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

Good afternoon, everyone. Welcome back to Morgan Stanley's Financials Conference. I'm Mike Cyprys, Equity Analyst covering brokers, asset managers and exchanges for Morgan Stanley Research. Welcome to our fireside chat with StepStone Group. We're excited to have with us today Scott Hart, Partner and Co-CEO of StepStone and Michael McCabe, Partner and Head of Strategy. StepStone is a global private markets firm providing customized investment solutions and adviser solutions. StepStone overseas over $420 billion in client assets in terms of AUM and AUA, assets under advisement with about $86 billion of assets under management. Scott and Mike, thanks so much for joining us today.

Hey, Mike, thanks for having us.

Great. So I'll kick off the discussion, and we'll see if we have time towards the end for any investor questions that can be submitted over the web.

So why don't we start big picture. You guys went public late last year. Maybe for those that are a little bit less familiar with the StepStone story, if you could just give us a quick overview of what StepStone does and how your offering is different from other private market GPs and private market consultants?

Sure. Thanks, Mike. So StepStone is a leading global private markets investment firm focused on providing customized solutions for our clients. But I think it's worth spending a minute on what do we mean when we talk about being a solutions provider in the private markets. And in our case, what we're generally referring to is that we work with our clients to build portfolios that are tailored to meet their specific needs. And that was really a founding principle of the firm in recognition of the fact that different clients have very different needs, particularly as the private markets have grown in size and complexity over time. And so therefore, in order to address a wide variety of different needs or challenges that those clients face, we assess their need to have a comprehensive toolbox. So maybe we spend a few minutes on what that toolbox looks like today. We are active across all main asset class within the private markets, private equity, infrastructure, real estate and private debt. Within each of those asset class, we tend through invest through 3 main investment strategies, those being primary fund investments, co-investments directly into companies alongside of our fund managers and secondary transactions. And we really think that these strategies are synergistic, both because of some of the portfolio management benefits that they offer. And because that there are significant sourcing and due diligence benefits associated with being active across each of these strategies. And then finally, as we think about the toolbox, these investments I've just described can really be packaged into a few different types of structures, whether separately managed accounts that are designed specifically for a single client, that's our largest part of our business today, both from fee-earning AUM and from a revenue standpoint, commingled funds or advisory relationships with our clients. So that's really the StepStone toolbox as it stands today. I think the one other point I would make in terms of helping understand what it means to be a solutions provider is to spend a minute on where we sit in the private markets ecosystem. And where we sit is in between our clients, the limited partners and the fund managers or GPs. And what we do is we help to facilitate or enable the commitment of over $50 billion into the private markets on an annual basis. For our clients who are oftentimes resource constrained, but are trying to cover increasingly complex and increasing global private markets' landscape, that's an incredibly valuable service that we offer. For the GPs or fund managers, given our scale and given the quality of our client base, we're an incredibly large and important partner of theirs. And then finally, for StepStone and for our investors, what it creates is a flywheel effect, whereby the more clients we work with, the more GP relationships we have. That leads to more information and deal flow. If we take advantage of that information, deal flow, it helps to better investment decisions and better returns. And thereby, attract additional clients and kind of keeps the flywheel turning, if you will. So that's a bit of what we mean when we talk about being a solutions provider.

And how would you say you differentiate against other solution providers that are out there in the marketplace?

