All right, before we get started, for important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. Note that taking of photographs and the use of recording devices is not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. All right, welcome. We're into the home stretch here. Thanks for joining us at the Morgan Stanley Financials Conference and staying with us. I'm Mike Cyprys, equity analyst covering the brokers, asset managers, and exchanges for Morgan Stanley Research. With us today, we are thrilled to have with us Scott Hart, the CEO of StepStone, and Mike McCabe, the head of strategy. StepStone is a global private markets firm, providing customized investment and advisor solutions. StepStone oversees $620 billion of private market allocations, including around $138 billion of assets under management.
Scott and Mike, thanks for joining us.
Thanks for having us.
Thank you.
Appreciate you making it out here. Why don't we start off a bit on the business model? As a solution provider in the private markets, you're a bit different than the GPs that most people are familiar with here. You help provide asset owners with access to the private market. Maybe you could talk about your value proposition, how that has evolved. What's the profile of the customers that are using your services, that as opposed to going directly to the GPs themselves?
Yeah. Look, I think that's probably a good place to start today. You're right, we are a bit different than the GPs that many of us are so familiar with, in that we really work with our clients' asset owners to help them deploy and allocate, in our case, over $80 billion into the private markets asset classes on an annual basis. We do that in a couple of different ways, either by helping them to build customized portfolios that are designed to meet their specific needs through some combination of primary funds, secondary and co-investments. Or increasingly, in particular, in parts of the business, like the private wealth space, designing products that are specifically designed to meet the needs of an entire class or category of investor.
When you think about particularly our institutional clients, one of the things that we shared at our recent Investor Day, if you look at our average private equity client, they have a five person team covering private equity. That's at a time when you think about the private equity or the private market landscape more broadly, it has become increasingly global. It's become increasingly complex when you think about the proliferation of the number of strategies, sub-strategies, underlying managers. When we look at the growth and the number of managers that we have monitored in our database over time, about half the growth has come from outside of the U.S. About half the growth has come outside of traditional buyout and venture strategies.
You know, relatively small teams, resource-constrained in the sense that many of them sit in a single office location, yet being asked to cover an increasingly complex global private markets landscape. In many cases, the conclusion these clients reach, or maybe are even forced to make, is to partner with a group like StepStone. It becomes more efficient, more cost effective to leverage our resources, our 300 person plus investment team around the world, the incredible amount of data and information that we have at our fingertips.
When you think about some of the key challenges of investing in the private markets, things like access, things like information and data, the you know, the cost of investing in the private markets, where essentially things like no fee, no carry co-investments or scale-driven discounts have been the true proven ways to bring down your overall fee burden. Working with a group like StepStone makes a lot more sense than going alone.
At Investor Day last week, you announced that you are targeting to double your fee-related earnings over the next five years, which equates to about a 15% or so annual growth rate. Can you talk about your growth algorithm, and what does one have to believe in order to see that 15%?
Well, we spent quite a bit of time last Tuesday, during Investor Day, unpacking the growth algorithms that led us to the statement and the message that we delivered last week, which was that we believe that there's a clear path toward doubling our fee-related earnings over the next five years. Culturally, it's worth mentioning, we didn't come forward and set that as a target, right? As a goal, reverse engineer how to get there. Scott, Jason, and I, and other executives in the firm really characterized that kind of growth in AUM and fee-related earnings as the reward. If we do a good job with our clients and we're serving them well, they'll reward us with additional trust and additional AUM. It's really the reward, not so much the target.
We did a bottoms-up an assessment of our growth drivers, which are largely in place today. What you need to believe is two or three things. The first is the managed account part of our business, which is roughly two-thirds of the Fee-Paying AUM, is growing from three sources. The first source is we're sitting on about $16 billion of committed capital that's waiting to be deployed, and as it does get deployed, it will convert into Fee-Paying AUM, and that will happen over the next three to five years. You just need to believe that we have the investment teams and the ability to deploy the $16 billion that's already been committed.
