Hamilton Lane Incorporated (HLNE) Earnings Call Transcript & Summary

Good morning. I'm Mike Cyprys, Morgan Stanley's brokers and asset managers analyst. Before we get started, I've been asked to direct your attention to some important disclosures on the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions around that, you can feel free to reach out to your Morgan Stanley sales representative. So with that out of the way, welcome to our fireside chat with Hamilton Lane, and we're pleased to welcome and have with us this morning, Erik Hirsch, Hamilton Lane's Vice Chairman and Head of Strategic Initiatives. Hamilton Lane is a global asset manager, focused on the private market with about $69 billion of client assets under management and overall, over $400 billion of assets under advisement for which they exercise influence. Erik, welcome. Thanks for joining us this morning.

Mike, my pleasure. Happy to be here.

Great. So I'm going to kick off our discussion here with some questions, and then we'll leave some time towards the end for any questions that investors can submit over the web portal. So maybe starting on the asset growth side. You guys have been putting up some very strong and consistent low to mid-teens growth in fee-paying assets. How sustainable is that, would you say, over the next couple of years? And what would you say would be the downside scenario where you wake up and it’s more low or low teens or more mid-single-digit growth as opposed to the kind of low to mid-teens growth that you've been putting up?

Well, probably a good business model, if your downside is sort of single digit, high single-digit growth. So I'll take that as a compliment. Look, the firm has been around since the early '90s, '91, to be exact. And if you look at our growth over a very long time period, through multiple cycles, it has remained incredibly consistent. The market continue to expand and so does our footprint. And if you think about the fundamental reasons of why are people in this asset class, it's really 2 reasons. They're here for returns and they're here for diversification. And so in order for that to change, those -- what it's providing has to alter. So you would need to create an environment where private equity is not delivering performance that justifies its existence or for whatever reason, it's perceived to not be a diversifier in a portfolio. We think those scenarios, they haven't really come to fruition over the last sort of 30 years. And so we don't see a scenario where that's going to be true today. Even over the last several years, when the public markets have been incredibly strong on the performance, you still saw both our firm and the industry as a whole, continuing to put up pretty aggressive growth numbers. And so we think that trend has been in place and looks to be kind of continuing.

Now you've commented in the past that some of the biggest drivers of growth are the re-ups and the new clients here. So maybe first on the re-ups, I think that's driving about 70% of the new flows, particularly into the SMAs. What portion would you say here are client re-ups with you? And how have those figures evolved here?

So I think it's important to recognize why does the client re-up, and the answer really is simple math, that in private equity world, you make a commitment. That commitment eventually turns into dollars invested and ultimately, that turns into dollars that are harvested. As those dollars are harvested, you're effectively taking private equity net asset value and converting it to cash where it goes back to the client into their cash account, it's not sitting in their private equity account anymore. So that exit event has actually caused their exposure to decrease. And so since the clients want to, at a minimum, maintain exposure, if not, in many cases, increase exposure, they have to continue to redeploy that capital. And so the vast majority of these vehicles are not Evergreen in structure. So the client continually has that reinvestment decision, which they like, but then that leads to that re-up dynamic that you're referring to. So from our business model, we think this has been a powerful driver of growth. As you noted in our separate account business, those re-ups account for about 70% of the new flows. And the fact that our installed base is as large as it is, and we're still getting 30% coming from brand-new sources, says to you that from a sales perspective, our sales team is doing a really good job of going out and identifying new people. The other benefit of that re-up is that your client acquisition cost is obviously lower. They're already a customer. And so your client support team is already in place. So getting that additional tranche of capital, sort of -- there's an -- the existing fee stream is already there, and now you're basically adding another fee stream on top of that. So it's a powerful part of our business model.

And what portion would you say with you -- if you look at the existing clients, are they all re-upping with you? Certainly, they're driving 70% of the new flows. But when you think about like what portion of the existing client base re-up, is it like around over 90% or so? Any way to quantify that?

Yes. I mean it's -- we -- our re-up rate is extraordinarily high because there's no incentive -- as long as you're continuing to kind of do your job here, there's no incentive for the client to make a change. They actually have more negotiating power with you because they're, again, sort of giving you more capital to manage. So the client doesn't really want to go start from scratch with somebody else where they don't have that negotiating leverage. And what we've been seeing is the clients don't want multiple service providers. They have -- they run the risk of duplicative portfolio exposure. They run the risk then of like multiple technology systems. So the trend here has been, basically, the clients concentrating all of their dollars in the hands of a single manager, service provider, us, because that is both beneficial for them from a cost perspective, and it makes kind of their ease of management, ease of use significantly better.

