Speaker 1The days of financial engineering, your way to higher returns, in my view, are over. Where you're really going to see the outperformance in private equity are going to be faster revenue, growing companies, lower multiple entry points, more fragmented ecosystem, private companies, and where you can add operational value. That just simply tends to be more in the middle market than in the large and mega cap private company market. Franklin Square, the analogy I use is Netflix. They were packaging and distributing other people's contents, in this case, GSO's middle market lending practice for BDCs. It's a little bit like red envelopes and DVDs. They had built this incredible distribution engine and pipes into all of these individual investors through the broker-dealer market. It had been my background to build out asset management companies. I thought, well, just like Netflix eventually came to the conclusion that building your own TV and movie studio and putting it through your own pipes might be a good idea, as long as the quality. Content is high. I thought, we can do that here.
Speaker 2I'm Ted Seides, and this is Capital Allocators. Our continuing exploration of the intersection of private wealth and alternatives takes us to Future Standard, one of the largest distribution platforms bringing the wealth channel exposure to the middle markets. My guest is Mike Kelly, co-presenter of Future Standard, and co-presenter of Future Standard, and co-presenter of Future Standard. Mike Kelly, co-presenter of Future Standard, and co-presenter of Future Standard, and co-presenter of Future Standard, and chief investment officer of Future Standard, a $90 billion alternative asset manager focused on private middle market strategies for the wealth channel. Mike has been in the alternatives industry for three decades, starting as an analyst under Lee Cooperman and Julian Robertson, helping build Frontpoint Partners, which began the institutionalization of hedge funds, serving as CEO of Oryx USA, where he led the acquisition of $250 billion global asset manager, Rubico. And for the last decade, turning to the democratization of alternatives. Our conversation covers Mike's path from working in hedge funds to building alternative asset businesses, including lessons about incentives, leadership, and culture. We then discuss his pivot from the institutional market to the wealth channel, and the growth from a single strategy at Franklin Square, with $12 billion in assets, to a full suite of strategies under the rebranded Future Standard, with $90 billion across private credit. Mike Kelly, co-presenter of Future Standard, and co-presenter of Future Standard, with $90 billion across private credit. private equity, real estate, infrastructure, and multi-asset investing. Mike also shares his views on performance expectations and what the flood of new capital means for the institutional market. Before we get going, it's that time of year when we turn to traditions, like the tradition of Thanksgiving, gathering family and friends to share what we're thankful for. One of which is the ability to eat enough turkey and tryptophan to fall into one of the best slumbers all year, that nap on the couch while watching football. While I'll spend the turkey days with my family, I'm particularly grateful this year for the incredible team of professionals that brings together what you hear and experience with Capital Allocators. That's Hank, our CEO, Morgan, our head of ops, Tamar, our head of business development, and Liz, our head of content. I'd put our starting five up against any individual. All-Star team, uh, off the court. Our values of quality, entrepreneurial spirit, intellectual curiosity, respect, generosity, and fun win championships. Although I can't say the same on the court for my getting dunked on, because at 6'1", I'm the least vertically challenged of our starting five. 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Please enjoy my conversation with Mike Kelly. Mike, thanks so much for joining me. Thanks for having me, Ted. I'd love for you to take me back to your original initiation into the investment business.
Speaker 1I started my career at Salomon Brothers. I spent a couple of years in the FIG banking group, and then one year up on the fixed income trading floor. When I went back to business school, I wanted to make the switch over to investment. Management and the buy side. And this is now we're going to talk about the mid nineties. So it always struck me as odd that who I viewed as the most talented investment professionals at the time were stuck in this arcane part of the investment business, hedge funds, venture capital, what we now call alternatives. So many of them that despite their young age had made tremendous impact. A part of financial services that was a pure meritocracy. And I thought to myself, I want to be part of that club. The hard part was how do I break into that club? I had an old hedge fund directory. I still have it paper directory of the names and contact information for all of the hedge funds of the day, the Julian's and the Bruce Kovner's and the Paul Tudor Jones's. How many pages was it? It's probably 20, 25 pages. I went down the list and I cold called all of them. The only one I got through to was, Lee Cooperman. Lee, who notoriously was known for doing more with less, answered his own phone. Lee, one word. And I made my pitch. I was a kid from the boroughs. He was a kid from the boroughs of New York. I told him that I wanted to come work for him. I would work for free and sleep on my parents' couch and do whatever it takes to break into the hedge fund industry. He told me that he only hired PhDs and I was getting my MBA at the time. So I thought I was ruled out. And he said that PhDs for poor, hungry, and driven. And I thought, well, I check all three of those boxes. He said, well, I'm a value investor. I like the price. You start Monday. That was the beginning of my entry into the hedge fund industry in the mid nineties. From there, I went on to work at Tiger Management. Incredible firm with incredible people, super talented from Julian across all of the analysts and PMs. After that, we started from point partners with the view to bring specialized alternatives, hedge funds to an institutional investor class. If you think back to the late nineties, early two thousands, that was actually a thing. We called it the institutionalization of hedge funds. It was 12 years of my life. I wound up being the chief investment officer and co-CEO of that firm with Dan Waters. We ultimately sold it to Morgan Stanley and ran it from Morgan Stanley for a few years. I'd love to hear what
Speaker 2stuck most in your early analytics. What stuck most in your early analytics? Most experiences with Lee and Julian and Tiger.