Yes. So I mean if you think back to that toolbox I described, we often describe the business as having 12 boxes, meaning the 4 different asset classes, the 3 different strategies. And what I would say is that within any 1 of those 12 boxes, there are certainly other competitors, whether those are advisory firms, whether those are fund-of-funds businesses or whether those are other solutions providers like ourselves. And the way I would generally describe it is there are competitors in any 1 of those individual 12 boxes. But there are a few that play across all 12 of those boxes. And there are few that play across those 12 boxes at the scale that we play today. That probably leads me a little bit to the decision and the thought process in terms of how we came to operate across the entirety of the private markets, we got our start back in 2007 as a private equity-focused firm. But overtime, added capabilities in real estate, infrastructure and private debt. And I think it shed some light on how we've made strategic decisions over time. And part of that is by listening to what we're hearing from our clients. And what we started to hear from clients a number of years ago, look StepStone, we love what you've done for some private equity. We're trying to find similar solutions in the real estate or the infrastructure market where we hear from a different subset of clients that -- look, we're looking for a single strategic relationship across the entirety of the private markets, not 4 different partners in each of the asset classes, how can you help me address that need. And so as we took that feedback on as we thought about the platform we had built, it became pretty clear to us that there was a real opportunity to replicate that success we've had in private equity across the private markets. But because those conversations we're starting with our existing clients, it was incredibly important that we offer the same high level of quality in each of those asset classes. And so what that led us to do is really go out and identify and bring in-house large experienced team that had spent their entire careers operating these asset classes. And we're proud to say over the last 7, 8, years that have really driven that forward. We've gone from a business that was 100% private equity AUM 7 or 8 years ago, it's now about 50% private equity and 50% spread across the remaining asset classes. And so I think that's an important differentiator is again, our ability to play across the 12 boxes at scale in the private markets.

And what would you say are the primary drivers of your growth?

Thanks, Mike. This is Mike McCabe. I think the 3 primary drivers that I would identify and talk through here would sort of overlap a little bit with what Scott had mentioned. And the first is asset classes. The second is location where we decided to set up shop and third is data and technology. When we think about asset class, as Scott mentioned, we have large dedicated teams in private equity, which includes venture capital, real estate, infrastructure and private credit. Each team has really deep track records and seasoned professionals And they can work across clients throughout their portfolios. What we're seeing is growth in any 1 of the 4 asset classes picking up as market conditions ebb and flow. So for example, in the past 12 months, we saw our private debt platform saw almost a 65% increase in fee-earning AUM, why? Because the rates and yields have been fairly resilient within our structures. So in any given year, we expect to see 1 or more asset class benefit in some way from market conditions, and we expect that to continue to be a source of growth. Dial the clock back 7 years, as Scott mentioned, we were really a PE-focused firm. So that's been a big, big source of growth for us. I think the second is location. We've decided strategically from the very early days of the organization to set up offices throughout the world in regions where we see new pools of capital coming online for the first time as allocations to the private markets are increasing from as little as 0 to small single digits to double digits. And so we intentionally build out a global footprint and that has resulted again in the last 12 months, something like 90% of our gross new AUM came from markets outside of the U.S. And that is -- that continues to be a driver of growth for us. And the really critical thing here, Mike, is making sure that our investment teams are located in those markets, working with those clients rather than trying to develop solutions remotely from some headquarters here in the U.S. And then the last driver of growth that I would spend a minute on is data and technology. Look, we're using data and technology as a way to win new business by offering technology solutions as a value-added complement to something we're already doing with them or creating new relationships that are database that clients are looking to get a better handle of what they own and what it's worth and how they can evolve what they own or something they do want to own. And so data and technology has been a really powerful way for us to win new business but expand existing relationships into adjacent areas as well.

You mentioned the global footprint. Maybe we could dig into that a little bit more. Can you talk about your geographic mix? And which areas would you say are most prime for growth?

Yes. We pretty much have the globe covered and we have large teams spread out throughout the world. What we've enjoyed seeing is, in the past year, an uptick in Europe activities. We've seen a large pool of capital, large pools of capital coming online for the first time in the Middle East. And surprisingly, what's been quiet over the last, say, 10 to 15 years has been Latin America. We're seeing flows from Latin America really start to pick up into the private market. So I would say Europe, the Middle East and Latin America are pretty exciting. Asia has been and continues to be a very strong source of capital flows for StepStone, and we expect that to continue to grow as well.

Great. And retail is a part of the industry that's getting a lot more attention. You guys certainly have some initiatives there. Maybe you could talk a little bit about your existing presence in the retail market, how that's evolving? And how big is the opportunity set that you see?

