James [00:00:02] Hello and welcome to the State Street podcast on the Future of Private Markets. I'm James Redgrave, Vice President of Thought Leadership and Editorial at State Street. And I'm joined today by James Jefski, Abdel Hmitti and Eric Chng, State Street's Heads of the Private Markets Business for North America, EMEA and APAC, respectively. State Street has just launched its paper, "No Going Back - New Realities in Private Markets," analyzing the results of our recent survey of nearly 500 institutional investors and managers worldwide. Well, we asked them an in-depth series of questions about their future private market strategies in light of economic market and technological developments. We're here today to talk about some of the research findings and the report's conclusions. But I urge everyone listening to visit statestreet.com to download the full paper. To begin with let's start with some of the findings related to private markets in the current macroeconomic environment. Most respondents to our survey disagreed with the statement that the current inflation environment is likely to be short-lived, and in particular, European and North American respondents were more bearish on the persistence of inflation than the Asian ones. So I want to ask and I'll throw this to you first, Eric, do you have any thoughts on why that might be based on your conversations in the market? And is that still the prevailing sentiment in your regions?

Eric [00:01:10] Yes, sure, thanks for having me and I guess it's kind of the same sentiment that we're seeing out here in Asia Pacific, given that, you know, the wave of interest rate regime hikes has been the ongoing inflationary environment, the [00:01:24]current [0.0s] expectation is that central banks across the world, starting from the Fed in the US, which has upped their interest rate regime by more than [00:01:31]100 [0.0s] basis points. And across the region, most of the G-7 economies, except Japan have helped us [00:01:39]in fuel price inflation. [1.4s] And this is especially so in Asian economies where it is a very US funding driven kind of market. And I think that our piece in this region will continue to have the expectation that inflation is here to stay. It'll take a few years to work it out and interest rate regime would remain high for a lot longer.

James [00:02:02] That's great, Abdel, anything you'd like to add to that?

Abdel [00:02:04] So I think the view is relatively the same in Europe. So while the ECB raised rates as well, not all the way to 5% as the US did, but they're up to three and a quarter as of this week. There is a view that inflation will be persistent for an extended period of time. So I think by the most aggressive estimates, the ECB's target of 2% inflation will not be reached until 2025. And that's one of the best scenarios we see out there. I think one of the new elements that we see in the market is the turmoil in the banking industry. Now, some say that that might tighten the credit like in the market and may help to ease some of the inflation, but the jury's still out on that. So the view here is that inflation will be persistent in Europe and all the central bankers view it that way.

James [00:02:57] Excellent, thank you very much, moving on from that, even if inflation does come down in the nearish-term and interest rates follow, what do you think the long-term effects on private markets are going to be on having gone through a high inflation, low growth stretch like the one in the last couple of years?

Abdel [00:03:10] Yes, I think over the last five, ten years or so, the environment that the property market industry has lived through is where cash is very cheap. So I think people, when they look at that environment, they say potentially investment decisions were not the most optimal when you can raise cash and pay a quarter of a basis point or 1%. So the view is that, you know, a lot of the opportunities that the private market industry will look at will obviously have to hurdle and have to meet a higher standard because you're not competing with multiple choices in the industry in terms of where you invest that money. And it also leads to an optimal allocation of capital to the best projects out there. When again, when you have an environment where interest rates are so low, it doesn't necessarily lead to optimal decision-making in terms of how do you allocate that capital. So I think this is going to be something that will impact the industry going forward.

James [00:04:11] Thank you very much, James. Do you like to pick up now?