Speaker 1What I appreciated the most was being around really intelligent people doing intense focused work, it always struck me that one of the most important lessons was to be intellectually flexible. And what I mean by that is come to a view based on your work, but be open to change your mind. If you see disconfirming evidence, don't just find evidence that supports your view and block out anything that disconfirms your view. The other important lesson that I learned, it really came more from Michael Steinhardt than anyone else, which is this idea of a variant perception. Think about what's already in the price. You might be bullish on something, but if everyone else is just as bullish, then where's the opportunity? Somebody who says, well, I like to be long, high quality companies and short, poor quality companies. Well, I wouldn't mind being short. I wouldn't mind being long, high quality companies and short, poor quality companies. Well, I wouldn't mind being short, poor quality companies and short, poor quality companies. Well, I wouldn't mind being long, a poor quality company, if it's going to get better, if I have a variant view on that and vice versa. This idea of finding your thought process and how it differs from what's already baked into the price was a big, important lesson early in the investment career.
Speaker 2What was it like sitting in those seats when hedge funds weren't even much in the institutional market? If you think
Speaker 1about my career in the arc of asset management, when you think about the 60s and 70s, the old A.W. Jones, model, which then talked about the early days of barbarians, the gate and private markets, went from the Bass brothers and Richard Rainwaters, that family office, Memphis mafia type capital through that 70s and 80s. And of course, as you're very familiar with, David Swenson, then in the mid 80s, adopted the endowment model and began to say, I want to invest the way these sophisticated pools of capital are investing. That begun the, you know, the, you know, the trend of institutions embracing that. When you're in the 90s, you're still at a point where it was mostly family office capital invested in these types of strategies. It was the early days of endowments embracing, and then ultimately pension plans, insurance companies.
Speaker 2What did it feel like doing the work on companies with the rigor that hedge funds had back then compared to what seemed like a much smaller pool of active managers?
Speaker 1Back then, information was, not as ubiquitous. There was extra legwork you could do that would give you a real comparative advantage. Looking at these companies, looking at trends, identifying sources of information on macroeconomics and data, working within the companies, understanding the supply chains. That was a time when there was far more inefficiencies that created significant amount of opportunity. As time went on, as we saw through the 2000s, the passive indexation and ETFs and the capital markets changes in the public market rendered some of those advantages obsolete.
Speaker 2What led you from, you could say, working in the business, doing research on companies, picking stocks, to the front point, which was institutionalizing the business itself, working on the business?
Speaker 1Early in my career, I went into macro investing. I wanted to be Stanley Druckenmiller or Paltrow Jones. It always struck me that people who went into investment management wanted to be the best. I wanted to be the best. I wanted to be the next Warren Buffett. They wanted to be the next Trillian Robertson or Stanley Druckenmiller. Very few people set out to say, I'd want to be Larry Fink or Chip Miller and manage these businesses and grow these businesses. I thought I could spend my life trying to become the next great macro investor. I might be good at it. There are a lot of people fishing in that pond, but actually building asset management companies and managing them, there seemed to be nobody that sets out to do that. I thought, well, maybe that is my career path. If I can do that, there are a few people fishing in that pond. It's a much more inefficient market and I could be a plus at that. That's where my head was at when we were building front point as opposed to using that as a platform to manage money. It was my original intention to go and help build asset management businesses.
Speaker 2As institutions were first starting to adopt hedge funds, what did you see that was important for front point to deliver to institutions who were adopting it for the first time?
