StepStone Group Inc. (STEP) Earnings Call Transcript & Summary

Sure. So as everyone is aware, we had -- we stood up a wealth management platform from scratch just before we took the company public in 2019, brought in a seasoned team of veterans who had decades of experience in retail and wealth management in the alternative space, which was a nascent part of the market. And we were at $500 million of assets under management just 5 years ago. Now we're sitting north of $20 billion. It is real economic value for everyone. And I think the vision that we have when we stood our wealth management platform up what was that this could be a significant part of our business. And so to really forge an aligned interest between us and the team, we created basically a partnership where there would be a put-call structure such that the success of the economics could be -- would be shared between the 2 groups for a period of time. And when that period of time expired, which is this year and next year, the teams would have the option to exercise a put or a call to bring all the economics together under 1 ownership. Right now, as you know, all of the economics are consolidated but there's an NCI line that goes -- that shows the economics that flow back to the team. The next 12 months, the team has the right to put the profits interest to StepStone and if they don't exercise that put option, we have the right to call that interest in September of 2027. The way it works, it's very simple. You take a look at the prior 6 months fee-related earnings of the wealth management platform, plus the performance-related earnings, which are spread out over the last 2 years in proportion, and then there's a multiple that gets applied to that combined FRE and that multiple starts with StepStone's trading multiple and a discount is applied to that multiple and that discounted multiple then is applied to the FRE to come up with the purchase price. And if we were to take a look at StepStone share price today and its trading multiple, that discount would translate to something like 30%. And so you can imagine from an accretion math standpoint, the 30% discount plus the rate at which this business has grown from $500 million to $8-plus billion, we expect it to continue to grow going forward. The accretion math is pretty compelling. And for that reason, the question that you asked, what's the management team's intentions here but we have not heard from the wealth management team that they have any intention to exercise their put. So we're signaling to our shareholders that you should expect StepStone to call profits interest this time next year.

Okay. Great. Maybe just 1 last very high-level question on the wealth channel. So historically, we've seen the sentiment from retail investors can shift very quickly. It was the REIT several years ago. The BDCs more recently, so in your view, where are we today? Where are retail allocations? And how do you think about the next 5 to 10 years of growth in this channel?

Yes. To use the baseball analogy, we're still taking batting practice before the game, right? So yes, investor sentiment will vary from asset class to asset class, maybe from structure to structure, but this is all in a secular backdrop where the individual investor has asymptotically approaching no allocation to private. The ultra-high net worth maybe are at 5% or a bit more, but the mass affluent are much closer to 0 than that. And so this is a multiyear, I think, 5-, 10-, 15-, 20-year cycle of private market allocations coming into the individual investor portfolio. And some of that will be through product innovation, but some of it will be simply through the passage of time, education and continuing to be out there in front of advisers and individuals. And there are a couple of secular things going on that I think will continue to give that a lot of room to grow. One, we talked about SPRIM being a model portfolio. But obviously, across traditional asset management and wealth, model portfolios in general, have been thematic over the last 10 years, and I think we'll continue to be for quite some time due to a lot of different dynamics in the wealth channel. The products that we've brought to bear, so beyond SPRIM so I think the pure play of step, the pure play of cred, the pure play of struck with ticker, interval fund structures, they fit very windows model portfolio. So that's going to give us a great way to participate there. And we haven't even talked about the 401(k) market yet. And obviously, it's a $15 trillion opportunity here in the U.S. with in essence asymptotically approaching 0% allocation to private markets, and we think we're just extremely well positioned.

Well, you give you a good segue into the next couple of questions here. So you're thinking about new growth opportunities, 1 of them is the still emerging U.S. DC opportunity. I think earlier this year, you hired a head of U.S. defined contributions. Maybe talk about what this person's mandate is? And how would you describe the goals for the next 12 to 18 months? And what would you say your StepStone's key points of differentiation to compete in this market specifically?

Yes. So we brought on -- her name is [ Taylor Benson ]. She's fantastic. So [ Shadotthe Taylor ]. Really happy to have her on the team, and I've spent a ton of time working with over the last several months. Her remit is the U.S. DC market, but it's all of the different system players, right? So she's covering record keepers, She's covering wealth managers, aggregators, target date fund managers, stable value. You name it. She's talking to them per calendar. It's tough to get on to for many, very busy. The reason we're going to win in D.C. is the same reason we're winning in wealth, which is we're bringing portfolio building blocks to the market. We're not bringing a product and trying to jam it at folks. We're just bringing the building blocks to players that need them. And these multi-manager diversified portfolios, whether it be step X for private equity or stocks for infrastructure, pretax for credit. They allow a portfolio measure. So think the portfolio manager of a target date fund or the adviser who's managing an adviser managed account to pick and choose what they need incorporated into a managed portfolio, which in Target data as a glide path. They need to be able to mix and match over the different vintages of the glide path, what kind of portfolio attributes they're trying to source. We give them a very easy way to do that. And as a result, we think that we think we're just going to be very well positioned for all of this. So over the next 12 to 18 months, we will have solutions that are incorporated into U.S. DC for sure.

