B (3:44)

So 50% less than 0.1.

C (3:47)

Yeah. Of vintage 2020 and vintage 2021 funds. Now it's still only, you know, five, six years later since those funds raised. But something that you see people talk about in other parts of financial markets is the lack of IPOs. The lack of IPOs in London, on the London Stock Exchange has cratered to near zero in America. IPOs. And something that you see a lot of investment firms and allocators and people talking about is maybe private is the new public. So people are clamoring for shares, for example, in SpaceX or in OpenAI, because a lot of these companies that historically would have gone public years ago, they just stay private forever. The key for allocators, though, is that they're not getting the expected distributions on a cash basis. Sometimes they're getting distributions of actual equity securities, or sometimes these funds are pushing the assets into continuation vehicles.

B (4:38)

So in 2024, we had 9% DPI, which was way below the 25% model. What is 2025?

A (4:48)

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C (6:13)

looked to be about the same look so far. We're still waiting to get some of the statements in, but what we've heard from allocators so far is it's looking to be somewhere between 9 to 12%.

B (6:22)

And what are the second order effects of that for allocators? Why does that matter?

C (6:27)

The portfolio grinds to a halt. You know, full stop. Literally full stop. You're making commitments to private asset funds, and your cash flow pacing model is telling you to make X number of commitments at this dollar amount size. But part of that model is also telling you to expect distributions which will support future commitments as well as support spending policy needs. If you're not getting those distributions, you can't support the spending policy needs. And how will you be able to make future commitments without tying up additional capital? So it becomes, in essence, a downward spiral of illiquidity.

B (7:03)

Tell me about this downward spiral of illiquidity.

C (7:06)

Part of what you get with investing in hedge funds, for example, it's very common to see maybe a three year initial lockup, and then you'll have the ability to withdraw capital on a quarterly basis with 90 days notice. But with private assets, the way you're getting liquidity is from the distributions of cash into your portfolio. And historically, private equity funds, once they sold an underlying firm to a strategic or financial sponsor, great. We've made a sale of one of the underlying firms that we invested with. Here's the cash from that sale. Or maybe it's a venture capital fund and they've taken it all the way up to ipo. Here's the cash after the lockup post ipo, usually six months. Here's the cash distribution to you as a representative LP investor in this fund. But what's happening now is that the funds, they're not selling the underlying companies and they're not taking them to ipo. Or when they do take them to ipo, instead of selling and distributing cash, they're distributing shares. Or what's also happening, and increasingly it's happening more and more, is that the private equity funds, instead of distributing cash, they're putting an underlying investment company into a continuation vehicle.

B (8:18)

What are smart GPS doing to address these DPI issues from LPs?

C (8:25)

So Abu Dhabi Investment Corporation, just a few months ago, they sued a private equity fund that moved an underlying investment to a continuation vehicle instead of selling it to someone else. That's very rare, but it does happen. The other thing that allocators can do are secondary sales. So secondary sales are when you know, hey, we have this remaining commitment in this underlying fund, or we have several funds with which we still have underlying commitments and we are going to go out to the market, usually a third party firm, to help you with this process. And we're going to seek to sell them for as much a percent of NAV as possible so that we can get liquidity. Today, oftentimes, executing a secondary sale of any private asset fund, you're going to take a haircut, hopefully you take the minimal haircut you can. But one thing that's tough for allocators when they decide they want to go to the secondary sale process is that it can be damaging politically to the relationship that you have with the underlying private investment firm. And it may mean that you are not allowed, that you don't get the call about the next fundraise that they have if they raise a second fund, if they raise the next fund. So secondaries, it's a very, very common process that allocators can take part in and it's very common in the industry. But there's a lot of allocators that just will not execute them for fear of damaging relationships and also damaging their reputation with other private asset funds for which they did not execute a secondary sale.

B (9:50)

You're working with hundreds of ERA down to the ground in terms of secondaries. What's the discount today, 2026 for private equity funds, venture capital funds off of NAV? What's commonplace in terms of where deals are getting done today?

