A (3:43)

And you're an investor in private markets as opposed to public investments. What drew you to that space rather than the path that many investors take where they're focused on public markets?

B (3:54)

Well, so from very early on, starting at Columbia again, I was an early believer in the efficient market hypothesis and that public stocks are relatively fairly priced. And I was a big believer in indexing right out of the gates. So part of it was that a second part of it was I had friends on Wall street and you'd hear stories about how the plumbing of that industry actually worked. And so I had a friend who was in a research department, and they would sell very expensive research to different investment firms. But the way it was explained on the inside a bit was that they, these firms had IPO allocations where the mutual funds or whoever could buy these public stocks at big discounts to what the price would be the next day. And that was sort of a lock for them to get to sell this expensive research. I don't know. So there was just a lot of the plumbing that didn't really appeal to me. And on the flip side, and we'll get into this more and more, I think there is genuine opportunity to provide lots of value and lots of solid returns in private markets.

A (5:02)

So maybe if I could restate it and tell me if this is accurate, if you're investing in public securities, there's a lot of efficiency there in that the information is fully or mostly discounted in the price. But if you go inside and you look at the plumbing, there may be inefficiencies that if you're possibly on the private market side, you could take advantage of. Does that sound right?

B (5:23)

That's correct, Alex. And I'm not selling short the benefits you can get from investing in public equities. So the S and P and different ways to approach the stock market. I've had great returns for investors over the years. But for me personally, I find that my potential value add to what I'm doing would be lower with public stocks than what I can contribute in a public and sorry, in a private environment.

A (5:47)

That makes sense. Would you talk about why you decided to launch your own firm back in 2015? A lot of people, it's a big step, you know, it's a big risk. Is there a reason that you decided to do that or were there circumstances that, you know, where all the stars align, where it made sense to do that and what do you feel like tilted the odds in your favor of success?

B (6:10)

So look, I had started investing in 2000 in coming out of Columbia Business School. I was investing in venture capital on the enterprise software side. So I had three years of investing experience there. I got into secondaries in 2005 and I had a 10 year run from 2005 to 2015. 2015 and really learn the ins and outs of the secondary industry. I built up a good reputation in the industry, had lots of relationships, had strong views on strategy and how to execute a business. And for me at that point, after 10 years there, it was simply time to do something else. And so I left my old job and I didn't have a specific defined plan when I quit, actually I had a fresh mortgage, I had three kids in school, plenty of expenses. But I wasn't dead set on launching a firm. And what had happened though is within three weeks of my departure being announced, a number of investors started calling me. People who had known my track record over the years, who had followed, you know, followed my progress through annual once, once a year, twice a year, interviews with me and said that if I started a firm they would be potentially interested in investing. I had a couple of conversations with other secondary funds at the time about potentially going to work at a big firm. But having these possible investors lined up emboldened me to get going with Klein Hill. And I also had a pretty strong conviction in the niche strategy that Klein Hill focuses on, which is doing these little smaller transactions that we'll get into in a bit. But I had a very strong conviction on this strategy, having an enduring opportunity to deliver strong returns. And look, and I was excited about the opportunity. So it was if I, and if I knew all of the difficulties along the way and how much work and effort and luck and meeting the right people and having amazing supportive investors and all these things require, I might have been maybe like didn't appreciate all of the long road that it has been. But yeah, I'm very glad that I'VE made the decision. And the second thing, Alex, about this point is in terms of, like, look, Clindale, I think we've been successful so far. Or people from the outside may say we've been successful so far. But one thing that I noted, like in my industry in the early days is I remember seeing people in the industry giving speeches at business schools or speeches at conferences or things. And then later on, as a secondary investor, I learned the details of the performance of their funds, see the multiples they're delivering and the distributions that they're giving to investors, maybe being lower than you'd expect. And I think it's an important thing to note that success in the industry isn't designed by how much capital you can raise or the size of your firm, but it's really defined in how your funds perform and how much actual cash you're giving back to investors. And so that, you know, that's what will drive it all in terms of like talking about, like what? Like things being successful, that's when it's a success.

A (9:30)

And it's obviously very helpful when you have backing to start because one of the hardest things about starting a business on the investment management side is to attract capital. When you don't have a track record that you can publish, it's just, it's very difficult. So having that reputation already gives you a running start. That definitely helps.

B (9:50)

And look, we've been super fortunate because yes, initially right out of the gates, we did have strong investor interest. And then I have to take a pause and thank our limited partners who have believed in us from the early days and kept supporting us. We have a great set of relationships. So we're about. Just so you know, Alex, about half of clientele's backers are charitable endowments and foundations. We have some really strong, very thoughtful groups such as RIAs and some insurance money and in different group of. Different types of groups of institutional investors. We're about 97% institutional and we've tended to have a bit over 100% of our investors come back from a capital perspective from fund to fund. And so I have to have a big thank you and big shout out to investors who have been supportive and great partners over the years. So thank you to all of our investors.

A (10:44)

That's great. Why don't we dive into the secondaries market and start with the most basic question is what is a secondary.

