Continuation Vehicles from the LP Seat – Scott Ramsower (EP.523)

My guest on today's show is Scott Ramsower, Head of Private Equity Funds at the Teacher Retirement System of Texas, where a 27-person team manages $33 billion in private equity for the $250 billion pension plan. Scott started his LP career at AlpInvest and joined Texas Teachers sixteen years ago, when the private equity program was six people and $7 billion. He also chairs the board of ILPA. Our conversation covers Scott's path from equity research to the LP seat and the growth of the Texas Teachers program. We then turn to continuation vehicles and the reasons LPs have grown wary of them, from conflicted pricing and misaligned economics to the loss of the right tail. We close with zombie funds, retail capital in private equity, and how a slower exit market is changing the way LPs underwrite their GPs. AlphaSense free trial https://www.alpha-sense.com/capital/ for Capital Allocators listeners. Learn more about Juniper Square here https://www.junipersquare.com. Learn More Follow Ted on X at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list (https://capitalallocators.com/) Access Transcript with Premium Membership (https://capitalallocators.com/signup) Editing and post-production work for this episode was provided by The Podcast Consultant (https://thepodcastconsultant.com https://thepodcastconsultant.com/)

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Speaker 00

  Continuation vehicles, continuation funds, GP-led secondaries. I'm a strong believer that they are neither inherently good or inherently bad. Each vehicle is unique and bespoke and requires examination on its own. With that comes some difficulties. If you go back, when CVs took off the second wave 10 years ago, GPs treated it like a new invention. Historically, there's been three ways to exit a business. An IPO, a sale to a sponsor, or a sale to a strategic. All of a sudden, we had invented this fourth way. You would think LPs would be super excited by this, and GPs were. They were metaphorically high-fiving each other because they had just increased the exit routes by a third.

• 0:42Speaker 00

  As I looked around and evaluated these on my own, as our team evaluated them, as I talked to my fellow LPs, it quickly became apparent that LPs were not nearly as enthusiastic as GPs expected them to be. Recently, I've seen frustrations hit new highs. I chair the board of ILPA. I spend a lot of time with some of the senior-most LPs in this industry. When I hear things like, "CVs are the bane of my existence," there's a joke now that CV stands for "conflict vehicle." Some LPs say, "My heart sinks when a CV request lands in my inbox." I've even heard some say, "CVs are going to be the death of the industry."

• 1:25Ted Seides?

  I'm Ted Seides, and this is Capital Allocators. My guest on today's show is Scott Ramsower, head of private equity funds at the Teacher Retirement System of Texas, where he oversees the private equity portfolio inside a $250 billion pension plan. Scott joined Texas teachers 16 years ago and has been instrumental in the private equity program's growth from six people and $7 billion in assets to 27 people and $33 billion today. He also chairs the board of ILPA, the Institutional Limited Partners Association. Our conversation covers Scott's path from equity research to the LP seat

• 2:07Ted Seides?

  and the growth of the private equity program at TRS. We cover the many reasons LPs are wary of continuation vehicles, from conflicted pricing and misaligned economics to the loss of the right tail, best practices for CVs, zombie funds, retail capital in private equity, and the new demands created by the current challenging environment. Before we get going, you're on a plane headed to an annual meeting. And this time of year, you're definitely on a plane headed to an annual meeting. With all the travel in front of you, it's a very busy time, so I'll keep this particularly short. Before you doze off in the thin air of the cabin, that's a great time to let the soothing sounds of Capital Allocators fill your ears.

• 2:51Ted Seides?

  And when you find yourself at a cocktail party at one of those meetings, in that uncomfortable moment where you're not sure who to talk to or what to say, that's a fantastic time to tell them about the Capital Allocators podcast. It's an icebreaker that's the gift that keeps on giving. Since you're at an event, if you've come to one of ours, that's a great time to tell someone you think highly of about our Capital Allocators summits. Because if you know, you know. Thanks so much for spreading the word. Capital Allocators is brought to you by AlphaSense. Every allocator sits at their desk for hours preparing the work around investment decisions, getting up to speed on a new theme, prepping for the next investment committee meeting,

• 3:34Ted Seides?

