Episode Transcript
[00:00:00] Speaker A: Decision making process is very similar to how we'd make any decision in terms of we were investing in a limited partnership vehicle, private equity or anything else. It starts with that. So it starts with we have to like the manager, we have to believe in the strategy, we have to believe in the collateral that we're being going to be exposed to and the manager's ability to generate alpha or in the case of credit, not lose money. And so those are the very two most important parts of what we do. And I think the third leg of the stool is we think about structured product and being exposed to rated feeders and things like that is the structure and really understanding the structure from a legal perspective.
[00:00:38] Speaker B: Welcome to the Institutional Edge, a weekly podcast in partnership with pensions and investments. I'm your host, Angelo Calvello. In each 30 minute episode I interview asset owners, the investment professionals deploying capital, who share insights on carefully curated topics. Occasionally we feature brilliant minds from outside of our industry, driving the conversation forward. No fluff, no vendor pitches, no disguise marketing. Our goal is to challenge conventional thinking, elevate the conversation and help you make smarter investment decisions, but always with a little edginess along the way.
Hi everyone. Welcome to another episode in our series on private markets. I'm Angelo Calvello, your host and today we're exploring how a property in casualty insurance company approaches and benefits from private market investing. And I could think of no one better to discuss this with than my longtime friend, Joe eppers. Joe's the CIO at Selective Insurance where he oversees the company's $11 billion in general account assets and over a billion dollars in retirement assets in DB and DC plans. Joe is also the Chair of the Management Investment Committee and is responsible for constructing and executing the company's investment strategy. Prior to joining Selective, Joe served as director in BlackRock's financial institutions group and he was previously senior VP at Endurance Specialty Holdings. Joe has been recognized for his leadership in the insurance investment community, including being named Institutional Investors 2025 Insurance CIO of the Year. Joe, well deserved.
[00:02:23] Speaker A: Thank you.
[00:02:23] Speaker B: And we're fortunate to have Joe's colleague, Veb Kalia. He's the head of Fixed Income at Selective and is responsible for sourcing public and private fixed income investments. Previously, VEB was at BlackRock and the RQA Group responsible for risk management of multisector fixed income funds totaling about 40 billion. He also was at HSBC, but we're not here to rebios. Those will all be in the show notes. You'll be able to see them there.
Joe And Veb, welcome to the show.
[00:02:56] Speaker A: Angelo, it's great to be here. I'm honored to be a part of your podcast.
[00:03:00] Speaker B: That's kind of you, Joe. Veb, I know you probably don't care, but it's good to have you anyway.
[00:03:06] Speaker C: Thanks for having me.
[00:03:07] Speaker B: All right, we always start off with a quick fire round. Joe, I'm gonna start with you.
Still or sparkling?
[00:03:13] Speaker A: Sparkling.
[00:03:14] Speaker B: Joe, you worked at a pizzeria when you were young. Not a lot of our audience knows that. And I didn't see it in your bio for being the C of the year in the insurance sector, but what's your favorite pizza topping?
[00:03:25] Speaker A: Oh, pepperoni.
[00:03:26] Speaker B: Oh, my goodness, Joe, Ernie Banks or Shohei Otani?
[00:03:31] Speaker A: Man, I gotta say Ernie Banks, because I'm a diehard Cubs fan.
[00:03:33] Speaker B: But Shane, I didn't know that. Joe, I didn't know you were a Cubs fan.
[00:03:37] Speaker A: Oh, come on. How long have we known each other?
[00:03:40] Speaker B: Hey, who was sitting next to you? Remember that?
[00:03:43] Speaker A: I remember that.
[00:03:45] Speaker B: And then this is kind of a. This may take you a minute, Joe, but if you were not working in the investment industry, what would you be doing? And don't say working at your father's pizza place.
[00:03:54] Speaker A: Yeah, I wouldn't be doing that. I'd probably be doing something related to architecture or construction.
[00:04:02] Speaker B: Okay.
[00:04:03] Speaker C: Yep.
[00:04:04] Speaker B: All right. VEB to you. Morning person or night owl?
[00:04:08] Speaker C: Morning person.
[00:04:09] Speaker B: Chatgpt or Claude?
[00:04:11] Speaker A: Chat.
[00:04:11] Speaker C: Chatgpt.
[00:04:12] Speaker B: Cricket or football?
[00:04:13] Speaker C: Cricket.
[00:04:14] Speaker B: Ooh, man, that was fast.
And the same question to you, my friend. What would you be doing if you weren't in the investment industry?
[00:04:22] Speaker C: I feel like I'd be a math teacher.
[00:04:24] Speaker B: Very cool. Okay, so you guys got through those unscathed, am I right? There is no. No blood drawn on those.