The second thing you need to believe in our managed account business is that our clients are going to continue to re-up with us in a manner that's consistent with the past. The past has enjoyed a 90% re-up rate with our installed client base. When they do re-up, they tend to re-up with a mandate that is maybe 20%, 30% larger than the prior mandate and/or they will bring forward an opportunity to expand into other asset classes. If a mandate was in private equity, and they say, "Hey, could you do something similar for us in infrastructure, real estate, or private debt?" What you need to believe is that our clients will continue to re-up with us, and when they re-up, they'll expand.
The third part of our managed account business that you need to believe is that we'll continue to add new clients. We've demonstrated an ability to add new clients around the world each year. On the managed account front, it's about deploying capital that's already committed. It's about re-upping with existing clients and adding new clients over the next five years. The second bucket, or the second algorithm, relates to our commingled fund business. We're now sitting on over 50 unique commingled funds. What you need to believe there is that those funds that we already have established, for the most part, will grow as successor funds are launched. There's room to grow. The fund sizes that we manage are anywhere between $500 million-$3 billion.
It's not like we have 15, 20, 30 billion dollar funds. You have to believe that these guys are going to get out there and raise another $25 billion. No, these are $500 million to $3 billion. There's a lot of room for our commingled funds to grow, particularly on the institutional front. On the wealth management front, where commingled funds are also enjoying quite a bit of adoption and uptake, is our inaugural retail product called SPRIM, which is sitting at about $1.3 billion, two and a half years into its launch. Followed by our venture capital and growth equity product called SPRING. Together, we're sitting on about $1.7 billion of fee-paying capital coming from wealth management.
What you need to believe there is that we're just going to continue to enjoy the success that we've enjoyed in the past with the successor funds in the commingled space. When we combine those two growth algorithms that are already in place, you just need to believe that with growth in those areas, we'll enjoy scale economies, and there'll be some operating leverage and some margin expansion from those two growth drivers. Those are the three main growth drivers that we outlined in quite a bit of detail last week. Said differently, what you don't need to believe is that there's anything heroic going on here or anything inorganic, that you have to believe, going on here in order for us to achieve a doubling of our fee-related earnings over the next five years.
Just to dig in there, if I could, just to make sure I understand. There is a margin expansion, embedded into that expectation. Is that getting into the mid-30s, or is it just modestly above where we are today? The other piece would be, is there anything from an NCI sort of impact in terms of taking on greater ownership of the subs? Which was a question that some folks had coming out of Investor Day. Is that at all baked in? Does that impact the outcome?
Sure. As far as margins are concerned, you know, when we took the company public a couple of two, three years ago, we had set an expectation for ourselves and for investors and sell side, that we would expect to see our margins reach the mid-30s, you know, over the long term. That was three years ago. We're three years into it, we've expanded our margins by 700 basis points. We expect to see that to continue into the mid-30s over the medium to long term. We don't set a specific time frame on this, mainly because Scott and I and Jason then are constantly evaluating where we want to invest for growth versus how do we want to manage the business for profitability.
There's this put and take between managing for growth and managing for profitability, and we're always going to keep the optionality available to us and the priority on investing for growth. That will lead to the economies of scale over time. We're not going to set a specific target date, if you will, on when we reach the mid-30s for margins. As it relates to buying in the NCI, which is the ownership that our teams share with StepStone in their individual asset classes, that won't affect our FRE margins at all. Our FRE margins are already fully loaded across the platform. Where buying in NCI would impact the performance of StepStone's bottom line is in ANI, in our cash earnings.
We would expect that, as we discussed during our Investor Day, to occur over the medium to long term, and it's likely to occur through a series of exchanges in equity between StepStone Holdings and the business units themselves. It's likely to be done with equity as opposed to cash, mainly to maintain that alignment of interest and that equity ownership and that entrepreneurial spirit that has gotten us to where we are today.
Great. Appreciate all the clarification there.
You're welcome.
At Investor Day last week, you also had this, I think, interesting case study showing how you've listened to clients over the last 15 years, and that's pushed you to expand the platform a bit to meet their needs. The question is, curious what you're hearing from clients these days in terms of services and capabilities that you don't have or that you have that are maybe not as meaningful in terms of the contribution?
