If you’re watching this video, you’re probably familiar with what stocks are — either through hearing about on the TV business news shows or investing them in through your retirement and brokerage accounts.
For the most part, these are shares in companies that are publicly traded.
But there’s a whole other world of companies out there that are privately owned and don’t trade on the financial exchanges.
This is the world of Private Equity, where the more deep-pocketed and professional investors operate — often gaining access to value that the smaller retail investor never gets a shot at.
That may be changing. New regulatory flexibility and new business models are now promising to help more individual investors tap into Private Equity when appropriate.
So what exactly IS Private Equity? What are its advantages and risks?
To demystify this asset class for us and help us understand its opportunities, we’re fortunate to have Bob Long, CEO of Stepstone Private Wealth, here on the program today.
Bob Long 0:00
The private markets, if you could accurately graph this or measure it, or specific you can’t accurately it’s hard to be specific, dwarfed the public market. So let’s think about the United States, just companies have 100 million of revenue or more so not sole proprietorships. Like real companies, they’re seven times more private companies in the US than public companies of that scale in size. If your opportunity set as a private market, or a public market investor today are more limited, while meanwhile, more of the opportunity set, particularly in growth exists in the private markets. And if you’re not accessing the private markets, I would argue strongly, you’re really missing out, you’re limiting yourself to a modest subset of the opportunities available.
Adam Taggart 0:56
Welcome to Wealthion. I’m Wealthion founder Adam Taggart. If you’re watching this video, you’re probably familiar with what stocks are either through hearing about them on the TV business new shows, or investing in them through your retirement and brokerage accounts. For the most part, these are shares in companies that are publicly traded. But there’s a whole other world of companies out there that are privately owned and don’t trade on the financial exchanges. This is the world of private equity, where the more deep pocketed and professional investors operate, often getting access to value that the smaller retail investor never gets a shot at. While that may be changing, new regulatory flexibility, and new business models are now promising to help more individual investors tap into private equity when appropriate. So what exactly is private equity? What are its advantages, and its risks to demystify this asset class for us and help us understand its opportunities. We’re fortunate to have Bob Long CEO of Stepstone Private Wealth here on the program today, Bob, I’ve been looking forward to this discussion for a long while.
Bob Long 2:02
Thanks so much for joining us today. My pleasure. And I’m looking forward to it also.
Adam Taggart 2:07
All right, good. Well, look, a lot of folks watching here have heard about private equity. I don’t think most people really feel like they understand well, what it is. So we’re going to really explain that for folks today. Really quickly, just to sort of set you up here as to how and why you’re a private equity expert. Can you just give us just just a quick background, to your career and to what step seven does? Sure. I’ve been in the private markets for about 30 of my 40 year business career. It’s been primarily focused over those last 20 years on expanding access to the private markets for individual investors. And the challenges that have prohibited individual investors from accessing institutional calibre private markets have been around liquidity of pay city and some of the other topics that we’re going to cover today. At stepstone, we’re expanding access to the private markets through a series of evergreen funds that we’ll talk about later, can you let you give you a little bit of background on stepstone. So stepstone is probably one of the largest firms. Even a sophisticated audience, like the Wealthion audience is not familiar with one of the largest allocators to the private markets globally. We manage our advisors on over $600 billion of assets, we commit over $80 billion a year in 550 separate transactions. We do that in all the major private market asset classes private equity, credit, real estate and infrastructure. You’ll notice that we talk about private markets, not alternatives. We’re not in the headstone business or the commodity business. We’re in the private market business. We operate our business from 15 countries and 25 offices, and we’re truly a global firm 1000 of us focused on making the best possible product market investments. Okay, so in this kind of, you know, a hidden world that I mentioned that the average investor doesn’t get to see stepstone plays a pretty big role. And obviously, you’ve been, you know, in the private markets for a good chunk of your career. So let’s actually define this term. When we talk about private equity. What exactly are we talking about?
Bob Long 4:14
Well, it’s interesting. So most people are more familiar with the public markets, even though the private markets substantially predate the public markets, you know, private investing goes back to the foundations of capitalism. On a more recent basis, you might think about the Rockefellers investing with the Carnegie’s and building businesses. That was private equity in a sense, when my mom Uncle Terry helped my uncle sneak by the local car dealership, his name was sneak. all goes together.
Adam Taggart 4:44
A great name for a car dealer,
Bob Long 4:46
perfect in 1965. That was a private market investment. But what we think of today as the institutional private markets are somewhat different. So this is an industry call it 50 years young. What we have today is organized pools of institutional investor capital that is allocated to a general partner or investment manager on a discretionary basis. Those pools of capital are typically organized as a limited partnership with a general partner, that manager I mentioned earlier, limited partners, passive investors, these large, sophisticated institutions, those funds organized with a limited life fatty, they go buy a company, and they sell a company. And then the manager, and the investors split the profits that generally organized around a 10 to 15 year life. And they involve making a commitment to a fund where you’re committed and your capital is drawn over time, and returned to you over time. So very different than the typical public market investment where you make an investment in a stock a bond or a mutual fund, you invest all of it, and then you sell a piece or part over time. So these are complex structures that are organized really for the needs of large institutional investors. And that’s, that’s a sense of what the the institutional private equity market is today. And now, does markets exist in private real estate credit infrastructure? I think well, we’ll try to for given our time today we’ll focus on private equity, principally. Okay, all right. So I guess first thing to note is, you know, obviously, these are, these are private companies, you’re really investing them in them through the structure that’s really a fund. And you are, you’re tying your money up for a certain period of time, right? It’s not, it’s not so much like a, like a fund that you buy in the public markets where you can buy today and sell tomorrow type of deal.