B (10:53)

First of all, I was going to step back and talk about what is a private equity fund even? And so if you think of investing from a Public stock experience. You can go out and you can press a button in your browser. You can buy different shares of individual public stocks. You could also buy mutual funds, buckets of stocks, and they're very liquid, very easy to buy, and very easy to sell. Public companies, when you step into the private equity world, it's a completely different story. So typically, to access private equity investments, you'll have funds that are set up where different general partners, they're called general partners or sponsors, will raise capital from investors one fund at a time. And any single fund will call capital from their investors over a period of, say, three or four years. So as an investor to commit to a private equity fund, you don't give them all the money upfront. You only give it to them after three or four years as they identify the companies they want to invest in. And then it's going to take each of Those companies individually, 5, 10, sometimes 15 years to grow and develop and to become hopefully worth 2, 3, 4 times what the capital was that was put into them so that the manager can return the money to their limited partners. So it's a very long cycle, takes a very long time to get your capital out. And as an investor, you're not just investing in one private equity fund, but you'll have a portfolio maybe of 10, 20, 30 managers across multiple fund vintages that they have. And she'll build a big portfolio of private equity. Now, there are a number of reasons why investors may want to sell these funds. Over time, they may decide they have too much private equity and they want to have less. They may have certain managers that have fallen out of favor that they want to get rid of. They may have cash needs. They may have a new chief investment officer that comes in and wants to change their strategy. And so they'll want to get liquidity from their portfolio. And this will drive what is called LP secondaries, which is half of the secondary market. The other half are GP LEDs. I'll go into a second. So an LP secondary is when an allocator to private equity will take typically a bucket of funds. Could be often at least 10 funds, sometimes 30 funds, or even many more. So take a number of these funds. They'll want to get cash for those positions, and they will go to a process, and we go into the details of that more in the future, but a process where a secondary buyer will bring capital that they've raised from other institutional investors to buy those assets and provide cash to the seller, and they'll become the new holder of the limited partnership interests in those funds. So those are LP secondaries. The second approach are GP LED secondaries, which also can be called, most typically continuation vehicles. And that is where the individual general partner, individual sponsor of a fund wants to provide liquidity to their LPs, and they drive the process. And what they would do is they would pick one company or a handful of companies and they would find a secondary fund buyer with a syndicate that would come and provide the capital to acquire the economic interest in that company to pass on that capital back to their LPs to return the capital. And typically that general partner, though, would stay on to manage the assets. Typically that happens after those companies have been very successful. So in 75% of those cases, those companies have already delivered two and a half times or more of invested capital. But that's the second half. So LP secondaries buying portfolios of LP interest by secondary Funds or GP LEDs, which would be driven by the fund managers for one or a few companies. And Alex, just so you know, in each of those cases, LP secondaries and GP LEDs are each just over 1% annual turnover of the $7 trillion that sit in the private equity industry. So it's a very small turnover in terms of the total asset size. And to put it in perspective, if you look at the public stock markets, Those turnover about 100% every single year. So the liquidity, while it is about $150 billion for 2024, is very small on a percentage basis.

A (15:34)

And I guess the other way to think about it is public markets have similar transactions for similar reasons. Maybe they want to reallocate or they want to sell. An underperforming manager or a new CIO comes in and wants to change the portfolio to their style. And the market for private investments was completely illiquid for some time. And at some point these transactions started and that market has evolved. Does that, does that sound about right?

B (16:00)

I think that's right. And one thing I'd also add, Alex, if you think about it, the ability to get liquidity in your investments actually increases the value of them quite a bit. So think if you had bought an automobile and when you go to the dealership, they make you sign something, that you can never sell the car, that you have to drive it into the ground. And so everybody would have to own their cars for 12 years, and that wouldn't be extremely appealing. Or if you had to buy a share of a stock, say IBM, and you're never allowed to sell the IBM stock, but you'd keep the dividends Forever and pass it on to your kids. That's not as great of a value. But having the liquidity actually increases the value of what you own. And I think as we go through time and, and the market evolves, if liquidity does increase and becomes easier and the friction costs of transacting go down, I think the secondary industry will provide more and more value to the private equity industry.

A (17:00)

And how has the secondary market evolved over the last 20 plus years since you've been involved?

B (17:06)

When I got involved in 2005, the total volume was about $5 billion per year. The market was substantially driven by limited partnership selling. I would go to annual meetings in 2006 where you're at tables of allocators, pension funds, endowments, foundations, and they would ask you what you do and you'd say you're in secondaries. And you would have to explain to all of them that you can buy LP interests, they could sell their interests and you have to really walk through what those, what those entail. At that time, it wasn't popular in the industry to be a secondary investor. And so if you think about it from the general partner standpoint, we would show up sellers that are selling our interest trust were there were their prized LPs who are fund after fund giving them new commitments. We show up and we're buying them out and they're going away. So we were tolerated by a lot of general partners. A number of them sort of welcomed us and helped us, but it wasn't sort of their favorite part of the, of the business in terms of like supporting the secondary industry. And then over time the volume grew from $5 billion in the, in the great financial crisis 2009 and 10, the volume really dropped quite a bit. And then LP volume really grew a lot as you step forward to 2014. But what had happened though, Alex, was that a lot of capital had come into the industry and returns had started to come down. And so if you think of returns in the secondary industry, most secondary funds may deliver low double digit net IRRs to investors. So think of 10 to 15%. And there was a lot of capital and a lot of competition. And at that point around 2015 is when the industry innovated and started doing these GP led transactions where the sponsors would drive the liquidity from individual companies or small groups of companies that initially was in the oldest funds and not always the highest quality assets. And then as we step forward a number of years till today, these continuation vehicles are typically much more trophy assets. About half of them are single company Trophy assets. About half of these deals are multi company and and then so it's, it's 70, you know, call it like 70, 75 billion of liquidity from GP LEDs today. 70, 75 from on the LP side. And if you think of the overall liquidity for the industry in the past 12 months, a meaningful percent has actually come from secondaries on the order of 10%.

A (19:52)

How did you first discover the world of secondaries and what was it about it that drew you in to kind of build your career on it?

