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

Well, good morning, and welcome to everyone here with us in Kohler and welcome to all those listening on the webcast as well. It's great to have everyone here, great to see some faces and be able to shake hands and meet in person. Today, we're very pleased to be doing a fireside chat with Mike McCabe from StepStone. Mike is Head of Strategy. And StepStone, if anything, right now is right in the middle of -- as is their business model, right in the middle of the alternative universe, and I think making some good things happen. Their recent earnings report showed some great resiliency. So Mike, it's great to have you here. Thank you. I know you've been on the road several times on, so we really appreciate you coming by.

You're welcome, Adam, and thank you so much. It's a pleasure to be here.

Absolutely. Absolutely. So I want to break the questions into -- I want to talk about StepStone's business. I'm going to drill into a couple of specific areas. And then because Mike is Head of Strategy, we'll talk a little bit about capital management and deployment. But I first want to hit on the theme of diversification. It was a key theme in the recent earnings call. Mike, could you speak to the importance of diversification to your business model, to your growth profile and your ability to serve your solutions clients?

Sure. Sure. Thanks, Adam. Yes. I think diversification is probably a key competitive advantage that we have in the marketplace. And when we talk about diversification, we talk about it through 4 themes. I think first is diversification by geography. We saw the international markets underserved in the private markets in the very early days of our organization. And so while the U.S. market being sort of a leader in a mature market, we decided to expand in the early days in Beijing, China; Australia; Europe; the Middle East and Latin America. So we really created a geographic footprint 12 years ago, 14 years ago outside of the U.S. to diversify the platform into the global markets. I think the second theme of diversification relates to asset class. Most investors in the private markets probably started somewhere between venture capital and private equity and buyout. As the markets mature and as the asset classes grew, we saw the need for solutions in real estate, in infrastructure and in private credit. So now we have a platform that's diversified across all 4 asset classes. And I think the third theme of diversification relates to the kinds of investment strategies we pursue, whether it's a fund investment, whether it's a co-investment, whether it's a secondary investment and of course, secondaries are topic du jour at the moment, given where we are in the cycle. But when you think about all 4 asset classes and those 3 strategies, we can create basically 12 unique or bespoke solutions for any particular investor looking into the private markets. And then the fourth area of diversification is by client type and investor type. The private markets are often categorized by some of the large, big public pension funds. The reality is StepStone has created a flexible business model that caters to the individual investor all the way up to the large sovereign wealth funds and everything in between, whether it's an endowment or a foundation, a family office, corporate pension fund and public pension fund, we've really created this flexible and dynamic business model to cater to a variety of investor types by geography, by asset class and by strategy.

Excellent. I think back to my school days and think about the permutations and combinations. So among your clients in reality, how many different products or strategies do they generally have? And what's been the trend in that area?

Sure. This has really been a key and central theme to our growth story. While we started out in private equity and systematically expanded into the other asset classes, the reason we did that was because our clients were saying to us, "Hey, you're doing a fantastic job for us in private equity." Could you provide us a similar kind of service or solution in real estate or in infrastructure or in private credit? And over time, we just build out these large senior veteran teams to do just that. As we sit here today, 1 out of every 3 clients does more than 1 thing with us across the 4 asset classes. And so the thesis and the investment has really played out.

Excellent. You talked about the different sort of segments of clients and sizes. And I want to ask you about the importance of StepStone as a solutions provider, maybe on the middle or smaller end of that. What are you delivering for your clients? And how are their needs changing during this current period of kind of disruption?