Adam Taggart 6:44
So there’s a and there’s a lot we’re going to get into here. But I know that there are sort of three subcategories of private equity, do you want to define what those are?
Bob Long 6:54
Sure. So at a high level, think of the private equity market as three segments. So venture capital, the most innovative highest risk, also highest return opportunity companies generally pre profitability. So that’s venture capital, and you can have early stage within that later stage. But think of venture capitalism and very high growth, generally pre profit, then you’ve got growth stage, which are companies that are profitable, generally not mature enough and established enough to take on meaningful leverage the private equity investment into a growth company or growth equity investments, typically the first institutional capital. And as the name suggests, those companies are on a high growth trajectory. The final category, the most mature, is what’s typically known as the leveraged buyout market. So that is acquiring companies that are either private or even public and taking them private, typically, through the use of leverage with the idea you can improve those companies and sell them. Those are the three segments venture growth LBO.
Adam Taggart 8:00
Okay, very useful. Again, we’re gonna get more into details here, it sounds like with private equity, you’re, it gets it’s different in every one of those three segments, but a big part of the return is the expectation that at sort of the the end of the funds life, you’re going to sell for somebody who’s going to pay you a lot more money than than you initially put in, correct?
Bob Long 8:27
Yeah, that’s right. So in a private equity fund, you may have some assets that organically yield and perhaps pay a dividend. Or you might own a preferred security that the fund might own and you’re you’re an investor in the fund, therefore, you participate, you might own a preferred security that pays out some dividends. But generally, these are investments that involve buying a company, improving its market value, and then selling it. Over time, the typical life would be most deals are underwritten at a five year life and some are shorter, some are longer. And then of course, the fun, this is what’s complex about it. A fund is making 12 to maybe 25, or even more, if it’s a venture fund, a series of investments and individual companies. And as the limited partner in the fund, you’re participating in all of that, by the way, that creates a lot of cash flows back and forth, which can be very efficient from a internal rate of return perspective. And ideal for large sophisticated investor who can immediately reinvest that capital in an efficient way. really complex for individual investors, which is something we’ll talk about more.
Adam Taggart 9:37
Okay. And in the benefit of these funds, is they’re being run by a general partner or whatnot that has a lot of expertise doing this. So So part of the benefit of this is when as an as an investor, I can own a piece of this company, I don’t have to go out and buy the whole company myself to own a bit of a private business. I But but more importantly, I’m leveraging the expertise, the experience and the skills of somebody who does this a lot. And they’re, in many cases deploying the capital in the fund, across a basket of opportunities. Right? That’s correct.
Bob Long 10:13
So the diversification point within a fund is critical. And you made that point. In addition to that, the sophisticated investors will diversify their private market investments. So if you think about university endowment or a sophisticated Foundation, they’re going to have 20 to 30%, maybe more of their overall pool of assets within private equity. And then within that, they’re going to be diversified across to ensure growth and LBO. And then within that, they’re going to allocate to a number of managers who have different expertise that might be size of company, that might be industry, that might be geography. So really, what you’re talking well think about your public markets portfolio, right? You don’t own one healthcare stock, or even three small cap stocks, you generally own a series of those to achieve the benefits of diversification that occurs in the private markets. It’s just a little harder to get there with this construction.
Adam Taggart 11:12
Got it? All right, well, look, I want to I want to now get into like, okay, so kinda understand what it is. What’s important about it, like Why Why should I care? As an investor? Why should I, why should I want to participate in that? Let’s get to that question. But just really quickly, to help folks kind of contextualize this, how big is the private equity market?
Bob Long 11:32
Gosh, you know, trillions of dollars, I mean, massive market, I don’t think I can quote you a recent figure. But think about it stepstone, we are 600 billion in the private markets, or maybe think about it differently. The private markets, if you could accurately graph this or measure it, or specific, you can’t accurately it’s hard to be specific, dwarfed the public markets. So let’s think about the United States, just companies have 100 million of revenue or more, so not sole proprietorships. But like real companies, they’re seven times more private companies in the US than public companies of that scale in size. If you went down, if you looked at even smaller companies, that ratio would increase so and and perhaps I’ll get into there, over my working career, the public markets have stayed flat, or even shrunk and the number of companies meanwhile, the private markets have dramatically expanded. And so your opportunity set as a private market, or a public market investor today are more limited. While meanwhile, more and more of the opportunity set, particularly in growth exists in the private markets. And if you’re not accessing the private markets, I would argue strongly, you’re really missing out, you’re limiting yourself to a modest subset of the opportunities available.
Adam Taggart 12:57
Okay, great. Yeah, I wish I had thought to answer the ask that question a few minutes ago, because I would have definitely mentioned it in my intro, which is basically, you know, if you are just investing in the public markets, you’re investing in a relatively small fraction of the opportunity set out there. And as you said, the majority of the growth tends to be in these private companies as well. And you’re, you’re just not getting a chance to play in that as a regular real retail investor, or at least you haven’t yet and then we’ll we’ll talk about some of the changes that are coming along here. But okay, so that’s super interesting. Okay, so then why care? Like what why should somebody who is, you know, happily trading stocks and bonds on the public markets and their retirement accounts or their brokerage accounts? Why should they care about getting exposure to this sector?