  and tracking what changes across an entire portfolio. AlphaSense just launched something built to help. It's called SuperAnalyst, an always-on agent that works like a power user on your behalf. It draws on over 500 million premium sources, including broker research, expert transcripts, company filings, and earnings calls, and keeps working long after you've gone home for the day. Point SuperAnalyst at a theme, company, or market, and it learns the coverage universe so you can easily turn new insights into the briefs, models, and memos you'd otherwise build by hand. It was designed to work like an extension of your team, so it remembers your projects, follows your templates and processes,

• 4:18Ted Seides?

  and links every output to its source so you can see where each conclusion came from. The best way to judge its quality is to give it a whirl. Pick the research task on your desk before your next committee meeting and hand it to SuperAnalyst. Start a free trial at alpha-sense.com/capital and see what it has ready for you. Capital Allocators is also brought to you by RidgeLine, the investment management platform built for firms who are rethinking how work gets done. You're at your desk looking at a line graph of your firm's growth. The line is moving sideways, linear growth, and you know exactly why.

• 5:00Ted Seides?

  You're constrained by your operational bandwidth that's been the same for so long, it just feels like the cost of doing business. RidgeLine is built to change that line's trajectory, to be the inflection point that takes your growth from incremental to accelerated with the team you already have in place. RidgeLine is the only AI-native investment management platform that brings together the front, middle, and back office with one set of data and powerful AI agents that automate away operational drudgery, so your talent can shift from managing old technology to materializing new ideas. RidgeLine helps asset and wealth managers understand and improve their firm's growth trajectory. To see how your firm compares to 16,000 of your peers,

• 5:45Ted Seides?

  visit ridgeline.ai/trajectory. If you file Form ADV, your firm is already there. Then talk to RidgeLine about how you can do more with the team you already have. Capital Allocators is also brought to you by Juniper Square, the operations partner trusted by the leading private market GPs. One theme that keeps coming up on the show is GPs that build the strongest and most durable relationships with LPs are the ones that have both strong returns and strong operations. AI raises the stakes on operations, and having Juniper Square as your operations partner helps ensure your data is organized,

• 6:27Ted Seides?

  accurate, and accessible, so you can unlock operational alpha. That's why thousands of GPs trust Juniper Square. Learn more at junipersquare.com/capitalallocators. Please enjoy my conversation with Scott Ramsauer.

• 6:46Ted Seides?

  Scott, great to see you.

• 6:47Speaker 00

  Good to see you, Ted.

• 6:49Ted Seides?

  I know we're going to talk a lot about continuation funds. Why don't we start with your background and path to the seat?

• 6:55Speaker 00

  Born and raised in Texas, I went to university in Texas, had an internship at Enron this summer that it all went wrong. Had an incredible experience, had an offer, but decided I wanted to move to New York. I wanted to work on Wall Street. I turned it down. I'm glad I did, because by the end of that year, Enron was no more. That was a formidable experience for me. I wanted to be a stock picker. I interviewed around, I networked, I got an offer with Morgan Stanley to join their equity research team. This was in the fall of 2001. The dot-com bubble had just burst. Around Christmas break, I got a call saying, "Unfortunately, massive layoffs. The economy's not good. We can no longer honor that offer."

• 7:40Speaker 00

  I said, "Oh, I was looking forward to having fun my last semester in college, and now I'm jobless." I moved to New York and I joined the litigation consulting business of PWC. I got to see a lot of interesting frauds as a forensic accountant. I always had at the back of my head this itch to get back and be a stock picker. Lo and behold, 2004 came around. Two years later, I got a call back from Morgan Stanley. They said, "Market's different. Can we talk?" I got an offer, I joined Morgan Stanley. They stuck the Texan on the energy team. I grew up in suburban Dallas, Texas, never seen the oil well in my life. I loved it. That's how I got into investing.

• 8:24Speaker 00

  Quickly, over the course of my two years as a stock picker, I realized three key things. First, I quickly realized I wanted to be on the buy side, not the sell side. I wanted to be making investments, not making investment recommendations. The second one, I decided, "Public markets may not be for me." I would get in early, work all hours, into the night, early morning, submit a final research report after the earnings came out to my boss. We'd publish our report, and nobody cared. The market had moved hours and hours before. I quickly realized I'm more of a longer term fundamentals type investor, which to me signaled private equity might be the right way to go.