C (10:02)

80 to 95% is what you're expecting. If it's a great fund, if it's a fund. And this is the tough part too. Imagine you're the CIO you're the head of private assets and you've been carrying a line item at 100 million on the balance sheet of a private asset fund that's been there for years. I've seen this myself when I was managing assets. And the fund is there. It's marked at a hundred million. It was marked at 100 million last year and it was marked at 100 million five years ago. You decide to get it off your balance sheet. If you get a haircut, maybe a fund that's older, lesser quality, a team that isn't as strongly held together or doesn't have a strong reputation, instead of getting 80 to 95% of the nav as you'd hope, maybe you're getting 50 to 60% of the nav. So the positive there is you're getting actual liquidity. You're getting out of a line item that has just been sitting deadweight on your balance sheet in your portfolio for years. The negative aspect of that is you have to acknowledge when the performance gets written down and that valuation comes down to your investment team, to your investment committee, that something you've been carrying at 100 million, in reality, the valuation when you realized it in the secondary sale, maybe the valuation was only 50 to 60 million. And sometimes that can be difficult. It's difficult to acknowledge sometimes that the valuations that we carry are not the true valuations of the assets.

B (11:17)

CVs are another tool in the marketplace. What do LPs think about CVs?

C (11:22)

Love them? Hate them. At the same time, on the positive side, you have to imagine that from the private investment firm perspective, they invested in this company, they watched it grow, they support it and they can try to sell it. But if they try to sell it, they may feel the private asset firm that there is unrealized value that they're leaving on the table. And they don't want that to happen. They don't want to.

B (11:47)

Is there generally distrust of the mark on these CVs and that the GPS have incentive to mark them lower, or is it truly an independent process where LPs are comfortable with a mark?

C (11:57)

Yeah, that's a great question. The example I was giving earlier about ADIC Abu Dhabi Investment Corporation, the reason they sued the private asset firm is that they believed the underlying company that was being put into a continuation vehicle could have had real life proceeds of maybe $7 billion in an IPO or in a sale to another firm. But the mark in the continuation vehicle gave a valuation of just 5.5 billion. And so the conservative marking into the continuation vehicle is in many regards beneficial to the private asset fund manager because then it can only go up if you are too positive. When you push it into the continuation vehicle, it may help out in the short term, but it may hurt in the long term. The key for the allocators, though, is that, and then I've seen this myself and I've participated in this, is that you trusted, you committed, you backed this private asset firm and specifically this fund that you committed to because of the quality of the analysis, the capability of the team that's investing, that's picking these underlying private asset companies. And if they tell you we think there is unrealized value that we want to hold on to, we think there's more we can do here, that's tough to argue with because you as an allocator are not a securities analysis.

B (13:07)

Your role, there's a cognitive dissonance in that you go to your doctor who's a specialist in the area, and now you're trying to outsmart your doctor.

C (13:13)

It's a great analogy for it of, you know, we trust this fund, we trust this firm, we trust this team. They've done great before. The flip side, and this is where the love and hate for it is great, we trust that there's more value that you as a private asset firm can wring out of this company. And you're telling us what you sincerely believe is the reason for pushing it into this continuation vehicle. But the other side of it is we could really use those distributions.

B (13:36)

Maybe it's undervalued by 5, 10%. Let's just pick a number out of there. It's still better than taking a 10, 15, 20% discount on the secondary. And there's no political issues with not committing to the cv.

C (13:49)

That's the other thing too, is that some of the larger brand name firms may say, you know, commit to the CV vehicle because this is part of our firm ecosystem. And you're either with the firm ecosystem and everything that we're doing or you're not. And that can be very difficult when maybe the firm has a great brand and a great reputation. And they have that great reputation for a reason.

B (14:13)

And the reason there's much fewer lawsuits like the ADIC lawsuit is because reputation drives access in the private markets. You call it out venture capital being an access class, not an asset class, where getting in the very top firms, the VCs are able to pick their LPs, especially in capital constrained strategies. The same is across the private markets. I've had several oversubscribed even lower middle market private equity funds. You're not just playing one iteration of a game, you're playing multiple iteration, where your reputation is your key to access.