Great. And just on the new clients, it sounds like that's maybe driving 30% of the new flows, but maybe if we think about new relationships that are coming on to the platform, any way to quantify about how many new relationships a year you're bringing in? What that trend has been? And can you also talk about your approach to how you're finding these new clients?

It depends on what type of client they are. So if you think about our world, we have different buckets of services. And in some cases, one client might be applicable across all buckets, but not in every instance. So if you take our technology offering, that has a sort of dedicated sales team that is out focused on investors who are looking for technology and data. And so those are relatively small check sizes. So obviously there, you're looking for higher volume. Our separate account business, those tend to be fairly large relationships, a figure that our average separate account is a couple of hundred million dollars. So by definition, that's a fairly large institution. And so that's not something that you're adding hundreds of those a year, obviously, based on the numbers. The product business has bite sizes that range from a couple hundred million dollars, which would be a very large ticket into one of our funds, down to a few million dollars. And so in a typical product, we could see 100 investors or more. And then our newest offering, which is that semi-liquid Evergreen, that is really targeting kind of more of a classic mass-affluent retail investor. There, the ticket sizes are quite small, but they're being bundled by distribution partners, primarily wealth management platforms. So there, you're dealing in much, much higher volume, again, just because the ticket sizes are so low. So different types of sales forces around the globe who are all kind of getting out there. We mostly divide by -- I mean there are some specialties among the sales team and then there's sort of a geographic focus on top of that. So one of the reasons why we have so many offices today, about 16 around the globe, is that we're trying to really be kind of on the ground local in these regions where we can build deep networks, establish brand and establish relationships.

Maybe we could shift and talk a little bit about today's backdrop in the current environment, particularly as it relates to LP client demand. Curious to hear your perspective here, if you think that they lean in more to the asset class here because of better return prospects at this point in the cycle and the history we've seen with prior vintages and crisis areas? Or do they pull back because of their own cash needs and because the realization cycle arguably has slowed, you're giving them less cash to invest back into the asset class. So how do you see these push-pull dynamics playing out? Where does this shake out?

Yes. It's a great question. And I think part of the answer is, unfortunately, it depends. And what it really depends on is what happens to the public markets from here. If we are in a completely stabilized public market environment, that is a very different scenario than if you believe that we are sort of set for another significant correction. And obviously, no one knows and there are competing sort of schools of thought on that. As we sit today, with this as the public market backdrop, we're not dealing with questions that we were frankly answering in March, which was the denominator effect, i.e., gosh, plan values have dropped because the public markets have dropped so much, what does that do to allocations? What does that do to how people think about the asset class? So today, public markets really haven't dropped much. Planned asset values are in good stable shape. So the question that investors are sort of dealing with is they know what kind of return target they're trying to achieve. And for most of them, that actuarial return target is somewhere between sort of 6% and 8%. So the question is how do they get to that? And that has to do with what they sort of view the public markets delivering them or not. And certainly, what they're experiencing right now is significant compression in return for their fixed-income assets. That we sort of already see driving sort of increased interest in private credit, things that are more yield-attractive. And I think what you start to hear is that people are concerned about the public market's ability to kind of continue to deliver. And so that interest, again, sort of tends to -- we tend as an asset class to benefit from those concerns. And Mike, to your point, yes, people have seen that in times of disruption, this has been an asset class that has outperformed. And so that certainly has some clients recognizing that pattern, believing that there will be more disruption coming, and that's causing them to kind of lean in and pivot in more.

Now you've introduced a variety of products, strategies, data technology in the private markets over the years. At this point, what would you say are the top 2 to 3 unmet needs of your clients? And how are you thinking about going about approaching that?