Bob Long 13:45
Well, past is not always prolonged and prior results are not always an indication of future results. But historically, the institutional caliber private markets, particularly in private equity market have outperformed the public markets by four or 500 basis points per year for 5% or more. Moreover, an investor who participates in private equity gets diversification benefits. So when your public market zigs, your private market Zags, you benefit from that diversification and lack of complete correlation in the private markets, the private equity is probably correlated 60 or 70%. With the public markets, and importantly in that regard, let’s think about periods. Let’s think about tough here’s the thing about drawdown periods, periods of tough performance or weak performance in the public markets. Historically, the public markets, the private markets have only participated in or captured to use the investor term captured 40 to 60% of the downdraft in major financial downturns like COVID like the global financial crisis, like the tech bubble 14 60% of the downside. Meanwhile, institutional private equity has captured 110 to 120% of the upside. So this is what investors look for. Right? It’s asymmetric risk reward. And high quality private equity has demonstrated that over billions and billions of dollars of investments over now 20 plus years. So we feel as an industry that that phenomenon is well established. And therefore, investors who want to capture a benefit from this return premium and diversification benefit need to be in the private markets in some form or fashion. Okay,
Adam Taggart 15:41
wow. All right. So that’s super fascinating. I’ve heard you mentioned at times too, that correct me if this is wrong, but that when you look at the public markets, right now, talk about this a lot in this channel. You will look at the indices, the major indices, right, the s&p, the NASDAQ, etc. The action has become so narrow, that capital flows are increasingly flowing into just certain sectors of the economy, really just in just a select few companies in the economy. And with all the passive investing ETFs and stuff out there, you know, for every dollar that comes into the market, a disproportionate share, I want to say it’s like 37%, or something like that go into like the top 10 stocks. Yeah. Right. Whereas in private equity, you there’s just a much more broader playing field, I guess, is maybe the way to say it.
Bob Long 16:41
Yeah, they those are really important points, I’d say a couple of things. First of all, the private markets represent today, a bigger swath of what I’ll call the real economy, as opposed to a handful of tech names with technology that most of us don’t really understand very well. So the bread and butter of the economy is being financed today, much more by the private markets and the public markets, you don’t see small IPOs anymore. You just don’t not out of you, and are roughly the same age. When we came along, you saw 40 to $100 million IPOs. Right, Amazon went public at a big attack name, I think, less than $50 million. So there’s a couple of things going on. And I want to capture them all, I think they’re important. First, a larger portion of the non tech or non headline sectors are financed by the private economy. Secondly, so much of the public markets today, or the IPO markets are companies that aren’t even profitable, you know, 20 years ago, 80% of companies that went public were profitable. 2019 2021 through 2021, basically, the reverse. So you’ve gotten more speculative companies going public. Moreover,
Adam Taggart 18:03
hey, sorry to interrupt you on that. But is it fair to say that the public markets are more of a casino than the private markets are?
Bob Long 18:12
You know, I probably wouldn’t make that strong statement, I’d say this, my faith in the efficiency of the public markets has declined. Over Over the last several years, I was trained in economics and certainly trained on the maximum of efficient markets. But But think about it. So when I was in school, actually, my wife and I were talking about this taken a walk recently, she has an MBA and keeps me honest, the thing about the leafs stock phenomenon, right. So our professors would have told us that a multibillion dollar company trading on a national exchange, we’re not talking the Pink Sheets, we’re talking a tiny we’re talking about a substantial company, I’m not going to name a lot of names, substantial company or companies trading on national exchanges heavily covered by the press, and equity analysts are trading at well above their intrinsic value, well above, not for days, not for weeks, but for months. So the professors that taught me, the mentors I had early in my career would have said that simply cannot happen. The markets are too efficient, for that happened. But we’ve all we’ve all seen that. So I do think there are risks in the public markets today that were not present in mobile years ago. And I really like the I like the fact that private markets have become more liquid, more transparent, more efficient. And so to some extent, the private markets and the public markets have switched places in that the private markets are financing sort of the real economy, the the bread and butter companies. We Meanwhile, the public markets seem fascinated by a handful of very large cap technology, primarily technology oriented companies. So if you think the central point is, if you want to invest in a broad swath of the economy, if you want to have a lot to choose from as a sophisticated individual investor, you need to figure out a way to invest in the private markets. And fortunately, the ease of doing that has opened up dramatically over the last three or four years.
Adam Taggart 20:31
Okay, yeah. And we’re gonna get to that in a minute. And look, I think I interrupted you when you were kind of on a roll there. So if there was more you want to walk through, please, please.
Bob Long 20:39
Thank you. I think those are the key points, but I reserve the right to come back.
Adam Taggart 20:44
Okay. Again, I just want to under underscore this, because I want to make sure I in the audience heard you correctly. In terms of sort of, like, where the profits are. It sounds like you’re saying that more. So these days, the profitable companies are remaining private. And obviously, we’re painting with a really broad brush here. But you’re you’re saying
Bob Long 21:07
yes, it this way. So take a company like SpaceX, right? Hard to imagine an enterprise that requires more capital investment than SpaceX. So 20 years ago, could a company like SpaceX, who needs to attract billions of dollars of capital? In order to build its enterprise? Could that company have stayed profit? Through 25, rounds raising? I’m not sure the exact number more than $10 billion? No, you had to go public. You know, 20 years ago, even 10 years ago, you had to go public, in order to get the necessary capital, to build an enterprise of size and scale. As we said, we talked about Amazon going public at less than $100 million valuation today. The private markets are deep enough to support the building of huge inner process that require massive amounts of capital on a global scale. And do so with the benefits of the profit, not having to report quarterly profits to a to an investor base that we’ve already discussed, in a market that’s perhaps not as efficient as one would hope it would be. And so the reasons to go public, but one of the reasons the fact he simply needed a sheer quantity of capital has basically gone away. And so the public market, the product markets are just so much deeper today than they were. And therefore companies stay private longer we we’ve done some research and some of the leading venture backed companies, the real innovators, they’re staying private, seven years longer than they were not that many years ago. So that sense of the fact companies, they may go public, and then they need to go public at some point. But you just don’t have to go public in a world where there are 10s of billions of dollars of very sophisticated, well organized specialized private market funds with expertise in your industry, that can support you as an entrepreneur and help you grow and scale. While not being exposed to the vagaries of the public markets and taking on the cost and expense, Sarbanes Oxley public reporting, et cetera. So why would you go public? It’s just not as important today.
