Private Markets 360° | Episode 42: Discipline, Deployment and the Rise of the Wealth Channel across Private Markets

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Jocelyn Lewis [00:00:01]:

Welcome to Private Markets 360, your insider's guide to the world of private investments. Today, we're thrilled to have Jeff Thiel, Managing Partner and Head of Investments at Adam Street Partners, joining us. With over two decades of experience in the private equity sector, Jeff has been instrumental in guiding Adam Street's investment strategies since he's joined the firm in 2000. His deep expertise spans across various stages of investment, from early-stage ventures to buyouts, and he has played a pivotal role in helping companies navigate their plans to exit. Under Jeff's leadership, Adam Street Partners has focused on high-quality investment opportunities, emphasizing alignment of interest and strategic growth. He's known for his insightful perspectives on market trends, liquidity challenges, and the evolving landscape of private equity. Today, Jeff will share his insights on the current state of private markets, the impact of macroeconomic factors, and the innovative strategies that are shaping the future of investing as the private markets are becoming more accessible via retail channels. Jeff, welcome to Private Markets 360.

 

Jocelyn Lewis [00:01:11]:

It's a pleasure to have you with us today. How are you?

 

Jeff Diehl, [00:01:14]:

I'm doing great. Thanks for having me on. I'm excited to be here.

 

Chris Sparenberg [00:01:17]:

Thank you so much for joining. Would love to kick things off with introductions to both you and the firm. Could you share a bit of your background and the path that ultimately led you to your role today as managing partner and head of investments at Adam Street Partners? And also tell us a bit about the firm.

 

Jeff Diehl, [00:01:31]:

Sure. I grew up in a small town in Wisconsin, ended up going to a university at Cornell in upstate New York. I had no idea what I wanted to do when I grew up, but I graduated and ended up taking a job with a boutique consulting firm in Boston and ended up going to business school at Harvard Business School and That's where I got the first bug on investing. I was taking an investment management class there and was spending time reading about various investment professionals that were, had various successes hearing guest speakers. And so I got the bug. So after business school, I ended up going back to the consulting firm I was with where I spent a lot of time with venture-backed companies. And then ultimately I moved from Boston to Chicago with my wife and I ended up connecting with what is now Adam Street Partners and I ended up joining in their direct investment team where I invested in software businesses, private companies, taking board seats, getting actively involved in those businesses. Did that for the first 15 years, and about 10 years ago, my predecessor, our founding CEO, asked me to take on the leadership of the firm as he was riding off into retirement.

 

Jeff Diehl, [00:02:35]:

A little background on the firm: Adam Street's a private equity and private credit investment manager with $65 billion in assets, roughly $50 billion on the private equity side and $15 billion on the credit side. And we invest about $10 to $12 billion a year across 5 different strategies, 4 private equity and 1 private credit. On the private equity side, we invest in funds across the venture capital, growth equity, and bio ecosystem that we could, that we believe can produce top quartile results. And then we try to get more exposure to the equity of the best companies through secondary transactions, buyout co-investments,, and venture capital growth co-investments. And on the private credit side, we're a lead lender to control buyout transactions. We really have one investment strategy despite having 5 teams, and that's to get exposure to companies, private companies that can compound value through top-line revenue growth and margin expansion. And this is our 54th year investing. We started in 1972 before the words leveraged buyout or private credit were invented.

 

Jeff Diehl, [00:03:38]:

And we've got about 350 people across 15 global offices. And importantly, we're 100% employee-owned with a very broad ownership, and that's really critical to our culture and our alignment of interests with our investors.

 

Jocelyn Lewis [00:03:51]:

Well, Jeff, starting the firm back in 1972 sounds like you were pioneers within the industry, and it's really grown significantly since then. I'd like to shift to a recent perspective that your team published on the evolving dynamics within private credit. The piece is titled Hyperscalers Risk Eroding Investor Returns. And for those who haven't read it yet, could you walk us through the core themes of that piece and maybe also mention what is the big takeaway that you want investors and market participants to understand and how you see those trends shaping the private landscape and how you see those trends shaping the private credit landscape going forward?