James [00:04:13] Sure, I think there are a lot of things going on at once, and it's tough to pinpoint the exact path or roadway that this will take. But in general, I think it comes with a few things. Number one is, you know, a period of inflation like this and a period of change will lead to folks looking at secondary markets because you have a vintage concept going on, right? So you have years of low interest rates, years of investment with perhaps a blip, let's call it, of different economic conditions. And so you're going to have this sort of staging effect of investment vintages and performance over time and capital deployed over time. So folks need to really think about that. And our clients are thinking about that as they move forward and against the secondary market opportunity, sort of come into play to help balance out perhaps what you think about in terms of your exposure to private markets. And one of the things that the study actually pointed out is there really was, I guess, a sentiment around the wave is not stopping. People understand the individual economic conditions pushing at the subsectors and they're making decisions based on that and the profiles that they have, you know, whether it be how do I think about real estate or how do I think about credit or equity or infrastructure. But the overwhelming comments were that we're not slowing down. So if that's the case, how do you think about vintages? And the other thing I'd say is in difficult and changing times, which certainly it is right now for a multitude of reasons. One could have the thought that a private company or private companies private assets will be the ones to turn this around so the innovation, the changing of the world economy, the change in how we do things, the movement towards a different culture, different services. Private assets themselves will most likely be the front end of that change. With publicly traded assets coming behind it is just due to their size and nimbleness and things like that. So not only do you have that vintage concept, but perhaps you have an opportunity to really catch lightning in a bottle with some companies, some assets that are really changing the way the world is going to be for the next five, ten, 20 years.

James [00:06:23] That's interesting, thank you, Eric, anything to add?

Eric [00:06:26] Yes, I guess I'll add two quick points to make the discussion a bit more holistic. In any economic regime, I kind of agree with the rest of my peers in an escalating interest rate regime, the cost of servicing goes up and we've seen a lot of portfolio companies and the ability to generate returns comes into question. And [00:06:47]all the last five years, I guess, especially as valuations come into focus, the one thing that LPs are looking for is back to basics, whereas in a low interest rate environment in the last decade, a lot of GPs were coming into a different kind of strategy. So we had public hedge funds going into private equity, we're seeing private equity going into multi-asset underlying and each of these asset classes are very unique in the liquidity spectrum. So I think LPs are going to place a lot more focus on GP specialisation [32.6s] and in areas like private credit in Asia, that is the growth area, as you know, GP's specialise in a particular market like India, which can [00:07:30]deal more effectively [0.0s] generally would generate more LP interest. So but it is certain private equity remains the most robust and most liquid spectrum of the private markets. And a lot of the respondents have echoed the same comments that they will continue to allocate to private markets, GE and well into infrastructure and private credit.

James [00:07:50] Thanks very much, I'd like to move on now a little bit more to the operational side of the responses we got and how respondents are reacting to the macroeconomic circumstances we've been talking about. So one thing the majority of respondents highlighted was that there's a smaller universe of suitable deals being generated by the inflationary environment that they find themselves in, and they are responding largely by citing the need to improve their infrastructure for gathering, analysing and communicating private markets data. They said that these improvements were both a source of competitive advantage and an area where they could identify processes and clear native improvement. And I'd like to get your reactions to those statements. I'll open with you here, James, because once again, there were some clear regional differences in this data. And in particular, North American respondents generally perceived their data processes to be more automated and efficient than those in the other regions. So I want to know if this [00:08:35]tallied [0.0s] with your observations?

James [00:08:37] Yes, well, certainly I can't compare our clients here in North America and their experience internally with clients in Asia or Europe respectively. However, I guess my clients, I would say perhaps have a level of comfort in where they are, but that doesn't necessarily mean it's built for purpose for the future. The other thing to think about is perhaps there's a longer tenor for some of the investors or investment managers within region. So that comes with some positives and some things to think about, which is I have a view that I've been doing this for a long time and so therefore systemically you can get comfortable with how you're doing it. It also means that you've been doing this for a long time and you have a lot of disparate data and disparate functionality and methodologies and so forth. So that comes with some challenges and it's a larger ask to sort of lift and shift and transform when you have a longer tenure of investment activity or investor activity so that's a piece of it. So I'm not sure if they're farther along or they're just maybe more comfortable. The other thing I'd say is certainly as you think about the sub segments of private markets and the alignment of private markets to the public markets, all of my clients, I feel, have a ways to go in terms of their growth around technology, data, etc.. If you think just about doing the sort of simple analysis, if interest rates move as they have periodically over the last year or so, if you have public assets, you can stress test that, you can do analysis very quickly. Probably at the touch of a button and you can assign scenarios and perceived outcomes. [00:10:25]In private markets, particularly across the different sub segments bringing that all in together and comparing it to the public markets is a challenge that all the clients face and the speed and accuracy and their ability to do it is far behind what it would be in the public. So there's room to go for sure [16.2s] here in North America.