By far, one of our favorite slides of the entire day was a case study of one of our early clients, it really began as a private equity advisory client. Over the course of the last 13 plus years, has increased 11-fold in terms of asset management. Not only in private equity, in fact, this particular client also moved into real estate and infrastructure, and led StepStone really to make the strategic choices that we made. They came to us and said, "Hey, we love what you're doing for us in private equity. Can you repeat that for us in real estate and in infrastructure?" That created a dilemma for us. We did not have the expertise, the core competencies in those asset classes, to deliver the same value that we were able to deliver in private equity.
We went out into the market, and we brought on large, capable, veteran teams with deep track records and networks in real estate and infrastructure and in private credit. We have a listen-first mentality and a listen-first culture in the organization, and then we follow up with a customized solution. What we're hearing today is, you have a commingled fund solution in infrastructure. For smaller and mid-size investors, infrastructure typically lends itself to much larger scale asset owners. The smaller and mid-size investor is looking for ways to access infrastructure, and so we came to market late last year with an infrastructure commingled fund, specifically targeting co-investments. That's a very exciting new development that was, again, a listen first, act second.
The other thing worth noting anecdotally is the acquisition of Greenspring has led us to, again, listening first and acting second, things that we would never have been able to accomplish independently of each other. For example, Greenspring was primarily focused commercially on the commingled fund business. They really didn't have a managed account business. What has happened is, StepStone has now been able to land a number of significant managed accounts in venture capital that we otherwise would not have won with our VC and growth equity team currently in place. Vice versa, the launch of SPRING. This is the wealth management product for the accredited investor that that Greenspring would never have been able to launch without StepStone's wealth management platform.
We're seeing real synergies by listening to what the market is looking for through the combination of StepStone and Greenspring. Those are a few examples. Scott, I don't know if there's anything you wanted to add to what we're hearing from clients, but I think I covered it. That's the bulk of it.
Great. Why don't we shift and talk about the mix of your business? If you look at it today, it's about 50% in private equity and 50% in non-PE verticals: credit, infrastructure, real estate. Also we see about 70% of your fees or so are from clients overseas, which is actually a big differentiator from most of the peers out there. My question is: where do you see this mix of the business heading over the long term?
Let me start with the asset class mix, because as you just heard Mike say, there was a point in time, not that long ago, where we were 100% private equity. If you look back, that was prior to 2014. If you look at 2018, we were probably 60% private equity, and today we're 50/50. That's despite the fact that we made a sizable acquisition of Greenspring Associates, which sits within the private equity portfolio. Part of what has driven that shift is exactly what Mike described, as we went out and brought on those large, senior experienced teams to lead our efforts in real estate, infrastructure, and private credit. Those businesses have grown quite nicely over the last, you know, six to eight years.
We've laid out recently the trajectory that those businesses have been on relative to the private equity business during its first six to eight years, and has been on a remarkably similar trajectory. We would expect that, not only because they're growing off of a smaller base, but those non-private equity asset classes have been some of the faster growing parts of the market. We would expect that despite the fact private equity has continued to grow quite nicely, it will be outpaced by the real estate, infrastructure, and private credit businesses, meaning that we will have an even more balanced mix over time. We, you know, we credit those teams, those large, experienced teams, who we've created an incentive structure and alignment structure that encourages them to go out and grow and build their businesses over time.
The other thing I would add is, one of the things that we noted after kind of years six to eight in the private equity business, is that certain things do become easier over time. You reach a point where not every single separate account or commingled fund is a first-time fund. You have the benefit of re-ups. You have the ability to expand client relationships. You have a more established track record. From an asset class standpoint, we would expect even more balance over time as these other asset classes continue to grow.
From a geographic standpoint, or you could even look at the mix between separate accounts, commingled funds, and advisory, I think we like the diversification of the business, particularly at a time where there's certainly been a narrative around U.S. investors being more fully allocated and some of the growth opportunity coming from overseas. We like the fact that we've been active in these markets and have such an established client base in places like the Middle East, Asia, Latin America, Europe, for us to build upon on a go-forward basis.
We don't have targets in mind in terms of what that mix will look like, but, you know, the one thing we know, certainly after the last several years here is, you know, the world around us will continue to change, and we think that the diversified platform we've built will position us to win, in nearly any market environment.