So we would say that today, we are -- we kind of have the full suite of products that people need and want. The focus now is scaling them. So we have a product now, certainly outside the U.S. to kind of meet the needs of that sort of retail mass-affluent investor in a semi-liquid Evergreen vehicle. But it's early days. So you've only had a chance to introduce that product to a relatively small number of people, and you're looking for that to grow. So I would say today, our focus is mostly on growth of the existing platform as opposed to, oh, there's 3 or 4 things that we need to offer that we're not currently offering. We feel like we've built out the suite, at least again, to address today's market needs. And so now it's just continuing to scale a lot of those offerings, which today, frankly, are pretty subscale, and we think that that's great because it just means that you've got a long road of growth ahead of you.

And on fee rates, arguably, you're delivering more for that same fee rate today. What incremental services would you say you're delivering that you were not delivering, say, 3 years ago? And as you look out, what additional services could you add on over the next couple of years to further enhance the value proposition?

Yes. I mean as you know, the fee rates have stayed very steady. We obviously publish that quarterly. And so that kind of blended fee rate across all of our AUM in the 3-plus years that we've been public has essentially not moved. And so -- and you're right, part of why that's happening is you're kind of working harder for the dollar. I would say most of the offering that hasn't been so much something brand-new that we were just not doing for them before, I think it's just sort of more. So if you look at our back-office technology and offering, what we're able to deliver them today in terms of granularity, real-time analytics, is just -- we were offering that 5 years ago. It wasn't as good. It wasn't as insightful. It wasn't as deep. And so you're just continuing to really expand around what they need. They want more analytics. They want more technology. Essentially, they just want to know what's going on with their investments in a highly granular, accurate and insightful way. And so anything you can do to kind of enhance that is seen as positive. And that, as you know, has been kind of one of the backbones of the themes that we talk about, which is continuing to partner, continuing to invest in the technology space, all with kind of an end goal of delivering just a better, more insightful kind of user experience. This is an asset class that is not known for its transparency. And so the more we kind of lift the veil for the customer and make them feel empowered and make them feel insightful, we believe that, that just heightens their comfort with the asset class. And as their comfort with the asset class increases, we think so too is their willingness to deploy more dollars into the asset class.

I want to shift over to expenses for just a moment. Over the past 3 years, we've seen your fee-related expenses grow about 100, 300 basis points faster than the growth in fee-related revenues, so a couple of hundred basis points negative operating leverage there. I guess would you expect a similar pace over the next couple of years? And what would be the scenario where we could see this gap narrow or even generate positive operating leverage on fee-related revenue and fee-related expenses?

Yes. If you look at the last several years around sort of just G&A broadly, I mean that trend has been -- you're absolutely right. We have certainly had meaningful growth across that category. It's been driven by a few things. Certainly, early on in that 3-year sort of period, it was driven by increased costs around kind of being a public company. Also what's flowing through there is continued sort of focus and spend on technology, where our view is that we're in kind of a growth mode. The other piece is launching some of these new products that we have, particularly, again, kind of that Evergreen vehicle takes -- there's real expense behind that, where you've got to sort of navigate the regulatory world and get those products up and running. We feel like we've now done a lot of that spend, and it's behind us. And so while I think we will continue to reinvest in the business, our expectation is not that, that sort of G&A growth is going to continue at the same rate that it has historically. In terms of more moving to kind of positive margin, I would say we have been sort of, I think, pretty consistent on this that we don't think that we're a margin story today. We think the margins are very attractive where they are. And that our first focus is, one, maintaining them. But our first focus is not trying to radically increase them. I think if you're in growth mode, which is where management -- that's where our head is, we're focused on how do we kind of make good spend to make sure that we're kind of continuing to set up runways for the future to maintain that same level of growth going forward. So whether that's new offices, new hires, new technology, new partnerships, that's kind of where our heads are around what -- where we think dollars are best deployed today.

Great. And if I could just dig in just a little bit more on the G&A side, that was up around 18% or so last year. It sounds like you're suggesting that maybe it wouldn't be growing at that level of pace. So should we expect the growth in G&A would be more tied to revenue growth? Or how should we be thinking about the growth on the G&A side from here?

Well, certainly, in this market environment, we're going to be aided by some expenses that are just going to come down whether we want them to or not. For us, most notably sort of T&E. So we historically host a lot of big events. We obviously are a fairly heavy travel-oriented company. And so we've seen T&E at a number of our offices basically go to 0. And so I think -- and that's -- while that will certainly slowly come back online as our offices are coming back online, so we've already had reopenings across some of our Asia offices. Our office in Tel Aviv is in process of coming back online. So we're seeing kind of a sort of a return slowly to a more normal operating environment. And so we'll certainly pick back up on some of that T&E. But a lot of the big international travel is going to be certainly quiet and gone for a while. So I would say, for us, we feel like, yes, we've got some visibility that, that is kind of getting trimmed back across the board.