James [00:10:43] Thanks very much, James. Eric, the respondents in your region were the most likely to sort of claim a degree of over-manualisation in their private markets data processes. Do you have any response to that?

Eric [00:10:54] Yes and I think the survey that goes on to describe the different segments and I think that is very prevalent, the trends that we're seeing here in Asia, I would say that Asia is a very interesting mix of generally LPs that have only begun to move away from public to private market investing for the first time that's the first dimension. And I'll talk a little bit about the challenges in a little bit. The second category is what we call allocators that have been investing in the private market over five, six, seven vintages and are getting more comfortable. They are seeking for opportunities to generate alpha and they're moving in a world of co-investments. And lastly, we have the very sophisticated investors in Asia that luckily have done all of the above. Plus they are not competing in the primary market by sourcing deals themselves. And in many cases, these sophisticated investors; they are building dual sourcing teams and investment committees across each of the different vertical of the private market. Now that as a backdrop, I'll talk about three key challenges that typically the investors here in Asia face. You know, obviously the data challenge becomes more acute as you're moving into direct investment. But generally, unlike the public markets that are used to treat order and lifecycle management is the first thing that they struggle with. How do you book a trade in public market? You have order management systems, you have a defined execution floor and generally a ecosystem of brokers and service providers and custodians so we're used to that. Now moving in the private market, [00:12:31]that all that [0.6s] lifecycle if you are an allocator is commitment based. So your ability to understand what you're getting into, the agreements and when to fund and being able to react to GPs calling for capital is the first point of call. How do you book it? How do you track it and how do you even make sure that you're paying them on time? Now, as you move into more direct investments, the lifecycle becomes you sourcing a deal, you probably have a deal sourcing committee. You then basically work on the terms of the deal, execute on the deal that you want to engage in, and then floor that deal execution from a funding and condition precedence perspective, right, to fund when certain conditions are met. Now, you can imagine this entire trade lifecycle is very bespoke. A building, if you want to acquire, is very different from acquiring a portfolio company so that's the first thing. The second thing is payment cycles in general. Unlike a very defined treasury funding process to settle trades in the public market, payment cycle, depending on the deal type and the deal size and how many GPs that you are exposed to as an LP that complexity is something that you need to manage as a universe. So as you expand into 100 GP relationship with multiple capital call now that central treasury function and that payment function becomes more critical because you're likely to miss payments and distributions otherwise. And lastly, I think assuming you solve problem one and problem two and you've invested all your capital, then how do you monitor your portfolio and how do you monitor each asset that you're exposed to? And how do you ensure that there are some exposure across different GP's do not expose you to a concentration risk as an institution? So now I could go into a lot of detail when it comes to that data challenge, but you know, we'll save it for another question. I'd like to leave some time to Abdel.

James [00:14:26] That's great, thank you very much, Eric and Abdel, I would love to get your perspective from the EMEA region.

Abdel [00:14:30] So I think when we look at the industry overall here and I'm not surprised that in the US people feel they're further ahead in terms of sourcing data and having a competitive advantage because it is obviously the largest private markets region in the world. So in Europe when we talk to our clients, they clearly get it that it is really going to be important for them to be competitive in this industry is to have an edge when it comes to data gathering, which will help them obviously in analysing the data they get on the private markets. So they view the largest gap is in sourcing data and in relation to investments. And I think there is a general consensus in the market that the industry overall will not benefit from substantial growth if they don't address this gap. We see this in various sub products, if you will, in the private credit and the private equity direct where sourcing and analysing data is going to be critically important. And as you get more and more folks and I know we're going to talk a bit more later about retail investors going into this space, data gathering data and analytics compliance is going to be critically important. So I think there's a general focus in Europe that is going to be the key for success in the industry. And I'm not surprised that the US is further had again, because it's the largest market and there are a lot more solutions that are being rolled out in the US and Europe will benefit from in the future.