Great. Why don't we shift and talk about fundraising? We continue to hear about a more challenging fundraising backdrop out there, just given the denominator effects and limited realization activity weighing on LP liquidity. Just from StepStone's perspective, how do you see the environment, and what does it mean just in terms of the funds that you guys have in the marketplace and the timing and appetite to bring new funds into the market?
Yeah. We see it from a couple different angles, right? We spend a lot of our time working with clients on the LP side of the table. To your point around some of the funds that we have in market or will be bringing to market, we also spend time fundraising. There's no doubt about it continues to be a challenging fundraising environment. It's not an impossible fundraising environment. I think particularly if you have strategies that are in high demand today, and to Mike's point earlier, around our current fund size, leaving room for continued growth, I think we see that things can get done in the fundraising market today, but they're taking longer than they otherwise would have.
You know, one of the comments I've often made is there's just a lack of urgency right now. You have many conversations with LPs who tell you, "I'm committed to the strategy. I plan to commit, but I wanna come into your last closing." At some point, it just becomes a game of trying to build up the momentum to get to that final closing and wrap up your fundraising so that you can move on. To your question around the funds that we have in market and those that are coming back, again, it's taking a bit longer with those that are in market, but we feel fortunate to have several strategies that are in high demand.
When you think about the sizable first closing on our real estate secondaries fund that we had recently, our private equity secondaries fund that's in market. Mike mentioned infrastructure co-investments, a number of strategies that continue to be in high demand. As for future fundraising, look, the reality is it'll be driven by when those funds are fully committed and fully invested. With the slowdown we've seen in the deployment environment, that means things have probably been pushed out slightly, but many of those funds will continue to come back to market on schedule. Again, it's certainly resulting in a scenario where our teams are spending a tremendous amount of time on the road, marketing.
We've recently brought on a new, head of business development, which we think is gonna be a great addition to the team over time here, but continuing to managing through a tough fundraising environment.
Private wealth channel, let's talk about that growing focus of yours and for many others in the industry as well. You have two products already launched and on platforms. You're seeing some really strong traction there. Maybe talk about your approach to product and distribution and why your open architecture approach you view as a differentiating feature.
I'd say product and distribution, I'd start with the product. As you can imagine, given our origins as a solutions provider, and Mike's comment around this listen first mentality, we've spent a lot of time first listening to the various different wealth channels to understand the need in the marketplace, and then think about how we can leverage the StepStone platform to create a product and a solution that meets that need. What we heard, excuse me, a few years back before we launched SPRIM, was there was a need for product that was available down to the accredited investor level, not wanting to have to deal with K-1 reporting, not wanting to have to deal with capital calls, a need for quarterly liquidity.
Importantly, because for many investors, this might be their single ticket for the private markets, you needed to have instant diversification. That's diversification across vintage years, across strategies, across certainly underlying portfolio companies, also across underlying managers. I think one of the unique aspects of StepStone's platform is the open architecture or multi-manager approach. I think it helps solve that equation I just described, whereby LPs, you know, want and need that diversification. I think when you think about the GP community, in our view, there's no single GP that is the best at everything they do, every sector, every industry, every geography, every style of investment.
One of the unique aspects that StepStone brings to the table when crafting a solution for the private wealth channel, is the ability to bring our open architecture multi-manager approach to the table. From a distribution standpoint, you know, we've continued to grow. The number of distribution partners are now on about 180 or so different platforms, and that's a number that continues to grow. We've built out a private wealth team of now over 50 professionals that are helping to lead that effort. It's certainly a channel where it takes a tremendous number of meetings and outreach, and education, all of which, with that team and with the broader StepStone platform, we are well equipped to provide.
From a product standpoint, the two products you have are both private equity oriented in the marketplace. How do you think about broadening that out further into real estate, infrastructure, credit? You know, what structures can make sense? How do you think about also providing some degree of liquidity in those asset classes?