 

Jeff Diehl, [00:04:37]:

Yeah, maybe I'll give you the punchline first. It's that we think that investors should be hyperfocused on hyperscalers in private credit. But a little bit of a background. We've been students for the private equity and private credit ecosystem for a very long time as we've had exposure on the investment side to thousands of funds and tens of thousands of private companies. And one core truth that we've observed over those many decades is that when an investment manager in private markets scales their deployment pace very rapidly, it can start to put pressure on investment teams to deploy rather than invest, which ultimately can compromise underwriting discipline. So we pay a lot of attention to how investment manager deployment pacing's changing over time. Historically, before the advent of insurance pools and wealth pools that were dedicated to the asset class, institutional LPs and drawdown funds were the norm. An institutional LP served as a governor on an investment manager's scaling ambitions in private equity and private credit.

 

Jeff Diehl, [00:05:40]:

But that's really changed as managers have built out retail and insurance offerings. And over the last 5 to 7 years, we were observing that some private credit managers or direct lenders, particularly publicly listed firms, were dramatically scaling their asset base through both business development companies and life insurance general accounts. And that's the impetus for writing the article, is we wanted to take a closer look trends there and how that might be impacting investor returns. As you dig into our article, if you look at the 4 managers that are overseeing the largest business development companies or BDCs, and these are perpetually offered in most cases, some are publicly traded, we estimate that those 4 must each invest about $23 billion a year to keep those vehicles fully invested. And the largest one needs to invest about $43 billion a year to keep that fully invested. And of course, these figures do not count the institutional pools or the insurance pools that those managers are overseeing. And so those are pretty significant numbers relative to history. And if you then shift your attention to the life insurance general accounts, which many of the private credit managers have either bought insurance companies or partnered closely with insurance companies, those are even bigger.

 

Jeff Diehl, [00:06:58]:

We estimate that the top 4 managers overseeing life insurance general accounts, must invest about $47 billion a year just to keep those vehicles fully invested. And so if you add those two together, you're talking about $70 billion on average that people in these large BDCs and insurance pools need to deploy a year. And that sort of deployment pressure is something like we've never seen before. And when that deployment pressure gets exerted, it can create compromises as it pertains to underwriting standards. And then maybe I'll dig one layer deeper. If you look at how you deploy more capital in private credit, the natural way to do that is to lend money to larger buyout-backed companies. And the private credit market's really broken into two. There's companies less than $100 million in EBITDA, and there's companies greater than $100 million in EBITDA, or pretax profits.

 

Jeff Diehl, [00:07:53]:

Buyout managers who buy a company in the less than $100 million EBITDA category tend to solicit term sheets from direct lenders or private credit funds who are competing against each other to become the lead lender and effectively buy and hold that loan to maturity. And so that's a fairly rational market with the counterparties interacting with each other and ultimately someone being selected. However, when you move up into the $100 million-plus EBITDA category, private credit lenders aren't the only option for buyout managers buying a business of that size. They, so they actually dual-track their direct lending sourcing. They go to private credit lenders and ask them for term sheets, but they also engage an investment bank who can help them tap into the broadly syndicated loan or liquid market for their debt. So if you're a private credit manager competing in that ecosystem, you have to not only beat your private lending peers, but you also have to compete against the broadly syndicated loan market. And that market is, you'd think, lending money to bigger companies. It should be safer businesses to loan against.

 

Jeff Diehl, [00:09:00]:

And on the surface, that may be true. But one of the challenges in the broadly syndicated loan market is the investment bank originating the paper creates the loan documents and then syndicates the loan out to buyers, oftentimes CLOs. And those CLOs really need rated paper, and they don't spend that time a lot of time reading the loan documents. And therefore, what can borrow syndicated loans are usually higher leverage levels, lower spreads, and fewer or maybe even absent lender protections. And so if you're a private credit firm competing against that alternative, you effectively have to match the price and terms that buyout manager has in the broadly syndicated loan market and effectively take those terms as a private credit lender. And so that's how you can really scale deployment. And so on the surface, again, a big company seems more safe, but ultimately that business has got more risk in terms of a loan loss. And that was what we observed in some of these large BDCs is that they tend to be populated with very large loans that have higher leverage levels, lower spreads, and fewer creditor protections.

 

Jeff Diehl, [00:10:06]:

So the punchline for investors, the punchline for investors is it's important that investors do their homework on the deployment increases that a manager managing a BDC or an insurance pool or even institutional pool, what's happening with their overall deployment trends. Take a look at the underlying loan tape where it's available to take a look at the credit statistics inside those companies. And also just think about alignment of interest with the manager. Obviously, publicly traded managers have incentive to maximize their stock price, which usually means raising more capital and deploying more capital. And so investors just need to be mindful of all three of those factors when they think about manager selection in private credit, because it really matters.