James [00:16:06] I think there's a big one and I'll ask you guys just to chime in, if you see it the same, in terms of who's using the data and who needs what and when so the different personas within our clients. Eric talked a lot about an ecosystem. I completely agree with both of you, but it's an investor relations person getting the same data at the same time as the accounting professional, as you know, maybe a third party is sending data in so those personas, those individuals, the timing and consistency of the data and how they look at it for their own purposes is something that our clients are talking about a lot, where as firms grow and the market grows, it's not one or two people in an office able to triangulate all those ask. It's multiple individuals, multiple data systems, multiple feeds. And so getting it all together and rendering it out accordingly is something that everyone's really thinking about. I don't know Eric or Abdel, anything on that?

Eric [00:17:02] Yes, I think I will let Abdel jump in and elaborate a little bit, but I kind of agree with everything that you say. You know, the data challenges, the last point I was alluding to, I guess, opens up the question on why are LPs seeing this data as a competitive advantage. Beyond just the persona, I think there are different kinds of LP in an ecosystem. But what we're seeing is that collecting the data at an asset level and then linking that to the funnel level and the whole host of the web of holding structures and being able to then slice and dice that data for a chief investment officer versus that of a finance officer looking at how to fund treasury in the next seven days. These personas that James' talked about, absolutely, spot on.

James [00:17:49] Very interesting points, thanks very much, guys.

I want to move on now to something Abdel did pre-empt this idea of increased retail or individual investor investment in private markets assets. So respondents were pretty consistent across all regions in seeing very strong demand for this from the individual investor base. One slight regional difference, certainly the sense that this demand existed was stronger in both APAC and North America than it was in in Europe. So Abdel, I'll open with you here and perhaps you can give some insight into that and also into what various different parts of the universe, regulators and governments, the financial service industry, the technology industry, etc. are doing to greatly facilitate this kind of retail access to the markets.

Abdel [00:18:32] Yes, sure, so I think again, the US took the lead and the democratisation of the private markets investment with the BDCs and we've seen the [00:18:44]ELTIFs [0.0s] in Europe introduced about eight years ago or so. Now [00:18:51]the success of the ELTIFs has not been massive, albeit, it's been of interest to a lot of our clients and investors in general. And the idea behind that is, you know, as people see the returns and again, in the backdrop of zero interest environments, they see attractive returns and broader markets, relative stability, risk, return, reward. There was a lot of interest in the private markets, but from a regulatory perspective, these products are not suitable for retail investors who are looking to invest small amounts of money. So the ELTIF's was a great idea in that it gave them that regulatory wrapper so they can benefit from a private markets investment. [42.0s] But with all the proper regulations to safeguard their investment now, I don't think, as I said, that this has been very successful in Europe, but we see ELTIF 2, which addresses some of the shortcomings of ELTIF 1.0 and is being rolled out right now, which I think is well received by the industry. And obviously the industry as a whole has played a role in shaping the ELTIF 2.0 to all the recommendations and discussions with the regulators. So to link this back to what we were talking about earlier in terms of data, what would make this attractive is obviously the regulatory wrapper, which we talked about, and there's a legal framework that's being discussed and being rolled out now, which I think would be beneficial to retail investors in Europe. The GPs in general, obviously looking to provide more data to the LPs will be investing in these funds so they can have a view as to the risk that is inherent in these products. So that will mean that firms like us, third party providers will have to facilitate those discussions and make sure that data is available to be provided. The other thing is they need to reach out to other distribution channels to reach these investors. And that means from an operational perspective, that we need to be ready to accommodate high volume of investors, albeit with smaller tickets and all the requirements that come along with that, that's different reporting requirements, different language skills that potentially will be needed and deal with distributors in different markets. So those are all challenges that the industry will be facing as it continues to go after the retail investors. And all of this is being done while trying to keep costs low because it's obviously critically important for the retail investor and the expenses are not higher than what they are normally accustomed to. I'll just pause there and let my colleagues bring up other points and then I can circle back on a few other things that we've seen in Europe.

