GCM Grosvenor Inc. (GCMG) Earnings Call Transcript & Summary

And I believe we're live. So welcome back, everyone. Thank you for joining us today. We're very pleased to have Pam Bentley, who's the CFO of GCM Grosvenor. Welcome, Pam.

Thank you. Appreciate it.

Looking forward to diving into a little bit more of the business, talking about the state of things right now. But I'd like to start with a little bit of the differentiation around GCM Grosvenor, so one of the aspects of your firm, which has been going for 50-plus years now is diverse and emerging managers, smaller managers and how that fits into, if I could, the GCM ecosystem of selecting GPs. So you were in that sense onto that initiative before it was -- well before it was cool for years and decades now. So could you talk a little bit about that and what it means to Grosvenor.

Sure. Thank you for having us here. The Grosvenor is, as you mentioned, 52 years old, and it had its origins back in the day. In the absolute return strategies, hedge funds business, right? It started out very small, quickly expanded and grew into the private market space. Really, we had our large institutional clients say we want a Grosvenor to also help us allocate to the private markets. And so we quickly expanded there. The -- so now we're covering all areas of the liquidity spectrum, right, private equity, real estate, infrastructure, credit, and the absolute return strategies business. So we were focused on diversity before diversity was the thing, it's core to our culture. It's core to our operating premise is actually -- we're one of the very few public asset managers that can proudly say we have a workforce at 60% women and diverse individuals. And really, that exists at all levels of the firm. So we're very proud of that. And we are a firm that practices what we preach in terms of really being early pioneers into the small emerging diverse manager space. We have over $20 billion of AUM in that area. And we are -- continue to grow -- or continuing to grow through that network and through the strong partnerships with those managers and with our clients.

What drove that? Was that Michael's vision as founder or yes?

Very much client demand in addition to Michael's vision. We're very heavily focused in the separately managed account business. That's our bread and butter. That's 75% of our AUM. We don't really care though whether a client wants to go through a commingled fund strategy versus an SMA, but we work very closely and collaboratively with our clients to construct a portfolio that is meeting their objectives. And we definitely have really worked with clients to bring them innovation and be able to access these small emerging diverse managers in a way that other GPs can't do. So that's been core to our strength. And it's interesting to note that if you look at the track records of our diverse manager business that the performance of our diverse managers actually outpaces the performance of our other managers across the investment verticals.

That's fantastic. You anticipated my next question because the one other of your peers that can plausibly make a claim to being a leader in impact or ESG, emphasizes that point as well that what we do with emerging and diverse managers and initiatives is non-concessionary. The returns are same or better, right?

That's right. And in our case, they've been better.

Yes. Excellent. So you mentioned the 2 main aspects of the business, the private markets and the really genesis around fund of hedge funds and what's now called absolute return strategies, which are semiliquid and subject to redemption. So fundraising is a hot topic, obviously, was challenging for all the firms that I covered last year. But I wanted to get your sense, it sounded on the last call, like maybe things were looking more positive. So just wanted to take your pulse on that right now.

Yes. Our -- I would say, certainly, in '22 and '23, right, we saw the challenging fundraising environment and continue to still see it, right? Everyone is talking about that here. The denominator effect was alive and well when markets were down in '22. That has since really corrected itself given the rebound in the public markets. So really, now you're just talking about liquidity constraints. The M&A environment continues to be depressed. The realization environment continues to be depressed. And so there -- our pipelines are larger than they've been over the last 12 months. So that's very true. So we're seeing signs of life with clients and clients do not want to miss out in this vintage of investment funds as they face re-ups with key managers and partners like ourselves. So we're seeing a very strong pipeline of re-ups with existing clients who have historically increased their allocations with us as part of those re-ups and then we're seeing continued expansion in certain client channels and investment strategies also driving fundraising, in particular, in infrastructure and credit these days. So lots of opportunity, lots of good signs of life in fundraising. Going into '24, we expect '24 to be a better year than '23, but absent any macroeconomic events, of course.