C (14:44)

Extremely well said. And that's exactly right. And so therefore it's very rare to see an LP suing a GP firm. It usually only occurs if they think there's something egregious and where you knowingly give up future access. And I think your assessment, I've heard that before of private assets, particularly venture capital and private equity, are an access class instead of an asset class is 100% true. And those relationships with those very few top firms, I saw somewhere that the top 10 firms last year raised over 4, 40% of all private assets. And if you don't have a relationship with one of those top 10 firms, you're not in what may be some of the largest funds. And then it feeds upon itself. The private companies want to partner with the largest firms because that gives them in turn access to a great network and great capabilities to grow as a private company.

B (15:34)

The very top GPS in the world, what are they looking for from allocators?

C (15:38)

The first thing is an understanding of the firm's mission, the private asset firm's mission, you know, the goal that they have as an investor. And is there an alignment of that understanding? Because the key as well, from the allocator's perspective and what the firm wants is not just an investment in this fund, but an investment in the next one and the next one after that, and almost always a growing investment in fund three and then a larger investment in fund four. The other aspect of it as well is that the private asset fund managers, the firms that are going to allocators, the gps, they're looking for great partners with which they can have great conversations, great support, and looking for help of hey, we're raising this next fund. Would you serve as a character witness for the quality of us as an investment firm and for us as a team? So each side are looking for great

B (16:30)

partners when it comes to the CV opportunities. What are the best practices that allocators should use in order to decide whether they should invest?

C (16:38)

The key thing is, does this align with the allocators goals for the portfolio? Do they have the ability to continue to withstand the illiquid nature of this continuation vehicle? And so if you had mapped out in your cash flow pacing model that you were expecting, for example, 10 years of, you know, about three to five years of the investment period and then between five to 10 years of the harvest period and we're late into that harvest period and now the underlying firm is telling you that instead of harvesting an asset or some of these assets, we are instead going to put them in the continuation vehicle. And maybe that is exactly what the firm thinks is the best thing to do for these underlying companies, because there's unrealized value. But from an allocators perspective, not just trusting what the fund is saying and trusting what the team is doing, but also their ability to continue to withstand that illiquidity.

A (17:33)

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B (19:22)

You can borrow against your public shares, sometimes also on your private shares. Why do you think that hasn't made its way into the Endowment foundation pension fund market where these are some of the best counterparties that you could have from a credit risk? Why aren't more allocators borrowing against their private book.

C (19:39)

That is a spicy question. That's a great question. I'll give you a simple answer to it. Which accounts for a huge swath of them. Number one, they're not allowed. It might be written into their legal documentation, usually their investment policy statement that any type of borrowing at the institutional level, so they recognize that there's a lot of leverage in a lot of the underlying investment strategies with which they're working. But borrowing for any purpose at the institution level is almost not allowed. This is usually also reflective of the fact that that a lot of institutions. So think of healthcare foundations or university endowments. They may already be in the debt markets themselves. And that debt market borrowing, they're usually so. For example, a healthcare foundation may put out a municipal bond and they're getting a decent credit rating because they as a sophisticated business have very good credit quality. And so therefore they're able to borrow at great rates. But that's for the institution themselves. The endowment or the foundation pool for our healthcare system may be a large part of the balance sheet, but the institution may be precluded legally from borrowing on that part of the balance sheet. The other side of it, in all honesty is a lack of exposure in borrowing from that part of the portfolio or thinking about borrowing from that perspective of the portfolio because of an understanding that, that historically crises when they happen, bubbles when they pop, almost always don't pop because of valuations. Bubbles almost always pop because of leverage. And if your underlying investment portfolio already has some baked in leverage, adding more may be detrimental, maybe adding a little bit more risk for quasi incremental return.

B (21:18)

Is the lack of liquidity in private markets and allocators portfolios a moment in time or, or is this a new normal?

C (21:26)

It feels like we've moved to this new normal of large private companies with billions and billions of dollars in revenue. Established companies with hundreds if not thousands of employees. Think of a company like Stripe. Two Irish brothers moved to America build one of the largest and most successful payment processing firms. They've been around forever, you know, over 10 years. Normally back in the 80s and the 90s, early 2000s, they would have already had an IPO. But there's a lot of commitments when you have an ipo, a lot of new governance structures, you have to put in place a lot of new governance requirements. And so this whole conundrum of private is the new public seems to have taken hold and there don't seem to be any material forces pushing back against that.

