Erik Hirsch: Tariffs, Inflation and Planning for Future Economic Changes

Richard, great to be here.

Sure. Hamilton Lane has been around for over 30 years. We are what's known as a private market solutions provider. What does that mean? We really help clients, both institutional clients as well as individual clients, access and build out portfolios in the private markets. Private markets, in contrast to public equity markets, which is where most people spend most of their investment dollars, but there's an entire side of our economy that are non-traded securities, non-public securities, and that is where we focus exclusively. Think about fields like venture capital, private infrastructure, private real estate, leveraged buyouts. All of that is in our wheelhouse. We manage and advise on well over $900 billion of capital, so the firm is quite big. 800 employees, and as you mentioned, offices truly all over the globe because our clients are truly all over the globe.

We are bigger than some countries.

It's very different. One of the ways is simply in its sheer scale. If you take just the US market, all of the publicly traded companies in the United States, it's about 4,000 companies. That number has actually been steadily going down over time. Why? It's hard being public, it's expensive being public, it's time-consuming being public. So a lot of companies today just don't feel a need to be publicly traded. So about 4,000 businesses. Now think about how many companies exist in the United States. The answer is massively more than 4,000. All of those are private. So if you think about the drivers of the economy, a huge portion of employees in the United States work for a privately traded business, and those privately traded businesses need access to capital. They need money to grow, they sometimes merge or get acquired. All of that is what's known as the private markets. So why do people invest in the private markets? One, for that diversification. The public markets are only about 4,000 companies, and if you look today, never have the public market indices been more concentrated than they are today. We can't pick up a newspaper or turn on a television or listen to a podcast without them talking about things like the Magnificent 7: Facebook, Nvidia, Amazon. What do those things all have in common? They're all basically technology businesses at their core. So a huge part of the S&P, the NASDAQ indices, are all tied to a small number of businesses that are all largely centered around technology. Not to say those aren't great franchises, but in a world where people have gone to a more passive public markets approach, they're ending up with a lot of concentration in a small number of stocks. So private markets are a diversifier, a big driver of the economy. Most of the businesses that you interact with as an individual every day — the coffee shop you go to, the local restaurant you attend, perhaps a boutique clothing line — those are all likely not publicly traded companies. So that is really the world that we occupy.

Well, the answer is you really haven't had the ability to do it until very recently, and I think that's something that's exciting. But let me answer the first part of the question of why. We talked about the diversification aspect. So few companies are actually public, so if you want to get access to the broader economy, accessing the private markets is really important. But the bigger reason is that if you look at performance over a long time period and you compare average public market performance to average private market performance, there's been significant outperformance by the private markets.

That's true. People have not. Institutional investors have. If you take a look at whatever state you're living in and you look at the returns from the pension fund in your state, if they've had a private markets program, most likely — certainly the case for the vast majority — it's been the best performing asset class inside that pension. If you work for a corporation who has a pension still, take a look at the performance of your pension. Most likely the highest performing asset class in that pension has been the private markets. So the issue hasn't been performance. The issue to date has really been access. It's been a world that's been exclusively occupied by institutional investors and really, really rich people. A few things have changed. One, technology is changing, and two, access points are changing. So firms like ours and others are now able to bring private market investment vehicles truly to the masses. Just last week we actually announced a product that's going to have a $500 minimum. $500 to get access to a diversified pool of private market infrastructure investments. So the world is rapidly changing, and you're going to start to see normal folks, individual investors, increasingly have private markets as part of their retirement savings.

Usually they're available through exchanges or partnerships. The example I just mentioned is available via our partner Republic. So if you went to their website, you could actually sign up for an account, you could actually purchase the security. One of the things that's the overarching change factor here is that our asset class is beginning to embrace blockchain as a way to — I'm going to use some funny words here — tokenize investment offerings. When we talk about blockchain, what most people hear is the word Bitcoin. Let me start by saying let's not do that. Let's recognize that blockchain is really the spine of the system, and lots of things can use that spine for access points. Bitcoin does rely on blockchain, but Bitcoin is its own thing, which we can talk about if you're interested. Tokenization is simply taking an investment vehicle like one of ours and digitizing it, turning it into a digital token that is housed on the blockchain. By doing that, we can dramatically lower the investment minimums and it allows a little bit more flexibility for people who want to trade that position or slice that position into much smaller pieces.

That's more Bitcoin. When you start to see people who are issuing coins, they are creating actual coins, digital currency that they're hoping is going to trade with some value. The problem with all of these is that think about why a dollar is worth something. It's fundamentally a piece of paper, a piece of cloth that you might have in your wallet or pocket right now. In the old days, there was a gold standard. We said the dollar is worth a dollar because behind me in that vault is a bar of gold that is counterbalancing it. We were on the gold standard. We as a country moved off the gold standard a long time ago. So why is a dollar worth something? It's really worth something today because our government says it's worth something and stands behind the stability of our currency. We have seen over history lots of currencies dramatically devalue when they lose government backing. Think about instances in South America, instances in Africa, where you have seen currencies completely plunge due to an instability of a government and therefore an instability of their currency. In the case of Bitcoin and other related digital currencies, right now I think one of the struggles that folks have is what's the basis for the valuation? Frankly, it's one of the reasons why you've seen currency trading with an enormous amount of volatility that is very un-currency-like. You've seen coins get issued, coins soar in value, coins plummet in value. The world of digital currency is still finding its footing and still needs to do a better job of fundamentally explaining its basis for valuation.

What I would say on a personal level is that I think digital currencies are very prone to market manipulation. What you see is people hyping a currency, a lot of online advertising, pushing something, pushing an agenda, pushing some sort of valuation prospect that may or may not be real. That market has not been massively regulated on some levels in terms of market manipulation of various digital coins. You've seen plenty of examples of new coins, existing coins, that all of a sudden get a lot of hype behind them, soar in value, people begin to dump the coin, the coin devalues. It's been a bit of the Wild Wild West.