And what about outside the U.S.? And how would you describe the private assets and retirement opportunity ex U.S.? And similarly, what are you doing to access these markets?

Yes, look outside the United States, every country is its own country and that really matters in the DC space. It's obviously a regulated area of the economy. If you look at Australia, we've been active in the Australian DC market or superannuation plans, basically since we started the firm, right? And these represent today some of our largest clients, and we work with most of the largest superannuation managers today and have for years. Their adoption of private markets into retirement is profound. You've got the largest of the Australian supers, they have like a balanced portfolios or premix portfolios, 25 locations to private. And that's representative of really what you've seen in that market. You look to the Mexican market closer to home, the Afore is there are target date funds. And they've been using privates in their target date funds for a number of years now, and we've been the Intel inside, helping them to do that. So different geographies are at different gestation points in terms of how they're going to do it. But the direction of travel globally has been from DB to DC, and the direction of travel has been from traditional assets to a total portfolio that includes private. So our global but local staffing model. We're in 31 offices around the world. We're well positioned to be on the ground, helping people to figure out how to do this. The most recent stuff that we announced, obviously, was in the U.K. I think we talked about it a couple of quarters ago with the AVEVA Trust and really happy to be partnering with a leading group there and more to come as well.

Okay. Great. Maybe a couple of the other newer growth opportunities. So your relationships across the GP universe gives you unique access to data. Can you talk about how this has enabled you to strike partnerships with FTSE Russell, Kroll, PitchBook and what you're doing there?

As I mentioned earlier in our conversation here. StepStone is overseeing close to $1 trillion of assets around the world. And that includes data of [indiscernible] 1990s and even the late '80s as such we're tracking nearly 20,000 general partners, we're tracking 150,000 funds and unique investment opportunities in companies across the private markets. The actuary of data StepStone is unparalleled when you take a look at venture, buyout, infrastructure, real estate and credit. Now we've used this data historically to drive our investment decisions, we've also used it to attract capital, whether giving access to our databases through commingled funds commitments or managed accounts. So I think the bigger enterprise value question is how can StepStone better monetize this data platform that really is so unique and large and scaled and diversified. And we realized we couldn't do it internally. We felt we needed a partner or 2 that understands how to make data available to the broader markets in a very effective way. And on the credit side, we couldn't think of a better partner than Kroll and the timing of it couldn't be better either, Ben, given all the headlines with respect to risks or perceived risks within private credit. And so we forged a partnership with Kroll to allow LPs, GPs and service providers to take a look at low level data to really try to measure the risks that are out there rather than some of the vernacular that's been used by certain people to describe what's going on in private credit. And we're now serving hundreds of subscribers to the Kroll StepStone partnership. The next question was, and Jason mentioned this a little bit in the 401(k) in D.C. and other emerging markets, particularly in wealth, what we're seeing is a drumbeat from LPs today that is getting louder and louder. Performance is table stakes. And I don't think that, that's in question anymore. So how to measure returns, time rated versus IRR, how to measure risk, how to measure volatility, what do I own? What is it worth? So all of these questions feed into sort of governance questions that our LPs are asking themselves, how do I allocate and to which? And what's the total return of my portfolio. Not just the return of my private versus public, Oh, and by the way, there are different measurement tools used for each. These are table stakes for this asset class to continue to grow. We could not have thought of a better partner to work with in making our data available to the broader market in a very objective, independent third-party way than FTSE Russell. FTSE Russell, of course, is 1 of the leaders in indices and benchmarking and data analytics. And they've been looking for a solution provider to partner with as well on the data front to add to their suite of indices. So earlier this year, we launched a number of indices with FTSE Russell, including the Global Private Markets Index. We also have private equity. We also have real estate, infrastructure and private credit. So all the asset classes are now available on the FTSE Russell and Bloomberg terminals. And these indices provide the traditional quarterly lag returns. But we've added some technology to make those quarterly returns available on a daily basis by cash adjusting the quarterly lag number and then layering on a beta through the quarterly lag of cash adjusted to provide with a daily value. And we're starting to see the FTSE Russell StepStone partnership really be embraced by the market. And last but not least, how do we serve the GPs with the data that they're basically serving us so that they can figure out ways to slice and dice their track records and market their future products, but also really analyze how their performance is on a company by company, not fund-by-fund basis among their peer group and you couldn't think of a better partner to work with on that front than PitchBook, who has the largest and broadest access to the GP community when it comes to selling data services. So pro for credit, FTSE Russell for the broader private markets and PitchBook for the GPs in particular.