B (22:11)

Do you know the origin of the four year Vesting schedule for startup employees.

C (22:15)

The numbers are easy. 25% a year over four years.

B (22:18)

Four years used to be the expected timeline to go from private to going public.

C (22:24)

I wish that we could see more

B (22:25)

of that today to give you a sense for how much we've drifted from the original assumptions, really going back to the 90s, we've went from four years to now really 14 years. This kind of feels like a new normal.

C (22:36)

I remember in 2012 when Facebook went public and I was working at JP Morgan, we were part of the desk that was distributing shares to ultra high net worth and high net worth individuals, institutions that were looking for shares of this ipo. And it was a big deal that had taken a while for them. They'd done so well and we were so grateful to be part of the team that was leading that ipo. But yeah, I don't know what changes because the benefits are so diffuse in terms of the allocators asking for it that it's hard to get them together as a group and advocate for it. Whereas the benefits to the private firms and the private funds that are managing this are so tight that it may continue like this for a long time.

B (23:14)

Assuming this is the new normal, what decisions upstream should allocators be making in order to prepare for this new normal in their portfolio?

C (23:22)

All allocators need to adjust models to acknowledge the fact that the expected distributions, the models that we had for years handed to us from David Swenson's team at Yale over 25 years ago, that these models of the expected timeline of distributions from all private assets need to be stretched out further. The only asset class in a private perspective where we're seeing distributions stay approximately in line with expectations is private credit. So private credit has historically been the one private asset class with a very short call down schedule and a very short distribution schedule. And that seems to be sticking to history. So for the last 25 years or so, it's had approximately a decent 24% distribution yield, and for the last couple of years it's still around 22, 24%. This is in stark contrast to private equity buyouts and to venture capital, where the distribution yield has dropped to low double digits, if not high single digits. So number one for all allocators, adjust the models to acknowledge the fact that the illiquid part of your portfolio is going to remain illiquid for longer than you thought.

B (24:27)

A lot of people are looking towards 2026 liquidity via IPOs almost as the savior in their portfolio. And, and although it might help minimize Some of the issues in the short term, I think you have to take a step back and look at what are the incentives that are driving private marks and private assets to stay private longer. I think the incentives are obviously on the asset level. These assets want to stay private longer. It's only become more and more difficult to become a public company. You have to deal with a quarter by quarter scrutiny, which in my opinion is value destructive. And two is you have to look at these other factors like CVs. I think CVs have now reached $100 billion. I think CVs are here to stay for many of the reasons that we talked about. And a great IPO run may even solve issues for one to two years. But if you're starting to deploy in the next vintage, for the next 10 to 15 years, you should not rely on a hot bull IPO market. I think you really have to look at the decisions of this new normal and of all these players and how their incentives are aligning. Because in many ways allocators are at the mercy of the incentives of GPs and GPs are at the mercy of the incentives of the portfolio companies. Obviously everybody has leverage and everybody has some power in the market. But ultimately the decision lies with the underlying asset 100%.

C (25:48)

And I would just summarize that to something you hinted at, which is why, why go public? In the past, private firms would go public to raise capital to help with their expansion needs, to help recognize the entrepreneurs that started a company financially. But if you can get that in a secondaries market, because you know you're doing another series round for your private investment firm or your private company, and you can raise the capital on all the capital that you need on the private markets, then why deal with the hassle publicly?

B (26:18)

There is a silver lining here. If we assume that this is a new normal, and that is that there may be the comeback of the illiquidity premium as more capital has come in and as liquidity has become more and more of a thing, some argue that the illiquidity premium has gone down. If the opposite happens, and now the new normal is that it's 10 to 14 years. The institutions, which primarily are these endowments and foundations, and to a degree pension funds are able to hold for that long, they should be the natural beneficiary of this lack of liquidity as long

C (26:49)

as they demand it. So if you're, if your assets are going to be illiquid for longer, then this illiquidity premium historically was based on, you know, a given understanding of A capital call and distribution schedule. But if that distribution schedule is going to be pushed out longer and longer, well then we should get a greater and greater return from it. Otherwise our IRRs are going to deteriorate over time.