Adam Taggart 23:36
Yeah, that’s, that’s just such a great point. So I think if you talk to any CEO, given the choice, they’d much rather be a CEO of a private company than a public company, right for not having to deal with being a CEO of a public
Bob Long 23:49
company twice. And they are Yeah, I could, I could talk a lot about that. But that’s a different. That’s a different longer conversation, those public companies were pools of capital that invested in private assets. So I sort of had the best of both of the worst of both worlds. But now the I’ve experienced all those phenomenon we just talked about,
Adam Taggart 24:11
okay, but correct me if I’m wrong here If your experience is different, but most CEOs would love to be freed from that pressure of having to play
Bob Long 24:20
value to customers, does it add value to investors? And not it’s less and less clear that that’s essential? It is, in certain cases, like needing a currency to acquire other entities that’s more liquid. But there’s no question that the the requirements to be a public company, or the compelling need to be a public company, it’s just so much less than a world where they’re deep, sophisticated private money,
Adam Taggart 24:48
right. So let’s let’s take your SpaceX example here. Let’s assume for a moment and other data is out there but let’s let’s assume for a moment that SpaceX is successful with their goals, right? So eventually, someday, you know, the massive amounts of upfront investment will be over. Right? And there’ll be more in a harvest phase, right? Where, okay, now we’ve got this fleet of rockets, we can the reusable
Bob Long 25:15
point, the venture capitalist and management teams that took a lot of stock will ultimately want to achieve some liquidity.
Adam Taggart 25:24
Right, and maybe they take it public, who knows what I’m saying with this is, you can now have a truly gargantuan cash burner like a SpaceX fund itself privately, get to the point where it gets into harvest mode, and it’s just making cash flow, positive cash flow is going through the roof at this point, right. So you’ve you’ve written, you’re getting those tremendous returns that you hope to get when you came in as an early private investor. Right. And that could be a phenomenal return for, you know, the folks that invested early on in it. My point I just want to underscore is you’re saying that opportunity, public markets aren’t getting a chance to play in SpaceX, right? Increasingly, they’re really interesting high growth companies that can get away with going public or private, and you’re saying more and more can likely will, least until things change, and, and therefore, more and more like really great opportunities are being taken off at the table or not even making it onto the table for the private or the public investor going forward. And that’s one of the key things I want folks to take away from this discussion here is like, the really interesting part of the game is increasingly happening in the private room that the regular public just not even getting a chance to look into. That is
Bob Long 26:42
a fair statement. Okay. All right. So further, just, I don’t want to fill this thing up with statistic, right, but just the highest growth companies in the economy or product, they’re not public. So if you’re particularly focused on growth, is just essential that you’re in the profit margins.
Adam Taggart 27:01
Okay. All right. So I think we’ve kind of caught people’s attention, right, we’ve given them a sense of, you know, what this space is, and why, you know, it’s attractive, there’s going to be some percentage of viewers saying, Alright, well, that Bob’s just talking his book here, right. So what are the risks of private equity? Right, everything is opportunities, everything has potential downsides. What are the potential downsides of private equity?
Bob Long 27:25
Really important question. So first of all, you need to understand that the dispersion of returns in the private markets is wildly different than the public markets. So if you don’t get into at least the top half of private fund investments, Your experience may not be that positive. So I’ll give you an example. So if you we tend in our world to talk about quarterly, you know, dividing performance into fourths. So if you look at the top quartile large cap US equities managers over a recent period of time, the top top quartile, call it a 9%, net return over a meaningful period of time, the bottom, that’s the top 25% 9%, that’s the 9% or better, the bottom 25% 7%. So the difference between seven and nine is meaningful. But it’s 2%. If you look at the product market, so let’s take leverage, let’s take leveraged buyout market, for example. The top quartile 20 to 24%, the bottom quartile less than 10%. So the the importance of being in a good fund, being able to identify and access a good font, I’m sure we can talk more about that. It’s just extremely important. asset selection is wildly more important in the private markets than it is in the public markets. And so you need to be able to access those strong manage other risks and challenges. So first of all, you’ve got the structure we talked about earlier with capital calls and distribution. So when you commit to a private equity fund, you’re committed, you’re not actually invested. And by the way, often you’re paying fees on capital that is committed before it’s invested. So you’ve and then you’ve got unpredictable capital calls. And then when they have a realization, they distributed back to you, then they may recall, so it’s a back and forth. It’s not like a stock bond or mutual fund where your capital is invested. So that back and forth is extremely important. Next, there’s some further logistical and tax issues. These These limited partnerships are partnerships for tax. So rather than providing you a 1099 in January, like you get from your brokerage account, you’re getting a k one, which has many, many lines and many many pages, but You’re getting that in October. So you are, if you weren’t otherwise, you’re amending and extending your tax return, you know, you’re filing a preliminary turn on April 15. And waiting till October 15, to file your full return. So they’re just layers and layers of complexity valuation. So valuation in private funds, tends to be quarterly and it tends to come off, it does come on a lag. So anywhere from 45 to 90 days after quarter read, you get a statement from the general partner indicating your value. So this is a fair amount of complexity, and fertilis for the average individual investor, which explains why individual investors have not flocked to the premium returns and return and diversification benefits we talked about earlier.