Sure. And so you feel like -- because part of the problem was, so it was client sentiment like I'm not sure if this is the vintage I want to be in, that seems to have shifted towards, yes, I don't want to miss out. And then the other issue was more of a practical constraint around allocations and the denominator effect. It sounds like that's kind of gone away as well. Is that right?

The denominator effect has lessened. It's still our clients are liquidity constrained. At the end of the day, they were used to -- they were used to getting realizations and distributions that were offsetting all of the capital calls that they were getting. And you saw that through '21 and then when the '22 market conditions hit, and we're all still considering -- seeing a slowdown in that activity. You're starting to see some large deals get announced. You're starting to see things start to unlock. You are seeing -- I mean, if you look at our -- just as an indication of health in the portfolio, as you look at our accrued carriers, almost $800 million, it's doubled since we went public in November of '20. So you see that there's a lot of future cash flow and realization events and profitable still investment realizations. There's a backlog of it, and there's a backlog of deals to get done, and they will get done. It's just a matter of time. So we should see the liquidity constraints start to relieve themselves, but we can't predict...

Not entirely there yet, but it's looking better.

The economic future. Not entirely there yet. We're not always but it's looking better.

Yes, got it. One more question on sort of flows and performance. And I do want to talk about realized carry. On the absolute return side, it looks as though the performance has been healthy, right? It's been in line with kind of your base case assumptions for performance. So just wondering how your clients have responded to that and maybe a little bit about what you've seen historically around, okay, performance gets better, what it takes 6 months or a year or whatever for clients to come back or what you've experienced there.

Yes. Our absolute return strategies business performed very well in '23, 9% average return and performed well versus peers in '23. And so we are seeing a pretty strong pipeline, an improvement in pipeline from past years in that business. But it would be -- I still think we expect growth in that segment, but most of the growth is going to come from compounding of returns as opposed to flows.

Got it.

I think that, again, as clients are liquidity-constrained themselves improving flows to hedge funds is difficult right now despite performance. And when the interest rate environment where it is and yields where they are, is that where they're going to really increase their allocation given their liquidity constraints. So maybe we are seeing -- like I said, we are seeing signs of life, and we're seeing a strong pipeline there, but it's a little too early to tell if we're out of the woods.

Fair enough. I will actually shift to talk a little bit about the mix shift at GCM Grosvenor because one of the concerns I, sometimes, get from clients is that ARS is a high fee business. And uh-oh, if that's not growing as fast as private markets, maybe there's an issue. But in general, the shift to private markets can be favorable as well as a little bit more of a shift towards direct investing. So talk about that in terms of the fee mix.

Yes. So we like to say we have kind of a double mix shift happening that's driving our earnings growth. So first of all, I'll say, our AUM of the business has shifted to be over 70% private markets. And so that means our ARS business is less than 30% of our total AUM at this point.

It was roughly 50-50...

It was roughly -- at the time of the IPO, it was just -- our private markets was just under 60%. So we're seeing a shift. We're definitely seeing a shift to the private market space as we continue to raise more capital there and see growth in those assets. So I expect that to continue to be the case. And that obviously continues to drive fee-related earnings and fee stability, right? It's a visible revenue stream.

Of blocked capital...

Exactly. Exactly. So on the flip side, and then if you focus it within private markets, we have primary, secondary co-investment and direct strategies. In the past, we had a higher proportion of our AUM in primary that is shifting. Most of the capital we're raising is in higher fee strategies. Over 60% of the capital we raised in private markets is in co-investment secondaries and direct strategies, which have a higher fee component than our historical primaries business. And so we are seeing a shift to those higher fee strategies. We're able to do it with scale, which is driving operating margin and to leverage existing infrastructure to service more assets. And so it's a really nice kind of effect that we're seeing this mix shift in our earnings growth.

Accretive to fee rate, yes. And it's interesting that you mentioned co-invest because I know that's very popular with your clients and others and sometimes thought of is, "oh, okay, well, isn't that free or whatever", but Grosvenor has been able to structure client accounts such that it's actually profitable and accretive, right?