B (20:01)

Coming out of business school In May of 2000, I had the fortune but the unfortunate timing of getting into venture capital and that was at the very peak of the nasdaq, right as liquidity fled the industry. And so I had three years of an excellent education on investing, but more on a crucible of hard times and lack of capital. We did have a number of successful companies but also a lot that we had to shut down. And it was just impossible to bring in capital at that time. And so I really learned to see how things can work out when the industry is going very poorly. So step forward to 2005. I was at McKinsey & Co. At the time, very much wanting to get back into the world of private equity and discovered an opportunity at a secondary fund. On my business school website. I had never heard of secondaries before, went to interview with the firm. They were as much pitching me what secondaries were as I was trying to apply for this position. And having come from the world of venture, what I really appreciated was that it had a much better risk adjusted return and a much better approach to the overall private equity industry because you're buying into portfolios of assets where the losers are already out. You're buying number of years later into the lifetime of these funds. You're closer to when liquidity is coming out of portfolios. And one thing that I think is great with regards to a career in secondaries is that we'll do deals here at Klein Hill that will close it. We're signing up deals now that'll close on June 30th. We'll have exits from that portfolio in the third quarter of this year. At the end of the year, you know, next year we're going to see a lot of results from our work very quickly. And for people on our team, that's a great learning cycle because we're doing all the work to value these assets, to make predictions on what the outcome is going to be. They're going to get very quick feedback. If you Think of it, if you go in, you're doing primary investing from the date you invest in a company, you might not get the result for 10 years. So anyways, I was drawn by it being a great risk adjusted approach to the industry. And it also now, with hindsight, has been one where you learn a lot as an investor. Very.

A (22:18)

Quickly. One of the biggest questions investors ask is why is there such a big discount and is it persistent, is it structural? And the reason I ask that is, or I bring that up is because there could be a lot of skepticism that you're going in and buying these assets at what you perceive to be a discount. But perhaps the seller knows more about the asset than you do and you think you're buying at a discount, but you're really not. How do you think about that level of.

B (22:47)

Skepticism? So look, I think there's three points I'd have to make on this. The one is if you want us to look at the returns that secondary funds actually get. Second is to look at the performance on the assets that are being sold. You may have already made a lot of money. And the third is on the opportunity cost that you have for the capital. So if you look at returns in the secondary industry, they've been very strong over a long period of time. So if you look at Cambridge Associates data going back to 1993, almost every vintage of secondary funds has delivered double digit net returns, except for a handful of most of which are high single digits. So it does perform very well. But most of Those returns are 10 to 15% IRR to secondary fund investors. And a lot of those returns, especially at the big funds, have a large component of leverage to get that return. So as a seller, you can think of maybe you're giving up 8 to 12% in terms of the return that you're walking away from by executing a trade that's really not that huge of a discount that you're giving up to give an illiquid asset where the buyer may have to wait three to 10 years for all the cash to come out. The second thing is, if you look at the portfolio that you're selling, you very likely have already made a large amount of capital from your investments. So you may have, you know, they may be up 50%, 100%. So when you're actually going to sell and you apply the discount to how well you've done so far, it may not be so much to walk away from. And the third is if you look at opportunity cost when you're allocating into private equity and you're rotating from one portfolio to another. If you're selling and you're losing 8 to 12%, I can bet you that most allocators are targeting returns much higher than that. For some of the amazing managers that they're going into, they're probably targeting 15, 20% or more. And so you can actually see that as being a pretty good trade. As a seller, some would argue.

A (24:47)

It sounds too good to be true. You can buy things at a material discount to what they're actually worth. Are there significant barriers to entry that allow these discounts to persist through.

B (25:00)

Time? Sure. So in terms of barriers to entry, I see there's two different angles to look at that question. One is for firms to enter the industry and for firms to compete. And the second is for the overall secondary industry to innovate and to change to be more efficient in the future. And so in terms of firms like entering the industry, first of all, raising capital is not always a straight line. It can take a great deal of time. You have to build up a platform, a team. It's not easy to get the capital. The second is it's very hard to build up the platform. And so if you think of what it takes to invest well in secondaries, you, you need a, like a massive investment team that's highly experienced. There's a great amount of valuation work, understanding different industries, different managers, different companies, and knowing how to get information that's not public and very hard to find. So building the teams is very difficult. I'd also say that from like a steel sourcing perspective, you see newcomers sort of show up on the stage and expect to just start doing lots of deals. They're not seeing the deal flow. So, so just even finding these illiquid secondary deals is very hard, then picking the right ones to work on is difficult. And groups that don't have a track record of getting lots of deals done often find themselves stuck and have a lack of conviction on which deals to even do or pay up for. And so what you've seen, Alex, is that there's some massive, very well regarded firms in the industry that have wanted to launch into secondaries. And they've tried to do it themselves with confidence on their own investing capabilities and their platform. And typically they have very often tended to either completely fail or take many years longer than they thought. And along the way of firms trying to enter the industry, they maybe have not been the best fiduciary of the capital that they, that they're managing trying to get there. So it's not so easy just to like launch and dive into secondaries and launch a new strategy or a new new firm. It's actually quite difficult. And the second thing is if you think about the whole industry and how the industry which may change over years or what it will take for that to happen, I think it's actually very difficult. And you've seen firms like Nasdaq that has come in and tried to make an exchange to have very efficient trading of interest on the secondary industry. It's been more challenging than I think they thought it would be in the beginning. And so why is that? I think there's four main reasons. One, first of all, when you're going through to execute these secondary transactions, you really need to know what the right price is. Unlike the public stock market there, there aren't these clearing prices. The valuations that are that need to be made to determine the price are based on highly confidential information that people don't want all over the Internet. It's not easy to access and actually we spend a very large amount of resources to like to dig very deep beyond what's easily available from the managers. So the information is very difficult. Second is the overall volume is just very low. So if you look at a lot of managers or companies, there might only be a transaction for them a couple times a year. So there isn't the volume to support the industry to instantly be hyper efficient. And so it has to be something that will take quite a while to build up. And then third is when you think of trades that happen in the secondary industry, it's not like with public stocks where you realize you want to buy IBM stock and you can research IBM, decide what price you'll pay to buy it or sell it in the secondary industry. First of all, as we mentioned before, you're not typically buying for LP trades one company at a time, nor are you buying one fund at a time that may have five companies. But a seller is coming with a package of funds that they want to sell. They're going to have picked out say 20 different funds. And so in one go for one transaction, you're going to have to understand 20 managers and all of those companies in that whole portfolio. And so that's a huge barrier, not just for a firm to enter like we were just talking about, but also just for the industry to provide simple liquidity when you have very complicated buckets of assets. And then the fourth thing, which today is complicated is maybe more easily fixable, is that the transfer process is complicated because each of these funds that you're looking to transfer is operating under different contracts and different agreements. And so you actually have to hire lawyers and spend thousands of dollars for each fund that you want to transfer. And typically those transfers are limited to the end of each.

