“I find that the more I begin to look around, I see so much good that people do that goes unnoticed. So many wonderful things.” – Ernie Hudson
Even if you don’t immediately recognize the name Edie McClurg, if you’re old enough to remember the 1980s and ‘90s, then you’ll almost certainly know her the instant you see her photo. Somehow she was everywhere and nowhere for the better part of my childhood, appearing in movies like Ferris Bueller’s Day Off, Mr. Mom, Planes, Trains, and Automobiles (a Thanksgiving classic for not-quite the whole family), and sitcoms including The Hogan Family. You can also hear her voice in several well-known animated films, like The Little Mermaid and Cars (so even my young daughters have familiarity).
Was she the star of the show? Never, as far as I can tell. Was she there time and time again as a very dependable supporting cast member? You betcha. She is even credited with the quote, “Acting isn’t a singular profession, it is a collaborative profession.” It takes a small army to create the shows and movies that have meant so much to us over the years (try reading the credits some time), and it seems Ms. McClurg embraced this notion.
C&R Show
Was talking about Edie McClurg today my idea? Not at all. I have to send a “thank you” to my guilty-pleasure podcast, The Covino & Rich Show, for bringing this to my attention. With a slogan of “Sports, Entertainment, and Life,” it’s the one podcast I listen to with no intention of learning anything. I discovered C&R in the early days of Sirius radio – probably around 2004 – and by this point in my life, listening to the show feels like hanging out with old friends. Despite my best efforts to learn nothing, they sparked this current blog topic with a recent discussion of Edie McClurg.
Uncommon Core
The point of this lead-in is that a diversified mix of Alts should be like Edie McClurg: playing an important role – dependable assets year after year, decade after decade – but probably never really standing out as the best (or worst) performers in your portfolio. These holdings can function as the core of a portfolio, providing a “slow and steady” contingent that complements other holdings with potentially higher growth and higher risk (after all, as David Bahnsen astutely points out in his new book, There’s No Free Lunch). That is not to imply that all alternatives are appropriate for the core role, as some – like venture capital – are far more opportunistic.
Building Back Better?
Infrastructure is a topic that has been making headlines recently – but it also happens to be an investment that functions well as a core alternative. According to CAIA Level I (Alternative Investments, 3rd Edition), “infrastructure investments are claims on the income of toll roads, regulated utilities, ports, airports, and other real assets that are traditionally held and controlled by the public sector (i.e., various levels of government.” Of course, one cannot just invest money into government projects on a whim. Making infrastructure investable requires some type of privatization: e.g., creating securities from existing infrastructure or building infrastructure using private financing. Infrastructure is generally necessary, kind of boring, and often has an element of real estate baked into it (as it has to exist somewhere). Those tend to be pretty good attributes for targeting the aforementioned slow-and-steady risk/return profile.
Thinking more about the infrastructure topic, I’m going to quit while I’m ahead, or else this will open a whole can of worms that could quickly turn this current blog into yet another unexpected series (if there’s one thing I’m good at, it’s rambling!). Thus, we’ll leave the above as the infrastructure lesson for today and move on to another topic I want to cover. Before we do, the main takeaway should be that several Alt strategies can function in that core “Edie McClurg” role, and infrastructure is one of them.
Let’s Talk Steaks
By now, everyone is sick of talking turkey and eating turkey, so, instead, let’s talk steaks… or, umm, stakes. Recently, I attended an investor day for a private credit manager, and a major topic of discussion was that of GP Stakes. First, these are just what they sound like: taking stakes (ownership) in GPs (general partnerships). More specifically, we are talking about taking equity ownership in private equity firms (aka “PE sponsors” aka “GPs”).
