The Exchanges

Q John, let's go from the macro to the micro, and maybe we'll start with The existing portfolio companies of your managers. The first question everyone's scratching their head about now is valuation. What are you seeing in terms of marks where they are today and where you think they might be headed based on conversations with your managers?

A I think it depends whether you're in the venture growthy part of the market or the general buyout market. I think throughout 2020 to everybody expected with the declines in public equity values that the other shoe would drop in privates. And frankly, we didn't see that underlying in company performance continue to be strong even in the second half of the year. And we saw, I'd say, low single digit declines even at year end. For the broad buyout market, probably plus or minus five percent. I think the place where we saw the most significant write downs were in the venture, but even the growth part of the market by and large, those are the places where you had a melt up in valuations on the tech side in 20, 21 into 20, 22. And I think certain managers, particularly the crossover investors, the mutual fund investors that publish their company valuations every quarter now, they really invested into that and took those valuations up to full value. That's where we saw the greatest declines. I mean, in some cases, 25% declines for those types of managers. But for the rest of the venture market that just had much broader exposure and frankly didn't participate in quite as much of the melt up, we've seen over the course of 20 to probably ten-ish, 15% declines in values for those broadly diversified portfolios.

AI assessment note: “For the broad buyout market, probably plus or minus five percent.”

Q John, are there distinctions between that you call traditional Portfolio secondaries and the single asset from the continuation funds in terms of what you're seeing in the market?

A I would tell you the single asset or the GP leads, I mean, that market evolved the way the LP market did. The early returns were spectacular. Capital follows the returns as it always does. And then people follow the capital, right? There's more opportunities. And so we've seen that develop admittedly in a much shorter period of time. I think last year might've been the first year or has been in 21 where the GP lead market was larger than the LP market. Those deals are pretty chunky. And in many ways, the market is capital constrained. When you look at the amount of dry powder and secondaries relative to the annual deal flow and you compare it to literally every other part of private equity, it's pretty extraordinary how undercapitalized it is despite all the large size funds that are being raised within the market. That momentum of the GP lead actually reversed course in 22, and Mario alluded to that. It's a lot easier for an asset owner to decide to sell a portfolio of LP interests at 80 because they have a particular objective in mind than it is for a general partner to convince their existing investors to take the option of selling at 80 cents on the dollar for that single company or that small portfolio of companies When the manager themselves are on sitting on both sides of the transaction because they're rolling their economics or they're going to benefit from continuing …

AI assessment note: “It's a lot easier for an asset owner to decide to sell a portfolio of LP interests”

Q So you mentioned there weren't that many private equity firms. What was Harborvest's investment offering back then?

A Oh, you're pining for the nostalgia of village life, right? Life was simple. Life was simple. So look, it had three businesses, but it had four product offerings. So each business, the multi-manager private equity business known as the fund-to-funds business, which the firm had become so successful at, in many ways identified with because of its success. We had a secondary business and a direct co-investment business, so three business lines, and the primary business was split between US and non-US, and so there's really just four products, and you raise one fund roughly every four years, so you're raising roughly one of those funds per year, and we served almost exclusively institutional investors. It was not quite yet the sovereign wealth funds had not entered the market yet. It was predominantly Public and private pension plans, U.S., non-U.S. endowments foundations in that commingled offering, and it was the kind of a simple, would you like Delaware or Cayman? There were eight items on the menu. It was a much more simple time.

AI assessment note: “it had three businesses, but it had four product offerings”

Q Why don't you take me back, I don't know, 24, 25 years ago. How did you find your way to HarborVest back then?