[00:04:30] Speaker A: I appreciate that. Yes, thank you.
[00:04:33] Speaker B: All right, let's jump in and explore why private market investing is an essential part of a PNC portfolio.
What are the core benefits that align with the company's needs?
Who wants to take that one, Joe? I feel like it's jeopardy. A toss up question. Go.
[00:04:51] Speaker A: I'll take it. And VEB can fill in.
Look, I think that the most, the biggest benefit is just diversification.
So many of our of PNC portfolios are, I would say, exposed to public investing, public credit and private credit. Private assets. Private markets give you an ability to diversify amongst different collateral types, different issuers, different maturity in terms, and so the diversification benefit is huge. I think secondly, as a PNC company, we really benefit from the ability to take liquidity risk because we are, as a going concern have lots of liquidity from, from our business and operations as well as from our portfolio. So we have the ability to take liquidity risk. We typically are very patient investors. And so I don't need to, you know, turn the portfolio or sell things in the private, in the private or the public side. So I can afford to take private risk as a result.
[00:05:44] Speaker C: Yeah, no, I think the premium that the private markets have afforded investors is unique. And it's come across not just equity, but within credit and fixed income as well. And for years life insurance companies have been the beneficiary of that. And for PNC companies to kind of take a leaf out of that book has been something that we've tried to do as well.
[00:06:03] Speaker B: I'm going to go a little deeper. I was doing my research and I say it's always dangerous when I do this. But I see on the, you know, in the insurance sector there are certain constraints in terms of capital.
I'm assuming that there's some capital efficiency embedded in these investment opportunities, otherwise you wouldn't touch them. You'd be penalized by your regulators.
[00:06:26] Speaker A: Yeah, no, I think so. There are capital efficiency and I guess we're going to probably talk about that more later in terms of how the market for privates has evolved to become more capital efficient.
But in general, private markets, traditionally, so I think private equity, even private credit real estate typically came at a pretty high cost in terms of capital. The capital that we as an insurance company need to withhold to invest in those, those types of, of sectors. But the returns more than offset the capital requirement. So it was still diversifying and still from a capital perspective, manageable. But the industry, and again, as we're probably going to talk about, has really evolved in terms of the development, evolvement of capital efficient structures that allow us to invest in those same products but do it more efficiently in terms of how our capital is utilized.
[00:07:16] Speaker B: Let's talk about that evolution. I mean, how has it changed in the past, say 10 years?
[00:07:21] Speaker A: Yeah, I think, look, I'll start and I think VEB can add a lot to this because he spent a lot of time looking at this. But in general, think about how the securitization market has impacted public markets and the ability to get exposure to whether it's residential mortgages or commercial real estate or asset backed securities that are backed by all types of collateral in the public markets. That's been around for decades. And what's happened in the last, say five, 10 years is the securitization market has come to the private market. And it's allowed us as investors to take advantage of that through the collateralization and securitization of certain types of private markets, hence making it more capital efficient for us to invest in privates.
[00:08:04] Speaker C: I think that that's the key. Right. So in the 10, the past 10 years that you talked about, Angelo, I think from our perspective, to see this kind of development on all kinds of collateral types, not just within cash flowing credit assets, but even sometimes on certain parts of the private equity market, having the ability to invest and choose where to invest, whether you're financing a particular cash flow or you're participating in the, or being the beneficiary on the equity side of those cash flows and being able to kind of choose your position in the stack. That ability to do that didn't exist 10 years ago and that exists now. So you can choose nature of cash flow and be like, we want to be top of the stack, mezzanine, or do you want to participate in the, in the upside there? So that innovation didn't exist 10 years ago and now it does. So I think that's kind of the key, from my perspective at least, is.
[00:08:54] Speaker B: The innovation manifest in a vehicle structure, a specific structure that might have been created to support these kind of opportunities.
[00:09:01] Speaker C: Right. And I think it is related to the capital situation with the insurance company balance sheet. So it is the origin of it is life insurance companies, again, because they control most of the assets in the insurance space, they have the majority pool. Almost 75% of the assets in insurance are with life companies. What you've seen there is they were basically competing with the banks to take away the financing or to some of these different kinds of asset classes. And the innovation that happened was utilizing the CLO technology or the tranching aspect of risk to kind of bring that to private assets. So that's kind of the key behind most of what is going on.
[00:09:38] Speaker B: And given the. Let's call it the innovation in structure. I mean, you've mentioned talking about the CLO like structures that are embedded in these. I don't want to call them funds, but they have a certain name. What's the name of these type of funds?
