Top of the Ops: Retail therapy

Speaker A: Foreign. Hello everyone and welcome to another episode of Top of the Ops, a podcast brought to you by the Drawdown. In each episode we take a glance at a hot topic in operations and finance within private markets. Delving a little deeper, uh, into a recent article covered on the Drawdown. And today we will be discussing GP's attempts to tap private wealth once again. This episode is sponsored by the good people at HSBC Innovation Banking. From mid market private equity to venture capital innovation needs different. Our uh, episode partner, HSBC Innovation Banking offers tailored financing, foreign exchange and banking solutions to match evolving needs. Backed by deep sector expertise and global reach, its strategic fund solutions team are uh, here to help UK clients and achieve their uh, financial goals. Discover more@, uh, hsbcinnovationbanking.com now my podcast partner today is the fresh faced Rivers Cartwright to my crusty and decrepit Jackson Lamb. It is of course the Drawdown's Deputy editor Matthias Plotz. Welcome Matthias.

Speaker B: Thank you for having me. I kind of want to say good morning, but it's noon.

Speaker A: No, yeah, we've just skipped over, haven't we?

Speaker B: So um, I'm not sure where that comes from, but for some reason your choice of words is making me hungry, which is probably because it's lunchtime. Not sure why specifically because again, I have no idea who you're talking about.

Speaker A: Yeah, and as you know Matthias, that is exactly uh, the intention. So, okay, we're going to move on to today's topic which is the standard uh, industry marketing jargon describes either as retailization or democratization of uh, private markets, but really just means methods of allowing uh, high net worth individuals, ultra high net worth individuals, mass affluent, these types of uh, uh, uh, wealth investors to access private funds. Uh, the PR around this makes it seem like a match made in heaven. And certainly uh, there has been an increasing number of evergreen vehicles being launched over the last couple of years. But what sort of operational challenges are being created by the tapping of wealth channels? And are the predicted levels of investor appetite, uh, particularly over the long term realistic?

Speaker B: Um, I think the investor appetite is definitely there. We've seen enough surveys and reports to kind of confirm that, um, with the caveat that you need to be aware that this is a possibility. I think there is still a large part of education that needs to be done, um, on that. Yes, this is now an asset class that is open to you and there are specific products like the eltif, um, or otherwise to facilitate that access and how it can be done. Um, but the biggest challenge still and especially Kind of for our mid market readership is absolutely the sheer volume of investors and the kind of associated work that you need to do around subscription and onboarding. And I personally suspect that this is in part why the Evergreen vehicle is of such a great interest at the moment. Because you will. The way I've seen them set up in most instances is with a sort of a cornerstone investment from your more traditional LP base, um, that doesn't have the, you know, the associated liquidity, liquidity question attached to them. And then alongside them you have kind of a pool uh, of private wealth investors where you give them a bit more that sort of your flexible investor pool that will come in and out in theory. M. And I know that the liquidity question kind of taps onto that and I've seen most of those funds launch with this sort of a two year lockup period and then the redemptions are open. But Evergreen, that as much as it is a possibility, the operational um, infrastructure that you need to, to run those vehicles in particular I spoke to um, a lot of advisors and firms who run them earlier this year for uh, my cover feature on feeder funds is that Evergreen vehicles take a long time to actually take off it. They're sort of something that you set up, um, and then it, it takes a whole lot of time to mature. Which if you are a large investor obviously that is something you can accommodate for with your own balance sheet. But if you're a smaller investor who kind of I guess also has more immediate needs in terms of management fees to keep your own operations running, you don't necessarily have the waiting time that others may have to do until that fund sort of appreciates to a critical mass. Um, yeah, I want to say, yeah,

Speaker A: so you're illustrating quite nicely there some of the tensions right around uh, operational burden and also investor, uh, um, relations, investor expectations, um, which all those complications are what we love to dig into. Um, we're at somewhat of a disadvantage today, um, because um, uh, the author of our recent article, ah, on this topic, uh, our intrepid reporter Tania Kushal is actually currently sightseeing in Madrid. Lucky her. Um, but uh, it just so happens we have an interviewee who is very well placed to provide some insights. So I just spoke to Tim Ball of Schroders, um, so let's listen to that interview. I'm delighted to be joined now by Tim Ball who's uh, the head of product management for Schroders Capital. As part of his role he leads on helping private wealth managers gain better access to private assets via Schroda's platform. Uh, and Tim, you know, I've seen some of the stuff that you've written that's out in the market. You previously, um, said about how there is a growing appetite from individual investors and wealth managers for private assets, but partly driven by that promise of higher returns, but also because so much of the economy now can only really be accessed via private markets. And I guess on the other side of the transaction, private market managers are in this prolonged period of difficult fundraising. And so they're very keen to access this previously untapped, uh, pool of liquidity. But challenges still remain, right? So, uh, not least around the education and understanding of the products being offered by managers such as, uh, Evergreen Structures. But Tim, you're very much at the front line of this. So very keen to hear your view, I guess, uh, to start off with, on, uh, what the biggest challenges, um, that kind of remain for GPs who are attempting to tap, uh, wealth channels.