Sure. So we've had a philosophy and a culture from the very beginning of listen first and speak second. And as our firm has grown and as the industry has matured, what we're seeing in the larger institutions is a strategic asset allocation model that has evolved to a decision that's sort of, I want to say, almost binary, how much of my portfolio do I want liquid, and how much can I afford to be illiquid recognizing the illiquidity of premium is where they'll find a source of alpha. Now within that illiquidity bucket, what do I do? How do I allocate? How do I find the managers? What strategies do I pursue? And who can help me navigate at all of that? And so what StepStone has done has created this sort of one-stop solution for all things illiquid for those chief investment officers of institutions looking to fill that allocation in that illiquid bucket, rather than having 4 or 5 or 6 different service providers, they can go to StepStone for a holistic solution. Then there are smaller opportunistic or midsized investors who are saying, "Hey, I'm really interested in pursuing co-investments in buyout." And for that purpose, we've created specialized commingled funds. Same thing in the secondary space. We're now seeing valuations come in, the market's repricing, certain investors might be looking to reposition their portfolios or seek liquidity. The secondary market now is becoming a very interesting place to invest. So we have a secondaries fund. And that commingled fund will cater to smaller and midsized individual investors. And that would go for venture capital, where we just closed the largest-ever secondaries fund at $2.8 billion. We just closed our co-investment vehicle for private equity, and we're currently in the market with our secondaries fund for private equity. So the commingled funds and the managed accounts and the various solutions that we've created cater to a wide variety in a very flexible way of investors.

Interesting. So it seems like the -- that same diversification that lets you be a one-stop shop to maybe a smaller institution that's looking to allocate to private markets. It also gives you a lot of kind of arrows in the quiver to be able to meet the needs of institutions that are saying, look, I want exposure right here right now and StepStone -- almost whatever that is, StepStone is able to provide that.

That's right. And we announced in our quarterly call this past week that nearly 60% of our growth in this past quarter came from asset classes outside of private equity. Why -- these are investors looking to invest in real assets that have some sort of inflation protection or some sort of hedge. And so we've seen quite a bit of demand in our infrastructure. We had a great quarter for real estate. And of course, our floating rate senior secured private credit platform is receiving an awful lot of attention given the way interest rates are moving.

Of course. No, it makes total sense. You mentioned co-investments in secondaries. I mean you talked a little bit about commingled funds versus separate accounts. But could you dive in a little bit more to the co-investments and secondaries because I think that's part of StepStone's business that not everyone understands as well.

Sure. So as a large primary investor and more of an extension or as a partner to general partners out there, they're looking to StepStone to augment what they're doing on the deal front by bringing us in as a co-investor. Most of the co-investments we do really is in the form of co-underwriting with general partners pursuing transactions and our clients and their clients overlap. But what's important is we're able to create a diversified portfolio for our clients in a multi-manager way across a wide range of different types of co-investments. And the same applies to the secondary space where general partners 20, 30 years ago, a secondary sale was almost why are they selling? And what does that mean for me as a general partner and who's going to replace them? Well, that's becoming a more and more important question today. And so general partners are sensitive to why a limited partner is selling? And who is that limited partner selling to? StepStone is by far the preferred and first call for that replacement limited partner in the secondary space. And that has become increasingly important. And as general partners, I have been looking to the secondary market to extend or continue the duration of some of their prized assets. They're trying to figure out who is the right partner to support that continuation and who in the secondary space, is it not only a reliable but a scalable partner, and StepStone has really played a big role in the secondary market, providing capital for those continuation vehicles.

Given the current backdrop, are you seeing a shift? I mean it sounds like the overall secondary business is certainly growing well. Are you seeing a shift GP led versus LP led?

Sure. I mean, over the last 3 to 5 years in this sort of procyclical expansionary period, we've all enjoyed the number of LPs looking for liquidity has certainly softened and there hasn't been -- there's been a stable and steady source of LPs looking to just manage their portfolio, diversify, switch from manager A to manager B, but it's not been -- it's been opportunistic. It's not been something systematic. What has emerged has been these continuation funds and these GP-led secondaries. And that has become almost more than half the market in the last 3 to 4 years. Now come 2022 post-pandemic, interest rates are moving up. Inflation is on everyone's mind, repricing is happening, denominators are shrinking. And so now investors in the LP table are saying, maybe I should either sell or reposition or pare back my portfolio. And so LP interests are now catching up to the GP-led secondaries and perhaps going a little bit beyond. It's just a great secondary market overall between increased appetite from LPs and increased appetite from GPs.

Do you think that increases LP comfort level with getting into private assets to begin with, the idea that there's a robust secondary market out there that's available should they need it?