Absolutely. So we have a very -- we have proprietary access to a whole host of upper quartile, small, emerging and middle-market GPs. So we have access, proprietary access to a world that a lot of our clients can't access themselves. That said, we have negotiated favorable terms with all of those managers, and we have a lot of co-investment deal flow that we can provide to our clients through all this proprietary access. So we absolutely drive -- can help clients get from a 2 and 20 fee structure to more of a 1 in 10 fee structure by giving them the fee-accretive co-investment alongside their primary and secondary strategies. So it's absolutely an area that are -- we're seeing more demand from our clients and we'll continue to see in the future.

Is that generally just to get into some of the mechanics of it, is it broad allocation to Grosvenor to like a separate account. And then, okay, we're expecting ex much co-invest over certain years? Or are there numbers around those different sleeves.

In terms of how we construct a client portfolio?

Exactly.

It really is up to the clients, right? It's what are they looking to achieve? What are their diversification objectives. We certainly work with clients to show them the different options that they have or -- and what the return profile looks like. But it really is about what is their overall -- what are their risk tolerances and objectives, investment objectives and where as they look at their overall portfolios across all of the firms they invest with where are they really looking to get more opportunity and more exposure.

Exposure with Grosvenor.

That's exactly right.

That makes sense. Okay. I wanted to ask, you talked about private credit, you talked about infrastructure, which are both growth areas from a product or asset class perspective. But I wanted to ask about channels. One of the things that we've heard at the conference so far is that even firms that are sort of mentally associated with private equity and buyouts and whatever, they're almost all saying to us, well, the growth channel is insurance and the growth channel is retail. So -- and I know Grosvenor is active in both those areas. So tell us about that.

Yes. Starting with insurance, starting several years ago, we invested in making sure we had insurance experts brought on to the team to, again, focus on the very fragmented insurance market and make sure that we hire people that are very well-versed and obviously, all the -- in the investment portfolio construction, regulatory capital requirements, but we've not jumped into the acquisition bandwagon of actually becoming an insurance company and underwriting policies. We're focused on hopefully serving that very underserved group in helping them increase their alt allocation for higher returns through that kind of small mid-market insurance channel, although we do have some large institutions as well. That group has been very successful so far. We raised more capital from insurance clients over the last 3 years than in many of the years prior and we're getting creative with the clients given our -- given these people's expertise in that industry to construct investment options that work within the regulatory framework. And so we do see a lot of demand, a lot of opportunities to help the insurance market increase their allocation to alts. So very focused continuing to grow there.

If you could give us a sense of the build of capabilities toward that. You mentioned hiring people with expertise. Where was the peak of that hiring or has it yet peaked? And how much work was required behind the scenes, particularly to develop the kind of products that were suitable for insurance clients.

Sure. Continuing to invest there, but we were one of the first firms to launch a collateralized fund obligation structure with rated notes that allow insurance companies to get access to the private markets, but through a rated credit instrument. So we were one of the first to kind of enter that space. But we are working with a lot of large institutional insurance companies on separately managed customized accounts where they are able to have a small percentage of their asset class allocated. I think we'll see some more of that given the credit opportunity that we'll switch to here in a second, I think we'll see some more opportunities with our insurance clients through really customizing to their objectives and more innovation there. We'll continue to invest in that space.

I guess it's natural to think about Grosvenor being part of the insurance company alts allocation, right? But I was just wondering certain notable peers that you have talk about fixed income replacement and investment-grade credit. Is Grosvenor participating in that as well?

Absolutely. Certainly, again, as I mentioned, we're one of the very -- in the beginning. We're one of the very few alts that can access investments across the liquidity spectrum. It's one of the benefits of having the ARS business is being able to structure products like the CFO product and manage the liquidity solutions within those products. And so, yes, absolutely, we are working with clients to construct a portfolio again to their -- that meets their needs and objectives that kind of can give them fixed income exposure as well.

