Introductions like this are often unnecessary, but I'll just remind everyone we have a co-founder of Apollo Management, a co-founder of Harris Blitzer Sports, and recently the founder of 26 North, a firm with strategies and positions in private equity, credit, and insurance. I wanted to start the conversation given that founder appears in all those experience sets. Your experience as a founder in the time when Apollo was founded and the time when 26 North was founded—very different industry. You came with a very different experience set obviously, but what were the big differences? What were the things that were still true then and true now about going to market in a business like this?
Yeah. So, a lot in that question, but just to try to unpack it, I would say that when I started Apollo, it was 1990 and it was really a cottage industry. I mean, you would go to visit US pension funds, endowments, and there would be the fixed income group and there'd be the equities group and then there'd be this office down the hall where people were doing something in private assets. It was a very small industry and what's happened obviously is now you have an industry that's multi-trillion. It's become institutionalized and everyone's focused on alpha and excess return for the investors. And then fast forward, obviously the big 10 firms are garnering half the capital. They're 100-plus billion dollar public companies in many cases, literally thousands of people, the new banks if you will. And I saw it—for firms that are managing a half a trillion or trillion of assets, you move from being alpha-oriented, being return-oriented to being asset management-oriented. You're gathering assets. It's really hard to move the needle if you're a trillion of AUM if you don't have a $25 billion strategy. So you've seen this bifurcation in the industry and a change in the industry and institutionalization in the industry but also really a drift away from what was the core mission of the industry which was creating better risk-adjusted returns for our partners. Personally, when you do a startup at age 25, you're a doer. You just do everything. It was a small group of people. We were birthed in the 1990 period where we pioneered something called distress for control which now obviously is commonplace and an industry standard. And now fast forward when you do a startup at the age of 55, you go from doing to managing to leading. So for me personally that's been my personal journey where now it's about culture and people and mission and getting a group of people to be on a mission for returns, for alpha, for our clients who we are blessed to be fiduciaries. And so that's been my evolution personally. And I'd say look, obviously when you're 25 you're looking to pay your college debt off, very focused on value creation. And as you get to be older, doing a startup at 55, you clearly have capital and other things and relationships that you can bring to bear that you didn't have in experience. And one of the reasons why I started 26 North was I felt I had a really unique position in the industry to do something that had never been done before which was start a small, a mid-size firm with big firm capabilities in alternatives. You have to fund a big overhead structure before you get paid. So, I was able to do that, but I'll stop there. Lot in that question. Could probably go on and on about it.
Yeah. Well, it actually occurs to me as you're talking, do you think it's even possible at this period in the industry's maturation for a couple of 25-year-olds to go out and launch something and have an opportunity anywhere near the one that existed in 1990?
Yeah, I think today we're living in a—the bar has gone up. And I think that today there is a lack of capital in the industry. Clearly there's an overhang and we as an industry haven't done a very good job of returning capital. You saw DPI up there with returns. I was looking at the numbers—you have to go back to vintage 2016 to get a 0.9 or a 1.0. Ten years ago that's like a good—you're doing a good job relative to the industry. That's ridiculous. I remember when we were so—that overhang makes it harder to raise capital but I think that certainly for specialist firms you can hoist yourself up but you're going to have to start a lot smaller and be a lot scrappier probably.
Interactions with LPs now versus then—have the question sets changed? Have the interactions changed meaningfully or is it still the basic set of concerns and questions?
I would say that by and large, again, there's been an institutionalization of the business and what we've gotten away from—so the LPs have now huge staffs of people in many cases that have done this for many, many years and they have a series of questions that they go through. Whereas when the industry started, it really came down to bets on people, bets on, you know, I trust you. And what I often say to our partners, and we're a very different firm, we're going back to basics and going back to how we used to do business. We obviously need documentation, we need to fill out all these questionnaires. But at the end of the day, if we can get to the point where you trust us to do what we're saying to you, then we can do really good things together. And the documents themselves never really come into play because there's that element of trust that we're all working together. In our case, 80% of our investors are in multiple strategies. So we start with one strategy and we've been able to even in our short life do what we said we were going to do and outperform in terms of value creation, alpha, and risk-adjusted returns and also our personal dialogue with the investors. For me this is personal. I feel lucky and I say to our team which is now 160-plus that we're all lucky to be in this room. What does it mean to be a fiduciary? It means that the investor capital is more important than our capital and our personal successes. So we're on this mission. It's about risk-adjusted returns, but it's also about how you treat people and transparency and being very investor-friendly every step of the way. And so that seems to resonate right now in this age where clearly institutionalization is important—you're investing billions and billions of capital on behalf of big systems. But on the other hand, these are really bets on people. No matter how much it says in the data room, you're really betting on a group of people, particularly in something like private equity where you give someone capital for many, many years. You're betting that they're going to do what they say they're going to do. And so I think we've gotten a little away from that. And I think we need to come back to it a little bit. And that's how we structure our dialogues.
Time horizons and risk-adjusted returns and all those conversation elements in the context of institutional investors. There's a lot of talk now about whether or where retail fits in the investor base for the asset class. You've expressed a point of view on this. And I think for those of you who may not know it, better to start with you expressing your point of view and then we'll drill a little deeper.