A (29:59)

Quarter. What about the sellers of the funds? You know, if you're buying at a discount or selling at a discount, the same discount. Is the rationale for selling so significant that they're willing to give up that discount, or is it because the market is just not that.

B (30:18)

Competitive? So I think in terms of the selling, it's a couple things. So one is they understand that it's the market rate. So let's say it's a 15% discount. No one wants to give up 15%, but they understand that's the fair range of where prices are, and that's the cost that they have. Second is, I think they're. The pricing is close enough that for portfolio, portfolio management, it's an acceptable loss that sellers are willing to take. And so, Alex, I think another big thing that drives this is if you look at the pricing over the last few years, currently discounts in the industry could be into the high single digits to say like 15%. So if you're going to sell, you'll get 85, maybe up to 95 cents on the dollar at the higher end of that range, or you don't have a very big discount when the pricing is high, you'll see massive volumes. And so I actually think this could be a record year for volume, say $150 billion. If you go back to, say, 2022, the second half of 2022, the volume was maybe a third as large, and that's because the prices were larger. So you definitely see a big. A big swing in volume based.

A (31:36)

On the pricing that makes sense. And if you take it to the extreme and you have public markets where the discount is almost zero, you have 100% average turnover. In private markets, it's like 1%. So obviously, the less the discount, the more interest there is in.

B (31:53)

Selling. One big thing here, Alex. So to understand in the industry is that the discounts are relative to the marks that a fund puts on the portfolio. And some managers are. So some managers carry assets very differently. So we see different companies where the exact. Sorry, we see different funds where the exact same company is held by different managers. And literally one manager can hold the same company for twice as much as another manager. And so there's very big differences in terms of the pricing. And so perhaps if liquidity did pick up enough that you could use it as a signal for how assets could be valued. Like in the stock market, you could have the secondary market driving valuations. Whereas today valuations are all driven by quarterly processes at the funds where they underwrite their own assets. So the question is, you're calling it a discount, but really it's an optical discount to where the GP has decided to mark an asset. And so if you look, consider intrinsic value, maybe the intrinsic value is the secondary.

A (33:00)

Price. That makes sense. Would you talk about the different approaches that secondary managers may take in managing their.

B (33:09)

Strategy? Absolutely. So look, there's, there are a number of different approaches. So one of the most common is that some is about half of the buyers in the secondary industry advertise that they have a primary platform and that they have a set of managers that they know very well. And another half of the industry does not have those and they're more asset buyers and they'll have different elements of their strategy. At Klein Hill, we do have an, we have about 30 managers that we back who are helpful to us with regards to sourcing deals and evaluating them. However, you have to understand that there are 6,000 different private equity funds in the industry. And so if you look at people with these primary platforms, Maybe they have 40, 50, maybe 100 managers at the highest end, but you're Nowhere near the 6,000. And when you're buying these portfolios from sellers, you're going to get diverse portfolios where you might cover a few of the managers. You're not going to cover like all of the managers out of the 6,000 possible ones. Second thing is that you're not the only one that has these primary platform investments. So if you pick a high quality middle market manager, then maybe five different secondary funds invest in the same manager. So you're not going to be unique with that strategy. But anyway, so that, but we do see value in that. We see higher value when you have a very niche focus with regards to your primary strategy. So for example, at Klein Hill, we've partnered with Sandana Capital, which is one of the top quality, one of, we believe, the best seed fund of funds in the industry. So what Sandana does is they go through and they invest in the best seed managers. And so what a seed manager does is it's a venture fund that gives very smart people capital to start businesses. And so they started doing that in 2012. They're in 3,000 companies today. And based on this huge portfolio of underlying companies, we can work with our partner, Sandana, we can pick the Best of those. So out of the 3,000 will pick third the top 30. And I have a top 100 list and target those specifically. And it's a little bit more of a, of a rifle shot where we have a differentiated approach, whereas. So I think there can be values to the primary approach if you're focused. So that's so one. So anyways, so one is having a primary platform. A second one is size. So you have some firms out there who have $20 billion funds and they claim because they have the largest pool of assets, they can buy things other people can't buy because no one else has their scale. But now there's a lot of people with $20 billion funds. On the flip side, there's client Hill. Our thing is that we buy lots and lots of small transactions. So Klein Hill will do deals much smaller than the industry. So on the limited partnership side, most LP deals are between 100 million and a billion dollars. At Klein Hill, we're doing deals under $30 million and even a lot under 10. So last year we did over 120 deals in that scope. And so we're by far and away the volume leader and the firm to go to if you're looking to sell those types of interests. And on the GP LED side, most of the GP LED deals are over $400 million. At Klein Hill, we're focusing on deals in the 100 to $250 million range again, when there is a lot fewer other firms in that space. And then also there are firms, Alex, that focus on sectors. So you have groups that specialize only by venture, or they'll only buy credit, or they'll only buy real estate. And you'll have different funds and different groups that focus on specific.