Speaker C: Sure. Well, thank you very much. Real pleasure to be featured. Um, I think there are still a number of obstacles which, you know, people are addressing. And I think we also must recognize it's. The market is very heterogeneous in the sense of, you know, every market requires slightly different approaches in terms of accessing it. And when we talk about the wealth space, we also kind of tend to sort of mix up very different client types within that. Um, so maybe just by first, by start, um, setting out what we would, how we would define the market. I think you've got those investors which are kind of single family office, you know, almost closer to institutional type, um, investors. And then you go down through the multifamily office, the ultra high net worth, high net worth, and then ultimately arriving at what we call kind of the mass affluent. Now all of those different types of clients have different requirements and different means of being able to access it according to regulation, according to the wealth partners, the intermediaries, the private banks and so on and the financial institutions that they work with. So it's a very diverse market. Um, and every country or every jurisdiction tends to have different considerations when you want to, when you want, want to, um, um, provide access to your products, uh, in those countries. The way. When I think about how the market has developed over the past few years and when I think forward in terms of what are the key things that we need to get right over the next few years, regulation has come a long way. Um, when I think back over the last 10 years, and that's certainly been a great facilitator um, for some of the growth that we've seen in the market. And I think regulators also recognize the importance in setting up right framework so that investors can access the private markets. It's in no one's interest to completely block and prohibit um, investors that you know, eligible investors from being able to access, um, these sorts of financial products. Um, and often you know, if you, you know, the, the way that the economy is changing, as you, as you mentioned, it's important that investors, um, you know, wealth investors are able to access similar sorts of opportunities which institutional investors are being able to do for many years. So regulation is a key one, but a lot of progress has been made. I think the other aspect that you also touched upon is the educational aspect. And this is one where we see again different types of clients have different sort of um, experience and different levels of understanding. Um, for me the most important thing is that the investors that we are speaking to and that we're offering um, private markets products to have an understanding in terms of the liquidity risks. Because that's typically where problems have been had in the past in terms of people misunderstanding in terms of how quickly they could get access to uh, those products. And there are certain things that are designed within the products to make sure that investors um, can't almost sort of react uh, in an impulsive way to be able to sort of typically um, exit the product immediately and therefore in some cases sort of imperiling some of the other investors in the firm. So there's a whole education piece about how people think about how these products are used and part of their overall portfolio. And then I think the other final piece would be the operational aspects. And that's where um, the industry is also making changes. But again, depending upon the country, you see different um, markets and depending upon the mutual fund infrastructure that you're working with, have been able to accommodate some of the features or the characteristics of these funds, such as for example monthly subscriptions or quarterly subscriptions and redemptions, the uh, frequency of information that is available, um, and whether for example, in the event of many investors looking to redeem from a product, the concept around this redemption gating, which is a common feature across many of the evergreen funds that we see in the market. So I guess if I was to summarize it, a lot of progress has been made. But still. And the opportunity is definitely very interesting for both, I think for managers and also for investors. But it's also, there is still a lot of progress that still needs to be made before we can say that it's completely an uh, open source, um, open access.

Speaker A: Sure, yeah. Let's dig into um, a few of those um, challenges that you mentioned there. So looking from a European perspective, um, in terms of the products that are available to, and you may have a nuanced view in terms of different types of investors as you've laid out previously. But in terms of the products that are on offer, are they sufficient to kind of reach the targets of fundraising around wealth channels that are often kind of stated, the ambitions that are out there? Um, do we have the products yet? If we do, are the products well understood enough yet to be able to unlock that capital properly? What's your perspective? As I say, from a European perspective?