Yes. Well, maybe I'll start with the second part of your question first. And I think the answer there is look, we think the opportunity is significant. And I think part of that is driven by the fact that when we look at the high net worth or the mass affluent part of the market, it is a sizable part of the market. But it's also the part of the market that is probably most underallocated both relative to other investor types, but also relative to where we think those allocations will go over time. And so I think when you look at the growth forecast for the private markets, I think we certainly expect to see private markets growing high single-digit, low double-digit type growth rate. But when you look at the combination of growth in the high net worth space, plus those increasing allocations, I think there's an above-market average growth opportunity available to us there. If we step back and think about our presence in the market and maybe starting with sort of the individual investor market broadly defined to include defined contribution plans, private wealth, the management platforms, family offices, Yes, that actually represents about 20% of our management advisory fees today. Those are parts of the market that we've now been active in for over the last 10 years, and have really focused on developing solutions that are tailored for each of those individual client types. So for example, again, we have focused on the defined contribution space, not so much in the U.S. today, but overseas, it's been an active area for us. Really developing separate account-type solutions with a long-term view for different client types such as Australian superannuation funds or the Mexican AFOREs. And so that has been an active part of our business for a number of years. And it's also starting to inform how we think about the potential U.S. target date opportunity. We've certainly offered and distributed our commingled funds, to family office and high net worth or ultra-high net worth individuals historically. We have created customized white label solutions for a variety of wealth management platforms, both in the U.S. and abroad. And we have powered multiple registered 40 Act perpetual funds that are available to a credit investors in the U.S. totaling over $500 million of NAV today. So that's a bit of where we have played historically. If I think about some of our more recent initiatives, that being the Conversus platform that we've launched and the CPRIM product, in particular, I sort of step back and kind of go back to some of the comments I talked about earlier around who is developing solutions that are specifically designed to meet the needs of a certain client or client type. And I'd say we approach this part of the market in a very similar way, spending a lot of time listening to the challenges that were faced, listening to the needs of those investors before developing our solution. And what we heard was clearly challenges around minimum investment size is about the ability to develop a diversified portfolio when you may only have a small number of investments or tickets to write K-1 reporting as opposed to 1099 dealing with capital costs. There's a number of different challenges for the high net worth community investing in private markets. And so we really looked to develop a solution that being our CPRIM product that addressed many of these. It is a single ticket solution that builds diversified exposure across asset classes and across strategies. It's available down to the credit investor part of the market, which we think is the widest part of the pyramid and a bit differentiated relative to some of the other products in the marketplace here. So again, try to take that same mentality of being a solutions provider when developing our solution for this part of the market.

And how should we think about the longevity of your clients' capital commitments as we look across the different clients and the different product types that you have?

They're largely very similar in terms of the duration of our relationships. As many of you know, the contractual nature of the private equity industry, infrastructure, real estate and private credit come in the form of partnerships. And these partnerships are 10-years-plus long in nature. And when we look at how that translates into our revenue model, it's effectively a recurring revenue model, not like -- unlike you see in the SaaS industry. So for example, we have -- our management fees are running at nearly 80% of which have a remaining tenure of say 3 years, and 58% have a tenure of more than 7 years. That just creates a predictive power for our recurring revenue that is all contractually memorialized in these partnership agreements, whether it's a managed account or whether it's a commingle fund. So our relationships are incredibly sticky. They're legally contractual, but they're also very much trust based. And given the long-term nature of these relationships, they often tend to span multiple cycles. And so it really is not just a contractual long-term durable relationship, it's also based on trust performance and discontinued growth.

One of the other things that's differentiated, I think, with StepStone is the technology capabilities that you guys have. Can you just talk a little bit about the technology and the data and how you think this differentiates you versus peers?