Okay. Maybe shifting gears to some recent events here. It seems there was a big milestone achieved here in the private markets with DOL letter that came out the other week, helping address potentially some liability concerns of planned sponsors. At this point, what do you see as the remaining hurdles at this point to get private equity funds as an allocation within a broader retirement fund or target-date fund inside of 401(k)?

Yes. I think it does depend kind of on the devil's in the details here. So let's -- I'll start macro. I mean at a macro level, you've now had both the SEC and the DOL make certainly positive public comments about a desire and an interest to sort of get private markets in the hands of more investors. So at a bare minimum, that seems like a good thing to us and that we would applaud that and say, that's a positive move. I think the DOL announcement this week, more specifically, is really around target-date funds, but that ability has sort of been there in various shapes and forms for a while, but there are still a whole lot of restrictions that make kind of the practical execution of that challenged. To have more of a fulsome 401(k) participation, there needs to be, and we're now about to get out of my area of expertise here is, I need the compliance officers and all the lawyers to weigh in, but we need a variety of changes to still occur at an SEC level. So today, it's like we're not -- the 401(k) market is not kind of open for business for us or anyone that really looks like us in some big, fulsome way. I think what is open and what has continued to open and why we have that particular product is that kind of Evergreen semi-liquid that today is the easiest, most accessible way for individuals to go get access. But that sort of is step 1, and we think that's all encouraging. We think, look, when it opens, if I -- presumably, if it opens, we think we're well positioned for that. We think that investors will want diversity, which is exactly what we provide because we're a manager of managers, not a single manager ourself, and we can kind of provide access to the entirety of the private markets, something that we suspect also most investors will find desirable. And so this is a space that we're watching closely. We're optimistic. And we think that if anything actually more fully breaks open, we think we can really benefit from that.

You've mentioned this Evergreen Fund a number of times, products strategy launched in Australia and Europe. And on your most recent call, you had noted some strong success here, I think $45 million inflows in April and May, I think you had last reported. Can you talk about the fund strategy here, the types of clients that are signing up and how you've been able to structure liquidity in this product?

Sure. So the product is really designed to give people an exposure to a diversified basket of private market investments. That includes both equity and credit. And so in a product like this, you got to be very mindful about cash drag. And so we're really not utilizing primary funds to any meaningful degree because that whole unfunded and the cash drag kind of sits there. So mostly, what this is, is us, again, kind of co-investing, if you will, investing directly in businesses on to the equity and the credit side directly with our managers. In addition to that, we also can buy secondary interest. So those would be fully funded or largely funded, and so again, kind of no cash drag issue. So cash flows to us on a monthly basis from our various partners. So our sales team is going out, engaging with wealth management platforms, introducing the product, it's being vetted. And the wealth manager needs to decide whether we are worthy of being on their platform, worthy of being the product that they recommend to their clients as a way to kind of solve their access to the private market issue. And then from a liquidity standpoint, the product offers essentially monthly liquidity. And so we are mindful of that and are kind of managing cash. And obviously, with some meaningful portion of the investment in a credit-oriented strategy, we have kind of cash flow coming in regularly. But I think it's important to note what that liquidity is. It's essentially maxed out at about 5% of net asset value. So it's not an ability for all of the investors to get full liquidity on a monthly basis. It's an ability for either a very small number of investors to get total liquidity or for a larger group of investors to get partial liquidity.

And you've been also pursuing an opportunity to bring this Evergreen product to the U.S. I realize it's still early stage here. Can you talk about how you're approaching distribution in the U.S.? And what, in your view, would be the key reason why clients in the U.S. would have interest in this? And is this more targeted towards the credit investors or qualified purchasers or some other subset?