Speaker 1When we started front point, many of the hedge funds at the time were run similar to a family office. We saw an opportunity to build a firm that could partner with institutional investors and help them demystify these strategies, understand what the risks were, understand how they fit into their portfolios, give them much greater transparency around holdings and around risk attributes and risk management. More akin to what they were used to in dealing with more traditional asset management companies, which at the time were long-only companies, we set out to build a firm that brought the best facets of the traditional asset management business to alternative and hedge fund strategies in that business. We saw an opportunity to be a key partner to institutional investors and help them embrace these strategies and how they could be helped to do that. and Doug Ostrover at GSO, along with. a good friend of mine, Scott Fletcher, had mentioned Michael Foreman and Franklin Square. GSO had had a relationship with Franklin Square. They were sub-advising the BDCs for them. Bennett and Doug thought it would be a good idea to go meet with Michael and talk to him about what I was thinking, what he had been doing already. That begun a series of conversations with Michael talking about his business. And it really resonated with me what Michael's vision was. He was bringing income strategies to the individual investor marketplace through the independent broker-dealer channel and wanted to build that out. At the time, Franklin Square, the analogy I use is Netflix. They were packaging and distributing other people's contents. In this case, GSO's middle market lending practice through BDCs. And I thought, well, just like Netflix eventually came to the conclusion that building your own TV and movie studio and putting it through your own pipes might be a good idea as long as the quality content is high. And that began my joining Franklin Square and working with Michael and the team to turn them from this packaging and distribution company into a world-class asset management company. What was the product suite when you arrived? At the time, Michael and GSO, had launched the first ever non-traded BDC. They had a BDC and a closed-end fund, and it was exclusively at the time with GSO as the solo partner. The first thing we set out to do was to undertake external partnerships with some other managers, Golden Tree, EIG, Rialto, and real estate, and building out the product suite in other areas of private markets, mostly around an income orientation. At the time, bringing strategies that delivered income in a world that was starving for yield into retirement accounts. We set about doing that. Then we began to internalize the capabilities. I'd hired Andrew Beckman, who I knew from Goldman Sachs and Magnetar. So Andrew Beckman and his partner, Nick Halebutt, and then built a team around that for internal private credit capabilities. That began a series of additional bolt-ons of teams and acquisitions. About three years ago, we made the decision to expand from income strategy, into growth strategies, and solutions businesses. We talked with a number of investment firms about that and came across Portfolio Advisors. Portfolio Advisors had been a private equity solutions business and been in business for 30 years, helping institutional investors navigate the middle market private equity business. So primary allocations, secondaries, co-investments. That began a conversation with them, which culminated into us merging, our businesses, two years ago. There was no overlap in our strategy base. So we took our credit and real estate capabilities and combined it with their private equity capabilities and integrated that under the common future standard brand. Today, we have close to 90 billion of assets under management across five different verticals, private credit, private equity, real estate, multi-asset, and infrastructure. We just announced an acquisition of Post Road Group in digital infrastructure. So that will be our fifth vertical and about 20 different investment strategies that we offer across those five verticals.
Speaker 2I'd love to tease through part of that capital allocation investment process. So as you started to go from a single relationship with GSO to what become five asset classes, some done directly, some with managers, how did you think about in a big world of asset managers, who you wanted
Speaker 1to partner with? When we set out for real estate, we thought about the individual spaces that we believed had risk reward that was appropriate for the private wealth channel. Varying forms of private credit stood out among them. Middle market, private credit, unit tranche lending, real estate, commercial real estate lending. These were areas that we felt strongly about, offered a very attractive entry point for individual investors through their advisors. We thought about the individual spaces that we were looking for, which again, going back was very income focused in terms of the objective set. We then came to who do we believe are the best of breed managers across these different areas. GSO and KKR stood out as that. Golden Tree in the hybrid between public and private credit, EIG and energy credit, Rialto in commercial real estate lending. A lot of these were personal relationships that we had. These were people we knew very well. We knew their team, understood their orientation towards risk. As with all forms of credit, it's not just someone who can source and originate an underwrite credit, but also someone who can deal with problems when they arise. In credit, problems always arise. We wanted strong risk orientation and workout capabilities across those areas. That's how we decided on the varying combination of personal relationships and core competencies.
Speaker 2Do you mention expectations and incentives in the first iteration with institutions? What are the expectations of that individual wealth vertical that led you to say yield is going to be the right place to get started? Backing
Speaker 1up, think about the post great financial crisis period of time when yields really started collapsing. Disinflation, globalization, everything driving yields down towards zero and culminated up to 2021 when we had zero interest rates. At that time, the desire to have an alternative in fixed income to what was historically high liquidity, high duration, low credit risk, most fixed income portfolios, the 60, 40, the 40% were mostly government bonds and agencies and mortgage backed, which had high duration, high liquidity, little credit risk. To be able to complement that with credit exposures that were less liquid, that had higher credit risk, were a shorter duration through their floating rate characteristics, was a nice offset and balance to what was in the traditional fixed income portfolios and picking up an illiquidity premium, in some cases, a complexity premium around that asset class. That to me was a lot of the main drivers of private wealth into private credit.
Speaker 2One of the things I always wondered is, why income generating strategies are so popular with this group of taxable investors?
Speaker 1If you look at the profile, the investments will often be put into a retirement account where taxes will be less the issue in factoring into the decision making. In other cases, even with a taxable account, the level of yield one can generate is oftentimes even post-tax, fairly attractive. If you can generate high single digit, low double digit yields in private credit and map that up against a cash alternative or where tenure yields are, it still may be considered advantageous or on a trade-off basis.