 

Jocelyn Lewis [00:10:49]:

Again, Jeff, following up on, on that, one question that comes to mind is if you are a manager, what are some of the benefits by deploying a BDC structure versus just deploying out of a traditional private credit fund?

 

Jeff Diehl, [00:11:07]:

Yeah, BDCs are an attractive product to manage, allow you new tax let me just start that one over. So private credit managers often do have drawdown funds, which are traditional commingled funds with institutional LPs, but those funds typically are not as appealing to wealthy individuals. They tend to be complex. They have capital calls, they have complex tax documents. And so one of the advantages for managing a BDC is that allows you to offer a very simple product to wealthy individuals that reduces all that complexity of tax and capital calls and thinking about what your exposures are. One of the challenges of managing BDCs on the counter side is that those tend to be perpetually offered, which means investors can come in and subscribe monthly, but also redeem quarterly. And managers have to be mindful of the fact that redemptions can happen and they need to maintain some liquidity buffer in those vehicles. So BDCs really allow you to access the wealthy individual, but Obviously they do come with some more complexity for the manager in terms of being able to manage those vehicles.

 

Chris Sparenberg [00:12:13]:

This is a fascinating discussion around hyperscalers. I think it's great for us to take a step back and explore the broader environment with deal volume still robust, significant dry powder in the system, this pressure to continue deploying capital and more competition. Can you just talk about how these hyperscalers who manage large BDCs can avoid loosening underwriting standards while aiming to deliver the returns their investors expect, and then other expectations that they might be managing from the market more and more generally?

 

Jeff Diehl, [00:12:45]:

Yeah, I'm glad you asked that question because it really hits to the heart of the article. Direct lending is about making money-good loans that pay interest and return principal at maturity. And return dispersion between managers is really all about did the manager have loans that defaulted and did not recover principal capital? The trick is matching the high-quality investment opportunities that you can access without compromising underwriting standards alongside the capital base that you're managing and making sure that capital base doesn't grow too quickly. And in, in order to have real investment discipline, you've gotta have origination, underwriting, and frankly, most importantly, win rate edge without compromising your underwriting standards. And so Adam Street focuses a lot on how much high-quality investment capacity access do we have, and let's make sure that we're raising capital to support that, but not going beyond that high-quality investment capacity. We can do that as a privately owned partnership without outside shareholders. One of the challenges of when you become a publicly listed company, your customer shifts from your investor to your stockholder because stockholders have demands. They want to see the business grow in value and they want to see the stock price increase.

 

Jeff Diehl, [00:14:01]:

And so it's a real challenge for managers that are publicly listed because they have to figure out a way to balance that tension between their investment underwriting and investment returns that their investors demand, at the same time delivering results for their stockholders who care a lot more about asset growth and revenue growth and profit growth than they do about ultimately the return. So there's a little bit of a tension between those two things, and that's a difficult thing to balance as a publicly traded manager.

 

Jocelyn Lewis [00:14:29]:

Jeff, taking that a step further, I'd love to understand how the investment discipline shows up in your conversations with investors, because some managers seem to highlight the number of deals that they pass on as proof of their rigor. And in your discussions with LPs, how do you convey the thinking behind what you choose to deploy or not to deploy? And how does that decision-making process translate internally when the team ultimately decides to walk away from a deal?

 

Jeff Diehl, [00:15:02]:

Yeah. So in our conversations with investors, investors, we try to get them focused on taking a look at what a manager or what we have actually done in terms of the investment activities. And in credit, median statistics or the decline rate of deals that you've seen to show your selectivity, those don't really matter. What matters is taking a look at the underlying loans that you've made and looking at the fundamentals of those loans, loan-to-value, interest coverage, the fundamental growth of the business, where their valuation is marked and how reasonable that is. If there's been material loan amendments. As a reviewer of a private credit fund, what you want to pay attention to is the actual underlying loans they've made. And in particular, pay attention to what I'll call the left-tail loans, the ones that are at risk of credit losses, because that's where your returns can really degrade in a private credit portfolio. Because in lending you don't get upside like you do in private equity.