Look, what I said before and I'll say again is that I've seen this before. If you think about the industry, it started with the endowment system in the US. It went to the US pension system. It then globalized and capital was plentiful. And there was more demand for the risk-adjusted returns in private assets and private equity and private credit were better. And so there was a chase around the world to deploy capital. And so people lost their discipline. And it's the old Warren Buffett saying—when the tide goes out, and then interest rates went down, down, down, then ultimately they went up—when the tide goes out you notice who's swimming without a bathing suit. A lot of people were literally buying a dollar of cash flow and then revaluing it and selling it, not adding a lot of value. So that was the situation that we found ourselves in. And so retail now—the institutional markets seized up because we haven't given back enough capital. And so the next big growth area is retail. It's the last thing that's left. If you look at the average retail investor, they've only invested 2-3% of their assets. And so ultimately everyone is designing products and things like that to in essence appeal to ordinary people so they can invest in alternatives. And so I think the problem is that—so this has happened before and it doesn't end well. The reason it doesn't end well is that the retail investors don't always understand and we haven't done a good job as an industry explaining that the liquidity of these products—even you can't—these are long-term assets with short-term liabilities and if you need the capital to live on or to pay for college you can't necessarily get it out when you need it. And also I think people misunderstand the duration of the products. And so for both of those reasons I think that you'll see cases and you're seeing some of it today in private credit where people want their money back and they can't get it and they end up selling at big discounts to get their money back exactly when they need it. And so I'm worried and concerned that we're going to go through this cycle again with retail investors and it will cause a backlash against the industry. I think as everyone in the industry also knows, the retail products generally have to be deployed right away and therefore they put a lot of pressure on returns and they probably get certain GPs to do things they wouldn't otherwise do because they have a lot of capital and they need to deploy it versus the way many of us have structured our relationships which is commitment-based funds where you get paid as you commit the capital. So for all those reasons, I'm a little worried and you're seeing some of it today, but we'll see what happens.
Is there a path where there's an alignment potential if you know that the retail investor is thinking long term? I'm thinking here about retirement as opposed to discretionary or what they may think of as a transactional account. Or is the compliance and the regulation and the burden of that just an inherent mismatch?
Look, my sort of view on this is that there's accredited investors that have a certain amount of net worth and a certain amount of sophistication and there's unaccredited investors that need the money to live on. And for unaccredited investors, there are pension funds, there are insurance companies. There are vehicles that are set up for them to invest in alternatives. And that may be the best way for them to invest in alternatives because they understand liquidity, they understand downside. There's a lot of regulation for accredited wealthy investors. Clearly, there's a place in their portfolios for private investment, private assets. But when you just mix it all together and you go out with like 40 Act companies and other things that may not be regulated in the same way, I think it's just a recipe for problems at the wrong time for the public.
Thanks for that. Let's shift the lens to the investment strategies and thesis behind 26 North. We'll begin with the private equity side. Sectors—what is the sweet spot for 26 North when you're looking out there?
Yeah. So what we try to do is create—what I've tried to do is hire amazing people and then create alignment with investors. So 26 North is a firm by investors for investors. I pay the same fee as everyone else. I'm amongst the largest if not the largest investor in all the platforms and the people that work with me also take cash hits and are very aligned in terms of their own economics around alpha, around returns. So I start with—you win with the best people and the best culture. Having said that, this is a good vintage year and we've decided that the upper middle market between the big firms and the massive amount of small middle market firms—$1 to $1.5 billion dollar TVs. Our check sizes are $150 to up to $700 million, a lot of co-invest in cases that are big. And then having a big opportunistic lens where you're trying to trade complexity and aggravation for rate of return and purchase price for value. So we're all about buying cash flow cheaply and going back to the basics of what private equity really was when at least I started. If you buy mid-teens cash flow yield and good businesses, you cure a lot of sins. If you pay low multiples for good businesses that generate mid-teens cash flow, you have a lot of downside protection and you have a lot of upside optionality. And that's how we're operating our business. And we're taking advantage of two big trends. One is that the public markets just don't care anymore about midsize companies. One of the things that I think is going to become apparent is even for some of the larger firms that the ability to exit in the public markets is going to be very difficult. And so ultimately unless you're one of the Nvidia or some of the top 10 tech stocks which are now 40% of the S&P and more than half the returns—the bottom 200 stocks in the S&P are like 6% of the index in terms of market value. And then you have thousands of companies below that. So the companies—the $500 million EBITDA, $700 million EBITDA companies that people are buying—who's going to buy those? It's going to end up being people are going to trade back and forth. And so as the investor capital seizes up, the ability to exit is going to be dependent on cash flow and debt markets and private equity markets. So we're the beneficiary of the fact that the public markets don't really care anymore about companies that are not significantly growing and big in size or really fast growing. And the second big trend is just the fact that the middle market is decimated. So about half the capital depending on the year in alternatives is going to the top 10 firms. And so the middle market is really for the most part really struggling and about more than half the deals we're doing are middle market private equity firms that either need to sell to raise another fund to generate the DPI that we're all talking about or really are out of business and are dying a slow death. And there's a lot of the industry that is like that—that once you do your first continuation fund at a discount, that says a lot to investors, you're sort of then end-gaming it. So that's how we're doing it. I could probably go on and on, but I'll stop there.