Speaker 2When you looked at the people that you wanted to partner with, best of breed managers, how did you align your incentives with them and their incentives with the ultimate investors that those expectations can get met in a way that everyone's rowing in the same direction?
Speaker 1In the early days of providing alternatives to the private wealth market, what was then called retail, although we don't call it retail today for good reason. There were a lot of products out there and partnerships that were adding fees on fees. Once you get through all the layers of fees and loads that are involved in these offerings, what's left for the individual investor? We wanted to avoid that situation. And the way to do that is identifying strategic partnerships where we offer one layer of fee and we share in the revenues between partners. We have contributions of capabilities to deliver that and deliver that with one layer of fees, as opposed to passing on two separate layers of fees to the individual investor. That's really been the mission of Future Standard from the beginning, which is we want to level the playing field for all of our investors. The private wealth channel and individual investors deserve to get the same treatment as institutional investors. So the same types of investments that institutional investors invest in to give them more fair fees, to give them better structures where they can invest more seamlessly directly into these underlying investments. That's been the point of all of this. And it's been an evolution because it's a big sea change from the early days of those offerings and the access to those original investments to today, where you have individual investors accessing the exact same investments as the largest, most sophisticated pools of institutional capital in the world at institutional levels of fees in structures that work for them in terms of liquidity and so forth.
Speaker 2When you're going to those managers, what does the team behind you look like that had cracked the code on the distribution so that a manager who already has a big institutional presence sees it as a net positive and is willing to share those fees?
Speaker 1with you. I joined 11 years ago. Not many alternative investment firms had spent time and money on the private wealth channels. They might've had a small team dedicated to it. In order for an investment firm to undertake serving the private wealth channel, it takes a significant amount of resources, a significant amount of patience and time because it does take time. We had a fully built national wholesale distribution capability across independent broker-dealers, registered investment advisors, wire houses, regional broker-dealers with national accounts, business development, sales and marketing, education and thought leadership, all of that built out. It's significant resources invested in doing that. That's an important distinction because when you think about a firm like Morgan Stanley, a wire house that has a significant number of advisors and their underlying clients looking at these strategies, they don't want an investment manager to say to them, here's a bucket, go fill it up with your private wealth money. You have to work with the advisors, help them understand the strategies, the risks, educate them, help them educate their client base. There weren't many investment firms that had that capability and set of resources and experience doing that. Through the years, some have undergone a lot of work, but I think it's through the years, some have undertaken to make that serious investment and done it well. Still to this day, there aren't many firms that are well-equipped to bring their offerings to the private wealth market.
Speaker 2If you look at that side of your business today, how many people are involved in that activity?
Speaker 1We currently employ 600 people roughly at future standard. Of those 140 are in that full suite of distribution and client relationships. When you had these
Speaker 2couple of acquisitions with portfolio advisors, how did you think about the buy versus build decision when you wanted to get into a new strategy? When it
Speaker 1came to portfolio advisors, their business had been operating for 30 years. They'd been operating in the middle market space of private equity, which the middle market's a broad definition of $10 million to $1 billion of revenues, private companies, there's 200,000 of them. But the focus at future standard is to get into a new strategy. So, I think it's a good idea to get into a new strategy. I think it's a good idea to get into a new strategy. I think it's a good idea at future standard is enterprises of a billion dollars in valuation and down, so core and lower middle market. That was the sweet spot for portfolio advisors across their primary and secondaries and co-investment business. So, it matched well. With that came capabilities in each of those areas, funds that had been around for many years. Also, they had built.
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Speaker 1already have. Several hundred relationships with high quality middle market private equity sponsors. And those relationships were a very powerful engine for sourcing deal flow. That was a distinctive point of you could try to replicate this, but it would take many, many years to replicate this business. And you can't replicate several hundred relationships overnight. Why that set of relationships matters is today we're able to work with a given middle market private equity sponsor and say to them, we can invest directly in your fund. We can co-invest with your portfolio companies across your funds. We can provide you with a solution for your business. And that's what we're doing. For your LPs for secondary liquidity, we can work with you at the GP level on a continuation vehicle. And we can lend to any of your portfolio companies from senior in the capital structure down to junior med solution behind a bank first lien. Why that matters is those private equity sponsors then view us as your strategic partner. There's a lot of capital out there and capital has become more and more of a commodity. Everyone in that ecosystem, you need to prove why you're not just a commoditized. Piece of capital. This strategic partnership model is something that generates significant deal flow across our five verticals. That deal flow is ultimately what begets the opportunity for our clients and the outperformance.
Speaker 2In the original credit strategy and some of the others, you either hired people and built it on your own or partnered with someone and said, what were the pivot points in those decisions to buy or build?