A I was a chemistry and physics major, and I fell in love with finance based on what my roommates were doing, my friends in undergrad. They were going to Wall Street and working in banking, and I, I was, I was building models around atmospheric chemistry, and they were building financial models, and we'd compare notes at the end of the summer, like, oh, that actually sounds a lot more interesting to me. So I went and I did our typical tour duty, if you will, as an investment banking analyst, and it was in New York, and I, look, I'm Boston, born and raised here, Went to college here, and so I wanted to come home, and in 97, right, 24 years ago, there actually wasn't a lot of private equity firms in the industry, so I reached out to all of them, and what attracted me to HarborVest back then, which actually, ironically, was it actually didn't have a name yet. It had just completed the buyout from Hancock Venture Partners. They had not yet branded. It was temporary HVP Partners way back when. And what attracted me was their market position, their vantage point in the whole industry, because we were a limited partner in many funds. We had a very small secondary business at the time. There was the direct co-investment side, which is where I was hired into. We, we did everything from co-investing in buyouts to late stage growth equity financing, late stage venture financing. And so that…

AI assessment note: “I wanted to come home, and in 97... I reached out to all of them”

Q What are the implications of all of that CovLite, all of that flexibility for the private credit and private equity managers on the potential for distressed investing and default cycles?

A I mean, the default cycles have been non-existent. It's probably the only asset class within private markets that I know of that had to give back capital. Over the last 10 years. Like, we raised a distressed debt fund, and then the distress didn't show up, and we're gonna have to give it back. That doesn't happen in other parts of the market. I think that the overall size of the distressed market, it's really become a traded market as opposed to a, hey, let's find the fulcrum security. Let's buy a toehold position. Let's actually see once it gets put into play, things get put into play. There are managers that have that strategy, but the relative size of that is nowhere near certainly the way every other parts of private market grew because of this structural evolution within the financing markets.

AI assessment note: “I mean, the default cycles have been non-existent.”

Q Are there other pockets of capital that you see coming into the space?

A I think we've touched the surface of the non-institutional market. Today, a lot of it is institutional packaging, mass affluent, ultra high net worth, high net worth. We're not even further down the triangle, if you will, if you've seen those. That's possible, but that market has even more unique needs than we call it mortal money. So when an individual actually is investing capital, They don't have the requirement of a seven percent actuarial return on the duration of the liabilities and the visibility that pensions have on the duration of their liabilities. Individuals have often much less visibility on their liabilities, so it comes with different packaging needs. That ultimately, if you think about the total wealth market, that's in many ways the next biggest realm for not every manager, as Mario states, but for managers with scale and the ability to actually do everything that's required. Earn the trust, invest the capital wisely as a good fiduciary, and equally as important, service that capital because that part is just as important.

AI assessment note: “I think we've touched the surface of the non-institutional market.”

Q So I'm going to slice your business in a couple of different ways. You mentioned early on China venture capital, and I know it's a global business. What are you seeing, let's say outside the US in other geographies across these different product areas?

A I think it would be a misconception to think that a market outside of the U.S. is just X years behind the U.S. or Y years. I mean, these are developing in their own ways. They're developing in a much faster pace than the U.S. private equity markets have. I mean, we, we've been international for a long time. We, we opened our first ex-U.S. office in, in 1990, 31 years ago. And our first office in Asia in 1996. Now we have 10 offices today. And a lot of those markets have continued to grow. So for many years there, the depth of the market was nowhere near it wasn't in other markets. Europe, of course, has been deep for a long time. But outside of the US and Europe, the depth of the market wasn't there. And so over time, just this is one of the amazing things about the private equity industry is You have a firm. It's like the story of TA. You can almost go through, it's like the Belichick coaching tree, and you can just see all the firms that have come out of that. Now, it's taken decades for that to happen in the US, but the same thing is happening in Asia. Individuals leave, and they start new firms, and they're great investors, and so those markets continue to grow rapidly at a fast pace. And look, the private markets, like all financial markets, they're also influenced by, of course, the rule of law and the And the structure and the maturity of the financial markets. So how yo…

AI assessment note: “these are developing in their own ways. They're developing in a much faster pace”

Q So what was it like then and how has it evolved since?