Got it. Makes sense. That's good. So turning to retail, which I mentioned before. Just give us a sense of how Grosvenor is approaching that market. You've begun to develop some products around that, which is -- we have had some success. And then also how you're approaching the channel, there's sort of wirehouses, independent broker dealers, some folks are even doing like a tech-enabled retail. Where do you stand on those?

Sure. Early days, huge opportunity as everyone at the conference was talking about a multitrillion dollar opportunity there. We have been successful in placing our products historically and recently with wirehouses. And so there is strong demand in what would have been the more traditional retail channels for alts. However, all the product innovation that's going on across the peer group to look at interval funds and other various fund technology to really get private assets in the hands of retail investors. Obviously, the industry has made a lot of investments. We have been a little bit -- we've been a little bit, I think, quieter on the investments we're making in that space, and we'll have more to talk about this year as we get through the year, but we're continuing to look at partnerships in placing some of our products, looking at various distribution partnerships and continuing to invest in the business organically to also build our distribution capability. This is going to be a game of all about sales force training and really helping the more traditional players really understand the alts.

What's your view on what I would call sort of tech or digital-enabled retail channel access? Is that something where Grosvenor would look to place products or maybe stick with a more institutional buyer framework.

I think that there is nothing off the table. And again, we're really looking to partner and build in all of these areas. So we have more to come.

Excellent. Sounds good. So we've talked about fee rate and fee mix and kind of touched on the margin implications of that. But I wanted to get your sense of the margin outlook, operating leverage, I mean, some firms talk about relative levels of margin, which I think is important, but operating leverage and a clear trajectory on that is also important. So how should we think about kind of expense growth, assuming times get better over the longer horizon, 3 to 5 years? And what might drive that in terms of investing in the firm.

Sure. We started our FRE margin when we first went public was in the low 30s. This past year, we finished at 38%. We're continuing...

Which was not a very long time.

No, right.

B2B.

Yes, exactly, exactly, a little less than 3.5 years. And we're continuing to focus on scalable top line growth. We have a very scalable infrastructure we built, even though we are -- we run highly customized portfolios for our clients, we are able to do it at scale and have really developed the operational expertise to do that. And we actually work to help many of our small and emerging managers in how they set up their firms and how they operate as well as one of the values that the small emerging manager set has in partnering with a firm like Grosvenor is that we use our operational prowess to teach them. So we really do see the ability to raise that next dollar of capital in our -- especially in our existing channels without much infrastructure investment and continuing to drive operating margin expansion there. On the flip side, we see -- I'll switch a little bit again to our embedded future incentive fee revenue growth, our carry and our performance fees from ARS. Our carried interest is -- has doubled since going public, right? And again, not that long ago. And we still have a lot of what we would call carry dollars at work or dollars we've raised from clients that have -- that are just now getting deployed, right? So carry hasn't even been generated on those assets.

They're eligible, right?

Right. So there's future growth in that kind of accrued carry number when the -- so that really does allow us to look at our compensation strategy. I think since going public, we've really looked at not just managing our operating expenses, but looking at our compensation strategy and making sure, first and foremost, that we're maintaining the culture of the firm and retaining our key people, but making sure that our senior folks, their compensation is really aligned to performance of the funds and that they're sharing more in the incentive fee revenues that, frankly, this -- the investors still don't -- I don't know why, but still don't seem to value enough.

Agreed. Fair enough.

I know Adam agrees, but -- but we certainly want to make sure our senior professionals are aligned with the performance of the funds there, managing in our incentive fee compensation structures. And then similarly, we're other tools at our disposal to make sure we're including stock compensation to make sure that we're very well aligned with shareholder and stock price appreciation and value growth. So there is more room for operating leverage to expand our fee-related earnings margins as we -- while maintaining the very strong culture of the firm that we have. And so we said on our earnings call a couple of weeks ago that we expect our margins to be in the low 40s in the very short term and that we hopefully will move towards doubling our fee-related earnings over the next 5 years.