Again, we started with SPRIM as a single ticket solution. We looked at what are some of the areas in the market where there's a need for an additional strategy or product that you know, the individual investor doesn't otherwise have access to, and where StepStone again, is well positioned to create that solution? Some of the first ones that we saw were, one, venture and growth equity, which to your point, falls within the private equity asset class. Next up, we've talked about the fact that we were on file with an infrastructure product as well, as yet another area where there is limited competition in that market today.
We, with one of the leading infrastructure platforms, feel like we are well positioned to meet that need. I think we will continue to look around the StepStone platform. Clearly, we're also active in real estate and private credit to figure out where there are opportunities for us to provide a differentiated solution for the private wealth channel. To your, to your point around being able to provide liquidity, but also the ability to manage a product that doesn't call capital over time. The important thing is that we've got a tremendous amount of deal flow, and deal flow that is actionable and allows us to line up new investment opportunities when the capital is being raised, but also build a portfolio that generates sufficient liquidity to meet potential quarterly as clients either look to rebalance or otherwise over time.
Why don't we change topics here and talk about capital management? You guys recently changed your dividend policy to have a recurring fixed dividend that grows with FRE, fee-related earnings, and also a special annual dividend that pays out the performance fee. What led you to change the policy? What's been the feedback that you've heard from your stakeholders? And, you know, what should we expect in terms of the overall payout compared to the, I think, 84% or so that you had in fiscal 2023?
Well, first and foremost, the feedback we've received from our stakeholders has been resoundingly positive. It's been we did a lot of research leading up to the decision, and there was just this growing sort of demand for how do we really learn to appreciate the performance fees part of our business. What we were experiencing was a couple of things. The first is, fee-related earnings and performance-related earnings are fairly independent cash flow streams. The former being very predictable, very steady and growing, the latter being a little less difficult, a little harder to predict, a little less a little more episodic, a little less stable. Yet, when you merge the two cash flow streams and pay out a dividend, cash will unnecessarily build, and we are a very capital-efficient business.
Having this cash build from the PRE side of the cash flow streams was becoming, you know, increasingly in focus at the board level. We hatched the concept of saying: Why don't we bifurcate the two cash flow streams and create a quarterly dividend that pays out the vast majority of our fee-related earnings, which we were paying $0.20 per share through fiscal 2023, and then augment. It's not a special dividend, it's an augmentation of a recurring dividend paid once a year, linked to our realized performance fees. Midway through last year, we announced the decision to pursue this approach, and the fourth quarter of our fiscal year, ending March 31st, was the first quarter in which we implemented the bifurcation of the two dividends.
Paying, you know, being paid out this month in June, will be two dividends: the $0.20 per share that's related to fee-related earnings, and $0.25 a share related to the accrual of what was not paid out in the 20 performance-related fees. Going forward in fiscal 2024, you can expect to see the same thing. Our intention is to pay out the vast majority of our earnings, whether it's fee-related or performance-related. The $0.20 per share that we have been paying out for the last four quarters is a good jumping off point as we head into 2024, and that will be augmented by a dividend that's paid in June of next year, as we accrue and build our realized performance fees over the next 12 months.
Great. We're gonna open up to audience Q and A in just a moment, so get your questions ready. First, let's talk about secondaries. It was mentioned throughout your Investor Day that you broadly expect market conditions to catalyze substantial deal flow activity across VC, growth equity, buyout, and also real estate. Question: Why haven't we seen it yet? What signs, if any, are you seeing that this is picking up? What catalysts might help unlock the potential for a deluge of activity?
Yeah, I mean, the reasons we're not seeing it yet, or the catalyst that will unlock it, I think, vary a little bit by asset class, you know, by asset class. Where we are seeing, the signs that lead us to say that the top of the funnel has certainly picked up pretty dramatically. If I think about our private equity secondaries funnel, saw a tremendous amount of activity in 2022, and if we were to extrapolate and look at the first five months of this year and assume similar levels of activity throughout the rest of the year, we would've seen 30%-40% increase even relative to 2022 levels.