Sure. Look, we decided very early on that technology would become a core part of our business strategy. And so we basically sought out to control our destiny there. And we tried using third-party vendors, ultimately got frustrated because of the lack of flexibility to customize data that our clients are using. And so at the moment, we've created 4 very powerful technologies. The first is called SPI. SPI is our front-end decision-making tool, visualize the entire investment funnel from all the opportunities that come in the top, all the diligence that goes on and then ultimately, the decision that's made. That entire funnel is digitized and captured in a technology that is used across the firm 24/7, 365, and in some cases, utilized by our clients as well. The second technology is called OMNI. Think about once a limited partner makes a commitment to a fund or makes an investment, that goes to the back office, which monitors, tracks, analyzes, slices and dices the existing investments that are owned. So think about OMNI as our back-end monitoring and reporting tool. Again, there are third-party solutions out there. We've tried pretty much most of them, again, trying to customize a reporting package for our clients required us to take matters in our own hands. And so we've developed our own technology there. The third is a pacing tool. Pacing is always a bit of an elusive activity for people in the private markets, why, how to predict the time at which capital calls happen, the time at which distributions happen. How to think about the evolution of net asset value, how to think about unfunded commitments. All of those variables are captured in a technology that we've created to help our investment teams, portfolio managers and clients optimize their portfolios. So the pacing model is now live, ready and being used real time through an interface online with our teams and our clients. And then the fourth and most recent technology, which is pretty exciting, ties back to something Scott had mentioned with respect to the retail strategy. One of the challenges with the retail strategy and having a liquidity feature in those products is how do we think about the daily value of the holdings? Private markets typically report on a quarterly basis, it's usually lag. And so there's a quite a bit of an inefficient source when it comes to data and valuation. What we've created is a daily valuation engine that's now being used for our more liquid solutions in the retail space. And this will provide a daily mark for private investments rather than waiting on a quarter on a lag basis. It's a large investment team that we've made in a data science and engineering team, but the speed of evolution across this suite of products has been really impressive. Some of our peers have decided either outsource or JV, they seem to work well. Ultimately, we feel long term, controlling our destiny when it comes to data and technology is really strategic.

Maybe just digging in a little bit on the client side. Can you talk a little bit about your client mix, how that looks and how you go about tailoring your solutions to meet their needs?

So it's a diversified mix of clients today and pretty well balanced across a number of different client types. And so I talked about the 20% of the business that comes from private well-defined contribution of family office clients. And just over 40% of the business today is public pension clients, both here in the U.S. as well as internationally. Insurance companies represent about 16% of our management advisory fees, sovereign wealth funds just over 10% and the remainder being down as the foundations and corporates. And so again, when we think about the customized solution -- customizing solutions to meet their needs, it really results in us spending a lot of time listening to those clients, understanding their needs, understanding how they're evolving over time. Within that client base that I just described, you have a range of different clients in terms of size, in terms of the stage of the build-out of their private markets portfolio, whether they're just launching a new program or they've been investing in the asset class for the last 20 years. You have a range of different capabilities where some have sizable in-house teams that's really looking at StepStone as an extension of their staff. While others that have a very limited in-house team that are, therefore, looking to outsource the management of their private markets portfolio to StepStone. So there is a range of different ways that we work with clients. Oftentimes, the way we work with clients may evolve over time. Increasingly, we are seeing clients that are looking to work with us across multiple asset classes, about 35% of our clients today do have a multi-asset class relationship with us. We're also seeing clients that are open to working with us across different strategies. And so for example, about 38% of our advisory clients today also have an AUM relationship. But just to give you a couple of examples of how we work with different types of clients and tailored solutions. I talked already about the private wealth and the high net worth opportunity. If we think about client types like insurance companies there, I would say that our private debt team, in particular, has done a very nice job of building solutions tailored to the insurance industry. One, because the private debt asset class is fairly efficient from a regulatory capital standpoint compared to other asset classes where we're active. And two, because of our teams' knowledge and experience working with insurance companies has allowed us to utilize different structures has allowed us to utilize rated notes, for example, in certain cases to help those insurance clients achieve their objectives. When it comes to some of our sovereign wealth or public pension clients, oftentimes, it's a mix, whether we might be an adviser on the fund portion of their portfolio managing on an asset management basis. For example, their co-investment or their secondary portfolio or really any combination thereof across the different asset classes. So it's sometimes difficult to generalize because of how many different ways we work with clients that gives you a sense for how we're trying to tailor different solutions.