A (36:54)

Sectors. Are there specific segments within secondaries where you generally tend to find the biggest discounts? And maybe there are segments where you find the highest quality companies like the trophy assets. And how do you think about that.

B (37:11)

Spectrum? Absolutely. So in terms of large discounts today, as you know, the venture industry went through some very challenging times post2021, when valuations were extremely high. Since then, quarter to quarter, the assets continue to get written down. We believe there'll be a bottom in terms of venture valuations around Q2, probably Q3 this year. But there's very large valuations there, very large discounts there. And there's different sort of just lower quality portfolios where you have challenged assets. And they could be lower quality, like weaker managers. They could be pools of assets and very old funds where you'll find larger discounts. You'll tend to on average have lower quality assets. On the flip side, there's a lot of very high quality pools of assets that are out there. And so we tend to think of those as buyout or growth buyout assets, especially ones where the funds are a little bit mature, that may have been paid down a bit and those can be more expensive, but you can also do extremely well. And so I think in the second example, for the highest quality assets, those will be the most expensive. They may do well. There could be a tighter band of returns for secondary funds going to buy those assets. On the flip side, for the lower quality assets, you have to be very careful with regards to, to how you might approach those, those pools of assets. And so, for example, when we think of the venture arena where discounts could be 20% to 70, 80%, we think that there is a great hunting grounds for deals in that space. But you have to be extremely careful. There are thousands of venture companies and you could waste years trying to go one by one to figure out who will be the winners of tomorrow. For us, what really helps cut through the haze is our partnership with Sandana. And so we can go through, we have this target list that it's very, very heavily curated based on relationships they have with the seed managers and specifically work on portfolio construction from an approach like.

A (39:32)

That. It goes back to what you said earlier, which is you really have to understand the real value of these funds. It's not, you can't just go off the nav because there's different pricing methodologies and if you, you know, if you go in there thinking it's a 70% discount and the seller has a very different valuation, real time valuation, then you may not be getting exactly what you think you're.

B (39:54)

Getting. Yeah, we have 56 people here at Klein Hill, which for our fund size is, is an army. And the vast majority of what like especially our deal team focuses on is valuation work. So we have tons of inbound deals, sourcing and deals just coming into us, but we need to be super careful with what we're buying and what we're paying for.

A (40:13)

It. And do you generally find bigger discounts on smaller deal sizes because of perhaps less competition or less worry on the seller side about the.

B (40:25)

Discount? So we tend to buy the same assets that you might see in large auctions at about 10 to 20 cents cheaper than you'd get for the bigger deals. And if you think about it, let's say you're buying shares of IBM stock On the Internet at scale, you're just pressing the button and buying and there's obviously market clearing prices. The difference is, let's say you had IBM stock on a piece of paper and you had to walk around and sell 10 shares here and there. So we're buying the same IBM stock, but it's something that's not as subject to the highly liquid liquid auctions. And look, part of the issue here also is that because of the small transaction sizes we are, we're not coming up against the same competition that the big firms provide because they're, you know, someone who's managing 10 or 20 billion dollars, doesn't want to do a 5 or 10 million dollars deal for 30 different funds. They also don't want to lead a GP led deal that's 100 or 200 million dollars. So sellers and sponsors will come to Klein Hill as the group that will lead these types of transactions. Same token, if you think about from a seller standpoint, they're also not as economically motivated as they would be for a large deal. So let's say There's a, a $50 billion pension fund. If they're going to sell a billion dollars of private equity in interests, that's a board level decision. They'll have very precise pricing they're looking for. They'll focus on that very closely. However, if they're doing a smaller cleanup of 10 or $20 million, they don't care about the price so much. There's some non economic reason they're doing this cleanup and they're much more willing to transact at a large discount. So fewer buyers and the sellers aren't economically.

A (42:10)

Motivated. And so does that give you, generally speaking the opportunity to find higher quality assets at a pretty material.

B (42:19)

Discount? Yes. So in terms of from a portfolio construction standpoint, we were sourcing about 35 to 40 deals per week. We filter out not only for deals that where we find there are reasonable sellers who have price expectations that we believe we'll be able to hit, but we're also filtering for decent quality assets that we want to hold. And so if you look at Klein Hill's returns, we do get very large discounts, 25 to 35% discounts at time of close. However, 60% of our deal level returns come from appreciation. And so for us it's important, yes, we do like the discount, but it's in some ways almost even more important that we're acquiring high quality assets that are over time going to be creating more value. That's actually like a fairly important part of our.

A (43:10)

Approach. Do you think of that as two different sets of returns, meaning the return of the underlying assets, you know, from the time you buy it until it's sold, and their closing of the discount gap, do you think of those as two distinct returns that are perhaps uncorrelated to one.