Speaker C: Sure. But I think you've seen a huge explosion in terms of the number of funds launched in the last 18 months. So, so some of your listeners may be Familiar with the LTIF rules, LTIF 2.0, which was sort of the second generation or iteration of the rules around these European long term investment funds. Um, and that certainly heralding a big increase in the number of new funds that were launched. Uh, and we've seen that uh, across the market. So I think there's certainly a lot more um, variety and choice available to investors which I think is definitely a positive. Um, I think ultimately what we tend to see I guess a slight sort of congregation of certain types of strategies and certain types of product features. So many of the funds that have been launched um, in the recent months have been evergreen funds really sort of which taking advantage of some of the flexibility that the LTIF2 rules um, brought in. I would say there's also been across the asset classes there's been probably, um, I think when I last looked at the data about one third have been sort of private equity focus, one third private credit and about 1/3 uh, infrastructure. So I'd say those are the three dominant asset classes where we tend to see the most activity. Real estate I'd say has tended to be kind of less, less dominant I think partly because real estate has often long been a feature of uh, investors portfolios. Um, and real estate is often I guess has been sort of provided for in more sort of typically local structures, so country by country type structures. So we have generally found that the demand for real estate has been sort of more muted compared to some of the other asset classes. But I think that was also, I think there was also a bit of a cyclical aspect there and I think we have begun to see more interest in real estate strategies in the Very recent months.

Speaker A: Mhm. So you would judge kind of the amendments to the ELTIF regime because of the number of uh, vehicles launched. That LTIF 2.0 effort has in your view been a large year success, um, and is kind of meeting the need in the pockets where there is demand, uh, at this stage.

Speaker C: Yeah, I think it was definitely a big step improvement. I mean under the previous LTIF1 rules, um, the restriction to closed ended funds only, um, I think kind of probably made sense in 2015 when the LTIF rules were first published. Um, but given how much the market has developed and the innovation we've seen on the product side, I think it was important that the LTIF rules were updated to accommodate evergreen structures.

Speaker A: Yeah, our focus here at the drawdown is very much come from a, uh, operational as well as um, ah, finance perspective. So let's talk about managing that. Some of the stuff that you mentioned previously, managing the volume of investors within those strategies, which is not something that private credit, private capital managers have had to um, deal uh, with previously. Um, how do you see that? Where are we in that evolution? Have uh, um, the people who are kind of leading the market on this, have they got that kind of smooth onboarding process, uh, cracked? Are there still aspects that need to be ironed out, um, in terms of communication and reporting? Where are we? I imagine you kind of highlighted the beginning. There's still a learning process going on here, right?

Speaker C: Yeah, that's right. I think, I mean, I think you know where it started. I think you know, where you know, managers first started sort of proposing um, funds to that sort of wealth, um, type of client. You know, typically, you know, it was almost trying to address the immediate problems which is a whole sort of subscription and onboarding process. And typically they tried to do that by setting up a feeder. Um, it kind of meant that they didn't have to do it if someone else was doing it. And typically, you know, some of the digital platforms that you've heard about now that we see in the market quite regularly were kind of key in terms of facilitating that access. So um, you know, that was, I'd say the first step. Um, you know, inevitably, you know, that kind of helped a little bit in terms of managing things such as the capital pools, the sort of, you know, fairly, um, you know, um, uh, complex sort of subscription process where you have to really sort of, you know, take investors through complicated subscription documents. But it didn't really give, it didn't really address the full need to, of the sort of clients that we're thinking about here the wealth clients and that's really where I think the evergreen structures have really probably taken that next significant step um, by building upon really the mutual fund infrastructure. So you know this was rather, rather than approaching it from the perspective of you know, a private markets manager, uh, you know, who typically you know, would set up limited partnership funds, you know, taking kind of, you know, an incremental step kind of to sort of open up that process to wealth clients. I think where you take it from the mutual fund infrastructure, you almost work from the other way. So you say okay, so how do wealth clients tend to access investment securities or investment funds at the moment? Using many of the platforms that are available, the ones that are typical with your standard usage funds or other sort of mutual funds. And thinking about how we can build a private markets strategy using that existing architecture. And I think that's where we've seen the most success. Because for the, for the, for the wealth managers, for the private banks it has allowed them to really sort of you know, be able to offer these funds without necessarily having to sort of you know, create new, new complex um, operational steps and processes around it. So for a, you know, for a private bank that is already offering for example global equity funds or regional, regional fixed income funds, you know to be able to offer private markets fund using their existing service partners on the, you know, on the, the kind of the um, um trading side or where they get the market data from, it's all there. It's a case of just being able to sort of extend their shelf to include private markets funds.

Speaker A: Mhm. Um, yeah, I guess we're always concerned um, or interested in the capabilities of I guess managers less um, progressed along the maturity scale. Obviously it's the largest managers who are doing this at the moment um, and are kind of pioneering this, how attractive that additional kind of operational lift is going to be to um, kind of mid market managers potentially in the future. And what do you have a perspective on that?