Very much so. The secondary market plays an incredibly important role in the illiquid universe. How do I get liquidity? And how much of a discount will I have to eat in order to get liquid? And all of those questions are on the forefront of LPs. It's a $100 billion-plus a year market, plenty of liquidity, plenty of dry powder, plenty of players, not a lot of new players, by the way, but there are plenty of players with capital and scale and the process is pretty straightforward these days.

Excellent. I want to take our discussion because we've been talking about the solutions that StepStone provides and you're really client-oriented role in all this, which is -- sounds like it's gaining traction with GPs as well as LPs, which is excellent. In terms of some of the vehicles that we've talked about and the impact on StepStone as a business, right, how does the mix of separately managed accounts versus commingled funds impact like the resilience is a big word these days, but the resilience of your earnings profile. Does the relative emphasis on SMAs provide a steadier growth path for StepStone?

It does, and separately managed accounts for something that we saw was an essential solution and a replacement for what were conventional fund of funds, and that was a one-size-fits-all model. We felt that larger scale institutional investors were looking for something a bit more customized, a bit more tailored, something that could be scalable. So what we did, we positioned this platform to do just that. And managed accounts are a very scalable, very flexible model that allows investors to pretty much go anywhere, they can help prescribe where we go, how we get there and over what time frame so we can provide discipline with vintage or diversification. We can provide discipline with a multi-manager diversification. We can provide diversification across strategies or we could get specialized and target a region, a strategy, a sector. And so managed accounts are really this incredibly flexible and incredibly scalable model. I think if we look at a new data point we shared on this earnings call, we wanted to really bring to light how our clients feel about the managed account space, and we've highlighted the re-up rate and we cited 90% of our clients re-up with us whenever a managed account reaches the end of its investment period. And when they do re-up with us, on average, they've expanded the account by about 30%. So simple math, the retention rate is over 100% when you combine the re-ups with the expansion. So it really does provide an outlook for us and for our investors, enormous visibility into the growth and scalability of our platform and the resilience of our platform. Keep in mind, these are also funds of one. But we are the only solution provider for that client in that account. The commingled model has been around for 20, 30 years. And it really is a more specialized strategy, whether it's a secondary or a co-investment, whether it's venture capital, whether it's private credit, it could be real estate, but they're targeted. They are specialized strategies with a stated goal, a stated return at a given unit of risk, and they cater to small-, mid- and large-sized investors. And they are a great augmentation of the managed account. And in fact, some managed accounts even allocate to our commingle products the target of specialized strategy or a niche area or something that they want to pursue on a targeted basis.

Interesting, I imagine StepStone has a significant role in advising many of them of that, like here's a chance -- I mean, they come in with an investment objective or an exposure objective and StepStone can say, okay, this is how we can operationalize that.

Exactly.

Yes. Makes sense. Stepping back into kind of the backdrop. I mean we've talked a fair bit about secondaries. And I want to ask you about VCs also, so don't let me forget that. But just in general, at this time where everyone's kind of questioning what the outlook is going to be like, how does the private assets backdrop across global regions and by asset class, you mentioned real assets and what have you. What are you seeing there? And are you seeing a shift from private equity, VC kind of the classic private markets to real estate and infrastructure more broadly?

So regionally speaking, Adam, we -- again, we look to the international markets as largely underserved and under-allocated. Many of them who are allocated started out in private equity and now are seeing how the illiquidity premium and the alpha can be generated in adjacent strategies, such as real estate and infrastructure. And so we are seeing an accelerated demand from the international markets in real assets. In fact, our infrastructure group has been our largest and fastest growing team on the platform. So we're going to continue to expect to see real assets, demand picking up, particularly in this environment with interest rates increasing and the need for some sort of inflation protection or hedged. So regionally speaking, we're seeing the international markets allocating more and more to real assets.

It was interesting because I asked Scott on the call, "Hey, is international kind of providing an offset for a domestic market that may not be so hot right now. And I was surprised by his answer because he said, no, you know what, Adam, it's mixed internationally. That's definitely a source of growth for us, but it's also mixed domestically. And there's folks getting in as well as a few either pausing or pulling back, right?