B (27:10)

Talk to me about private Marks.

C (27:13)

Oh, oh, very controversial, very controversial. Thankfully, most firms have very serious third party valuation processes that they use. And a lot of times something that we see with a lot of allocators is they have a good understanding of the private investment company. So the underlying companies with which they're invested in a venture capital or private equity fund, sometimes there's investments from other firms. And so you'll see marks. So Kleiner Perkins has a valuation, a 16Z has a valuation, everyone has a valuation. And so hopefully these guys are all in line with each other. There's sometimes differences. Fidelity for example, sometimes will have a very stark difference between how they're marking it on their books relative to how Silicon Valley may be marking the exact same company. But most of the companies are keeping their heads above water because ultimately they want to maintain what is their most important asset in the industry, especially with allocators, and that's their reputation.

B (28:09)

Professor Steve Kaplan, previous guest, did a study on this and he found that the bigger funds, the more traditional and established funds had a more conservative marking than the emerging managers. In that the emerging managers wanted to maybe mark a little bit more aggressively, hoping to land into the next fundraising cycle, whereas the more established firms really focused on the long term relationship with the LPs more. That's what the numbers show.

C (28:36)

That sounds right. That feels right too, because the newer firms have to establish themselves and are just trying to raise fund two or fund three. And so by their nature might be a little bit more aggressive, but the larger, more established firms, they don't need your money. There's a line out the door waiting to invest. So they can be much more conservative in their marks.

B (28:55)

Talk to me about why there's not more pressure from LPs towards GPS to mark down their books.

C (29:01)

Partly it's because if the LPs pressure them to mark it down to maybe what the LPs think it should appropriately be in one part. Well, that would mean acknowledging that the LP's performance is also going to drop and they have to explain that to their investment committee, to their trustees, to some politically exposed persons. If there are political appointees to a pension, that can be a difficult conversation. And in some cases in the past, performance calculation updates have led to people losing their jobs. So not a conversation you want to have Sometimes. But the other part about it is much more functional from an LP's perspective of what is their role in managing a portfolio of assets. And their role is finding, evaluating, investing, trusting GPs, trusting the investment managers and their processes. Their roles as LPs are not securities analysts, they're not valuation analysts. And so they may think it from a big picture perspective, but just historically and professionally it's not something that they're always comfortable with doing, even if, and I remember sitting around table, joking, seeing in 2018, 2019, I'll never forget there was a 2006 vintage year fund that was still being marked at 1x on the book 10, 15 years later with no distributions. And we used to joke about it, what are these guys doing? When are they ever going to give up the ghost? But a large part of the LPGP relationship is trust in the separation of duties.

B (30:23)

And there's also career management aspects to this. On the LP side. Tell me about that.

C (30:27)

Most senior investors working at an allocator, I saw somewhere that their average tenure working at a given allocator may be between five to seven years. And if you're making investment decisions, you're locking up capital with a private equity or venture capital fund that's expected to be on paper 10 years plus optional two one year extensions, great. That's, you know, at least approximately a 10 year life on that investment. And if there are continuation vehicles and it just keeps going, well, we may never see the end of that fund, but it may not matter to you because you're already working at your next role. And so the outcome of the investment decisions you made at the prior place, you never actually get to see how they fully played out. It is rare to see a senior investor, any allocator stays in one place their entire career. The David Swensons, the Dean Takahashis of the world, were rare in their time and are rare still today.

B (31:19)

What are some other ways that there's a principal agent problem between the allocator and the pool of capital that they're managing?