[00:09:53] Speaker C: The naming convention is the one area where people have fallen short. They're being called rated feeders, you refer to. That's kind of become the most generic form in which folks have talked about these structures. But essentially to the extent there are covenants and forms to make the class A versus the class B versus the bottom part of the stack different in terms of risk in terms of putting in LTVs or putting in other kind of covenants to determine how the risk is shared between the different branches, which is no different than what happened in securitization markets going back 20, 20, 30 years. So that's kind of the key from the perspective of investors. How do you kind of separate out the risk in the.
[00:10:37] Speaker B: So it's not like the usual limited partnerships. These are structured specifically for your needs and they give you within these structures remarkable flexibility. And you've talked about it, but give me an example of that flexibility and how you can slice and dice and pick the middle of the stack or equity exposure. I mean without giving away anything proprietary of course.
[00:10:57] Speaker C: But so I think the simplest one comes to mind is on the middle market lending side. So direct lending is the, I guess the elephant in the room when it comes to private credit. And what you have seen in direct lending historically, we could only be an LP in a fund where raised by one of the GPs out there and get exposure to the entire collateral pool and you'd be exposed to all the defaults and all of the risk that comes with investing in smaller kind of companies out there. So what middle market clos did in the space and now they've become mainstream, 10 years ago they were not mainstream was essentially this aspect where you could choose to be a financing party and meet up the stack, be a AAA investor, get diversification through the collateral pool, yet have the self healing mechanism that exists in a CLO and you could get paid 200, 300 basis points to finance a pool like that. Historically only banks were able to do that. That kind of translated then to insurance companies being able to do that. And with the rated feeders and structures now even smaller investors like PNC companies can participate in this. So a smaller investor earlier was completely cut out of a deal like that, which they can choose to now when you tranch out further, you can kind of go into an A rated or BBB rated tranche and and if you go back three to five years or when there is stress in the market, you could be investing in investment grade asset with 500, 600 spread, something that didn't exist again for investors of the way this market has gone is you've converted a private asset into a public asset where the bonds are actually trading. And we expect that to even happen to rated feeders going forward at some point. But middle market sales is probably the best representation of how one could choose risk and get paid for it. Even as a small investor, something that didn't exist for investors before Joe, I'm.
[00:12:40] Speaker B: Going to call on the right hander from the bullpen. Anything you want to add?
[00:12:45] Speaker A: I think Bev covered it really well. I think the flexibility that it affords us as investors who want to be exposed to private markets, it's just given us another tool in the toolkit in terms of diversification, enhanced yield.
And as VEB said, we can choose to be at the top of the capital stack for a given risk or we can choose to be in the middle or even take the equity risk at the bottom if we really believe in the collateral and the manager or in some cases maybe the entire vertical strip of a rated feeder as an example. And in that case, the way you think about that is if I'm the vertical strip, I'm essentially getting 100% of the return that I would be getting if I was in the traditional drawdown fund or limited partnership structure that historically we've always invested in.
But I'm getting it in bond like format as opposed to a limited partnership format.
[00:13:35] Speaker B: Thanks. So these structures are clearly beneficial to your, I guess beneficial, but more importantly, I guess they meet your requirements in terms of capital efficiency at a base level and they offer the flexibility. But what type of investments do you look at?
[00:13:50] Speaker A: We're looking at and seeing deal flow across all types of collateral. I think the most prevalent one we see is direct lending. You know, there's a lot of asset managers currently raising these rated feeders that are, you know, tied to direct lending as the underlying collateral pool. But what's been growing the last, I would say couple of years, certainly in the insurance space has been asset backed finance. So lending to hard assets, whether that's, you know, you could tie in real estate in there as a hard asset, but you could also tie in equipment, leases, music royalties. There's a number of different cash flow generating hard assets or soft assets in the case of music royalty that can be securitized in a private structure and then sold to investors like us as insurance companies. And again, we can participate in the senior part of the stack or somewhere in the middle, or we can take the whole stack or anywhere in between. And so I think the, the evolution of this market has moved from direct lending, which was the easiest kind of asset class to securitize because of the cash flows to now we're seeing a lot in asset backed finance and so we see a lot of those opportunities.
[00:14:53] Speaker B: So you've got these benefits that are associated with these types of investments. You like the structure, the structure meets expectations.
This idea of asset based financing.
But okay, how do you make your investment decisions? You know, you guys, you got this palette to paint from, but how do you make those decisions? What's the process for making an investment decision?