B (43:26)

Another? 100%. And so if you think of the discount, Alex, we're locking in an immediate accretion of value when we sign up the deal and close. And that's something that will immediately accrue to the buyer, even if the cash pays out later. And the only slight tweak I'd make here is to not only think about it as a discount to the GP stated NAV, because as we mentioned before, the NAVs, the net asset values, the valuations, the GPS place on the assets can be a bit all over the place. But we're still buying these assets at a very large discount to current intrinsic value. So what they actually should be worth. So yeah, and that will correlate different to the appreciation of the assets over time. One thing to also mention here is that from a strategy standpoint, the reason that we want to acquire assets with a strong appreciation is a it tends to correlate more to healthy assets. So assets that are generating cash, that have organic growth, that can execute on M and A strategies, those are all assets that, if we think we're going to hold it for two years, then we end up stuck with something for five years or six years or seven years, or we want a company that's going to create value and it's going to help continue to give us a strong IRR over time if we're stuck with it longer. Second is if you're buying assets that could have just flat performance and you're hoping it comes out quickly or forbid something that loses value over time, I think that's when you can really get into trouble if things go the wrong way. So it builds in a.

A (45:05)

Buffer. How do you think about the risk reward or the return to risk ratio of primary investments and secondary investments, even if we're talking about the same assets? How do you think about that? How do you compare the.

B (45:19)

Two? So look, if you look at the statistics, it sort of stands for itself a bit. So secondaries do have higher net IRRs on average than primary investments do, whether you're talking about buyout, growth, venture. So that's. So one thing is they tend to have higher return. Second thing is if you look at the volatility of return, it's actually much tighter for secondary funds. So whereas there are pockets of better performance within the secondary industry that may perform a bit better. But on the flip side, the firms that underperform, the gap is much smaller than you'll see for other areas. So not only in secondaries do you have higher returns, you have a tighter band of returns. And the third thing, Alex, is, is the cash return for secondaries is much quicker than for primary funds. So when we're going through and doing these investments on the GP LED side, we're expecting our cash back in a two to five year window. If you're investing into a primary fund, you're probably getting your cash back in five to 10 or even 15 years. And so whereas we do believe it's higher returns, the quicker cash also a de risks that investment because you're taking the cash off the table. But then it provides the allocator more opportunities to update their portfolio construction or whatever they need to do strategically for their portfolio with the quicker returns of.

A (46:41)

Cash. And all that makes sense if you're buying at a discount and you're buying, let's say, over time, similar assets, you should get a higher return with a tighter band and less risk because you're buying effectively the same assets at a.

B (46:57)

Discount. And so if you think about it, a primary manager comes in and on the buyout side, they're putting leverage on these deals, often seven times. EBITDA is a current average and that's very high. And if things go wrong with the company or the economy, you do run a lot of risk that that company could hit covenants that the debt could take over the company. It could end up like it could end up being a zero or could be very impaired. But that same company, as it performs over time into years, five, six, seven, that debt gets paid down to say, three or four times ebitda. And so when the secondary fund comes in five or six years later, that asset is heavily de risked because secondary funds are buying more mature companies and the debt gets paid down over time. On the same token, on the tech investing side, if you're buying tech assets from a secondary basis, venture investors are going into companies that may have product market fit issues or might need multiple rounds of financing. As you're coming in years 5, 8, 10 into these funds, a lot of the early losers are already gone. And so we're buying into much more stable, diverse pools of.

A (48:12)

Assets. So on that note is your general sense that the quality of the remaining assets is generally higher than younger.

B (48:23)

Funds. Look, I would say that the risk is Much lower with regards to a secondary portfolio than a primary portfolio, especially in the early years. And another thing I'd mentioned, Alex, in terms of the secondary industry, if you think about it, part of it is the portfolio that you have in the ground and how it's going to perform. The second part of it is how the commitment you've made to a secondary fund or how the commitment you've made to a primary fund is going to perform. And a big part of what may drive that is when the capital is called. And so if you think of 2000 or the financial crisis or 2022 times when there was lots of market turbulence, when you commit to primary programs, a lot of times their investing can really dry up for period of time. In fact, in the financial crisis, LPs told those funds don't invest, we don't want to see your capital call notice, we're going to shred it up and mail it back to you. Like they said, that was pretty common. And that also happened more recently. I think with secondary funds, we get a lot more leeway by managers and they're actually excited in times of turbulence and they want secondary funds to go deploy capital. And so if you think about it, from your committing to assets, you'll see more capital being deployed in times of crisis when pricing may be better. And so I think you'll also find that will happen at lower prices and you'll tend to be screening out the biggest problem companies. So you'll actually be acquiring relatively high quality assets. And so I think it's another way to look at risk. But the dry powder I think can have advantages with secondary.

A (50:07)

Funds. So maybe this is taking it too far, but if you're an investor and you're allocating capital and you want to have some target allocation to private investments, private markets, let's say limited to private equity in this case, is there a reason to not to, or is there an argument for not having any primary investments and just wait for this, for these investments to become available in the secondary market and just build your portfolio that way? Is there an argument against.

B (50:33)

That? No, look, I think you can completely do that. I would say that you would want to do it through a secondary manager. We've talked about a lot of the reasons. It's not so easy to just, just do your own secondaries. But yeah, I believe if you had a secondary only portfolio, you could be highly diverse. You'd cut out a lot of the, you know, first year potential issues with funds, I think you could do quite.

A (50:58)

Well. Yeah, it's interesting that you don't see that very. You don't see that commonly, that approach commonly used. But perhaps it will be over time as the market grows and there are more opportunities.

B (51:11)

Available. So we actually do have some smaller community foundations that might have 100 or $200 million where I believe Klein Hill is their only allocation to private equity. Because what we're giving them is in one commitment we're giving them a. We do a lot of deals. So every year Klein Hill is doing over 120 deals per year in diverse pools of assets. Those assets are diversified by vintage. So you're getting assets in different maturity stages across number of types of industries. So we actually do have people where we're their only private equity.