Speaker 1After we separated with Blackstone, Blackstone had gone on to build their, own private wealth business and undertake building their own BDCs. We partnered with KKR. There were only a handful of firms that had the origination scale to be able to undertake originating several billion dollars a year of private credit lending. And our BDCs are of significant scaled size. It made it easy to decide we were going to partner not to try to build that from scratch. In terms of bringing Andrew and his team in, in terms of opportunistic private credit and non-sponsored private credit, Andrew had been doing that for many years. And we had a smaller pool of capital, which he took over permanent capital vehicle and began to manage that set of portfolios and built over time a team of 30 credit professionals. Today we're managing close to $10 billion. I think that's an incredible amount of capital. Of vehicles both offered to private wealth, but also to institutional investors, as well as a CLO business. And now has a team of significant size to build that over time and originate private credit.
Speaker 2When you joined Franklin Square, BDCs were the vehicle where a lot of the wealth individuals were accessing these strategies. That's evolved. There's now interval funds. I'd love to hear your thoughts on the strengths and weaknesses of different vehicles and where you're seeing that demand today.
Speaker 1BDCs originally were created through a congressional act in 1980 as a way to bring capital into private businesses in the United States. The original BDCs back then was more of a venture capital model. It was really only after the great financial crisis that BDCs became this private credit lending model with proliferation of funds like ours and Aries and others. There's an advantage in terms of the ability for individual investors to invest in those vehicles at low minimums. It's friendly for an individual investor model to be able to invest their capital into BDCs for income. There are advantages for the end investors through the leverage that's allowed in the vehicle to deliver the type of income objectives that one has. Now, there are limitations as to what's qualified assets and not qualified assets and structural limitations to the types of things that can be put into a BDC. The interval funds have greater flexibility on the one hand, but more leverage limitations. You might have an interval fund that, for instance, could have all asset-backed financing strategies, which, as a BDC model, has a limitation of qualified versus non-qualified investments. You don't get the same degree of leverage in a closed-end interval fund. Different strategies will have different types of wrappers. Private equity interval funds, private equity RICs today, are typically offered in a tender offer fund. In evergreen strategies, credit fits quite well into those wrappers because they're more cash-flowing than private equity. You have cash income refinancings, shorter duration, three to five year assets, whereas in private equity, these are longer duration assets. The reason you see secondaries so often in private equity evergreen strategies is there's greater ability to provide for leverage. The structures that have evolved over time, the wrappers that you create to deliver that to investors have to take that into account. Real estate can fit well into a REIT, private equity assets into a tender offer fund, credit into interval funds. That's typically what you see in the market. Where are you seeing
Speaker 2the adoption of private equity compared to what's been some massive surge in adoption of private credit in in these markets?
Speaker 1It's still early, but the education learning curve advisors have come up and have understood these evergreen structures and are now looking at opportunities to invest in growth strategies in private markets. The offerings themselves, the advantages of a private equity evergreen structure are that your capital is drawn immediately and invested. You have vintage diversification. You mitigate the J curve. You're not waiting for capital drawdowns. You have continuous compounding as opposed to waiting for your capital to get called and brought in. There's a managed expectation of putting your capital to work. The trade-off, and there's always trade-offs, include the fact that these are not liquid strategies, so they're in semi-liquid structures, that you're not going to generate the same level of returns, in a private equity evergreen structure as you will in a private equity drawdown structure. You might be looking at high teens net IRRs or higher. Given the fact that you have to manage for liquidity, you're not going to generate that level of returns. The returns will be more likely a 12% or a 13%. You're trading off the return there. The advantage goes back to continuous compounding and J curve mitigation, vintage diversification. Those are the trade-offs that you need to weigh between locking in your capital and investing in a private equity evergreen structure. Your capital up for 10 to 12 years in a drawdown vehicle, if you have the investment minimum to satisfy that, or investing in an evergreen strategy, you get lower investment minimums, but you're going to trade-off returns for that.
Speaker 2How do you think about increasing adoption, particularly in the private equity side, as it relates to where we are in the cycle? Rates are a little higher. Private equity prices are higher than they were in the past. You can look back at the returns and say they have been great, but most people think this is a harder starting point. As a result of that, you're going to have to look back at the returns and say, the advisors are talking to the wealth channel about coming into this for the first time. They're growing it significantly for the first time. How do they think about the expectations for what forward returns will look like?