 

Jeff Diehl, [00:16:00]:

It's all about avoiding the downside and avoiding loan losses. We spend a lot of time with investors helping them see what our loan tape is, which is detail on every single company's fundamentals, all the key credit statistics that investors would be interested in, and pay a particular attention to what I'll call the left tail loss risk exposure. And that's what we encourage all investors to do as they think about manager selection is don't pay attention to median statistics or decline rates. Really focus on the, on the left tail and the details of them. And as it pertains to how I think about investment capacity at Adam Street, managers that we are investors in roughly do about 600 new biotransactions per year. And our plan is to lend money this year to about 30 of them. So you can see that just in terms of the total addressable market for us relative to the expected market share that we will generate today, there's a pretty significant gap between the opportunity set at the top of the funnel and our selectivity at the bottom of the funnel. I think that pace will continue to grow over time, but it's really important to assess where the edge exists for a manager in terms of origination, underwriting, and win rate.

 

Jeff Diehl, [00:17:11]:

And ultimately that plays out in the quality of the loan portfolio.

 

Chris Sparenberg [00:17:14]:

Jeff, let's switch gears here a little bit and talk about the importance of investor transparency. Fundraising is becoming more of a challenge in different parts of the market. One of the things driving that LPs are pushing for greater transparency across their portfolios. So curious to know what additional types of information you are seeing LPs ask, and given Adam Street's unique position, because as you're both an LP and an investor in other managers and deals, how does that dual vantage point shape the way that you understand, respond to, and anticipate those evolving LP needs?

 

Jeff Diehl, [00:17:47]:

Yeah, the fundamental questions that investors are asking about today They probably don't vary much from what they have asked about historically, or we as an LP ask of our managers. I would say the one incremental piece that's become more heightened is a focus on liquidity. The last several years for the entire private equity industry has been very low M&A activity and low IPO activity resulted in less cash back in investors' pockets. If you have less cash in your pocket, that means more value is trapped in the fair value of the investments. And so investors are asking more questions about how is the value, how are the valuations marked of the underlying portfolio companies and what are the company fundamentals. And so we have always been publishing the company fundamental statistics in both our buyout book and our venture capital book on buyout. What's happening with revenue growth? What's happening with EBITDA growth? What's happening with loan-to-value in the portfolio? Where do valuations sit in terms of enterprise value to EBITDA multiple and how's that changed over time? So those are the— you really have to dig into the underlying company fundamentals to really get a sense for is the fair value appropriate? Is it overstated? Is it understated? And because that tends to drive a bigger factor in returns when you have less liquidity or what I'll call DPI in your pocket, you're going to spend more time on what the fair value of the marks are. So those are probably the biggest things investors are spending time on today.

 

Jeff Diehl, [00:19:16]:

But it's fairly consistent. I think the drumbeat just gets a little louder when liquidity's been lower because there's more value trapped in fair values of assets.

 

Jocelyn Lewis [00:19:24]:

Building on that, but shifting to the retail side of the market, Jeff, what do the conversations look like when you're speaking with retail intermediaries? So the wealth platforms, broker-dealers, and advisors who are bringing private credit to individual investors, and based on your experience, how effective are those intermediaries in evaluating the underlying risk and communicating that to their clients.

 

Jeff Diehl, [00:19:51]:

Yeah, this individual investor or wealth market is a very interesting evolution for private markets. Private markets have played a very important role in institutional portfolios for decades, hopefully delivering alpha relative to what investors can achieve in liquid markets, but also providing some very nice diversification and correlation benefits. And it's really great that wealth investors are now starting to be able to access that, those same investment opportunities. And I would say today it feels a little bit like the early days of the liquid mutual fund industry where there was a lot of product innovation, new product launches, lots of managers coming into the market. So I think it can be very confusing for the end investor, their financial advisor, and potentially even some of the wealth platforms where they have curation groups. And so I think there's a lot of learning and education happening. I'd say that there's some Well, platforms who are very far along at basically applying the same sort of diligence and rigor that we apply as an LP when we invest in, in a manager. And there's others that are still going through that education process.

 

Jeff Diehl, [00:20:58]:

So I think it's really important for managers to engage and educate the whole ecosystem. Most of our conversations are happening with the platforms, curation groups as they think about onboarding a product from us. And then with the financial advisors that are ultimately trying to advise their end investors about which products are right for them. And so I do think some underappreciated factors are top-down portfolio construction and risk management. I mean, that's one of the two hallmarks for us. That plus our bottoms-up selection are really critical to being able to design portfolios that can generate return per unit of risk that can be attractive to clients. And so I think that's an evolving factor today because there's a lot of products in the market and the discipline that managers have in terms of experience managing top-down portfolio construction, risk management, about managing an evergreen product, which is the predominant form factor that wealth investors consume today, is still evolving. Conversations are, I'd say, highly engaging and a lot of education still required in order to help this ecosystem evolve and work smoothly.