A (51:46)

Exposure. And it's interesting because, you know, some time ago you had fund of funds and a lot of those didn't work out because there's multiple layers of fees. And so in effect this is sort of like a fund of funds but at a pretty significant.

B (51:59)

Discount. I think that's fair. And actually there's one, there's one time we were going to have an LP was going to make a fairly small commitment to us. We from time to time offer co invest and instead of giving us their commitment, they just went into our co invest as their only private equity strategy in one deal that had 28 funds and probably like well over 100.

A (52:19)

Companies. Is there a reason you focus on private equity and venture as opposed to real assets or real estate or.

B (52:26)

Credit? We definitely believe a fair bit in portfolio construction and portfolio allocation by these strategies. And so the highest returning area that we found over time for these is both buyout and tech. And even within buyout and tech, sometimes we overweight one than we will do another. So for example, in the late 2000 and tens, client Hill had a higher percentage at that point of tech investments that were allocated into the portfolio. When 2020 going into 2021 came along, we saw valuations from revenue multiples and EBITDA multiples go through the roof. And we actually drastically cut down our allocation to venture. So first of all, at Klein Hill we do buy out and venture, but not always at the same ratios. Second is there are areas that we have seen perform not so well in the industry. So if you look at real estate over the last 20 years, real estate secondaries across the industry have underperformed by a bit. At Klein Hill we've kept them to under 1% of our portfolio. That could change if there's a huge crash. But right now we've kept it small. For example, we don't believe in investing in China. So clientele funds are less than 1% China. If you know the top China managers that are launching today and they have amazing CFOs and there's different risks that you're comfortable with, that's great. But I don't believe secondary investing and 10 year old Chinese funds is the right way to get access to China. So we don't do China at all. Similarly, if you think about diversification, there's also recent asset secondaries and older secondaries. And at some times the dry powder in the industry can be very attractive when multiples are very low and new deals are getting done at great pricing at the same time, sometimes old assets can be very attractive where exit multiples are really high and people are getting tons of cash out for their existing investments and liquidity is flowing great. And so Klein Hill, over its history has invested about a third of its capital into vintages in the last six years. A third of its capital in the vintages, call it like seven to 12 and a third in older vintages. But as we go through time, we may adjust that based on relative value in the industry. And so we're very fortunate that our investors gave us sort of a broad mandate. But we're constantly looking and twisting the dials for the best value at any point in.

A (55:00)

Time. Let's for a moment talk about what happens during very difficult market environments. In my experience, a lot of investments do poorly at the same time. How do you think about secondaries in this.

B (55:13)

Regard? I have to admit, Alex, I felt really bad during COVID because it was an amazing time to invest. But people are dying and we're hunkering down. We're seeing these amazing deals. We. But it was, it was a time like when it was great to deploy capital. And so if you think about it, not just during COVID but anytime there's a market dislocation, there's a large crash. What happens is the price of secondary assets tends to roughly track the public stock markets. So even early in 2024 and as far as January, February, the stock market went up 5%. Within a week, secondary prices were going up a similar percent. And so there is a fairly close tracking to the prices and to the prices. And if you think about these large secondary sales that drive the industry the hundred to billion dollar deals, what will happen is if there's a market crash like in second quarter of 2020 when interest rates went up and the markets crashed, secondary pricing maybe dropped 10% or 15% depending on the types of assets. These sellers of multi hundred million dollar deals, they had very precise price expectations. When those were clearly not going to be achieved, they pulled their pro their processes. And so the liquidity evaporates during a crash. And so during COVID when the market tanked, pricing dropped by more than 90%. And in these different periods of time, the pricing go, the markets go away. What's fortunate though about the smaller deals, these smaller transactions, is that at Klein Hill, we're not buying so much from individuals. 85% of our sellers are large institutions. And so when the market crashes, they will pull their $500 million deals, but they tend not to pull their $5 million deals. And so what actually happened during COVID was in deals that we sourced in the month of May, we did over three quarters, almost a full year worth of deals by transactions we sourced in a 30 day period. In Q2 of 2022, we did 2 quarters worth of deals in the fourth quarter of 2018, there was a market wobble, we did a very large amount of volume. And so we tend to go very contrarian to a market crash in terms of our deployment of.

A (57:38)

Capital. And assuming you can accurately assess the underlying intrinsic value of those assets during those market dislocations, is your sense that the discounts generally increase during periods of market.

B (57:52)

Distress? Yeah, so absolutely. So the discounts increase a ton. And so like I was mentioning before, they may increase with the stock prices. So during COVID maybe they went up 15 to 25% in terms of the disc, the extra discount you're getting for something. But Covid was a very interesting time, Alex, because if you think about had a very material impact in different ways on different types of businesses. And so you can't just close your eyes, see a discount and go buy lots of assets. And so what we developed was the Klein Hill Partners Covid index. And so we rated every company on a 1 to 4. Some companies like Zoom or different healthcare companies or things where you deliver to home would be a one because they actually were better off with COVID But if you think if you're a movie theater or a restaurant or some other industries where people were not going to be going to you and giving you their dollars, those industries were a for and they were hurt. And so we took advantage of the bigger discounts, but then we indexed all the companies by almost like a factor, if you think of hedge fund factors. And so we overlaid the discounts with these factors that were a sign of that time to Acquire a targeted portfolio at the bigger discounts. Same thing with interest rates. So when the market tanks because interest rates are going up, you don't want to blindly just buy a pool of assets at a bigger discount. But you again can look at factors that will drive the value and performance of companies based on the.