Impressive. Yes, I mean, you touched on a couple of things I want to follow up on. One is realized carry, which I said before that I'd asked about. So just to be clear, Grosvenor earns the private markets realized carry that's in some ways conventional for the alternatives space, at least the public alts, but then also incentives around the ARS strategies, which is more like a hedge fund construct, where it's more of an annual crystallization but can be meaningful as well, right?

That's right. On our -- on the absolute return strategies business, assuming our normal assumed rates of return, which is 8% for multi-strategy investments and 10% for opportunistic funds. We -- assuming that run rate of return, our embedded annual performance fees would be around $28 million for 2024. So that's kind of the information that we talk about on our earnings call. So that's obviously on top of what we expect on the carried interest side. Given the muted realization environment, our -- the carried interest distributions and realizations have been lower this past year of '23 for all of the alts lower than it had been in a decade. So there is significant future earnings and future cash flows embedded in that accrued carried interest number and the carry dollars at work. And so we continue to see adjusted net income, you're going to see substantial adjusted net income growth in the future as the realization environment improves.

Sure. And it leads to a discussion, a little bit about capital, and I've asked this of other firms as well as assuming the accruals and the pent-up carried interest and other incentives start to really materialize and monetize -- asked the question, I think, of Grosvenor, okay, here's some capital. What can we do with this? So I want to get your thoughts on allocation of capital share repurchases, and I know the float is a consideration as well. And also some of the minority interest that you have, one of your peers recently announced an initiative to really buy down the minority interest. So just wondering where Grosvenor stands on that as well.

Sure. I think we look at our priorities to return capital to shareholders. And we are very focused on -- we're focused on one -- or obviously, we believe in the company. We've had and continue to have a large stock buyback program in place to really help us manage any dilution from any of our compensation strategies or otherwise. And so we continue to believe our stock is undervalued and is the best way we can use our capital right now in terms of our capital allocation philosophy. From a leverage perspective, we are very comfortable with our leverage, especially given our growth trajectory, so we're very comfortable with our leverage level. We're hedged -- 75% hedged on our debt tenure of 2028. So we feel pretty comfortable there right now where we're at. Continue to obviously see a lot of organic growth in the business and expect to be able to increase our dividend over time based on embedded cash flows -- future cash flows in the business. And then we'll continue to look opportunistically at inorganic activity to help us -- we look at our capital structure and obviously, they continue to expand in either geographic channels or product verticals where we may be subscale right now. So we're continuing to look at those opportunities as well in terms of our capital allocation.

Speaking of product expansion, one of the things that's come up in discussion so far has been seed capital. And that's -- for a balance sheet like alternative or traditional asset manager, one of the main uses of capital is to seed new funds. And in particular, in the retail channel, folks have made the point to me directly that UBS won't consider funds unless there's a certain scale or whatever and that takes seed capital. Is your need for seed capital increasing?

Yes. So Grosvenor's history actually, even in the absolute return strategies business goes back to seeding managers. And not only obviously making an equity investment in those managers, but also potentially revenue share through some sort of a joint venture. We have a long history in again, small emerging managers, seeding managers. Last year, we also announced a product called Elevate, which is a GP seeding product for private equity buyout firms and that fund has made its first investment this past year and continuing to raise capital for that strategy. And so we see definitely continued demand there. We see a lot of it in the real estate space, so seeding real estate managers in the areas that people are chasing from a demographic trend perspective. So we see a lot of opportunities there. We see it a bit in terms of the infrastructure space. And again, seeing a lot of it in the more traditional private equity space that has more individual spinout from large GPs.

Makes sense. I have more questions, but one the features of the conference is that folks here in the room are able to scan the QR code on your screens and either text the question to this iPad here, which I managed not to kick off the stage yet or on a more old school basis, you can just raise your hand and a microphone will come to you. So I'm scanning -- the lights are quite bright, but I'm scanning out in the audience for questions. And I'm not seeing any right now. So you'll have another opportunity in a few minutes. So we started in some ways with culture talking about small and emerging managers and diverse managers and Grosvenor support for those. So the question, I guess, is how -- what aspects of the positive culture you feel are most distinct? How do you maintain those and to get a little bit nitty-gritty, how are incentives within Grosvenor structured so that it supports collaboration.