[00:15:17] Speaker A: Yeah, look, I would say to start off with the decision making process is very similar to how we'd make any decision in terms of we were investing in a limited partnership vehicle, private equity or anything else. It starts with that. So it starts with we have to like the manager, we have to believe in the strategy, we have to believe in the collateral that we're going to be exposed to and the manager's ability to generate alpha or in the case of credit, not lose money. And so those are the very two most important parts of what we do. And I think the third leg of the stool is we think about structured product and being exposed to rated feeders and things like that is the structure. And really understanding the structure from a legal perspective.
What are the four corners of the legal document? What are our covenants, what are our protections in the case of whether we need them? And if we're lending at certain areas of the capital stack, making sure that we understand those risks, making sure we understand how we can potentially lose money in a downside situation. So the structure becomes extremely important in evaluating these. And so we have, they all go through legal review, we stress test them. We're really trying to understand how the structure is going to perform in a downside scenario to make sure we're well covered based on where we're playing in the capital stack.
[00:16:32] Speaker B: So the differentiator between your traditional versus here is focusing on covenants.
[00:16:39] Speaker A: Covenants, the structure, how we may get burned as a bond investor from a.
[00:16:43] Speaker B: Structure standpoint, I think, Joe, you told me in the past you need real teeth in these covenants to make sure they actually are going to work when you need them.
[00:16:52] Speaker A: That's exactly right. And so as we think about the NAIC and their involvement of understanding this asset class, they've been very helpful in terms of laying out some framework around making sure that investors consider different characteristics of these deals to make sure they can be treated as bonds. And so covenants is important around, for instance, around LTV tests to make sure that from a loan to value perspective, if the collateral starts to underperform, we as potentially senior investors would get our money back quicker and the deal would amortize faster in that situation.
Interest coverage tests and then importantly leakage. So how does, how does collateral, how does cash flow leak out of the system to the equity at the detriment of us as bondholders. So those are a few very important characteristics that we look at.
And as I said, the NFC has been very helpful in kind of laying out a framework for the industry to kind of think about these things so that we can indeed carry them as bonds on our balance sheet.
[00:17:51] Speaker B: Cool. Deb, the floor's open if you want it, but don't feel you got to dance.
[00:17:55] Speaker C: No, I feel like this particular question is a great one. And what we have seen really happen within the Cielo space and how that structure has kind of being tested through several crises and how the mechanism in that structure has kind of evolved to allow for the debt investors to be well supported with from the underlying cash flow. That's kind of being what is being borrowed in a lot of the structures that we're seeing now. And that is kind of what makes us really comfortable in utilizing the structure. And when we're. I know we already talked about, you know, the track record of the manager and what the collateral pools could be, but the, the.
What are the teeth in the structure, like you pointed out, I think that's kind of the, the key from our perspective there.
[00:18:35] Speaker B: So you go through this process then of, you know, identifying an investment need. You go out, you find an external manager or managers that will assist in that and you make the commitment.
In private markets, it's, how would I say, a.
It's an opaque market.
Now you can have great performance here.
I'm sorry, you're going to have a great process, but you need to know it works. So how do you measure performance? How do you benchmark within this, you know, kind of opacity?
Feb. I'm going to ask you that one, Joe, if it's okay, I'm going to. I mean, he's been kind of quiet and I want to make sure he gets a chance.
[00:19:13] Speaker A: So I'm curious to hear what he says. So.
[00:19:15] Speaker B: Yeah, me too.
[00:19:16] Speaker C: Benchmarking is one of Joe's favorite topics.
[00:19:18] Speaker A: But I'll take it.
[00:19:20] Speaker C: So currently, within private assets, there have been multiple ways in which people have looked at performance for funds, right? IRRs, TVPI or MOICs, and then calculating PMEs, which is comparing it to public markets for each of the underlying assets. So private equity against S and P, for instance, or private credit against leverage loan or high yield indices.
So you've had a lot of those kind of benchmarking being done on the alternative side. But I feel like the, the nature of the assets that we are mostly investing in are debt instruments and they are non benchmark. Debt instruments. So by definition they're not present in the benchmark historically in use of fixed income. So you may use Barclays AGS or now Bloomberg aggregate indices, but none of the securities that we are investing in end up in those. So it's really tough to think of benchmarking. We are actually thinking of when we invest in this is what is the alpha we're producing over and above a benchmark of a similar duration, similar credit quality. And one, you have to believe in the credit quality, the instrument that you're buying.
So it's a very tough question to answer, to be honest with you, on what is the right benchmark and how do you think that your performance is in excess of that? And given the last 10 years that we've been investing in, you've had pitfalls, you've seen success stories on this. In the end, it is about what is the excess OS or excess spread you're generating above the benchmark and whether the loss adjusted spread is worth the risk. And so far on an aggregate basis, we've been happy with the outcome there in terms of what. And these assets are now compressing in spread. So at a particular point, you do not want to necessarily invest in it if you don't see the value of giving up liquidity and taking up the structure risk without getting the compensation for it.