A I'd say it's changed in really five ways. Data. The benefit from secondaries and directs, and that gives you from a vantage point. ODD, operational due diligence, ESG, and DNI. If you think back to the 1997, it was really just, it was a very relationship heavy You largely had the data that was given to you by the manager. You had an analysis of, of the people. Do I think that these are good investors and do they have a strategy that's coherent with the market opportunity? Are they aligned? All of that is still the same. That's a constant, but I'd say that the depth of the data, both what managers give to you and make available to you in consideration of your investment, the data that we have, I mean, we, we didn't have 40 years of data back in 1997, but we do today. And so we just have this unbelievable set of data and analytics that go on top of that to really pierce and identify, you know, how does a manager create returns? Is it multiple arbitrage? Is it largely safe bets, but cashflow pay down? Is it M&A? Are they good at that? You know, who's actually doing it within the organization, right? Is it really the still the partners or is it someone else who's, who's learning the business? And do we really want to be, have somebody learning the business on our client's dime? And then I'd say the ODD, ESG, and DNI, those are all new dimensions that are very important today that r…

AI assessment note: “I'd say it's changed in really five ways. Data. The benefit from secondaries”

Q With all this information you're gathering at the experience of the company level, both through the due diligence process on co-invest and your actual investments, I'm really curious, how does that talk back to your primary evaluation? So you're on the primary side of the business, just investing in the funds. How did those two talk to each other?

A So on the co-investment side, it really comes through. Of course, there's an insight on the underlying company level that gets fed back, but the real insight that our primary team captures from our, our co-investment business is really through the manager effectiveness, the manager leadership on the underlying company level. And that was invaluable in the part of our industry's history where club deals had become prevalent, and you'd have three, four managers come in. And what was interesting is, because oftentimes with our size and scale as a co-investor, again, you are a minority investor, but you often get information, right? So you can attend board meetings. You actually get an up front row seat on what the manager is actually doing. And interestingly, in the club deals, you have the advantage point of, well, whoo, Who's actually doing the work? Who's actually just a financial investor? And who, who does management call when they have issues? Who does management defer to in the board meetings? And so that is invaluable. And then you can bring that back to your primary analysis. I'd say at the company level, because it's more broad than just single co-investments, that's where the secondary business comes in. Because we're evaluating all of the manager's prior funds. We have underwritten forecasted outcomes for every fund that we track every quarter. And then you can see how…

AI assessment note: “the real insight that our primary team captures from our, our co-investment business is really”

Q How do you process all that information? I'm imagining you're looking at a new fund. Could be an existing portfolio manager, a new portfolio manager, and you've got now reams of data from all of their past deals. What do you do with it?

A Just to be clear, our diligence on a manager doesn't start the day they print the PPM. It just can't. And the interesting part of the private markets is That the best managers in the world often are oversubscribed, even at an incredible size funds. Apollo at over twenty billion, oversubscribed. No one would have thought that before it happened. So it does happen because there's tremendous demand for the returns that exist in the private equity markets. So if you're showing up with the PPM as it's printed, you are late. Like you, you are at the back of the line. So, what I give our teams a lot of credit for is they have a multi-year pipeline and map of the entire industry, and we are tracking returns every year, every quarter, on every manager that we have access to and we have data on. To me, there's no greater way to measure or test a manager's credibility Then to verify that they did what they said they would do a year or two or three ago. And so then you bring into the analysis our secondary and our direct co-investment, and you can actually get a up close look at the underlying portfolios and the older funds and the guidance from the managers and what they intend to do with them and what type of return they expect to create. And then the fun part is then you measure it against actual outcomes. And what ends up happening is you end up developing relationships with the manage…

AI assessment note: “verify that they did what they said they would do a year or two”

Q How's the pricing environment changed on all these secondaries?

A It ebbs and flows with the cycle. Where we are in the cycle is a lot of transactions will run in the nineties or at par. What's interesting is if you look back at our history, and we've committed thirty billion dollars to secondaries in our history, and you look at the total returns we created for clients, the misconception of this market is like, oh, it must be all about the discount. So an asset purchased at 60 must be a better return than an asset purchased at 95. And, and the discount is the only predictor From the discount is the likelihood of the seller selling, because it's always easy to convince somebody to sell something at a hundred, or one on one, or 99, than it is at 70. So to me, that's the only predictor, and if you look at our gains, our returns over our history, yes, there's a benefit that comes with buying an asset at a discount, but you get that discount once. And if you buy the right asset managed by the right manager, that manager and those assets can create gains year after year after year until they get realized. So some of our best returns have been investments we've made at par or at one Oh five because it was with exceptional managers and they were great assets right at their, right at the point of their portfolio where the gains were really about to explode.