Right. And maybe just tying into the financial question. So you guys have indicated publicly several times that it's quite early. How would you frame up, say, the medium-term P&L opportunity in the indexing space? What types of early adoption from LPs are you seeing?

Well, we're pleased with the adoption rate so far. But I'm going to borrow an analog from Jason, you mentioned how the wealth management platform went from 0 to 60 in 3 seconds, it's education. And it's going to take some time for all 3 partnerships to get out into the marketplace and educate all of the various constituents who may have an interest in subscribing to these services. In the near term, we're not expecting to see much revenue growth. In the medium term, we're expecting to see adoption rates really pick up. We're not expecting to see significant subscription revenues relative to the total platform where there might be a medium or longer-term opportunity from an economic standpoint would certainly be if any of these benchmarks turn into investable indices or wrapped in some sort of asset management product you could expect to see some real economic value growth there. And I think the DC and 401(k) market is going to be needing some sort of investable index for the individual investor across your portfolios and we think StepStone as well positioned to lead that charge.

Okay, great. Just a couple of questions left here. And if there are any questions in the audience, we can open it up as well. Maybe just kind of moving to capital allocation. We talked about the NCI buy-in earlier. What else are you thinking about under the capital priority umbrella?

Well, as we've said in the past, and remind everyone each quarter, StepStone is a very capital-light business, balance sheet-light business. We don't expect that to change. And as a result, we are a high cash-generative business. The first dollar of after-tax cash flow goes back into the business for driving whatever growth opportunity that may be available. We've already touched on a few today. So the first dollar goes back into the business to drive growth. The second dollar goes back to you, our shareholders. And we have 2 dividends to support that thesis. The first is a quarterly dividend, which is tied largely to fee-related earnings, which is a very stable predictable fee stream. And the second is an annual dividend that we will pay out each June based on the Board's decision at the end of the fiscal year. What we do is we accumulate our performance fees throughout the year and we distribute our performance fees. Think of it a carried interest payment back to our shareholders in June each year. I would say the third would be M&A or some sort of transaction that provides strategic value to the firm. And we've built the business on a number of M&A transactions, the most recent 1 being the acquisition of Green Spring, which led to the spring product that Jason spent some time talking about. And whenever we've done an M&A deal, it's really been adding to something we're already doing or accelerating something that we felt was important. We feel we've built platform out geographically, asset class wise and strategy-wise. And in doing so, we've created these partnerships with each asset class and wealth management. And so I think the third dollar after distributions and investing for growth, we'll go to be buying in the NCI, the profits interest from our infrastructure, real estate, private credit and wealth management. And I think it's the safest and most reliable form of M&A you could come up with, given how we've lived and worked with these partners now for 5 to 10 years. And that's the safest form of M&A we could come up with.

Makes a lot of sense. Before I ask my last question, anything from the audience in the room? All right. Okay. Last 1 for me here. StepStone's margins have expanded pretty meaningfully over the past several years. We talked about capital priorities. Maybe like on the OpEx side, what are your other investment priorities? And how should investors be thinking about the longer-term margin profile of this business?

I remember being asked this question in 2020 when we took the company public because we were sitting at an FRE margin of like 26.5%. And the question was, well, your peers are substantially different category, do you think you could ever get there. As we sit here in 2026, we're approaching an FRE margin of close to 40%. So we've added nearly 1,200 basis points of margin expansion. I think, Ben, that speaks to the operating leverage of this business as we scale up capital. And we expect that operating leverage to be a key part of anyone's thesis in the StepStone's story. As we approach 40% FRE margins, you can see wealth management has been a big driver, given the margin profile of the wealth management products. as well as the commingled fund products because they are at a substantially higher fee rate than the managed accounts and other activities. So our view is we're sitting comfortably in the high 30s, close to 40% FRE margin. 5, 6 years after a public offering. And frankly, we don't see any constraints to seeing further upside to margin expansion. But as we've said from the very beginning, our first priority is going to go to invest in growth. And so you will see a nonlinear development of our FRE margins as we decide to invest in future activities. We have a history of putting the cart way before the horse, and I don't think that philosophy or culture of StepStone is going to change anytime soon. So that will be nonlinear, but you'll expect to see additional margin expansion as private wealth continues to grow, and we continue to add capital to a very strong foundation.

Okay. Great. We're nearly out of time, so we'll leave it there. But Mike, Jason, thank you so much for being here. Pleasure to have you.

Thanks, Ben. Thanks, everyone.