[00:21:00] Speaker B: Joe, what do you want to add to it? Anything.
[00:21:02] Speaker A: Yeah, I'll just add. So I think as we think about investing in anything that's private and let's say private debt, private credit, it really has to, we have to believe, obviously, as VEB said, believe in the rating, but believe that the spread is durable. Right. And the spread relative to what we could invest in our public, public side of our portfolio, which as Web said, everything we do is kind of comp to the public side. And if we're not earning a certain spread hurdle that we think compensates us for the liquidity risk and for potential credit risk, it's a pretty easy pass for us. We, we don't have to invest in privates. And that's the way we kind of look at it. Privates are a nice tool and when we can invest in them at levels of spread and perceive risk, we will, we will do so, but if not, then where? It's an easy pass. And so it's not really, it doesn't really get to your question around benchmarking, but it does get to how we think about those dollars could either go in the private, in that private vehicle or it could go in the Public, public portfolio. So we're constantly weighing the trade off between the two.
[00:22:01] Speaker B: It makes sense to me. I mean, I could see it. If it doesn't provide the juice, you don't buy the orange. So I guess then the opacity and the, you know, the struggle with some getting marks. And I know Joe, in the insurance industry, you know, on the underwriting side, you know, you're marking on a quarterly basis, you know, more frequently and clearly with probably better transparency into the marks than you're doing in the private market side. You're the cio. You've got to report to stakeholders and you need to tell those stakeholders or demonstrate empirically to those stakeholders that what you're doing is achieving the result that they've charged you with.
[00:22:43] Speaker A: Right.
[00:22:43] Speaker B: It's a governance issue at some point. So this, this benchmarking or performance reporting, it has to flow through that governance structure.
[00:22:52] Speaker A: Right.
[00:22:53] Speaker B: And I mean, how do you do that?
[00:22:55] Speaker A: Well, look, it's not, I would say it doesn't happen overnight. So I've been here 10 years now and in that 10 years and VEV's have been here 11 years and I think we've just built an enormous amount of credibility with our stakeholders. We've been very transparent. You know, every quarter we report on our performance, we have provide lots of transparency into what we're doing.
We stress test the portfolio from a liquidity standpoint, from a stress and credit standpoint. So our stakeholders, I think have a very good sense of how the portfolio will perform, how it is performing and they understand the risks that we're taking because of that level of transparency.
And I think a lot of that's grounded also in the fact that we have, I think, a very solid process on how we make decisions. We are a small team, we're very collaborative in our approach. So it's not just Feb off on his own buying bonds or doing things in these structures that we as a team don't know about.
And so as a team we're, we're quite collaborative in our approach and decision making and we share that with, with our stakeholders. They understand what our approach is and so they get it. And that doesn't happen overnight. Right. I didn't show up 10 years ago and say, hey, we're going to do this and just trust me, it took many years and lots of education along the way to educate them on why privates make sense, why our process around how we invest in privates makes sense. And then as the returns began to come in and the success that we had really kind of created a snowball effect in terms of the confidence in the team and in the process.
[00:24:24] Speaker B: Joe, how do you deal with the patience that's necessary on the private equity side? Because, you know, you've got the J Curve issue and I don't know how old your portfolio is, but I assume there's some seasoning that's occurred. But you know, these stakeholders have to understand, it's not like you're looking at the index, the S and P index, you know, it was up, you know, 3% this month.
How do you deal with that kind of incongruity between the reporting and the patience and the need for understanding performance?
It's all trust, I guess, right? It's built on a fundamental trust.
[00:24:59] Speaker A: Well, it's built on trust. It is built on outcomes. Right. So, you know, there's two, two ways, two things to think about. What, what is, how do you evaluate or what, how, what's the quality of our decision making and that we can lay out in terms of our process and we believe we have a good process, so the quality of our decisions are good. And then when you map that against the outcomes, if the outcomes are good or bad, those are, you know, those are going to happen. And so what I kind of think about is making sure that the quality and the process is there so that we know we're making good decisions. We are going to make mistakes, you know, as investors, we're going to make mistakes, have made mistakes.
And I think being transparent about that is important, but trust is a huge part of it. As you said, there's no easy answer because these things take time. The portfolio, our private equity and our alts portfolio is now 10 years in and it's shown really good results.