Adam Taggart 30:51
Okay, let me just take into a couple of those. So first off on the access side, I think that word access is really important. Yes, everybody wants to invest in the top quartile deal if they can’t, right. That’s just common sense. But it’s Can you right, and I’ve heard in the you with – retail investors who historically get into private deals, you know, a real estate deal, whatnot, right? You know, oftentimes, the average person hears about it from a friend or whatever. And the big question they have to ask themselves is okay, why is this still being offered to me? Right? It’s sort of like, there’s an adverse selection, right, where by the time the deal makes its way down to the inexperienced private investor, it’s probably not a very good deal. If it was a good deal, the big guys would have snapped it up right away. Right? So we’ll maybe talk about this more specifically about some of the new things that are changing, but that sort of risk of like sloppy seconds, or sloppy thirds, or even sloppy forest like, like, that’s a big concern, and you raised it. valuation, I just want to ask a couple of questions on because, I mean, the valuation that matters, right, is what the company eventually, you know, what the exit is, and what you get paid for at the end along the way. The valuation number is that is that basically just a number you know, there’s there’s some process, there’s a annual assessor or something like that that comes in. So it’s not like the stock market hyper efficient and valuing what,
Bob Long 32:27
whether and you know, what, you can sell it out whether you think that’s intrinsic value in the public market or not, you do know what you can sell it or where you can buy.
Adam Taggart 32:34
Right, right. So so if I’m sitting here in one of these private deals, and I get my quarterly valuation, from the general partner, how’s that been determined?
Bob Long 32:44
These are really important questions. And the thing that I bear in mind, most of all, is valuations are ultimately confirmed by realizations. So I’ll digress for a minute, we just finished our annual audit for the two funds that we run for individual investors. And one of the things I focus on is looking at where were the realizations in our portfolio versus the last valuation where we mark them. And I’m pleased to say that those valuations came in or realizations came in very, very close to the last valuation, which gives me comfort that the valuation process that we’re undertaking is accurate. So let me expand that back into the broader ecosystem. since the financial crisis, actually unrelated, it was the accounting standards changed in 2007. And they went from a world that was basically lower of cost or market to a fair value, every quarter system, I’m generalizing. But that was essentially what happened. And then, since the financial crisis, and coming out of it, valuation processes have gotten better and better. So what you see today, and it wasn’t always true 10 or 15 years ago, for the best general partners, the best fund sponsors, they’re valuing their portfolio companies in a rigorous way and doing it every quarter, sometimes with the help of outside experts to validate. But they’re doing it in a way that they believe and their investors believe is the best possible and most accurate value. So we today, those statements that we get, are pretty darn accurate. It’s obviously harder in venture, because the companies are just newer and younger, what will be the comparables easier for the very largest leverage biotech companies, but nonetheless, as an industry, I’m very proud of where we are in terms of valuation processes, and around that, once you’ve seen develop, and because valuations are solid, you now see a secondary market. And we can talk more about this later if you want to go down that path. The fact that there are solid reliable valuations has led to a secondary market in private equity funds, which is Much, much more robust and larger than it was prior to the financial crisis. But back to the valuations point, I think we, as an industry have moved to a place where we are responsible and accurate. And that what you find is the actual realizations when companies are sold, do validate valuations. Now, to your other point, this is a little technical. In the regular way drawdown fund what we’ve talked about so far, limited partnership, those valuations do not matter a lot to the limited partners along the way, unless they’re choosing to try to sell in a secondary market, which most don’t, because the management fees are based on the invested capital, they’re not based on the market value. And the profit share that the investors pay for a successful deal only comes at the end, when, as I’ve said, the valuation is confirmed by a realization. So yes, while I believe those valuations are robust, and pretty accurate, they are not as important to an investor, you know, in a Limited Partnership Fund. Now, the Evergreen funds that we run, they’re very important. Okay, we can talk about talk about that later. Or we can go there now as it suits you.
Adam Taggart 36:17
Okay, um, let’s put it off just for a moment, because I do want to get to kind of how the industry is evolving to provide access to the individual investor. But let me ask one last sort of negative potential question. And we trigger warning, I might be spinning you up here. So there is, you know, there is a mentality or point of view of some that I’ve heard expressed of that so much a rocket derogatory towards private equity of hate, you know, these guys just come in, and they just sort of, you know, rape these companies, and they dump them on, you know, the unsuspecting buyer at the end. And they’re, they’re kind of hollowing out. Business, I already know, you’re going to have a totally different opinion on this. But I literally did, like I just talked to Bethany McLean, I interviewed her last week. We did not talk about this, but she is finishing up a book that will be coming out in the fall that has to do with with some of the sins of a private equity, and I can’t speak specifically to what they are. So it’s really unfair to just drop that bomb and walk away from it. But I’m sure you’ve heard the biggest, you know, criticisms of private equity. How much there is there?
Bob Long 37:41
Yeah. Well, we are not without sin, that’s for sure. But I think
Adam Taggart 37:48
public markets are out without saying either, but But yeah, sorry, go ahead.
Bob Long 37:51
Well, most of what I read is criticism that is, frankly, pretty shallow. First of all, if you look at all the statistics around private equity, institutional caliber private equity, what you find is it is a net job creator. The gains in returns are driven to a large extent by increasing revenue, increasing profits, and not just increasing profits, which of course, can involve cost cutting, which is probably one of the concerns that your guest, your guest is focused on. But revenue growth in private companies is dramatically higher. So that’s coming from the increase in sales that’s not coming from from cutting cost. I think there’s also a completeness or understanding on how private equity firms these are the general partners make their money. Yes, they earn a management fee along the way, but the bulk of their profits come from selling companies profitably, when unfortunate incidents happen like a a bankruptcy of a company owned by private equity that may have had a substantial amount of debt and that may have contributed to the to the downfall of that company. Well, those losses were suffered by the private equity investors. And those are typically done in a fund and the way these funds were, if that loss has to be made up other gains before the general partner or fund sponsor participates in the profits. So picking out individual companies in indicting an industry, I think is not analytically rigorous. But the key messages are net job creator, net revenue grower and the profits and returns speak for themselves over 1000s If not 10s of 1000s of data points over good markets and bad now for 30 or more years of the modern private equity industry.