• 9:08Speaker 00

  The third piece I had to figure out is, did I want to be a GP or an LP? And this was in 2006. The LP industry was much smaller than it is today. I started doing as much research as I could. I started networking with as many people as I could. I learned a lot about LPs and what they do. I knew what GPs were. I lived in New York. I had roommates that worked at GPs. This is neither good or bad. I call a GP an inch wide and a mile deep. The more I learned about LPs, I decided they're an inch deep and a mile wide. For me and my own interest, skill sets and intellectual curiosity, that sounded pretty interesting. I interviewed with anyone that I could, ultimately got a job with Alpinvest Partners.

• 9:49Speaker 00

  I spent four years with Alpinvest, learned everything there is to know about being a private equity LP, fell in love with the LP side of things. I also met a woman along the way. We got married while we lived up here in New York. She happened to be a fellow Texan. After spending eight years in the Northeast, both of us looked around, said, what do we want to do at this next phase? And where do we want to plant our roots? We decided for us that was going to be back home. In 2010, we packed up, left the city, moved to Austin, Texas, and I linked up with the teacher retirement system of Texas where I am to this day. I've been at TRS, or Texas Teachers, for 16 and a half years. I focused exclusively on private equity.

• 10:31Speaker 00

  When I joined, the private equity portfolio was six people, 7 billion of NAV approximately. Fast forward over 16 years later, we're now 27 investment professionals on the private equity team, about 33 billion in NAV and private equity. It's been a fun ride. It's been a great time to be an LP in this industry. Today, I lead the private equity funds team within Texas Teachers.

• 10:55Ted Seides?

  What are some of the key lessons or inflection points?

• 11:00Speaker 00

  The first one was coming out in the dot com recession, having my dream job swept out from under my feet was a little bit of a blow to the ego, blow to the plan. I thought I had it all figured out. The world had a different plan for me. My lesson learned was, that's okay. Life is sometimes not a straight line. It's a series of decisions. I still generated an incredible network from that first job, some great skills. I saw some cool stuff, a little bit of a different route than I had planned in my own head. The next key lesson was, I was at Alpinvest investing in private equity when the bubble burst in 2008 in the GFC. The lesson learned there was, when others are pulling back, go in.

• 11:43Speaker 00

  2009 ended up being an incredible vintage. 2010 was an incredible vintage, an incredible time to deploy capital.

• 11:50Ted Seides?

  How about once you got in the seat, taking a program from the size it was to the size of this today?

• 11:56Speaker 00

  That's been a lesson in Rome wasn't built in a day. I look back and think about how much our program has evolved. I was just a small piece of that evolution. Never once did any of us sit down on the team and say, this is where we're going to be in 16 years. It was, this is what we're going to do today. This is the next stop along our journey. We'd accomplish that and then say, what's next? The Texas Teachers Program was built over a long period of time, one step at a time.

• 12:25Ted Seides?

  As you look at your portfolio in the industry today, there's been this big exit bottleneck. Continuation vehicles, perhaps not as well understood in the community as you would like. Would love to get your thoughts of, how did you come about thinking through all of the challenges in understanding what a CV means to an LP?

• 12:50Speaker 00

  Continuation vehicles, continuation funds, GP-led secondaries. I'm a strong believer that they are neither inherently good or inherently bad. Each vehicle is unique and bespoke and requires examination on its own. With that comes some difficulties. If you go back, when CVs took off, the second wave 10 years ago, GPs treated it like a new invention. Historically, there's been three ways to exit a business. An IPO, a sale to a sponsor, or a sale to a strategic. All of a sudden, we had invented this fourth way. You would think LPs would be super excited by this, and GPs were.

• 13:33Speaker 00

  They were metaphorically high-fiving each other because they had just increased the exit routes by a third. As I looked around and evaluated these on my own, as our team evaluated them, as I talked to my fellow LPs, it quickly became apparent that LPs were not nearly as enthusiastic as GPs expected them to be. Recently, I've seen frustrations hit new highs. I chair the board of LP. I spend a lot of time with some of the senior most LPs in this industry. When I hear things like, CVs are the bane of my existence. There's a joke now that CV stands for conflict vehicle. Some LPs say, my heart sinks when a CV request lands in my inbox.

• 14:15Speaker 00

  I've even heard some say, CVs are going to be the death of the industry. These are strong statements that clearly are not high-fiving the GPs for creating this fourth exit tool. I started to say, LPs have strong emotions about this. GPs are not fully appreciating the nuance of the concerns. I started to write down some ideas as to how to articulate why LPs can be concerned about this. It started with the conflicted nature. That's where GPs thought that it started and ended. As I started jotting more and more down, I realized there's a lot more to this that GPs might value hearing beyond the conflicted nature of the transactions.

