to do this. And I think it's exciting and I think this is where this is all going. And I think it's inevitable because I keep going back to we all have to meet the customer where they are. The customer's not going to sort of morph themselves to us. And where the customer is, I think, is very clear. They are a smart device driven, instantaneous, want it now, want it cheaper, want it faster. That is what the customer looks like because it's what they want in every facet of their life, whether it's groceries or clothing or car repair.
- [18:41]
A
Mm.
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B
It's all the same common denominator. That's where we are today. And just how fast this adoption occurs will. Will remain to be seen.
- [18:50]
A
Well, Eric, as I said at the outset, you sit in a fascinating place at Hamilton Lane in the private markets and you have access to all kinds of relationships and data that have provided for a wonderful conversation. I know I've learned a heck of a lot. I'm sure our audience has too. And I really want to thank you for coming by today. It's been fantastic.
- [19:08]
B
Hugh, my pleasure. I really appreciate the opportunity.
- [19:14]
A
I'm Hugh MacArthur. Thank you for listening.