Speaker C: Yeah, I mean I think it's look, I mean you know you're definitely right in that you know you tend to see some of the largest managers that are most active in this space. I think partly that's partly a consequence of brand being quite important. Um, you know, so I think we've tended to see sort of um, you know, and especially you know I'd say in certain markets like in Asia for example, branding is especially important. I think the private bankers, the wealth managers that operate in Asia, um, take a lot of comfort from being able to kind of you know, to offer their, the, you know, the well known, well established private markets, um managers to their client base. We have certainly seen some smaller managers, um, beginning to launch funds. I think the greatest challenge though is scale really and I think maybe sort of six years ago when we launched um, um one of our first evergreen funds in the private equity space, um, I think there were very few funds to choose from and really we saw kind of incremental growth um, over time as more investors came in. I think now for a evergreen strategy you really have to almost start it with at least 100 million of AUM, um, um, ideally larger. So I think there's almost this sort of, there's this shift of people kind of really focusing upon, you know, going for funds which are well established in terms of size and that will make it harder for the smaller managers that either don't have the balance sheet or they don't necessarily have the sort of the partnerships with private banks or wealth managers in order to be able to kind of get that sort of anchor investor or cornerstone investor at the beginning. So you know there are some considerations which I guess have kind of increased the hurdle or increased the sort of the, the entry barriers for some of the, the smaller managers. But you know, I think we do see especially you know, coming back to the ltif regime, um, you know we do see in certain markets where you know either the sort of the, there's a fiscal situation, for example the tax benefit for being able to offer very sort of niche type strategies. So, so for example in Italy there are certain tax benefits for investors that invest in Italian focused strategies and that certainly helps some of the local managers. And again we also see in France with the unit linked insurance market, there are certain sort of structures in order to be able to. Has to be a French structure in order to be able to tap into that client base. And that's also I guess has been to the benefit of some of the French managers. So you know, on a, on a global basis I would say definitely sort of the larger managers have the benefit and the bigger scale and the balance sheet. But we do also see some uh, some success with more sort of, you know, specific or specialized type managers that have been able to tap into the wealth market as well.

Speaker A: Okay, great. Um, finally Tim, I just wanted to touch on that sticky question around liquidity and I guess you know, connected to that uh, education around products as well. Do you think that um, expectations around liquidity and what managers ideally would like to offer. Do you think there's alignment there at the moment do you think there's still work to be done in terms of um, either side kind of seeding ground in terms of how realistically how often redemptions are going to work or uh, other liquidity, um, mechanisms?

Speaker C: Yeah, it's definitely a key question. I mean I can give you two reference points. One is I guess from our own experience with our own funds, um, and the investor behavior, um, and then I think the broader perspective as we think kind of going forward. I'd say in terms of our experience we, you know when we launched our private equity Evergreen fund about six years ago, we within six months we had Covid, um, we were pretty nervous about how investors would behave. Um, I think on the whole we saw very little change in redemption levels. We then had the Ukraine crisis and then a few months later we had the gilt crisis. In both instances we were a bit nervous whether investors would start to panic. I'm pleased to say that in none of those situations did we see sort of investor redemption activity have uh, a noticeable change. I think partly because of the liquidity uh mechanisms that people have generally built into these funds. So for example having to provide, in our case it was three months notice, for at least three months notice for an investor to leave meant that investors tended not to see it as a sort of ATM as people sometimes describe it. So it didn't provide an immediate sort of exit route. So investors were having, if they wanted to redeem, were going to have to make the decision about a price but they'll be trading on a price in three months time. So I think that's one factor. Uh, I think as we go forward the concern around um, you know are we are investors making the decision with you know, having the right expectations around. Liquidity is a key one and that's really when it comes down to you know, making sure investors are provided with the right information, making sure the selling process is, is appropriate. Um, because the last thing I think anyone wants in this industry is, is another miss selling concern. I mean I think you know, financial services, you know, over the sort of, you know there've been various instances of uh, miscelling issues and you know it's in no one's interest to have that. So it's really important that ah, you know, both the end investor but also the wealth managers are kind of provided with all of the information about when it comes to you know, needing liquidity, what the various points are. And at the end of the day I think these products are best suited for long term savings plans. You Know we still say that even though this fund has sort of quarterly redemptions, you should still think about it in terms of five year type hold.

Speaker A: Mhm. And so that suggests there's been increased regulatory interest around this question of potential Miss Selling. You would welcome that right for uh, uh, adding additional transparency and understanding across the market.

Speaker C: Yeah, I think it's really important. I mean we've had, when we launched some of our funds especially at the beginning the regulator was very interested to understand how the liquidity mechanisms worked. I think regulators have got a bit more comfortable with the number of funds that they're seeing in the market and also how many of those funds have been able to um, how to have been able to operate through various times of market tension. Um, you know investors should be able to, they should understand that when they invest in these sorts of asset classes they are ultimately illiquid and um, therefore they should be doing it with the basis of a long term. Long term horizon.