Speaker 1On the private credit side of the business, the state of play today is you have tighter spreads. There's a lot more capital in credit than there has been. You have higher base rates. We did exit a zero interest rate period. If you're looking at a loan, SOFR is a lot higher than it was three, four years ago. The expectations have to be base rates are coming down. Distribution rates and yields will come down in those private credit floating rate vehicles. In the middle market, once you move into smaller companies or mid-sized companies, you do get an additional premium of spread for those types of opportunities. When you move into more opportunistic credit and non-sponsored base credit, you have even more of a premium. When you move into more opportunistic credit and non-sponsored base credit, you have an additional premium that gets added. The trade-off is those are riskier. Those are more fragmented. More risk, more return. Weighing the trade-off across that is the job that we undertake in diligence, but also the advisor needs to think about in terms of what's suitable for their clients and their objectives. On the private equity side, if you think about private equity going back 10 years ago and decomposing returns, private equity returns, had witnessed increasing degrees of leverage. We saw LBO multiples of leverage of six, seven, eight times. Decreasing cost of financing that leverage, each turn of capital as debt capital became cheaper and multiple expansion, which we saw prevalent over that period of time. Well, now fast forward to today, cost of financing is higher by hundreds of basis points. You're not getting much multiple expansion on large and mega cap LBOs that are trading at 17 to low 20s times EBITDA. You really don't have to worry about that. You don't have to worry about that. You don't have lever beyond six, seven, eight turns of leverage on these LBO turns. The days of financial engineering, your way to higher returns, in my view, are over, where you're really going to see the outperformance in private equity are going to be faster revenue, growing companies, lower multiple entry points, more fragmented ecosystem, private companies, and where you can add operational value. That just simply tends to be more in the middle mark than in the large and mega cap private company market. I do think that the outperformance that you've seen over time with middle market private equity funds over their large and mega cap peers is only going to not just continue, but move even higher.
Speaker 2It's easy for us to talk about the historical perspective and where we think it might go today. It strikes me it's harder for that end owner who doesn't have the history in the market to understand and calibrate their expectations of what they should get out of private equity. How does that education process get to that end client so that they're not disappointed five or 10 years from now if returns are okay, but they're not what someone might have pitched them looking backwards?
Speaker 1You do need to understand history to start. You need to understand what the historical returns have been. You need to understand the underlying fundamentals that drive those returns, revenue growth, EBITDA growth. If there's leverage being incorporated, how much leverage is incorporated, what is the cost of that leverage? There's the quantitative metrics that have to go into it. Then there's the fundamental and qualitative understanding of impacting these companies and helping their businesses. There are private equity firms who have expertise in industrial services and they have some great firms that work in healthcare services and they are used to working with these businesses, improving their governance and people and innovating and getting value and what impact the contribution of not just capital, but their partnership can have on the underlying company and its fundamental prospects. It's that shared appreciation of the drivers to then translate that into what the return potential of a business like this is over a course of five or seven or 10 years and trying to translate that into a base of expectations for what you're offering to people and how that can pay off. There is frankly against public companies, large cap stocks or the Russell 2000. I think the education has to move across the full understanding of investments that they have in their portfolio today and the trade-offs of liquidity and complexity and fees. How do you think this will play out in the 401k market? Defined contribution is 12, 13 trillion of assets. 401k is a significant piece of that. Much of that in target date funds. Qualified default options. Ultimately, we will see more partnerships between traditional asset managers and alternative asset managers that create structures like collective investment trust to be put into target date funds and 401k plans that have a mix of liquid traditional investments and less liquid alternative investments. Now, private market alternatives might comprise 10, 15% of that pool. But I've always viewed that as a missed opportunity to begin with. If you're someone in your 20s or 30s and you have a multi-decade long horizon to invest your retirement assets, why should all of your assets be in 100% daily liquid instruments? It doesn't make any sense to me and it never has. At least having the opportunity to avail yourself of an illiquidity premium over a long duration that can diversify your exposures and enhance the returns of your exposures makes common sense. We will inevitably see that find its way into defined contribution in the 401k market. One of the reasons we like working with advisors generally is who better to determine the suitability of these investments than an advisor who's closest to the individual investor client and knows whether or not those trade-offs, because there's no right or wrong. Alternatives aren't better than traditional investments. They're different. They bring different trade-offs in liquidity and fees and complexity. And knowing those trade-offs to make a sensible decision around whether those trade-offs work for a particular client in a particular situation, that's why we work with advisors. They're best suited to help make that determination.
Speaker 2I'm curious in this space, almost like MAG7 in concentration, there are a small number of mostly large public alternatives. I'm curious in this space, almost like MAG7 in concentration, there are a lot of alternative asset managers who have addressed this market with products and distribution. What's it like competing with them in this space?
Speaker 1I have nothing but admiration for our competition. They are the best at what they do. Our focus is on private markets. Our focus is on the middle market, a future standard. We do think that's distinct from some of these larger alternative players who are operating in the larger mega cap space. They're providing equity and credit capital to companies that 10 years ago would have been publicly traded. That is the upper middle market. Distinguishing what we do from what they do is important. We think that our offering has differentiation and brings something to the table for clients that they can't access with those large players. But I think it's tremendous that individual investors now get access to the likes of private investors. I think it's tremendous that individual investors now get access to the likes of Blackstone and KKR and Ares and Apollo. These are tremendous firms. It's a great evolution for all individual investors.