Maybe shifting gears a little bit over to ESG, and that's a topic that gets a lot of interest these days, a lot more interest today than perhaps a couple of years ago. Can you talk about the importance of ESG factors within private markets and within StepStone and how you see yourselves positioned there?

Yes. Certainly an area that's getting a lot more attention. It's a timely question in the sense that we actually just this week put out a white paper on impact investing in ESG. And one of the things that we talked about in that paper is the evolution of ESG in the private markets over time. They really started with more of a negative screening, what types of investments or companies are we unwilling to invest in from an ESG standpoint. It's evolved to more full ESG integration into our investment evaluation and thinking about it as a risk that we need to mitigate similar to other investment risks that we are considering. That's sort of where we're at today. And then it also outlines where we're headed in terms of different potential impact investments, really trying to quantify having measurable nonfinancial impact as well. So again, where we're at today at StepStone is that we have now fully integrated ESG into all of the investments we make across the different asset classes and across the 3 different strategies. We are tracking a variety of different metrics. We've developed a scorecard to evaluate managers over time. But what I really think about, to your question about how StepStone is positioned. What comes to mind for me is that given our position in the marketplace, I think it's really part of our responsibility to help to continue to drive ESG forward across the private markets to be a resource for our managers as they continue on their own ESG journey. And part of what I mean by that is one of the conversations that we'll have at our investment committees, if say, a manager does not currently score well from an ESG standpoint, what do you do in that case? Does that mean that you can't invest with that manager? Or how do you think about that? I think in our view, what's important to us is not necessarily where they're at their journey today, but where they're going and their commitment to ESG. And finding ways that we can be helpful to them because what's unique about where we sit in the overall private market ecosystem is we see what all the different managers are doing. We have a great sense for what best practices are and we can help educate and inform our managers who really only know what they're doing in the vacuum to help inform best practices and drive their own efforts forward. So I think that's really part of the way that we think about our responsibility and our positioning in the private markets from the ESG standpoint.

And speaking of managers, maybe you could talk a little bit about your diligence process, how you go about selecting which managers to deploy capital into? Maybe you could talk a little bit about the funnel there? And how that ties in with the data side of the equation at StepStone?

Yes. No. So there are a variety of different ways that we source different manager and fund investment opportunities. One is that having been active in the private markets and as active as we have been, there's clearly a large universe of existing testing managers that we are constantly tracking. But there are also new managers, whether it's spin-out crews or first-time funds that are very much on our radar. I think a lot of it goes to how we have organized our team. One of the things that we are constantly trying to do at StepStone is not only benefit from specialization within our teams, but also benefit from being a large and global platform. But the way we've organized our teams are not only into the 4 different asset class, but within those asset classes, specialized teams that are really tasked with knowing all the different managers that operate in their market, tracking their performance, understanding when they're coming back to market. I would say, in today's very active fundraising market, we want to fund our -- we're going to be out in front of these fundraises oftentimes starting our diligence, even in advance of a fund formerly being in market to make sure that we're positioning ourselves and our clients to secure allocation to some of the funds that are in the highest demand. And then ultimately, those same teams are tasked with evaluating and diligencing those same funds. So it's a well-established process today. Again, we have clients that have a parallel process alongside of ours where they may have some involvement in that process along the way or ultimately just wait for our recommendation. But again, a very well-established fund process. And I think to Mike's point earlier, when we think about the data capture, all of the information, all of the data we're receiving through that process, whether track record information, whether portfolio company metrics, we look to capture through our technology offerings. And I think one of the really interesting things about the data that we have access to is both the level of detail that we receive as well as the quality of the data being that is coming directly from GPs. But this is not data that is only tracked at the GP or at the at fund level. Oftentimes, it's down to the individual company or asset. Oftentimes, it includes not only cash flows or return information, but increasingly, the operating metrics, financials, valuation multiples, leverage multiples that we can track and certainly analyze over time.