 

Chris Sparenberg [00:22:07]:

And Jeff, One of the things I love most about talking to firms like Adam Street, where you have indirect and direct investments, where you're lending on deals, you're in the middle of a lot of flow, and it feels like that gives you an interesting perspective on the secondary market today. When you look across secondary activity, what signals or patterns are you seeing that help indicate where true asset marks may sit? And how does Adam Street generally just approach that conversation?

 

Jeff Diehl, [00:22:38]:

Adam Street's been investing in secondaries since the mid-'80s before it was really considered an asset class. And when I joined Adam Street back in late 2000, the industry probably had turnover of maybe $1 billion or $2 billion a year in terms of private equity interests that transacted in the secondary market. Last year, that number was probably in the neighborhood of $150 to $200 billion. Of transactions where either limited partners selling their economic interest in funds or general partners catalyzing what they can now call continuation vehicles or GP-led transactions. So the entire secondary ecosystem has changed dramatically. But what's interesting about it is most investment markets ultimately have a secondary market that allows investors to rebalance their portfolios, get liquidity. There's a lot of motivations for why someone might be interested in selling. So despite the rapid growth of the ecosystem, I still think this has got a lot more running room to go.

 

Jeff Diehl, [00:23:34]:

And so we're seeing significant growth and interesting investment opportunities in the secondary market. We ultimately are underwriting the underlying investments or the underlying companies when we think about a secondary transaction. But there's really 3 deal types in the market. Large portfolios where you probably aren't underwriting an individual company. Those are called very large LP transactions. You've got concentrated GP-led deals where you've got maybe 1 or 2 or companies, and then there's something in the middle, which is more targeted portfolios that have got a little bit more diversification, but you're still doing company-level underwriting. Those latter two are generally where we— I would say the secondary market is a good investment opportunity in normal times, and in times of volatility or dislocation, it becomes a very interesting business because usually in volatile times, people get more nervous. Investors have liquidity or leverage issues.

 

Jeff Diehl, [00:24:27]:

And they tend to then enter the secondary market to sell. And usually in times of dislocation, discounts tend to widen and opportunities present themselves. We're seeing that today. There's been in the headlines concerns about AI completely disrupting SaaS or the SaaSpocalypse. We obviously have seen a geopolitical conflict in the Middle East, and we've seen prices of assets in both the secondary credit market. You can observe that with broadly syndicated loan pricing. And in the secondary private equity market become very attractive for those investors that have got capital and also have access to the ability to underwrite the underlying assets. So we are seeing very interesting opportunities today, and I do think that whole secondary market is going to continue to grow and evolve.

 

Jeff Diehl, [00:25:12]:

The other part of the secondary market is in individual company investments in venture and growth land. You know, companies are staying private longer. They are often doing tender offers to allow their employees, early employees to get some liquidity. So The direct company secondary side on venture or growth is estimated to have transacted about another $150 billion last year. And that's a massive increase from where it was 10 years ago. I just think private companies being private longer, taking longer to look at liquidity, the secondary market's going to perform a very valuable function for people who are looking to rebalance or drive liquidity. And we always tell people on the investing side, it's important that you're doing it in normal times where you've got lots of credible bidders. Don't be a forced seller.

 

Jeff Diehl, [00:25:58]:

Try to avoid that if you can. Obviously we are a buyer and take advantage of those dislocations, but we want people to be mindful about the cycles in this industry.

 

Jocelyn Lewis [00:26:05]:

Yeah, I completely agree. Nobody wants to be a forced seller, but it is pretty interesting just to see the transactions that happen and the reasons why some choose to exit certain deals and others see it as really a great opportunity. And Jeff, another area I'm just curious about is the discount gap between the venture and the growth or buyout secondaries, primarily being driven by— you referred to that lack of liquidity in the market, or particularly on the venture side. And how do you reconcile that kind of lack of liquidity with the fact that we haven't really seen pervasive down rounds in venture, or at least not to the degree that you might expect despite the pressure in valuation.