AI assessment note: “Where we are in the cycle is a lot of transactions will run in the nineties or at par.”

Q How do you think about the pricing environment? So you touched on earlier, one of the ways that some of these firms have made money is just multiple expansion. And now we're entering this period where it's always possible, but multiples feel pretty full.

A They've felt pretty full many times. So I think if anything, what the industry has done, you know, I think a lot about like the, the first generation of the industry, like the industry pioneers, the names that we all know, extraordinary entrepreneurs, Versus the second generation of the private equity people that we work with every day today. And I think what has changed in the industry is Not to take anything away from the pioneers, because they built incredible businesses, incredible returns for investors around the world, but I see the level of expertise and sophistication in the people making the investments today. Like you, you have to be better today than you were 20 years ago, because there's much more competition. Some of the parts of the markets have become more efficient. You need to have a very clear strategy and thesis. You need to have Exceptional execution capabilities to actually make that happen. So yeah, the pricing is high, but what we see is managers who, when they're underwriting a company and going in at 12 times, they're not underwriting to exit at 15. Actually, they're underwriting to exit at 10, because the market does go through cycles, and all that does is to get to your underwritten returns. It raises the game for those managers To execute on the plan that they have to get from A to B so that they can still generate the returns investors deem acceptab…

AI assessment note: “when they're underwriting a company and going in at 12 times... underwriting to exit at 10”

Q And how about some of the differences between buyouts and say venture, your two core areas of investing?

A Yeah, so from our vantage point, again, I would take Asia, for example, split it between developed markets and developing, very different. The developed markets, North Asia, Australia, they are predominantly buyout, predominantly buyout markets. There's mature managers there. A place like Japan, where the private equity as a percentage GDP is probably the lowest of any developed market in the world, as you see some of the daily headlines, that is changing, that is evolving, and so that's a quite attractive market today. On the venture side, for us, it's predominantly China. We've made some investments in places like Vietnam, but it's predominantly China where, for all the reasons that we all know about the size of the China market, the growth of the China market, we've had some of the largest exits. That we've ever had across the history of our firm come out of our China venture portfolio because the numbers are just so unbelievable. And if you look at the venture industry, you know, the growing number of the, the Midas 100 list, the number of unicorns, number of deca corns, it's growing and it's slanting more and more towards China as becoming a peer with the U S and look, I don't know why it wouldn't be the biggest market someday.

AI assessment note: “The developed markets, North Asia, Australia, they are predominantly buyout... On the venture side”

Q How do you think about exit strategy on Coinvest?

A Our anchor is alignment with the manager, and that's true going in, too. We want to align with what's their entry point, what's their entry value. Sometimes, though not often, there are some economics that exist within that market, and do the economics exist in a way that deviate enough from the alignment with the lead sponsor? That's something we evaluate closely. So if we get that alignment right, then, for the most part, some managers will say, hey, it's like a limited partner. It's tied into the Co-investment partnership and the general partner, the lead sponsor will decide. So in which case we don't really have a choice. It's as if we're investing as a limited partner. When that doesn't exist, then we often, even though it's not structural, we often will align with the general partner around that. They want to know that they can deliver a clean solution to the next owner of the business, right? So they, they often will have a drag. We have no Likely no desire to remain an owner of those investments after the lead sponsor has exited. Other than what's been interesting is sometimes you go from one lead sponsor to the next lead sponsor to the next lead sponsor. And so that's been an interesting dynamic because we often have relationships on both sides and then can evaluate. Do we want to stay invested with the business? We've been with it for four or five years. It's performe…

AI assessment note: “Our anchor is alignment with the manager, and that's true going in, too.”

Q So as you look at that now, after two decades of doing it, what is your own process for filtering the ideas that come through the transom of what you'd want to participate in as a co-invest?