But admittedly there are periods where the results aren't as good as public markets. And we show that and we talk about that and we're very transparent on that. But I think over a long period of time, you know, it takes a while to actually see the results play out. And our constituents, our stakeholders understand that they may not necessarily like that. They, you know, immediate gratification is, hey, you know, want to, want to see performance more on a more real time basis, but it takes time for, for these things to unfold. You know, it's a question I ask managers. I had a meeting yesterday with, with a manager and I asked that very question, how do you evaluate your performance? Or how do you evaluate what are key performance indicators that you look at on a short term basis that tells you about the quality of your decisions without just relying on, you know, we'll, we'll wake up in 10 years and see if, see if we made good decisions. And you know, they kind of smirked and said, you know, that's a great question. I haven't really thought about that.
But you know, they believe it really begins with having a solid process in how you make decisions. And I agree wholeheartedly. I think it's really around process.
[00:26:57] Speaker B: It sounds like the process is twofold, Joel. One is the investment process and two is the governance process that surrounds the investment decision making.
[00:27:06] Speaker C: Right? Yep.
[00:27:08] Speaker B: All right. I'm going to go in a little different direction here, but one that you guys should be comfortable with. Joe, to you, there's been this talk about the democratization of alternative investments in 401 plans that opens up private markets to a new group.
What do you think the consequences of this expansion might be? And I know it's hypothetical because it hasn't happened yet, but you mentioned, or one of you gentlemen mentioned fee compression earlier in a comment and that's in the back of my head.
So Joe, please.
[00:27:40] Speaker A: Well, I think so you can look at it really on the upside and the downside. I think on the upside you would hope to see fee compression much like we've seen in the mutual fund space and ETF space as more capital comes in, becomes more competitive and fees should come down. And so that would be good. I think in the short term though, I'm worried that that's, that's not going to happen soon enough for some of these vehicles that are going to be exposed to 401ks and just retail at large because they're very high fee. You know, the retail share class of some of these funds are pretty high, high expense ratios. So fees could, you know, fees come in, that could be good, I think, giving investors exposure to things other than the Mag 7 and what's in the public markets. I mean you think about what's in public indices today, it's heavily dominated by tech in the Mag 7 and it's really unfair to investors, retail investors, to not have more diversification in smaller companies that are really great run companies owned by private equity sponsors that retail investors just have no exposure to. They don't have exposure to the next OpenAI or the next meta and so forth. So I think that's an important potential benefit to the retail investor. On the downside, as an institutional investor, what I fear is that you're going to see a compression in spreads or in valuations. So in credit as an example, as More money comes in. I think the supply or the demand will outstrip the supply. And so you might see a compression in returns and spreads. And I think, look, that's an advantage for us as institutional investors. We can take liquidity risk. We can earn that liquidity spread. If the retail investor comes in and crushes that, it makes owning privates that, you know, potentially less attractive for us relative to public. So I fear that that's going to drive a lot of spread compression. And then I think the last thing is, you know, it's going to. It's going to create a lot of just bad strategies and bad managers out there. Right. And so we saw this when hedge funds, you know, several years ago, tried to. Tried to get, you know, tried to provide more liquid kind of public avenues of investing in hedge funds. And it was not a great outcome. And you had a lot of money chasing bad strategies with bad managers. And so I think in anything that we do, it really comes down to manager selection is a really important part of our process. And so that's going to be the way we kind of try and mitigate that risk. But there's going to be a lot of bad actors, I think, that come into this space to raise money and to deploy money potentially aggressively. So that's what I worry about.
[00:30:10] Speaker B: And I guess given your role in terms of sourcing and vetting, that's going to put an additional kind of criterion. As you think about managers, if they're heavy in the retail space, you may.
I mean, does it influence your sourcing?
[00:30:27] Speaker C: I take the positive view on this one. So my two cents on this is when you have these evergreen structures and evergreen funds, they are held to a higher standard of reporting. So they are disclosing every position. So the opacity and the asset class kind of disappears. They're having to disclose their positions quarterly, semiannually, so you can actually see who owns. Who owns the cockroaches and who doesn't. Right. A lot of these names, you may not actually be familiar with some of the portfolio positions that exist in some of these funds, but you could get a lot more transparency into the underlying asset class because of the funds being being marketed to one being evergreen or being marketed to retail.
So, you know, I kind of draw a comparison to what happens in public markets. As soon as first brands happened, everybody knew who owned the first brand loans because it was in the CLO market. And all the CLO trustee reports are available through Intex or other tools. So you could exactly see how much your first brand Was in every CLO manager's book the same thing. When it happens to a private name, there is very little ability to kind of find that out. Unless there's a public product like a BDC that exists out there or an interval fund, for instance. That's the only way to find out who actually was involved in a credit like that. So I think there'll be more information that comes out if some of these funds get available for retail. So.
[00:31:48] Speaker B: And I guess, you know, you guys have a DC plan. If I remember, you're a sponsor.