James [00:21:29] I'll jump in on that, Abdel, thanks, so first off, you mentioned the US had sort of started the trend, whether it's [00:21:35]BDCs, REITs, [0.8s] etc.. Interestingly, you know, BDCs were formed in 1980 under the Small Business Investment Incentive Act. And so it's taken, you know, 40 years, 40+ years to be where we are right now in terms of success. And what I will say is there is significant regulatory interaction and shaping of these particular vehicles over time to end up with a package of product, if you will, that meets the needs of both the investment manager community, the investors, and also importantly, the investments. So if you think about how it was formed in the United States, there's a lens towards small American businesses and so all that needs to come together for the good of the product to be successful. Over the last decade, there's been explosive growth in that particular business line where the BDCs [00:22:29]are now traded REITs [0.5s] by, again, some of the half [00:22:31]turns or turns [0.5s] of those regulatory or structural enhancements to make it more suitable combined with, I think, you know, an advancement in technology. So the other thing that comes to mind here is it's one thing to come up with an idea and then you need to come up with a package. Okay, well, if we boxed this like that feels like it would be attractive and makes sense for all those three parties to build something that has meaningful growth over time. But then you have to figure out how are we going to enable this to happen? And so there's a real technology play in terms of moving from a closed ended private fund with institutional capital, where it's really a relationship between the investment manager and their investors in a direct way to something that goes much more non-institutional, where you bring in hundreds or thousands of participants coming in with less of a relationship. So you need that technology. You need to think about your workflow. How do you have a process that's scalable, controlled to take in that kind of volume? To your point, it's going to be small ticket, very different than the way an institutional investor would come in, so are you ready for it? And what needs to be done to get there once you get that wrapper, if you will, or that product crafted correctly?

James [00:23:48] Very interesting points, thanks very much, Eric, anything to add here?

Eric [00:23:51] Well, I guess I'll just touch on a couple of things of my observation in the Asia-Pacific region. If I were to summarise what Abdel and James have said, which is spot on, the US market is deep and the retail participation high. I would say that the financial markets are fairly homogenous and the regulatory regime is really one, right, you're dealing with the key regulator in the US market. You go to Europe and I think Abdel touched on the [00:24:20]ELTIFs, ELTIFs 2.0. Largely a [3.0s] common market in the European region, but when it comes to Asia, you tend to note that the markets are extremely fragmented. The capital pools within each of the Asian economies vary considerably. So if you look at Southeast Asia, it has a very young and affluent demographic investors hungry for access in the private market because they are seeking yield. And you look at a more mature Japan, the Chinese market, which is developing very fast when it comes to innovation, but rather than north region markets of Korea, Japan, the investor protection there is very different. The regulatory regime is very different. So there is the rise of the aggregators, as we call them. So there's been a rise in technological innovation when it comes to robo advisory, right, where people can get fractional investments into public markets through ETFs. The same robo advisors are now coming up ideas on how to create that wrapper that James touched on. And in Asia, a US dollar driven offering touching investors in key markets. And how do I, you know, offer this for sale as a demand aggregator and then collecting those into [00:25:33]GPs [0.0s] that they will give access to. I think that the pace of technology will rise, the investor appetite will rise, and regulators are watching this space very carefully. I would say that we're five or six years away before private markets will ever become mainstream to retail participation. But it is happening in very small pockets that we see in some economies in Asia.

James [00:25:56] Yes, so that's a good point, Eric, that you hit on that fractionalisation you know, if you think about at least in the United States, BDC reads tender offer funds, etc. that give access to these. It's pretty clear the subsectors or asset classes that have had the most success are real estate and private credit with infrastructure and traditional private equity significantly behind, it's the inverse. If you think about the size of the private equity market, it's much larger, in fact, than the other sub segments. And so a big piece there is without that fractionalisation the time it takes to achieve returns in a private equity investment so you have to add a closed ended fund traditionally, you're investing in deploying that capital and waiting for that harvest period a number of years that becomes a little challenging if you think about a product meant for more retail investors without that fractionalisation or without some of their mechanics to provide real returns on a periodic basis. And I think that's part of the reason why credit, for instance, that pays a regular dividend, etc. has that ability to so far anyways match up with the investor demand. It didn't necessarily need that fractionalisation that you're talking about; some of the other asset classes might actually need it.