A The way I would describe this, our firm is organized where we have dedicated people to each strategy, and that's a deliberate choice. The alternative would be to everyone has manager relationships and everything that comes from a manager, the new fund they're raising, A co-investment opportunity, secondary investment opportunities , you have the same person on point. From our vantage point, that presents a challenge. So the challenge is, guess what? The person who was on that point on the manager relationship, everything that that manager, this is the best set co-investment opportunity. We've got to buy this secondary at one Oh five because they're such a great manager. And so really from the beginning, We organized our teams around dedicated disciplines because we, of course, the person who is the manager relationship on the primary side has an important voice in the process, right? They may have even sourced the investment opportunity. They provide a perspective on diligence, but we want dedicated co-investment teams who wake up every day and say of the 800 opportunities that we see this year on co-investments of which 780 of them are actually going to happen. What are the best 50? And it may not always be from the same manager. They're good investments. We're glad they're in our primary portfolios, but it just isn't that enormously tight screen that exists on the co-investme…

AI assessment note: “dedicated co-investment teams who wake up every day and say of the 800 opportunities”

Q So along those lines, what has been the biggest mistake you made and what did you learn from it?

A I don't want to be too specific because I don't want to reveal exactly when it was and be like, oh, I remember that. There was a moment in my career where we had a really important meeting for the firm. And again, I want to go too deep to reveal what it is, but I would tell you is every indication leading up to the meeting Was that it was going to go our way. It was just like, oh, it's so obvious, the internal chatter, the dialogue, the feedback we got, even some explicit discussions, and it's amazing, Ted, because when, when 20 people tell you the same thing, what happens, you actually begin to believe it, and I remember going into the meeting expecting that we were just going to win, and we didn't, And we didn't. And it was humbling. And as a result, I have committed, as all of our partners that experience that, never to be unprepared again. Never to be unprepared again. And if I think about my One of my college football coaches, he would always tell me, he said, the game's not won on Saturday. It's won on Monday and Tuesday. And when you, it's not the will to win. It's the will to prepare to win. What are you doing on Thursday before the game? And so for me, that's a, that's a cultural element of the firm as well, which is like, be prepared. Don't assume anything and run hard through the tape.

AI assessment note: “I remember going into the meeting expecting that we were just going to win, and we didn't”

Q And what was your early experience in the due diligence process like?

A I grew up on the co-investment side, right? So that's really where it started, and I will tell you, this is one of the things that I think is a good example of our culture today. I mean, I remember, I was probably there for a month, a twenty-five-year-old analyst, and I had to write an investment committee memo, and I wrote it all up, I submitted it, it came in the investment committee meeting, and you know, you're, like, adrenaline pumping through my body, I'm all excited, like, oh, this is great, I present this investment opportunity, and I'll never forget. I was sitting at the end of the table. It was like, you know, the typical classic long table. The two founders were sitting in the center of it facing each other. I couldn't even see one of them because you were that far in the corner, so you could kind of just only see one of them, and I'll never forget, you know, Ed Cain turned. He looked down my way at the table, and he said, we don't pay you to make copies. We pay you because we want to hear what you think. And I just stopped short and presented the investment opportunity. Of course it didn't go anywhere, but I just remember from that earliest step, it was like August of 1997. I remember that vividly and that still persists today, right? We want to hear what people think. And so on the direct side, it was very similar to what you might see in any opportunity today, rig…

AI assessment note: “a twenty-five-year-old analyst, and I had to write an investment committee memo”

Q about these examples where you have a relationship with the manager in the primary business. You start to see things through the co-invest business that either you're just repeatedly passing on their co-invest deals, or maybe you do one and their behavior isn't quite what you thought. Where do you draw those tensions between that information and how you would just underwrite the primary fund manager without that additional information?

A Managers generally aren't doing anything nefarious, but there are times, I'd say it's more the, the shade of conservatism or aggressiveness with which they view the world and with which they communicate what they're doing. That, to me, is the real, the real value. We've had some experiences on the co-investment side where the general partner treated the other, us and the co-investors as an afterthought, and it wasn't a good experience, and that becomes part of the discussion. Becomes part of the discussion, of course, with the manager, but it also becomes part of the discussion around, around this. Our business is, we have commingle funds, we have separate accounts, we've got some other ways that investors access our expertise. We have to, and we do run each of those independently. So it's still, the information informs your decision. But there is never any other, other criteria on an investment decision other whether that fits in that program. Is that the best opportunity that we can invest in a client's program?

AI assessment note: “So it's still, the information informs your decision.”