[00:31:54] Speaker C: Yeah.
[00:31:54] Speaker B: And one of the issues that I've been hearing from other sponsors is concern about litigation in this space.
Cause we're talking about suitability. We're now offering perhaps exposure to investments that previously required a certain accreditation. Correct. Does that enter into your calculus? I'm gonna ask Joe this question Feb. Since he's probably the name fiduciary on the DC plan and it'll be his ass. Oops, he'll. It'll be his nose that they sue. Is that an issue for you, Joe?
[00:32:26] Speaker A: Absolutely it is. I think, look, I think we're still early days in this process. I know the current administration is trying to craft some rules, some safe harbor rules for sponsors to invest in these products.
I can say that, you know, we're following it and you know, we'll probably at some point make a decision on whether it's. It's suitable for our participants or not.
But I don't think that's going to be anytime soon. I think I want to see the market evolve. I want to see how disclosure is going to be for this.
And what type of education do we need to provide our participants as a sponsor to make sure that they have all the facts and circumstances around why they should.
What are the risks around investing in this particular product?
The other thing I worry about is this stuff is probably going to start showing up in target date funds. And target date funds are more than half of most plans are more than more than half exposed to target aid funds. That's generally the default option. And so I'm curious to see how that's going to play out because most participants aren't going to know they have privates in their target date funds if they start showing up there. So I guess another thing to keep an eye on is are the large target date fund managers, how are they going to implement this and what's it going to look like?
[00:33:41] Speaker B: Veb, you still there?
[00:33:43] Speaker C: Yeah, I'm right now.
[00:33:44] Speaker B: Okay. I couldn't tell. I mean, you're so still, I mean, you know, I got to keep moving. Do you want to add one more thing about this democratization?
[00:33:52] Speaker C: Yeah, sure.
[00:33:52] Speaker B: Okay. You don't have to. Please, if you don't want to, you don't have to, but go ahead.
[00:33:56] Speaker C: I mean, so there's always, you know, positive and negative associated with this. And, you know, for us, you know, the return kind of goes away as more investors come into the place. And that's the negative for us, the positive for US currency. If you ever asked us for a wish list of what would be, you know, what do we want from our exposures within private sector, given how much it is, how big a part of the portfolio it has become over a period of time, would be how do we monitor it actively? And I think if there are tools that come out to do that, if the data that becomes available to do that, all that would be the positives that would come out of the Democrat, in my view.
[00:34:30] Speaker B: So what's interesting, you use the word wish list. This is my final question here, and it's going to VEB Joe, because he's got a background in electrical engineering.
And I know electrical engineering guys are AI guys. So what's on your AI wish list? I mean, you know, what would make your job, what would make you more effective if you had this type of AI?
[00:34:57] Speaker C: So it kind of goes back to what I just talked about in terms of monitoring your exposures in your portfolio, like in our role of playing offense and defense, in terms of finding the right managers and the right investments and then kind of monitoring how those investments are doing. I think we sometimes fall short in the use of technology that exists in the space and we're always on the lookout for what is the best technology out there to monitor your exposures. And with AI coming in scope, there are a lot of new startups and new products coming out that help you more efficiently monitor your exposures, despite the fact that a lot of these exposures are opaque, not easily visible in terms of structures being created on top of structures, kind of like CDO square. So to explain, like if you were to pull an int in index, a cdo, you'd only see the positions that your first video has, not your next and so on. Right. So I think with AI and some of the databases being created in the public domain, there could be at some point new tools that come out that let you better understand the exposures that we have, so we are much more informed and capable of understanding what are the managers and the credits to avoid and so on.
[00:36:04] Speaker A: Right now, that process is very manual. Right. So we get trustee reports every quarter or some curiosity that we have to kind of look at on a very manual, spreadsheet driven process.
And I think what Web is talking about is the ability to use AI and technology to really streamline the process so that we can spend less time manipulating the data or calling through the data, calling through the reports, the trustee reports, and more time on analyzing the actual data and how the trends are unfolding. And so the extent that we can find technology that allows us, similar to way Intex has evolved over the years, over the CLO market, that would be, I think, a huge, I think, wish list on probably every allocator's mind.
[00:36:44] Speaker B: It sounds like it's sort of an overlay on top of an existing structure that'll improve the operational efficiency and maybe identify red flags or. And you have a process of escalation from there.
[00:36:56] Speaker A: Right, right.
[00:36:58] Speaker B: Joe, you sure don't want to build like your own avatar, the Joe Eppers CIO avatar.
I know people that can do that.
[00:37:05] Speaker A: But, you know, I'd be afraid if I did that I'd be out of a job.
[00:37:08] Speaker C: Right.