 

Jeff Diehl, [00:26:55]:

Yeah, you've got two interesting points there. The first one is around venture secondary discounts relative to where buyout discounts trade, and that's a fairly rational component of the secondary market. So if you think about a secondary underwriting exercise, what you need to know is when are companies going to exit? And what will they be worth when they exit? If you go to a buyout manager and you ask them those questions, they have a pretty good sense for when companies will exit because they control them, and valuations are fairly straightforward because you can see enterprise value to EBITDA multiples on the current business, and you need to make estimates about what that's going to look like when it does exit. In venture capital, it's the exact opposite. The managers generally do not own control of a company, so they do not control when it exits. That's a decision that gets made usually by the CEO in conjunction with the forward. And then secondly, if you ask a venture capitalist to predict what this business is going to look like at the point it does exit in terms of what it'll be worth, there's huge degrees of freedom around that. So it's very difficult as a secondary underwriter to be able to put certain assumptions in the model in the venture space.

 

Jeff Diehl, [00:28:01]:

And so therefore that just leads to deeper discounts when you're doing secondary venture transactions relative to secondary buyout transactions. In terms of the phenomenon though, and to your second point, the phenomenon of companies staying private longer. I think the reality is I've been invested in 25 to 30 private companies over my career, and 2 of those have gone public. And I can tell you that when a company goes public, it's very difficult to stay focused on what matters at the board, which is who are our customers? What do they want? How are we better than our competition? How do we continue to advance our product to be able to help penetrate more customers and grow our share of wallet with current customers? You spend a lot of time on things that don't matter. You spend a lot of time on quarterly earnings. It becomes very short-term focused. You can spend a lot of time on worried about short sellers or what analysts think. And so those are things that are not material to the value creation of the business.

 

Jeff Diehl, [00:28:55]:

And so it can be a challenge to be a public company CEO. There's a lot of pressures that go outside of just being able to execute the business. And so it makes sense to me that companies would be interested in staying private longer. I mean, that's not great for public investors, but that is the reality. It's also true that the public markets have not been very receptive to new issuances over the last 4 years. And so there's a combination of two factors. I do think when the markets become more receptive to new issuances, and we do expect that to pick up as we go through this year, we should see a return to companies being willing to go public. The secondary market's a really critical market for that, let's say, evolving individual company shares.

 

Jeff Diehl, [00:29:34]:

And a really interesting opportunity there to be able to get into great companies. But it all comes back to being able to select the assets, pick the right companies, get into the right valuation, and then construct portfolios so that you don't create too much risk for your end investors.

 

Chris Sparenberg [00:29:47]:

I think we're all hoping to see that change in attitude and a return to healthy IPOs. But as we're thinking about today, we can't really look past some of the macroeconomic factors affecting markets, affecting perspective. Jeff, it'd be great for you to talk a little bit about the current macroeconomic factors that you're monitoring at Adam Street and how that impacts underwriting new deals and also the performance across your existing portfolio.

 

Jeff Diehl, [00:30:13]:

Yeah, so at this particular moment in time, obviously the conflict in the Middle East is on people's minds and disruptions to oil markets and the Strait of Hormuz being shut down temporarily. Obviously we don't know ultimately where this conflict will evolve and whether markets will return to normalcy or we'll see a lot more increased volatility or oil shortage. So it's very difficult to predict these outcomes of geopolitical conflicts. So what we typically do is spend a lot of time thinking about, call it long-term shifts. Private equity and private credit tend to be long-term asset classes. You're generally investing in businesses that are going to ultimately build their value creation plans over many years, possibly even up to as long as a decade. And so you care a lot about what I'll call the very microeconomic and individual sector and competitive ecosystem of that sector. You spend less time thinking about the macro.

 

Jeff Diehl, [00:31:07]:

But I would say there are a couple macro factors that do matter. One is ultimately shifts in technology. If you think about 30 years ago, people didn't do internet shopping, and today that's basically taken huge market share from offline retail. The advent of mobile applications has really changed the way people interact with customers, suppliers, et cetera. Even podcasts. If you think about how people used to consume news, it was through newspaper or television, and now obviously podcasts have really taken off and other forms of media. So technology shifts are really important to be mindful of. And a big part of our investment thesis is investing in sectors that are going through growth, change, and dislocation through technology, where private companies should have an edge over public companies who are larger, trying to protect their market share, trying to protect profits, and frankly have the innovator's dilemma.