Similarly, if I think about our venture capital business, really since Silicon Valley Bank, have seen a dramatic increase in the amount of LP secondaries on the market there. Tremendous top-of-funnel activity. We've seen less that's actually been executed on, although I think that is starting to change either as some of the markdowns in GP portfolios have started to flow through, and therefore, the discounts that one can offer are a bit more palatable to the seller, as one driver of more deal flow actually being executed upon. The other, if I think about the real estate business, I think what we're gonna need to see is some of the refinancing that we expect to come over the coming years.
Something like $500 billion of refinancing here in the U.S. in 2023, two and a half trillion dollars over the next five years. We think that's some of what is going to reset values. And as those maturities approach, you know, clearly existing owners of real estate are either going to have to sell assets, fund assets or refinance and recapitalize the assets, and I think that's particularly where our real estate secondary strategy comes into play.
Great. Do we have any questions here in the room? Just raise your hand and we'll get a microphone. We have a question right here.
Hi, thank you. I apologize if this is sort of basic, to your opening premise about what an LP might need your help with, I don't know if there's this particular asset class where you think, you know, that five-person alternatives team looking globally is most overwhelmed or most needs your help in scouring and expanding landscape. Thank you.
It's a good question. I think, l ook, I think our view would be that really across all asset classes, they need our support, but maybe for different reasons and at different times. I think certainly when you think about the number of managers in the private equity and the venture capital space, and one of the things that we had walked through at our Investor Day is just a very wide dispersion of returns between the large and mega buyout firms versus venture capital and small buyouts. The fact that much of our time is spent with our clients focused on the small and mid-market part of the market, where there's both greater reward if you get it right in terms of manager selection, but also a greater penalty if you do not.
In terms of areas that we can add value, we spend a tremendous amount of time with our private equity and venture clients, covering the thousands of underlying small, mid-market, and venture capital managers. In areas like real estate and infrastructure today, it's a bit more of a concentrated GP base, but you see many investors that are looking to, for example, go direct. In our infrastructure business, you see quite a bit of direct activity in the form of either co-investments or what we call investment partnership, where LPs are clubbing up together, and those are strategies that, you know, many clients cannot pursue on their own. Again, we see opportunities across asset classes, but maybe for slightly different reasons, in each one.
Other questions in the room? Maybe we can talk about private credit. Talk about your positioning in the marketplace for private credit, how you approach sourcing, and how you might be able to capitalize on some of the dislocation we're seeing in the banking sector.
Our positioning is pretty similar to our positioning in the other asset classes, which is that we are one of the larger allocators in the private credit space, having deployed over $30 billion over the last three years. We have one of the larger dedicated investment teams with over 70 professionals. If you think about the return profile in private credit, where it's a lower return, You know, there's capped upside. You can imagine a lot of our time is spent on deal flow, deployment, diversification, and downside protection, in the sense that we are of the view that important to generating the maximum number of investment return dollars, as opposed to maybe being IRR-focused, requires that you get and stay invested efficiently.
Important to ensuring downside, you know, protection is really diversification and having a number of sort of restrictions in place to make sure that we are investing in some of the higher quality transactions in the marketplace. The way we've tried to achieve that is similar to the rest of our business. We are active in co-investments in secondaries and primary funds. In the case of primary funds, what we've actually done in the private credit space is set up a series of separate accounts with over 40 different managers, where we've negotiated a certain amount of investment capacity. That is what helps us get and stay invested more quickly than simply deploying into private credit funds. I think that's one of the key differentiators.
I think on a go-forward basis, expect to continue to supplement that deal flow with an increasing amount of co-investment and secondary activity, which would be quite similar to what we do across the private equity, real estate, and infrastructure space. To your question on how do we capitalize on the banks pulling back, I think there's a few different things. One, we would expect to see increasing deal flow as the private credit managers step in to fill the void that is created. Two, I think the pullback of the banks and the regional banking crisis really opened up the eyes of our clients and other LPs to the private credit opportunity.
Even those that may have looked at the opportunity historically and said, "Well, is the strategy really proven and battle-tested?" I think today they see it as a massive opportunity and one that they're looking to capitalize on. I think it's an opportunity for us to work closely with those clients.
Great. We'll have to leave it there. Mike, Scott, thank you very much.
Great.
Thank you.
Thank you, Mike. Thanks, everyone.