[00:37:09] Speaker A: Why do they need me then?
[00:37:11] Speaker B: Well, it's a good thing, Joe. You have great tenure in the industry, because I think we're moving towards that over time. You may have to worry, but you seem like a smart guy, so.
Well, I want to wrap this up by asking the question I ask everybody at the end, and I'm going to put it to you individually, Joel, what's the worst pitch you ever heard in all your years being on the other side of the desk?
[00:37:37] Speaker A: So I've heard a lot of bad pitches. Not one really sticks out of my mind, the exception of.
[00:37:42] Speaker B: Don't say the one I did, Joe. The one I pitched you on.
[00:37:45] Speaker A: No, no, that one I. Yeah, you did fine.
[00:37:47] Speaker C: You did fine.
[00:37:49] Speaker A: Back when you were schlepping product.
[00:37:50] Speaker B: I remember open my suitcase down in Indianapolis, go to the steakhouse Elmo's or whatever it was afterwards.
[00:37:57] Speaker A: Yeah, I remember that. I remember that. So I can look back on this and say this was a really bad pitch in hindsight. But at the time, it didn't seem like a bad pitch. It seemed like a bad idea, not a bad pitch.
This was going back to 07 when I worked for a large reinsurance company. We were asked to participate in a.
Or look at potentially providing a reinsurance cover for one of the financial guarantee companies, who I won't name who that is that at the time was providing insurance wrappers for subprime mortgages, DDOs, munis, other areas. You know, that was a very popular insurance strategy years ago.
And so we went in, we. We heard the pitch and we left. I think our view at the time was one, we really. We didn't have any expertise in underwriting mortgages. So it was an easy pass from that perspective. But I think the reason I was in the room and my boss was in the room is from an investment perspective, evaluating kind of what we thought about the risk. And I remember kind of leaving that meeting and thinking there seemed to be a pretty high level of cognitive dissonance on actually what they owned and what they were guaranteeing and which scared us.
And so we didn't participate. But obviously we didn't know what was going to happen in 08. And that really, the depth of the crisis and not even sure if this firm's around anymore, to be honest. But in hindsight, I can look back and say, what a terrible pitch that was.
[00:39:23] Speaker B: Good timing on that one. Joe, I have to tell you, that's a career ender if you would have taken that one. Jesus.
[00:39:29] Speaker A: Yeah.
[00:39:30] Speaker B: Well, veb, you're on the front lines. I mean, you know, in your current position, working with external managers, I'm sure you get pitched all the time. So, you know, be gentle, but be transparent.
[00:39:42] Speaker C: So I think the bigger issue for us is, you know, this is a relationship business and you were talking to over a period of time, kind of develop a lot of relationships, talking to a lot of people we've been here, like Joe talked about, over 10 years. So in our period of time that we've been here, a lot of the folks that we spoke to over the last 10 years have moved five to six firms. So it's very difficult to know if they're still representing which firm they're still at because they keep moving to, you know, different IR firm or a different.
Sorry, a different investment firm. And it is interesting, if they come into the room, they may be still talking about the prior job that they were at in the most recent one. And let's be clear, are we talking about private credit or real estate? Which one are you talking about? So we've had some of those kind of instances over the last 10 years, knowing the folks that we've known have moved between five and seven roles in that period.
[00:40:30] Speaker B: That's an out trade where I come from.
Well, guys, this has been great. I really appreciate you sharing what you've done here and the patience you've shown given my questions that sometimes go in the wrong direction, but you always pull me back to a center, so I appreciate that. So guys, thanks. Anything you want to say in closing?
[00:40:49] Speaker A: No, it's been great. Thank you for inviting us and this has been a lot of fun.
[00:40:54] Speaker B: Thanks for listening. Be sure to visit P and I's website for outstanding content and to hear previous episodes of the show. You can also find us on p and I's YouTube channel. Links are in the Show Notes. If you have any questions or comments on the episode, or have suggestions for future topics and guests, we'd love to hear from you. My contact information is also in the Show Notes, and if you haven't already done so, we'd really appreciate an honest review on itunes. These reviews help us make sure we're delivering the content you need to be successful. To hear more insightful interviews with Allocators, be sure to subscribe to the show on the podcast app of your choice. Finally, a special thanks to the Northrop Family for providing us with music from the Super Trio. We'll see you next time.
[00:41:45] Speaker D: Namaste the information presented in this podcast is for educational and informational purposes only. The host, yes, and their affiliated organization are not providing investment, legal, tax or financial advice. All opinions expressed by the host and guest are solely their own and should not be construed as investment recommendations or advice. Investment strategies discussed may not be suitable for all investors as individual circumstances vary.