So the product and the products audience in the U.S. is going to be virtually identical to what it was outside the U.S. So then the question is, well, why did you go to the U.S. later? And the answer is simply a regulatory one. The hurdles of structuring these vehicles in the U.S. is significantly harder, higher than it is outside the U.S. And so like others who have kind of gone before us in the space, the start initially was outside the U.S. And then while you were sort of plowing through the various regulatory hurdles, we very -- that's why we sort of went public with it on the last call, we're happy that we feel like we've got more than enough kind of vision and clarity at this point to be willing to kind of put it out there that we think we're going to have this up and running in short term. The distribution will be very similar. Going to wealth management platforms, big ones and small ones. And again, introducing this offering as a way for that client base to gain access to the private markets. So again, we never really interact with the end customer. We're really selling to the wealth management platform, convincing them that we think we are kind of the right partner for them and for their customer base and hoping that they agree with us and then making us kind of their preferred -- sort of solution preferred partner.

The other initiative you have on, it would seem, the retail side is the white labeling that you have going on with distribution partners around the world. Can you just give us an update on how that's progressing and how this solution here is unique in the marketplace?

Yes. So it's -- I would say the progress has been strong. As you've heard on the past earnings calls, I mean that certainly has been a driver of that sort of product growth. Essentially, what we're finding is that a number of, again, wealth management platforms, they want a multitude of solutions. There's not kind of a one-size-fits-all, which is great for our business model since that's exactly what we sell. We don't sell a one-size-fit-all, we're a totally customized-driven organization. And so for those that want kind of a branded under their name or, again, a strategy that is selected by their investment committee, then we're the perfect partner because we can be there to actually do the execution. So those white-label funds can come to us from a partner who says, look, here's what I want you to build. We have told clients that we think there should be an overweight to either the sector or this geography or the style of investment. And so here's the parameters, here's the mandate. We're going to launch this under XYZ brand and Hamilton Lane is effectively the sub-adviser. We're then going off and doing what we normally do, which is vetting investment opportunities, picking the ones that we think are most appropriate for the mandate and then handling really all the logistics around that, legal negotiations, closing in, monitoring, reporting. And so what we're not doing in that situation is we're not incurring a sales cost because we're not the ones who are going and selling to the customer. Sometimes we'll do teach-ins for the wealth management platform for their employee base to get them educated so that they can turn around and talk to the client about what's happening. But again, that would really be no different than the way we interact with our normal clients. We do normal market calls and update calls, et cetera. So from our team's perspective, this looks and feels like a separate account because there's usually a 2- or 3- or 4-person team from the white-label partner who we square off against, just like we would with a regular customer. They're just handling the client service aspect to the underlying customers, and they're handling the distribution. So we think this is a terrific business. We think, again, it's sort of early days right now. Most of these products, they start fairly generic because they don't want to get overly specific with customers. But as this marketplace matures, what we think becomes inevitable is them offering these kinds of products in all different shapes and sizes so that you're simply not buying the private market sleeve, but you truly can buy just the European small-cap sleeve or the U.S.-based venture growth sleeve. And we think as that kind of growth happens, that just means that, that product offering for us gets further diversified and gets bigger over time.

And we're just about getting to the end here from a timing standpoint. Maybe just final question. As one of the largest investors in the private markets for many years, you've amassed a proprietary data set that has access to thousands and thousands of private market funds, trillions in assets. What insights would you say you've gleaned on the private market trends here now in response to this COVID crisis that we're in?

Well, I think we've been surprised at how quickly businesses are pivoting because we're seeing it real time. I mean we've had -- as you know, if we're invested in literally hundreds, if not thousands of funds, than the number of underlying companies that we see goes into the tens of thousands. So we've seen restaurants that heretofore have really never had kind of a takeout model or a big online presence, completely pivot their model, recover a meaningful portion of lost sales in an online environment. We have seen -- we have a gutter cover business. And apparently, one of the things that we're all getting around to doing right now with our free time is fixing our gutters that has absolutely exploded. So we've been surprised at the trends of interesting spend in some retail categories, interesting spend around some health issues and some food issues. But I would say, in general, what has surprised us is there were trends that have been in place and growing slowly. This has simply just mashed the fast-forward button in a huge way around a bunch of those initiatives and the speed at which change is occurring and people are pivoting business models has been remarkable to watch.

Great. And we're just about out of time here. Erik, thank you so much for joining us today.

Mike, my pleasure. Thanks for the opportunity.

Great. And everyone, please join us for our keynote lunch session in about 30 minutes starting at noon today. Thank you.