Speaker 2As you've addressed this market, you joined Franklin Square at some point in time, it was renamed FS. There's a theme here, now Future Standard. How have you thought about the branding exercise for all of your team to go out and distribute your product?
Speaker 1It's important that we have a common brand and identity. At Future Standard, we did not set out to build a multi-boutique firm. If you look at the most successful alternative firms and talent shops, they have a common cohesive brand and they do that for a very good reason. Despite having a series of acquisitions, we wanted to identify across a common brand and a common platform with the proposition that future is about anticipating what's next in the marketplace on behalf of our clients. Standard is about ratio. Our standards and what we can deliver for our clients. That's the identity upon which we have identified ourselves as Future Standard.
Speaker 2As you see this wave of money increasingly coming into the space, what risks do you have your eye on?
Speaker 1I don't weigh the risks as much as the quantum of capital coming in because that question often gets asked around whether or not private markets and private credits a bubble. If you look at the sheer amount of economic activity, USGD, GDP going from 11, 12 trillion of GDP pre-great financial crisis to 30 trillion today, the number of banks and the consolidation in banks and their move away from lending to private companies and middle market companies, the rise of the number of private companies and companies staying private, all of those trends speak to more and more opportunity for that capital coming in. It's a supply-demand matching. The bigger risks, revolve around this idea of management of expectations, ensuring that why investors are embracing this match up with what can be delivered. It's awareness, education, and expectations management where it has the greatest surface area for risk. That's why we spend so much time on education for the advisors and their clients and thought leadership. These are less liquid opportunities, and there's no guarantee you can exit if you want to exit. That lesson will be learned. There needs to be an appreciation you are getting these characteristics of returns and diversification and access to an illiquidity premium. The trade-off is you may not be able to get out any moment that you want to particularly get out. That matching of expectations needs to be clear and well laid out. That's the biggest risk.
Speaker 2So, and, in addition to making sure there's a calibration of what people understand, there's the potential very large volume of capital coming into these strategies. We've already seen it in private credit, and maybe it happens in private equity. What does that mean for, say, the institutional owner who's there today who sees a lot more demand than they had in the past?
Speaker 1They should understand that it's here to stay. This isn't a temporal situation. The demand from private wealth will be the fastest growing source of capital, and the demand from private wealth will be the fastest growing source of capital. If you're an institutional investor or allocator, you can think of it as competing with your capital. You can look at it as displacing your capital. You can think about it as an opportunity to potentially partner with that capital or use it in some advantageous way. If you think about that last category, there are institutions, and we work with a number of them, who will, seed vehicles that will be primarily offered to private wealth channels. By doing so, they will gain economics and ownership in the revenue stream of those vehicles. There are institutions that are buying GP stakes in managers who, for the first time, are offering their strategies to private wealth. So they will take advantage of the growth of that channel on those businesses and the value of those businesses. And there are institutions that are using that as an opportunity to avail themselves of liquidity in the secondaries market. If you take endowments that are looking at selling some of their private equity and venture positions, the primary demand for those secondary positions are coming from evergreen private equity vehicles. If you try to continue to carve your assets away from that trend, you can do that. You can avoid by investing, earlier stage companies. You can invest direct co-investments. You can create SMAs. There are ways to carve out opportunities that private wealth capital will likely not enter directly, but we're going to see more of it. So institutional investors should learn to coexist with it.
Speaker 2What created the tipping point for a decade ago you thought this would happen? And it's really only the last few years. Where we've seen the adoption really kick in on the credit side. Maybe it's starting to on private equity. Why now? These opportunities
Speaker 1always take longer than one thinks. We felt the same way when we were building Frontpoint. We were wondering if this institutional trend was ever going to happen. It pays to be early, but it also requires a lot of patience. In some ways, what I would call the golden era of the market backdrop that started in 1987 when Volcker stepped down. It ended in 2021 with the end of zero interest rates. And thus began a cycle of more challenging backdrops for say stocks and bonds together in a 60/40 portfolio and for bonds generally and long duration fixed income instruments. And that accelerated this trend of wanting to put assets into private credit, private equity vehicles. We also had a tremendous evolution in structures in private wealth in the platforms themselves. So the wire houses and large RIAs and their level of sophistication and their build out of resources. The operational and regulatory complexities were being solved. The infrastructure that firms like iCapital and Case were putting in place to help facilitate these investments. All of that took time. It was a confluence of all of that coming together over the past decade. What opportunities most excite you both on the investment
Speaker 2side and on the business side?