C (31:28)

The biggest thing for the allocator is the risk that they're taking in the portfolio. And their understanding of the managers is so much deeper because they're in the markets every day, they're seeing what's going on in the news and they're making investments that they think and the decision that they're making are the best ones from a fund perspective, from an allocation perspective, from the asset class perspective. But from the institution side, the institution is forever. And so if there's incentive compensation involved Then there might be an incentive to have great performance this year for the next couple of years. But if the incentive performance compensation is based upon relative performance, not realized relative performance, then there can be an incentive to make lots of illiquid private investment decisions that may not pan out at the end of the day. It's tough, though, because everyone I've met, at least in my career, from an allocator's perspective, and almost all, Almost all of the funds that I've met with are sincere, hardworking, dedicated investment professionals doing their absolute best. It is rare. It is rare, especially today. So you might meet some sketchy or shady people or interesting people back in the early 2000s, but post Bernie Madoff, post Amaranth, post Bayou, post Galleon, post all of the frauds and the blowups that we saw in the 2000s and 2010s, they are much, much more rare today. Something like what happened with Ken Leach at WAMCO is almost unbelievable because so many processes and procedures have been put in place to prevent any bad actors. So for the most part, the LPs are trying to work in the best interest of the institution. You know, the investment office, the team themselves are trying to work in the best interests of the institution itself.

B (33:09)

We started talking about AI tools and whether they'll replace us. Last time we chatted, you mentioned Mike Trotsky of Mass Prem recently said that AI tools can be used to outsource work, but not to outsource thinking. What do you think he meant by that?

C (33:21)

Yeah, I thought it was a great quote. One fun fact, almost no one who has joined the Mass Prim team has ever left, which speaks to the quality of the work and the quality of the people that they work with. But his quote about AI tools and outsourcing thinking, you know, we can outsource a lot of work. So AI tools, I'll give you a few examples of where we see allocators using them. They can be useful, but we can't just offload the most important part about being an allocator, which is the analysis side. What we're doing up here in analyzing the markets, the investments, the firms, the people, everything. So AI as an example on talent and recruiting, it's made things a little bit more difficult. So back in the old days, meaning just a few years ago, you'd get a lot of different and a spectrum of the quality of resumes, but now everyone can use an AI tool to have a perfect resume in operational efficiency. It's really helped. This has been one of the greatest Places that AI has come to play for allocators and for a lot of other folks. So for example, it will take notes for you, it will take meeting minutes, it will draft emails, it will sort all of the incoming files that come in. So it's allowed you to not have to do a lot of the drudgery work. The key phrase that we had at the Cleveland Clinic when I worked there was maximum value per unit of effort, maxview. So maxview in terms of operational efficiency for an office means that a managing director, for example, should always for the most part be doing managing director work. And if there's something that the managing director or the CIO is doing that could be done by an analyst or an intern or could be offloaded to a third party tool, then we should go for that. And AI tools really help with that.

B (34:58)

So before we started recording today, you said that the five factor analysis could be completed in under a minute. How can investor very quickly ascertain the factors in their investment?

C (35:10)

The first thing I tell you, and this is I just want to reference a great white paper that all allocators should take a look at, which is from Barbara Huang and Odeon 2019 and one of the key things they found

A (35:21)

for today's episode of How I Invest. This conversation gave you new insights or ideas.

B (35:25)

Do me a highlight, share with one

A (35:27)

person in your network who'd find valuable or leave a short review wherever you list this helps. What we're doing is bringing you these classes conversations. The first factor, thank you for your

C (35:37)

continued that was really discovered and understood in factor model analysis, but we're ignoring every other factor research, every other factor insight that's come out since then. And this white paper that I mentioned, Barber 2019, they noted that almost all allocators, almost all investors, they pay attention to beta CAPM first factor, but they ignore every other factor. And Fama French came out with a three factor model and then they expanded it with a five factor model. And there are tools, portfoliovisualizer.com, finpilot, AI Excel, where you can run this five factor model research. You can get all the data for free. Fama French still put it on their website for free. You can run it within minutes for a given fund. The key insight though from this white paper was that nobody's doing this. They are not running this research and they are relying just on the CAPM beta and attenuating to alpha. What is actually beta? What is actually factor exposures from the other four factors.

B (36:36)

On that note, Alex, it's been absolute masterclass. Thanks so much for jumping on. Looking forward to doing this again soon. Thanks so much for coming on.

C (36:43)

Absolutely. So good to see you, David. Thanks.