You’ve probably heard about private equity funds charging high fees and also about how wealthy some private equity managers have become over the years – with some being multi-billionaires. I wouldn’t say achieving billionaire status is the norm. Still, I do think that managers at good private equity funds tend to do VERY well for themselves between management fees and incentive fees (profit sharing) for the funds that they manage. At least anecdotally speaking, PE is considered one of the most lucrative businesses around in the financial services industry. So, if we could essentially sit on the same side of the table as PE management, that seems like a pretty good idea, right?
Too Good To Be True?
Pretend I have a fantastic business that is highly profitable, and everything is going very well. It may not make immediate sense why I would want to share my ownership with others. However, if we think about this more, we can come up with a few reasons.
For one, by sacrificing equity to bring on an experienced partner, maybe I believe we can grow the business in a way that’s impossible on my own. There could be real additive value in what the partner brings to the table, and a smaller piece of a bigger pie can be far more valuable than 100% ownership of a company with no growth. Or, if I’m getting older, it could be prudent to take some chips off the table and even reduce my workload – adding some certainty to my situation and lowering my equity risk. Another possibility is that I value my employees, and I can give up some ownership to incentivize their growth and the growth of the business in a more aligned (potentially better) way. These are just a few off-the-cuff ideas, but you get the picture: there are legitimate business cases to be made for sharing equity.
Align, Grow, Succeed
On the PE sponsor side, there are general business considerations (as above), but also unique motivations we can cite for why they would be willing to sell a piece of the GP pie:
- Alignment:
As a refresher, the way PE fund (“drawdown”) structures commonly work is that they a) raise a fund over the course of a few years (during which they draw down capital from investors – known as “capital calls” – and deploy it into investments), then b) those investments (e.g., properties or businesses) are managed for several years with the goal of adding value, and then c) all of the money (and, hopefully, gain) is returned to investors as the investments run their course.
For each fund that GPs raise, it’s pretty standard that at least 2% of the fund will be capital from the partners, as this demonstrates alignment with investors. It’s like the “eating your own cooking” concept, and it’s also something that almost always comes up during the due-diligence process. Imagine a PE sponsor is raising a $1 billion fund. That means at least $20 million needs to come from the GPs (i.e., owners/partners/management team). Some firms may have multiple funds, and those funds are typically raised in vintages – i.e., a new fund is raised every three years or so. While it may be easy for founders or older (and wealthier) partners to shell out millions of dollars per year to personally invest in their funds, it may not be feasible for the up-and-coming generation.
Thus, equity capital from an outside partner can help provide the liquidity needed for younger partners to make their required investments. - Growth:
As with any business, bringing in the right partner can increase wealth for all involved, even if it means sacrificing some percentage of ownership. In this particular case, the GP-stakes fund has multiple resources and ways to add value to PE sponsors – so much so that some PE sponsors will (and have) select them over higher bidders. - Succession:
At some point, older partners may require liquidity for retirement purposes, or the GP may want to clean up the ownership structure. Bringing in a new equity partner may help the GP buy out smaller equity owners that don’t help with growth in favor of a more significant, value-add relationship. Selling GP stakes can accomplish both of these while creating a more robust succession plan for the business (which may also help attract more investors).
Not So Fast
While I’ve loosely been in touch with a GP-stakes manager for a handful of years, the opportunity has historically been very client unfriendly and essentially purely institutional: restrictive qualifications, extremely high minimums, and completely illiquid. A newer structure in development may alleviate some of the present pain points of investing in GP stakes, but we’re still in wait-and-see mode until they reveal it in the coming quarters.
Giving Thanks
In the continued spirit of Thanksgiving, I encourage you to keep an eye out for the vitally important parts of life’s daily infrastructure that are easily taken for granted: our personal supporting casts (at home, work, and during our commute), the structures and technologies constantly surrounding us, and the insane conveniences afforded to us as citizens of America. The amount of collective effort laying the foundation for our general existence is astounding!
I’ll try to do the same – beginning with taking a moment to appreciate my current view of midtown Manhattan on this sunny November morning – as well as continuing to look for core Alts that can do their best “Edie McClurg” within portfolios of the future.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