Speaker 1In terms of opportunities, if you're looking over the long arc, there's still tremendous opportunity in private credit. Despite recent concerns about individual credits, despite the fear that there might be a bubble forming, we are still undercapitalized in private credit to where the opportunity set is. The amount of dry powder in private equity, the number of companies that want access to lending capital. We are just scratching the surface on areas like asset-based finance, which is a multi-trillion dollar market. We're only just beginning to offer those in private credit. There's still significant room for growth there. In the secondaries market, we have a $10 billion private equity market globally, only $200 billion of volume in private equity secondaries this year. It's 2% of the stock. In private credit, that number is $100, $120 billion, almost $2 trillion of stocks. Small amounts of secondary markets will grow. We're in the very early innings of secondary markets for both fund-level investments, individual GP-led single asset secondaries, pre-IPO secondaries, and things of that nature. That area is another big area for growth. Outside of that, AI gets a lot of the press in terms of what that will do for the economy, for financial services, and healthcare, and all of these businesses. The area that probably doesn't get a lot of press is longevity. What I mean by that is the reality is our children are going to live much longer lives than our parents ever did, by decades. What is that going to mean for investment products, for insurance, for retirement plans, the complexion of asset allocation, and how we design portfolios? We're just starting to think about these things. It's changing rapidly. Kids today have a life expectancy, I think, 103 years old or something to that effect. With AI, who knows how long they'll live, but we don't really design insurance and investment products encompassing that and the duration of what that's going to entail. That's a huge area that needs to be further explored. It's a huge area that needs to be further explored. It's going to provide a significant amount of opportunities in the future. What excites you most about future standard over the next couple of years? Delivering for clients. We're in a new regime. In the market backdrop, it's going to be more difficult. Higher uncertainty, higher volatility, higher inflation. The old playbook is not going to work for the markets we're heading into. Helping investors, both institutional investors and individual investors, navigate that and offering them investment strategies that will work well and provide the kind of income growth and diversification that they're going to need. to need. That's what excites me.
Speaker 2Mike, I want to ask you a couple of closing questions. Before we dive into that, I'm going to just share this. Our closing questions are brought to you by Oldwell Labs or OWL. OWL is the very best software I've seen for allocators to find and track managers. And I've seen a lot of them. So if you haven't seen OWL, check them out at oldwell-labs.com slash TED. That's O-L-D-W-E-L-L hyphen labs.com slash TED. And trust me, it'll be worth the look. All right, Mike, what's your favorite hobby or activity outside of work
Speaker 1and family? Anything fitness related. The more intense, the better. I used to enjoy triathlons. I'd say nowadays I like lifting heavy objects. What's one thing most people don't know about
Speaker 2you that you find interesting?
Speaker 1I am the sun. Of a single Irish woman who gave birth to me and put me up for adoption. She was living in the United States. She died shortly thereafter, sadly. I was adopted by two amazing parents. My dad was a World War II veteran, age of 16, an NYPD cop in a few precincts, South Bronx and Queens. He was an amazing guy. My mom raised me and my four siblings and just passed this year. I owe her and my dad everything. They gave me the gift of education. I was the first in my family to go to college. How I wound up here, but for the grace of God and some amazing parents, I'll never know. Great. Which two people have had the biggest impact on your professional life? I have to start with Lee Cooperman. Without him, I don't think I would be here for giving me the opportunity to break into the alternative investment industry. And then I would say Gil Caffrey. Gil was the head trader at Tiger. He was my partner at Front Point. He's been my mentor now for, gosh, about 25 plus years. Just someone who impressed me with his integrity and how to treat others with integrity. Outside of that, there's honorable mentions, Julian Robertson and Suni Harford. Anyone who gave a young me a shot deserves a place on my personal hall of fame. What's the best advice you've ever received? I don't know where it originated from, if it was the Bible or Bruce Lee, but something to the effect of, so you believe, so you will achieve. My own interpretation of that is about mindset. The mind can be the greatest limiter to your own progress, but it also can be the greatest force accelerator, if harnessed correctly. If you believe that you can achieve something, that growth mindset can take you very far.
Speaker 2Great. Mike, last one. If the next five years, are a chapter in your life, what's that chapter about?
Speaker 1As you know, Ted, I have two teenage boys and our kids know each other their whole lives. For Kristen and me, it's quality time with the family. Now that we'll be empty nesters here in a couple of years. In a work setting, it's more towards servant leadership. Helping others, teaching others. I've been blessed in my career, what I've been able to do. Now I'd like to help other people achieve what they're setting out to do. Well, Mike, thanks
Speaker 2so much for sharing these great perspectives on the institutionalization and now democratization of all terms. Thanks very much for having me, Ted. Thanks for listening to the show. If you like what you heard, hop on our website at CapitalAllocators.com where you can access past shows, join our mailing list, and sign up for premium content. Have a good one and see you next time.
Speaker 3All opinions expressed by Ted and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital Allocators or podcast guests may maintain positions and securities discussed on this podcast.
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