Speaker A: Absolutely. Tim, I think we need to um, wrap it up there but thank you so much for taking your time to chat today.

Speaker C: Thank you very much.

Speaker A: Matthias, you were sitting, listening to that interview um, as it was being recorded. What are your initial thoughts?

Speaker B: Um, I think the thing that stood out to me immediately was kind of the geographic differences in terms of attitude um, towards private market investments I'm going to call it. As someone who was born and raised in Germany and spent the uh, first 19 years of his life there, there is a, I want to say cultural aversion to more complex investments. I um, think partially that might be because the part of Germany that I come from is a bit um, more traditional, uh, but also because of um, the consequences of 2008 and the GFC and what they did uh, or how they played out in the country. Um, on the other hand you have countries like France where I think the whole um, retailization, democracy, democratization conversation is almost not happening as much as it is especially here in the uk. But that is because private wealth and private banks have been part of PE investor portfolios for a long time. It's not really a novelty there. Yeah, there might have been through the eltive, um, or other products. There might have been some sort of tweaks and changes that make it easier. But it is not a new conversation that firms in the market are ah, having And I think if you look at someone like Adyan, um, I believe that their last four funds always had so I think 20% private um, wealth investor base, don't quote me on any of those numbers that conversation happened a while ago. Um, but I think that that is quite interesting. And at the same time, where you have geographic differences in the investor base, you also have geographic differences, um, in terms of the product. So when the ELTIF 2.0 came around, um, I looked at the ESMA register, which uh, lists every single Eltif, um, that has been launched.

Speaker A: Quite helpfully.

Speaker B: Yeah, quite helpfully indeed. Great resource. Please keep that up. Um, but they also tell you where it's been, um, incorporated, shall we say. And obviously Luxembourg is the forerunner and I don't think that will change anytime soon. But a sizable amount of them often sit in either France, Spain or Italy. And that's um, partially to. I think what Tim was alluding to is that within those countries there are then very specific national investment strategies, um, which either help you kind of from a tax structuring perspective or from an educational perspective to sort of incentivize um, investment there which can then benefit um, I guess also the broader economy in those countries.

Speaker A: Yeah, I guess it's. It's important to clarify why we're kind of interested in digging into this topic because as you say, actually the, the fundamentals of it aren't necessarily that new, but what's new is kind of the, the volume of activity and kind of the spread of it. And I guess we're quite interested in how deep that goes at the moment and how deep it's likely to go. And you know, it's largely the preserve of large cap managers. Right. Um, I've seen some data recently which suggested that, you know, over half of um, Evergreen Private Credit aum, um, which this report put up, uh, just um, over 500, um, billion dollars. Half of that is controlled by the five largest GPs. And the top 20 managers control more than 80% of that market. Right. So it really is the biggest guys who are really aggressively going after this. Um, and there's very good reasons for that, as kind of Tim alluded to a little bit. There's that brand recognition, they've got the extension distribution networks, um, the product development capabilities also needed to launch and scale these products. And that they've got the resources, they've got the talent, they've got the capital, they're able to build the systems that are required to kind of address some of these operational needs that we're, um, uh, talking about.

Speaker B: Yeah, there's. If I can jump in there because I kind of. I looked at this, um, I think I mentioned it in the intro as well, but I looked into feeder funds earlier this year, um, precisely because that was a point that Tim made, is that feeder funds were sort of the first, um, prototype or step in the evolution, and then the first iteration and Evergreen sort of are the next step. And I think for a lot of the Mid M market, they are, I don't want to say stuck, because that implies that it's sort of their fault, which it isn't. Um, but they're kind of still stuck on the feeder fund level because, um, they don't have the scale to operate the feeder fund due to all of the reasons that you just said. Um, no, sorry, not the feeder fund, the Evergreen fund. Um, but for them, Axis, I think, is still very much restricted to making use of a feeder fund through a partnership with a private bank or a larger asset manager that does all of the grunt work, shall we say, um, that has the resources to do it. And then the mid market GP can just invest that capital through their own fund.

Speaker A: We've probably waffled on, um, for too long. I think we've. That's probably about as, uh, enough time as we have for this episode. Um, thank you, Matthias.

Speaker B: Well, thank you, John.

Speaker A: It's been an absolute pleasure, as always. Thank you, uh, to our sponsor, uh, hsbcib, and thank you to everyone for listening. Until next time. See you soon.

Speaker B: Bye.