Well, that's exactly right. I think Scott highlighted that this past quarter was one of our strongest quarters ever domestically here in the States. That was in part because U.S. pension fund re-upped and expanded an account with us. And it's also in part because of the Greenspring acquisition brought onto our platform, thousands of new investors that are largely domiciled here in the States. And so we really do have a strong balance and mix between North American and international clients.

I think you peaked ahead of my listed questions. I got to keep this close to the vest here. I was about to ask, could you talk a little bit about the integration of Greenspring, in particular, and also the demand you're seeing for venture capital and growth equity at a time where in the public markets, that doesn't necessarily look so attractive?

Sure. Well, look, we are thrilled with the way the Greenspring team and the StepStone team have integrated. We had a small and very successful venture capital and growth equity team. The opportunity to merge with the leading venture capital and growth equity provider in the market by far was just exciting. And we spoke then and we speak now a very similar language, and we approach the market in a very similar way. So the integration culturally and on all metrics has gone really well. I think we're really excited is the team had a very successful fundraise on their secondary fund. So our venture capital secondary fund closed $2.6 billion, the largest secondary fund in the history of venture capital. And if you think about where we are in the market where valuations and repricing has taken place, it's perfect. We could not be more thrilled with the dry powder we have in venture capital. But by the same token, we have our direct opportunities fund, which closed on $800 million, which goes directly into venture capital companies in partnership with GPs. So a general partner may say, "Hey, StepStone, could you please think about leading around for this portfolio company or would you be interesting in working with our portfolio across here and here." So now we have this direct opportunities fund to lead and colead rounds with venture capital companies. So we have the arsenal to play both offense and defense in VC, and it couldn't come at a better time. And to address your demand question, a lot of investors, we believe we're sitting on the sidelines waiting for some sort of correction, thinking, well, valuations are a little rich, the market's a little frothy, let the market blow off a little steam and then maybe we'll find our entry point. We're hearing that conversation more and more that this is a particularly interesting point in time to enter their venture capital and growth equity space.

Yes. No, that's a great point because a lot of times, we as analysts and investors think in terms of, all right, well, something is selling off, maybe there's some kind of fundamental problem or what have you, and it doesn't seem like as an attractive space. And what you've just said, which we all know and which makes sense, is that the reverse and that importantly, LPs and StepStone's clients are thinking in that same way of this is an area where I do want exposure but I'm not going to write the ticket to StepStone just yet because I see out in the market how valuations are and a little bit frothy and what have you. And so it's interesting and exciting that they're taking this opportunity to step in.

As Howard Mark said, buy on strength -- sell and strengthen buy on the weakness.

Exactly.

That's what's happening.

Exactly. Just to shift gears a little bit to distribution and particular retail, right, which is everybody's big focus these days. How are you looking to build out the distribution platforms for the retail evergreen product where the performance is just phenomenal. I don't know if I can say that, but I did, both in the U.S. and international?

Yes. We agree the performance is phenomenal. The product that we launched, we'd to called it CPRIM, which is a multi-manager product. It's a 1 ticket that provides investors with a diversified way to get exposure to the private markets across asset classes in a multi-manager way and in a multi-strategy way. It's out of the gate sitting at a 78% net return in part largely because we led with secondaries. We'll layer on some co-investments and then we'll layer on some fund investments in a multi-manager way. We really felt that the individual investor, again, listening first, was looking for a diversified way to get access to the private markets in a very cost-effective way. And so we led with this really creative product and could not be more thrilled with the way it's developed in the market. From a distribution strategy standpoint, we invested in a very large team a couple of years ago that these are veteran experts that have known this industry for a long time, and they said, look, the way this works is you start with the RIAs, build some track record and some take up there, move to the IBDs and then eventually the wire houses. That's exactly how our playbook has been implemented, and it's pretty much how it's working out. So we're sitting on 120 RIA channels right now. We're sitting on a number of IBDs and we had our first wire house come on the platform at just this couple of months ago. And in fact, the last 2 months, both June and July, have been our strongest month so far in retail.

Really?