Adam Taggart 39:42
Okay, good. Thanks for going there. I just in case some people in the back of their mind had heard, you know, some of those criticisms and that was keeping them from fully engaging in the conversation. I wanted to give you a chance to address that head on. Okay. Now in the remaining time that we have, you know, To get to the really exciting part of this, right, which is that, as I said in the intro, not only is private equity oftentimes been a world that’s it’s kind of been invisible to the average investor didn’t even know it existed. But even if they did, it was, in many cases, extremely hard, if not impossible for many to actually get access to it sounds like things are changing now to make this more accessible to folks. So if you can kind of tell us what some of the biggest new opportunities are, that are out there that my viewers here, you know, would be most interested in learning about? And in your answer, if you cannot touch on that access issue, right, which is okay, great that they’re getting access to private equity. But we want to make sure that they’re not just getting access to the sloppy fourth, you know, that are out there.
Bob Long 40:47
Right? Well, let’s recap in so the challenges for individuals getting the private equity have been pasted, right, understanding the returns, they meant access, actually been able to invest in the best managers, they’ve been higher fees, and neither products offered individual investors have had higher fees. And then you’ve got the lack of liquidity, which most investors struggle with, you know, these funds are, they’re generally set up to be 10 years with two one year extensions. But if you actually look at what happens from first cash flow to last cash flow, tends to be about 15 years. Okay, that’s, that’s a marriage. Right? That’s not everybody has that horizon? Absolutely. Not everybody has that has that horizon. And then of course, you’ve got the tax issues, which I mentioned. And then you’ve got high minimums, the products offered individuals have typically had minimums, the low end of the minimums generally been $250,000. So if you happen to be the client of a private bank, and they offer you a feeder fund into one general partners, private equity fund, typically a $250,000, minimum and often more than that. And then finally, we’ll think we’ve covered this at all. The investors in those funds have to be qualified purchasers is defined by the SEC. 5 million or more of investable assets. So just a lot of barriers.
Adam Taggart 42:09
Okay, and sorry, just because you mentioned is a qualified purchaser different from an accredited investor is yes, even higher standard. Yes, it’s
Bob Long 42:17
five times as high. Okay. So an accredited investor has a million dollars in investable assets, and obviously, on broad brush over some nuances here. But in general, qualified purchaser 5 million accredited investor, 1 million. Okay.
Adam Taggart 42:33
All right. So those are all the things that were kind of keeping people out. Right. So what’s happening now to be able to bring those walls down a little bit?
Bob Long 42:41
Well, we’re very excited about the growth of evergreen funds in the private markets that invest in institutional caliber assets. The challenges that have been faced or overcome to a large extent by the Evergreen fund, and let me describe what that is. Evergreen funds are basically look like mutual funds. Now, to be clear, this is not the liquid all’s strategy that people heard about hedge fund strategies packaged in a mutual fund. That’s another thing entirely. But these funds are regulated like a mutual fund. For those who know, regulated under the Investment Company Act of 1940. They’re also typically registered under the Securities Act of 1933, like a public company, so they file similar reports, they’re subject to that level of oversight and governance. So the Evergreen fund is offered in this mutual fund type format. And what’s particularly interesting about it, when you invest in one, you’re fully invested, you’re not committed with capital called in return capital called in return, those who run these and we do the sponsor of an evergreen fund takes on the obligation to manage your cash flow for you. So you’re invested, you’re not just committed to a fund. Moreover, these funds offer liquidity, typically on a quarterly basis at 100% of net asset value. Now, that liquidity will not be for 100% of the fund, it will be for typically 5% of the fund, not 5% of your investment 5% of the fund. So most investors can get out of their investment fund in a quarter or two, under most market conditions.
Adam Taggart 44:26
Okay. And so just to be clear on that, does that mean that this evergreen fund rather than saying okay, you’re in you’re locked up for 510 15 years? Yeah, it’s quarterly there will be there’s an offering an off ramp it Yeah. And if at any, you know, it’s not daily, it’s not on demand, like the stock market, but it’s Hey, every quarter we’re gonna give you a chance if you want to get out.
Bob Long 44:50
Yes. And and really the way I think about it is the Evergreen fund allows you to deliver most of the liquidity premium of the private markets and a structure with quarterly liquidity, okay? So and, and unlike your private assets, well, then your public assets, you can sell them every day, you may not like to price, your private assets almost impossible to sell if you’re an individual investor, the Evergreen fund, it is a hybrid, you can sell every quarter, and you will like the price because it’ll be 100% of net asset value. So that’s the, that’s the liquidity profile. Importantly, and this might not be obvious to your audience. When if you invest in an evergreen fund, and they typically accept investments daily, weekly, or monthly, but she’s monthly sees this example. So if you were to invest, decide you wanted to invest in one of our evergreen funds this month, well, we’ll hold the closing at the end of the month, you come in and buy a pro rata piece of the investments that aren’t in I was in the first close, I’ve been invested in those funds for a couple of years. We have 5000 other investors invested in our core fund called S prom, you would come in just like a mutual fund, you know, if you put it in a mutual fund order before four o’clock today, on Monday, you know, you’d have gone into that, that pool at a price that struck overnight. This is the same thing, you’re buying a mature diverse portfolio on the run, if you will. And it’s designed to give you that access so that you’re immediately invested into a pool. So mature, diverse, with relatively easy irregular access, and then quarterly liquidity. The Evergreen funds are organized like a mutual fund. So they provide you a 1099 not a k one. There none of these calls and distributions. So it’s not nearly as onerous from a tax perspective. It’s not onerous in that respect, you get a 1099 in January, again, like you would from a mutual fund. And then the minimums range, but the minimums are generally about $50,000 for certain share classes for most investors. And they’re available some, some are, well, many are available at the accredited investor level, the million dollar net worth, some are available below that we don’t offer those funds, but a million dollar net worth versus the $5 million net worth of a qualified purchaser.