Eric [00:27:09] Yes and I was going to say spot on by James and add to that, I think it makes sense. If you look at the private equity market traditionally, remember we started out by talking that the interest rate regime has been very low for over a decade. GPs for raising money without having the need to conform to more onerous reporting requirements [00:27:27]as [0.0s] you move into the retail space and private equity is the largest and deepest right and so but with interest rate rising, GPs are now forced to diversify other sources of funding, which can be more stable. But again, on that note, a quick point that we should touch on quickly is liquidity, and that is as retail investors come into private market, a lot of retail investors are not prepared to lock in the money for ten years, for example and how do you build short-term liquidity buffers if you faced a sudden, you know, a swarm of retail investors panicking and wanting to sell out of those assets that are illiquid in nature. So I think liquidity profile matching will be a key consideration as we move to retail and that's the other point I would add.

James [00:28:11] Thanks, Abdel, I'll bring you in here.

Abdel [00:28:13] Yes, look, liquidity is going to be critically important to the retail investors and even when they go into open ended funds, liquidity is a challenge and all the central bankers and regulators are looking at liquidity across the system to see how, you know, the investment industry is going to manage that because it's an inherent risk that could blow up at any minute if it's not managed properly. But I think it's important to note that with all these products that are being rolled out now, disclosures in terms of the risks associated with investing in these asset classes, and that suggests they may not be prepared to lock in their money for ten years. But, you know, potentially that would lead to the growth of the secondary market where it would offer them an opportunity to sell their assets to other parties. And also, I think disclosures are going to be critically important. People know that there is limited liquidity of these assets. So they need to make sure that they only allocate a small portion of their assets into these products, because there will definitely be periods where if there is market uncertainty or a run on redemptions that there would be [00:29:26]gaining [0.0s] and so on, which is to be expected in this asset class.

James [00:29:29] This has all been really interesting and it's been a great discussion where we're coming up to time now, but I would like to just open up to any final points anyone wants to make before I close off.

James [00:29:37] Thank you, James, for having me, just in closing comments, I think as I look at the survey, the breadth and depth of the survey, the respondents are quite intriguing. I ask all of you to take a look and see what piece of information you can carve out of it, as you think about your own personal situation wherever you sit in the industry. And for me, I took it as extremely insightful. But again, as I started with just the wave of private markets really isn't slowing down in all the ways that will be deployed and all the questions and growth that we'll expect to see both in the short-term and in the long-term so thank you very much.

Eric [00:30:13] And likewise, thank you, James, for having me on this podcast, I hope it will be beneficial to whoever is listening to this. And in closing, I would say that consistent with the survey results, private markets are here to stay. In fact, I think the frequent forecasts that I've seen recently, the private markets are expected to grow about 12%, down from a 20% year-on-year growth over the last five years. Nonetheless, keeping close to $20 trillion in the next five years. I would say also as we look across the region from US to Europe to US globally, dry powder has fallen slightly, 10% to 12% but still, that's about $1.2 trillion in dry powder waiting to be deployed. And the survey results clearly suggest that allocators will continue to increase their allocation or maintain allocation in the private market so that's a long-term faith. And the short-term correction triggered by the macroeconomic environment will no doubt impact short-term investing but definitely the message is clear. We're helping our clients overcome the data challenges and to build data models that are purpose built for future generations of investments into the next 5 to 10 years. Thank you.

Abdel [00:31:25] And from my side, I think as we look at the overall macro environment, we see some challenges and some headwinds that ironically may present some opportunities in the broader market space. So the high inflation that we talked about at the start of the conversation may not be all negative for the industry. In fact, real estate, as an example, has auto escalations that kick in so it's an inflation protection. So it could potentially be favoured by certain investors as we see the turmoil in the banking industry that could potentially present an opportunity for investors and private markets participants to fill that gap and start to lend to some of the mid-market, the smaller firms that would not necessarily be now getting that funding through the banking sector. So along with the challenges come opportunities in this environment, which again will be interesting to watch over the next few years.

James [00:32:20] Thanks very much, thanks to all of you for joining me. This has been a really interesting discussion. I hope that everyone listening has found it interesting and useful. And I'd like to thank you all for joining us, too. Once again, please do check out the full paper on our website and I hope you find it as well as this discussion, useful. Goodbye.