A (59:21)

Times. And as competition grows with time, how do you maintain your information edge? That's a big part of buying things at a.

B (59:32)

Discount. Well, you know what, Alex, you can't like wait for competition to grow at the time because the competition was already picking up last year and two years ago. So unless you're worrying about that constantly, you're already behind. And so look, a couple things. So one is for like, and depending on which focus you are in or your niche, the answer is different. For us, it's a few things. So one, I think it's very important for our small deal space to have scale. And so look, we're buying over 120 deals a year. That's an awful lot. We need a huge team. So we have 56 people rapidly growing to be able to provide good valuation services, to understand the assets, to do a good job with those. A big part of that though also Alex, is that we've already done over 550 deals. We're in about 2,000 funds. And as you go to buy funds again with team members who, we've been very fortunate, very low turnover, who have bought these time and again, we can be not just more accurate with our valuation work, but also quick and responsive to sellers. And I think, look, I think in our industry, customer service and white glove service to sellers is very important. So we also try to be a great counterparty and easy to work with. We provide project management services as we're closing deals to provide very clear transparency to timing and progress as we close deals. So, so customer service is a big part of it, customer service scale. Look, we're also investing in new information processing approaches. So in the secondary industry, you'll see that a few of the very largest players have been investing a lot of money in machine learning and AI. And we believe that that's an opportunity that we're also investing in. I don't think we're at the point at all where you press a button and pricing comes out or they'll make your investment committee decisions for you. But I do believe that information that we're sitting on, tons of information based on all of the buying that we've done is becoming more accessible. And also you can have more productivity from the information that you have by overlaying, by overlaying technology. That's another.

A (61:51)

Podcast. I just wanted to ask you just a couple questions about your outlook for private markets and secondaries. What do you see going forward? We've had pretty significant growth. How do you see it playing.

B (62:05)

Out? Look, private equity has been growing 12% a year for a very long period of time and I don't see any reason that would not continue. Part of the thing is that the overall industry GDP continues to grow by a little bit. But I think the private markets are a little more attractive than public markets in general. There are the public costs of being public, if anything, are increasing and becoming more difficult. If we look at the secondary industry, turnover right now on the limited partnership side is just over a percent and it's just over a percent on the GP LED side. Given that it provides more value to the industry to have a higher rate of turnover. So we were talking about like, if you can never sell a car, the car is worth less to you than if you could sell your car every few years. If you're on a lease, even better, you can get a new car every three years like clockwork, every two or three years. So we provide value to the industry, we increase the value of assets, we provide value to sellers. Sellers, I think, look, will benefit from having better liquidity. So I think it's hard to argue that a status quo turnover rate of assets in the industry should be much higher than the current 2%. Should it be 5% or 10%? Should it be public stock market level 100%? I don't know the answer, but you could also tie into there some deeper questions, Alex, on the structure of the private equity industry. So today, from the very beginning of this podcast, we talked about how individual private equity funds will bring in investors and you'll get pooled into a group of 15 to 25 companies and then you're stuck with that vehicle for 10 to 15 years. Is that the right construct for the next 20 years to have everything pooled this way? It may be, I don't know, but maybe those get broken up into smaller pieces. Maybe there's different ways to do that, I don't know. But look, I think if anything, I've seen a tremendous amount of innovation on the secondary industry over the past number of years. I think the private equity industry is always looking to innovate. So I would expect to see lots of change and growth for a.

A (64:09)

While. Are there any major risks that you're thinking about that you'd like to.

B (64:15)

Share? So look, unfortunately, the risks that actually scare me, I don't think there's a lot you can do much about. So if there was a situation of hyperinflation, think of where in other countries where they start adding zeros on bills because you just can't keep up. If the bond markets were yielding 100% a year, we'd be very challenged to keep up with that. And that would take all the capital and be so, like, hyper, like. So I think the scary areas would be like hyperinflation, you know, government regulation. If, like, look, it's created increased costs for public companies. If it's done the right way in privates, could it help a little bit? Maybe. Could it cause harm? Potentially. But I think, I think the type, I think as long as we really focus on doing an extremely good job at what we're doing, will provide like, good value to the industry, good value to our investors, good value to sellers. So I think that the big risks are sort of out of out of my.

A (65:16)

Control. Mike, the last question I have for you is, do you have a unique insight that you'd like to share with investors, Perhaps something they may not have considered.

B (65:27)

Before? Look, when you're looking at investing, whether it's investing in a fund or a deal or any type of transaction, one thing I like to think about with regards to whether it might be a good deal or not is why me? So if you're going to invest in a private equity fund, why are you the right allocator to pick that fund over other funds? If you're going to invest in a public stock, why are you the person who could be smarter than a hedge fund or a mutual fund and picking that public stock? If there's not a compelling reason for why you're the right person, it might not be the right approach. So that's. We talked before about going into index funds. I believe in indexing. I don't see how I could possibly beat the market on picking a public stock. So I think the question of why me? And look, we look at a lot of deals where there could be one or two other competitors. I want to know why Klein Hill is the right firm to buy that asset at the right price. And you want to understand what that is, and then that helps you learn where you may have advantages and to grow those advantages. But I think it's always good to ask why me? When.

A (66:32)

Investing. And that obviously works a lot better in private markets where there's less competition, less availability of information. A lot of it is relationship based there's oftentimes a lot more answers to your question of why me in that arena. Mike, you've been very generous with your time and I appreciate you sharing all your insights with us today. Thank.

B (66:54)

You. Hey Alex, thank you so.

A (66:55)

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