I think there's possibility. What you're seeing right now with the US, with this current administration, is saying, for example, why do we have the penny? It literally costs us more money to create than it's actually worth. There are a lot of reasons why digital currency is a more convenient way of transacting, particularly on a global basis, where changing currencies, dealing with currencies, dealing with different pricing becomes ineffective. You see us today as a society. For you and I, we're a little bit older, we probably like to carry around cash. I know I do. But as we talk to younger folks, you say, 'Where's the closest ATM machine?' and you get stared at like you're an alien. Everything is pay by phone. We've already taken huge leaps away from cash transactions. People who are proponents of things like Bitcoin and other digital currencies believe that that's just the next evolution of a much simpler, very trackable, simple way to transact across borders, across industries, and across individuals.

I think we're a ways away from that because I go back to my instability comment. No government, in my opinion, is going to want to be transacting in huge volumes in something that appears to be as volatile as what these digital currencies are today. For your listener, if you have a free moment, just go back and Google Bitcoin pricing from inception to current, and you're going to see a chart that is very, very different than if we look at the relationship between the US dollar and the Euro, or the US dollar and the UK pound, or the Japanese yen. You're going to see some movement, but those charts are not going to be going like this on a daily, weekly, hourly basis.

Correct. Currencies are not by definition perfectly stable, but the magnitude of the movement and the frequency of the movement are important things, and you want those to be lower frequency and lower highs and lower lows.

The average consumer is not going to be investing directly into the private manufacturing business, just like the average consumer today is not putting the bulk of their money directly into single stocks that they choose. Most of us are using things like ETFs or mutual funds, vehicles to access the market. So true on the private market side. But fundamentally, the valuations are very similar. In the public markets, most stocks trade on a price-to-earnings ratio, and we think about what that multiple of earnings is based on growth of the business, profitability of the business, and long-term prospect of the business. If we put two businesses side by side — let's use two private bagel companies. One is extremely well-run, great brand following, great management, great profitability, growing at 15% per annum. The other one, the product's not as good, management's not as good, brand isn't as good. They're both bagel businesses, they both make money, but one of them, if they were both public, would trade at a much higher multiple than the other. The rational person would say of course they do. They shouldn't be valued on the same metric if this one is more profitable and growing faster. It should garner a higher multiple. In the stock market, that's what we're governed by. You mentioned a couple of those tech businesses. Their stocks have traded up because they're growing a lot, and the view from the street is that they're going to continue to grow. Take the current stock darling, Nvidia, manufacturer of chips. They have been growing at huge rates quarter after quarter, and the market believes that that growth is going to continue. The market believes that as we continue to adopt more and more AI, that will be powered by chips that Nvidia is producing. All of that means high growth to date, high growth in the future, and so the company is very highly valued, big multiple, etc. In the private world, it's the exact same. We're looking at multiples of earnings, how much is the company growing, how profitable. We're still talking about the same kinds of companies. One has just chosen to stay private and one has chosen to go public. There's no difference about the business or how those are getting valued.

I'm giving it an incomplete. I think the issue is if you look at fundamentals of the economy today, I would say the economy is strong. But yet we're starting to see early signs of the typical consumer, particularly the mid and lower end of the consumer, beginning to pull back on spending. Why are they doing that? I think the word hovering over the economy right now is uncertainty. We don't know exactly how many people in the government are going to be laid off. We don't exactly know what kinds of roles are being targeted for layoffs, and therefore we don't exactly know how many of those people are going to be able to find new jobs in the private sector.

I go back to the incomplete because we don't know today. Are we going to lay off 100,000 government workers? Are we going to lay off a million government workers? Because we don't know the magnitude of the number. And we don't know what kinds of government workers. A government worker who was in a very particular governmental role that is hard to transfer to the private sector is very different than someone who might be getting laid off from the IRS who was an accountant by background and could much more easily move from the IRS into a traditional private accounting job. So today we just really don't know what we're dealing with. So that's an unknown. Tariffs are also an unknown.

To your point that one side says this and one side says that, I would say both things can be true. In the case of tariffs as it impacts the consumer, it's absolutely something that in most cases, rising costs tend to get passed back to the consumer. If we're going to put a tariff on alcohol, as has been discussed, and we're going to say wine coming in from Europe is going to have a large tariff on it, then you as a consumer should expect to pay a lot more for wine coming from outside the US. Can they pass all of it to the consumer? Maybe, maybe not. But nonetheless, you would absolutely see rising prices. So one side says, 'See, I told you.' That's okay, true. But I go back to we can have multiple things be true at the same time. These are not exclusionary. The reason why you might think about putting tariffs in place on neighbors or friends is that you worry about the positioning of the US economy. For example, if we as a country are both exporting and importing a good, in an ideal world you want that barrier to be zero. You want our ability to buy and to sell to be on a free and level playing field. If, for example, when we go to sell a good manufactured here to another country, if that country doesn't want that good coming in, or they want to give an advantage to that same good produced in their own country, they could say anything coming from the US we're going to put a 15% tariff on it. If it's steel manufacturing in the US coming into Canada, that's going to get a tariff. That hurts our steel manufacturer's ability to place product in Canada, and vice versa. In an economic ideal world — I'll leave the politics to other people — in an economic world, you want goods to be able to freely flow across countries, letting the market decide. If we're able to produce something better, faster, cheaper, then good for us. The way to solve that isn't necessarily to tax everything else. I think what the administration is telling you is they don't believe in all situations that the field is level. So they want to try to level the field, and they definitely want to provide economic incentive to have jobs, manufacturing, and production re-shored back here in the US.