Adam Taggart 47:24
Got it? All right, great. So that’s super, that’s super interesting. So those are evergreen funds. I’ve also heard you talk about Tinder and interval funds.
Bob Long 47:34
Yeah. So a tinder fund is the manner in which the Evergreen fund provides liquidity, so the Evergreen funds as the as the universe, and then within that you can have Tinder funds, interval funds, a non traded BDCs, non traded REITs, we’ve sort of focused on private equity. So we’ll stay over there. But those would be the four categories within the Evergreen fund world. So an interval fund has firmer liquidity. The liquidity is basically mandatory, every quarter, a tender fund gives the board and independent director group to manage the board game like a mutual fund, they have more discretion around the liquidity. And that’s the difference between between the two. And therefore the investment strategies followed by Tinder funds tend to be more flexible. And you see more private equity oriented strategies in the tinder fund and more credit oriented strategies, or yield oriented strategies in the general fund. Engine.
Adam Taggart 48:36
Okay. Okay. So, you know, now that we’re kind of beginning to get into details, it’s super clear that this world of private equity is a big world, right. And so, you know, Bob, I wanted you to come on to the program here to kind of provide people with, you know, kind of a newbies, you know, are expected or, you know, explanation of, hey, what private equity is, you’ve been doing a great job, by the way. But obviously, I can tell that a lot of cases you’re having to really give me the for Dummies version, when there’s a lot of depth beneath the actual explanation. So I’d love to have you come back on the program, again, as much as the audience wants and as much as you’re able to Bob to help people, you know, really develop a full picture of the space, where the opportunities lies, how to play in it, etcetera. Folks, if you’d be interested in that, please let me know in the in the comment section below. And if there’s, you know, continued interest, we’ll keep bringing Bob back on. So Bob, it again, probably an unfairly complex, or simple question to ask you that has a complex answer. Is that, okay, so we have these new evergreen funds, like from an investor standpoint, how do you evaluate them? How do you determine whether one’s good or not?
Bob Long 49:54
You know, Adam, I feel like I need to go back and pick up a step that we we didn’t get to. Yeah, go for that. Typical private equity fund, you experienced the dreaded J curve effect. And the J curve is you commit capital, you don’t get any back. And you actually have a negative return in the early years because you have fund expenses. Without fun gains.
Adam Taggart 50:16
Sure, let’s use SpaceX, all they’re doing is burning rocks.
Bob Long 50:20
And think about a fund in which you’ve got some organizational expenses and management fees to go out and buy great companies that don’t get marked up for a few years, because they don’t deserve to be marked up for a few years. And you don’t have realizations, okay, you’ve so you’ve got a J curve and cash flow and a J curve, in returns. One of the benefits of the Evergreen fund or the goal is to start and stay on the upswing of the J curve. So if you come in to a high quality evergreen fund, you’re buying mature assets that are closer to their realization phase. So you’re benefiting from those gains as the companies are sold. And then that capital is constantly being reinvested. So again, analogous to a mutual fund very different from the typical limited life Limited Partnership Fund, where you bought some companies experienced a J curve effect, if it’s a good fun, you know, you, you benefit from that you get paid back for it. But a lot of individual investors, so aren’t really set up or not comfortable with this J curve effect. And a good evergreen fund avoids the J curve effect or is offset starts and stays on the upswing of the gender.
Adam Taggart 51:32
All right, that’s super fascinating, I totally get the benefit of that for the investor that doesn’t have the Iron Stomach and necessarily the years to sit through the trough of the j. So how are how, how is the Evergreen fund managing this? Or they are the only buying companies that have kind of crossed the chasm? If that’s the answer, obviously, that’s where they’re really big gains are in private equity is if you’re early, you ride the negative part. And then you get the moonshot later on. So do evergreen funds. How did their returns compare to the public markets? You know, I’m presuming that the comparison you mentioned earlier on included the whole j. So how much does it narrow?