 

Jeff Diehl, [00:31:57]:

So I think shifts in technology are one huge one. The other one is just, I'd say, overall consumption patterns and buying behavior. Or changing preferences of consumers, I think is a really important thing to keep in mind as you think about trends in investing. Generally, you don't want to in private markets to be investing in things that are huge headwinds where you're worried about declines in revenue for your sector or for your company, because it can be very difficult to ultimately generate good returns either for an equity investor or a credit investor. So it's really important you be on the right side of changing patterns in consumption and technology.

 

Jocelyn Lewis [00:32:30]:

And speaking of patterns changing, We're in an interesting time too, where you have the private markets, and we touched on this a little bit when we talked about investor transparency, but where the private markets just continue to open up to individual investors through the retail channel. Jeff, what trends or behaviors are you seeing emerge via this channel, and how is that shift shaping the way that people access and understand the opportunities that really were once only reserved, almost exclusively exclusively for institutional investors?

 

Jeff Diehl, [00:33:07]:

The wealth investor is becoming an increasingly important part of the private markets ecosystem. As we discussed before, the wealth investor globally probably has a less than a 1% allocation, maybe a single, low single-digit allocation to the asset class. And if you look at most institutional investors, they have about 10% allocated to the asset class. The wealth investor growth potential for this asset class is huge. And investors who look at public markets see a high concentration in the Magnificent Seven in say the S&P 500 index or any other major index fund. And if you think about ultimately where growth could come from, small and mid-cap companies have historically been the ones that ultimately turn into those big companies. And all the Magnificent Seven are venture-backed companies. They were startups at one point.

 

Jeff Diehl, [00:33:57]:

And so to capture The next wave of growth and the next category leaders, it's very difficult to do that in public markets today. If you look at when the Magnificent Seven went public, most of their value creation for investors has occurred since they've been public companies. And that doesn't seem true any longer today. If you think about Anthropic or OpenAI, who've done financing rounds privately in the hundreds of billions, mid to high hundreds of billions of dollars of valuation. There's huge value creation that's occurred in private markets. And so to capture that opportunity, wealth investors really need to turn their attention to private market products that are available to them. And obviously, hopefully have their financial advisors and their wealth platforms help them with the curation and selection of those. So I really think private markets and wealth are an intersecting ecosystem that's going to be important for both sides.

 

Jeff Diehl, [00:34:48]:

It's important for managers who can tap into a diversifying investor base,, but it's super important for wealth investors who can now tap into companies who just aren't available to access through liquid markets.

 

Chris Sparenberg [00:35:00]:

So Jeff, maybe as a sidebar, what are your observations from the IPO pipeline? What are you seeing across private companies that is interesting to you?

 

Jeff Diehl, [00:35:08]:

I've been at Adams Street for 25 years, and I will say that right now the growth and scale of private companies, venture-backed private companies, that would normally be public. I've never seen anything like what we're seeing today. So companies in the artificial intelligence space that are not just growing their revenue at 50% or 100% or 200%, I mean, we're talking about things that could be growing at 1,000% plus per year, just explosive growth. And so I think we are poised to have a very positive set of developments in the IPO market very high qualities wind up delivering growth in new markets that investors really haven't seen before. So it obviously remains to be seen when that all opens up. I think there's a sentiment that will happen later this year. SpaceX, OpenAI, Anthropic have all been reported to be looking at IPOs, but there's a very long roster of companies that are of scale and producing growth that is very difficult to capture. In public markets.

 

Jeff Diehl, [00:36:12]:

So I'm incredibly optimistic, and I think that investors who've got exposure will be very happy. If you don't have exposure today, you may be a little disappointed. How do I get that? But maybe they'll be ultimately available to tap into in public markets. So I'm very bullish on the IPO window and the opportunities for some really great companies to go public, greater than I've ever seen in my history at Adam Street.

 

Chris Sparenberg [00:36:33]:

Jeff, thank you so much for sharing such a comprehensive and candid look into today's private markets. Your insights from the dynamics of hyperscalers in private credit to the discipline required in underwriting to the evolving expectations of LPs and the rapid rise of the wealth channel, give our listeners a deeper understanding of how the industry is shifting beneath the surface. Adam Street's dual vantage point as both an LP and a GP, along with its long history of navigating cycles, adds a unique and valuable perspective to these conversations. We appreciate you taking the time to breakdown the complexities, highlight the opportunities, and shed light on where investors should be paying closest attention. And thank you for joining us on Private Markets 360. We hope you found this conversation as informative and engaging as we did. Be sure to subscribe to Private Markets 360 for more expert insights and the latest trends in private investments. Until next time.