Great. We have a few minutes left. Maybe we could touch upon the secondaries marketplace and some of the trends that we're seeing there. In particular, it's getting a lot of attention that we're seeing a surge in continuation funds and single-asset secondaries. Can you talk about how StepStone is participating in that? And what in your view is driving that sort of activity there? And how do you see that space evolving?

Yes. No, it's certainly a good observation. I think 1 of the interesting things about being active across the 4 asset classes is that there is a certain amount of pattern recognition and spotting trends that maybe have played out in 1 asset class and are likely to play out in others. And also, I think one of the big drivers of secondary activity tends to be that it follows primary fundraising activity with a few year lag is certainly, as we think about some of the non-private equity asset classes, so infrastructure, private debt on the back of very active fundraising over the last several years. We expect to see and really are starting to see a more active secondary market evolve. Now I think there are key differences across each of those asset classes that may influence how the secondary opportunity plays out. Certainly, what we're seeing in private equity today, exactly, as you just mentioned, is a real increase in the GP-led or continuation vehicles. I frankly think that's a trend that suits us well. When you think about where those deals are being sourced from, they're being sourced directly from the GPs where we've got a significant number of deep relationships. And when you think about which assets are trading hands, they are ones that have historically been owned by those funds or perhaps we've even had insights into to our co-investment business. So very well positioned there from a due diligence and from a data standpoint. But clearly, the GP-led and continuation vehicle, which we think is represented probably north of 60% of overall private equity secondary activity is a major trend and one that we are certainly participating in. I think that's a trend that will likely play out in infrastructure as well. When we think about the long-live nature of those assets and the fact that GPs will be finding -- looking to find ways to hold on to these high-quality infrastructure assets for a longer period of time, we would think that, that may be a trend that plays out in the infrastructure. Whereas in, for example, real estate, we historically have seen a slightly different trend where you have a significant number of assets that are held outside of the fund structures in JVs or other partnerships, other structures. As a result, we've seen sort of a special situation, secondary market evolve, and that's been one that we've been active in really since the GFC when our team originally developed their strategy there.

Maybe just lastly on LP-led secondary. Just curious what you're seeing there. Just in terms of LPs looking to restructure their private market portfolio. Certainly, values have rebounded nicely. But what's the pipeline look like? What sort of activity are you seeing? And how would you say that pace has evolved over the past 12 months?

Yes. Mike, I mean, is that -- Mike McCabe is that one you want to chime in on?

Sure. No, thanks. When we look back -- it's a relevant question, we look back a year ago when the pandemic hit, and we all thought that the secondary market was going to have its golden year ahead of it. The reality is and was that as we saw in prior cycles, the spread between the bid and the ask just grew to the point of where getting transactions done was really difficult. So it was a bit of a quiet year for secondary relative to prior years. But I would say the last 3 to 5 years, sequentially, have seen record transaction volumes in the secondary space. As Scott mentioned, it follows the primary fundraising cycle, which has been up into the right for the last 10 years. And so the secondary market is robust, it's strong, it's growing and it's continuing to grow. And we think 2022 will be yet another record year of transaction volume driven largely by fairly mature investors looking to reposition their portfolios, thinking about getting allocations or exposure to other segments of the market, it's really all about portfolio optimization rather than saying, "Oh, I'm in trouble. I need to sell." That activity, I think, is very far and few between. It's really about portfolio construction. Valuation plays an important role in volumes. But given how well the markets have held up, the secondary market has benefited from that. And financing is also a big part of the secondary market and the financing markets have been open and very active along those lines as well. So we remain fairly bullish in our outlook toward the secondary market transaction volumes as it relates to regular way LP interests.

Great. We're all -- I'm afraid we have to leave it there. Mike, Scott, thank you so much for joining us today. Really appreciate it.

Thank you, Mike.

Bye.