Bob Long 52:25
E to think about that. So I’m not going to speak to the returns of our specific fund. They are available on our website. And we’re very proud of them. They have dramatically outperformed the public markets during during our life. But of course past is not for a login. Prior results are not necessarily indication of future results. And if you’re thinking about our funds, you should look at the prospectus. That all said what what the high quality evergreen funds do is they give you a a return profile that’s more analogous to owning a stock or mutual fund. You know, one of the criticisms your your guests whose name you mentioned earlier than I didn’t capture. One of our valid criticisms might be internal rate of return, which is generally the way product market funds, you know, is is a pretty different return from a multiple of invested capital. You know, if I buy a mutual fund today, I’ll put in $100,000.03 years out sell it for $250,000. I know what my point the point in return is, as opposed to a private equity fund with an IRR, which involves capital coming back at IRR is a discounting of cash flows back based on the return. Again, probably a topic for a longer conversation. But the Evergreen funds really give you a true point to point return. So you can compare them to a mutual fund or a stock there. But back to your question, how do you evaluate them? Here’s how we think about it. We designed our business around three pillars. First of all, convenience. Is it easy to invest in? Is the information easily accessible snack and efficiency, which is a nicer way of saying inexpensive? Are you being charged fees that are a significant premium, to what retail sorry, other retail investors being charged a premium to what an institutional investor would have to pay to access the same investment strategies. And then lastly, transparency. We’re very focused on making sure there never any surprises for our investors and high quality funds and competitors that we have are also no surprises, what they charge and what the expenses are for service providers to know the third party expenses. All those are very clear and clearly disclosed. No surprises. So focus on convenience, efficiency and transparency. Beyond that, you mentioned sloppy third sloppy folds. This is a key issue and frankly a lot of the reason that our team built this business at stepstone. You want to be involved stead in an evergreen fund that is getting equal access Perry passou, to use a financial term, equal access to the same deals that the firm’s institutional clients are getting. So stepstone serves about 150 of the world’s largest and most sophisticated institutions, sovereign wealth funds, insurance companies, very large foundations, endowments pension plans, are to Evergreen funds, really, it’s for including or offshore funds. Think of it as think of it as two strategies, our strategies are simply another client of stepstone. So when stepstone is able to access are really attractive co investments are really attractive secondary purchase of assets at a nice discount. Our funds are getting our pro rata piece based on our annual deployment budget alongside those other large, sophisticated institutions. So we’re able to buy a package of funds from a sovereign wealth fund. To do that we did at a 22% discount to net asset value, and a very large pension plan. That’s a stepstone. Client, it was in that deal. We’re getting the same deal at the same discount at the same terms. So asking that question is really, really important. Are you getting the same institutional caliber deals? So convenience? Efficiency? Sorry, convenient, efficient, transparent? And then deal allocation? That’s really critical.
Adam Taggart 56:29
All right, wow, that is super useful. All right. Well, look, I’m sure we’re gonna get a ton of questions coming out of this video, Bob about? Alright. So you know, what are the ways to play this? Right? What are the options that are out there on the table? You’ve mentioned into your credit, really, just as examples, in your answers, you know, some of what stepstone does, I didn’t give you the real chance to open the kimono and tell the whole stepstone story. Maybe we’ll do that in a future video to help people kind of understand how at least one big player is doing it. But presumably, there are many other ways to play in this space, too. Again, if the demand is high enough, we’ll have you come back on to, you know, talk all about it. Maybe even what we can do at some point to Bob is we can if you’re up for it is we could do we have the ability to do these discussions live where we can open it up to the you know, the audience to actually ask questions live, and you can just field whatever they care about most. So sadly, just looking at the time here, I’m gonna have to begin to wrap this up. Question I’ve sort of been thinking that you’ve been going through all this is because the private equity world is now you know, so much larger than the the public equity world. And so many of the opportunities that used to go public are now going private. I’m just curious, as you look across the scope of your career, here, we’d love to hear, you know, an example of the best the best return you’ve ever had on an investment. I mean, you’re you it seems like there’s an ability there to hit some real grand grand slams, I’m curious. Any particular one standout for you?
Bob Long 58:05
Well, I’m gonna give you an off the run answer. Not best personally investment is what I would call an infinite IRR. I’ve been fortunate to be involved with gift of adoption. And many of your viewers probably don’t know that it cost 25 to $35,000, to adopt a child in the United States. And even more, if you’re trying to do that offshore. And there are 1000s and 1000s of families who have most of the money, but don’t have that last 5000 or so that last mile, that last piece to complete an adoption. And so a gift of adoption, we do grants of about $5,000. And with a $5,000. Grant, we effectively create a family, which we think of as an infinite IRA.
Adam Taggart 58:48
Oh, my God. All right, yeah. Who can compete with every turn like that? That’s, that’s amazing. All right. All right. Well, look, so many questions still. But you’ve done a great job of kind of laying out the basics for us here. Thank you. And like I said, we’ll have you back on the program and really start continuing to appeal back this onion here. You know, I kind of knew some of this coming into this discussion, but just the magnitude of how much of the activity and honestly, how much of the growth and profitable activity is happening outside of the public markets. It really is. I mean, in some ways, kind of irritating to learn about it. In terms of what we it’s just regular investment.
Bob Long 59:34
reaction. And again, if you’re I don’t know what your feedback system is, but another I give a talk to Chartered Financial for Chartered Financial Analyst societies across the country and one of the talks we give is on increasing liquidity in the secondary market, and how that works, and how you can access so if you’re, if your viewers are interested in learning about secondary market liquidity, either I or one of my colleagues would love to talk about that. I think it’s particularly interesting
Adam Taggart 1:00:00
Okay, great, folks, you want to hear about that? Let us know below. All right, Bob, we’ll look for folks that have really enjoyed this discussion, and would like to learn more about you and your work and perhaps stepstone where should they go?
Bob Long 1:00:11
stepstone Pete obvious stuff. So private wealth, you can Google that or our website at stepstone PW a.com.
Adam Taggart 1:00:18
Okay, pretty straightforward. All right. Well, look, folks, if you’ve enjoyed this discussion with Bob, and we’d like to see him come back on to continue to peel this onion. Again, let us know in the comment section below. But please do us a favor support this channel by hitting the like button, then clicking on the red subscribe button below, as well as that little bell icon right next to it. Bob, this has been great. I really appreciate your giving us so much time for this discussion. I really look forward to having you back on the program again soon.
Bob Long 1:00:45
Thank you so much.
Adam Taggart 1:00:47
Everyone else thanks so much for watching.
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