Absolutely. I joined the firm in October of '20 to obviously help it go public in November '20. I came to the firm from over 15 years at the Carlyle Group, and I was not looking to leave Carlyle. I was -- Carlyle is a great firm, still have a lot of friends there. When Michael and Jon had reached out to me, they -- and I had the opportunity to meet many of the other senior professionals at Grosvenor. I was struck by its culture. It is an inclusive, collaborative culture, really no sharp elbows. And that's also how we work with our clients. We are, again, used to offering a highly customized products product and making sure our clients are that we're achieving, first and foremost, obviously, their return objectives when they win, we win. And then secondarily, that frankly, they think we're good partners and an extension of them. And we're embedded in their business. And we treat all of our internal professionals as professionals. It's an amazingly employee-friendly culture and Michael always says the most important assets ride up and down the elevator every day. I think post-COVID, I don't think we'd say every day anymore.

Right.

That is how we feel. I would say additionally, it is an incredibly diverse and inclusive culture. Over 6 -- it's not widely focused on, but over 60% of the firm is women and diverse employees, something we're very proud of. And so we're practicing what we preach in terms of making investments in diverse and emerging managers as well as being a diverse firm ourselves. And it has been a pleasure to be there, and I'm glad I made the change. I miss my Carlyle friends. And I'm super thankful for everything I learned there. And -- but I will say that it continues to be a joy to go to work every day at Grosvenor. In terms of maintaining culture while being public, that's hard for everyone that goes public, right? It is a transition for employees. They've handled it very well. Again, and we continue to make sure our compensation strategy is articulated and that it is clear how their financial interests are aligned to clients and then secondarily or equally to shareholders. And so...

And to each other, I guess, to the extent that you have...

And to each other, yes. Like I said, it's a great place to be and everybody really does work well together and help each other out. Our investment verticals are all working with each other. Our BD professionals are cross collaborating on clients. You don't hear a lot of breakdown in communications across the platform. And I hope that's something we can continue to maintain and to the benefit of our clients.

Absolutely. I appreciate the personal story because we all -- we all are interested in companies and interested in stocks, but I don't know anyone who's not interested in their own personal career. And for you to have made that move and be more than satisfied with it and with the culture of Grosvenor speaks extremely highly. So I appreciate that. In the couple of minutes that we have left, we've talked about sort of more near-term fundraising considerations, margin considerations. As you look out 3 to 5 years, how do you see the strategy of Grosvenor evolving? And what is the vision of the firm for the longer term?

Sure. As I mentioned a bit ago on -- obviously see margin improvement and hoping to double our FRE. Over the next 5 years, we said, how are we going to do that? We're going to continue to please our clients. So first and foremost, we're going to have strong re-ups with our existing clients, hopefully, at larger account sizes, and that's going to continue to fuel us as it has in the past. We're going to continue to expand in various client channels, like we talked about different geographies, insurance, retail we're going to continue to innovate there. We're going to innovate in the product set, right? We're going to focus on continued expansion of infrastructure, real estate, credit and GP seeding, GP stakes and taking revenue share in business. So we're going to continue to organically grow and invest in the business. And then there's always hopefully some inorganic opportunities out there that makes sense. We always say, first and foremost, it has to be the right cultural fit. And secondarily, it has to be a team of people that want to invest into the business in the long term and take a stake in the business with us. So we're very focused on the right inorganic opportunities that fit the channels that we're looking to expand in.

Excellent. That's a good summary and a wrap up, I think, of our discussion. So I appreciate that. The fireside that I did before this one, the clock actually ran out and I wasn't even sure if we were broadcasting on the web anymore. So you'll forgive me for being a bit skittish, giving into the tyranny of the clock I'd like to thank everyone for joining us this morning, and I hope you'll thank -- join me in thanking Pam Bentley from Grosvenor.

Thank you for having us.