• 14:55Speaker 00

  I've come up with the top 10 reasons LPs are concerned about CVs. You and I were talking at a conference this summer and I mentioned it. Here we are.

• 15:05Ted Seides?

  Let's have at it. We don't have Letterman anymore, so it'll be the Scott Graham Sour Top 10 list.

• 15:10Speaker 00

  We'll start with one and go up to 10. The first reason LPs are concerned are exactly what GPs expected. These are conflicted transaction. There's conflicted pricing. There's imperfect price discovery. The GP sits on both sides of the trade. They act as the agent for the seller, which is the legacy LPs. Functionally, they also act as the agent for the buyer, which is the incoming CV investors. That makes it hard to know whether the price is real, whether a competitive process was run. That's the main and the original concern around LPs. Around CVs is the conflicted nature of the transaction.

• 15:46Ted Seides?

  Before we move on, now that that's been in the market for a while, what do you see as best practices in an inherently opaque pricing environment?

• 15:57Speaker 00

  LP has issued a 2.0 of continuation vehicles best practices. It's in the draft process, collecting community input. It comes down to four things, one of which is pricing. The first is the rationale. Is there a genuine case that the CV is a deliberate solution as opposed to a default? Is this the best option that exists? The second one is the process. Was a truly competitive auction run? Did third-party, non-secondary buyers participate? Was there a process to seek a wholesale sale of these assets? Is there full price transparency around what the final bidder is offered?

• 16:40Speaker 00

  For example, if one bidder is willing to pay 90 cents on the dollar for an asset, another bidder will pay 89 cents on the dollar, but commit to the GP's next fund. That's something LPs don't always have transparency into. Usually, the LPAC just says, this is the bid we've decided to go with. LPs are now requesting more transparency to prove, is there more to the bid than just the headline pricing? In addition is to support the valuation as a third-party fairness opinion. A lot of LPs say that those can have limited value. They're a important process check through it all. Finally is checking in on governance and alignment. Do the LPs get sufficient time to review the roll or sell decision?

• 17:22Speaker 00

  Are LPs economically neutral, meaning that they're no worse off from an economics perspective? Is the GP rolling its own carry? Full transparency into the alignment.

• 17:32Ted Seides?

  If you look at the totality of CVs that you've seen in your seat, do you find the pricing fair in general? Is there a wide dispersion, heavily discounted? What should you expect when a CV lands on your desk?

• 17:50Speaker 00

  It's a complicated transaction. Every time we're talking about these internally, I'm learning something new. A lot of times, the questions are similar. There's more bells and whistles getting added to all of these. LP is trying to help and come out with a standardized checklist for the GP to fill out. Did you do X? Did you do Y? Oftentimes, you have to peel back the onion. It's similar to a co-invest in a lot of ways. There's an asset. You have to form a view on that asset. Is it an asset you want to own or an asset you don't want to own? On top of that, something you don't have to do in a co-investment, but you do have to do in a CV, is determine alignment. Almost always in a co-investment, you're fully aligned with the GP. You'll buy at the same terms. You'll sell at the same terms.

• 18:35Speaker 00

  If they win, you win. If you win, they win. That's not always the case with the CV. You have to understand, where does the GP's alignment lie? What are they getting out of this transaction? What is the third-party offer? Is that a fair price?

• 18:50Ted Seides?

  We start with the obvious one that is more complex than it seems on the surface. Why don't you bring me through the next nine?

• 18:57Speaker 00

  Beyond conflicted pricing. Number two, dilution of GP mindshare. Every hour a GP spends managing a CV is an hour they're not spending managing my co-mingled fund, the fund to which I committed capital. I may be an investor in that CV, but if I'm not, I'm losing their mindshare. It's not restricted only to CVs. There are other things that cause loss of GP mindshare. It's one of the reasons that LPs can be concerned about these. The third reason would be dilution of alignment. A CV is a new economic vehicle that will bring in a new stream of revenues from management fees from carry.

• 19:37Speaker 00

  This opens the door for the GP to win, even if the original fund loses. LPs are always trying to create scenarios of perfect alignment, such that if LP loses, the GP loses and the LP wins, GP wins. Continuing on, the fourth, LPs can potentially be paying worse economics for a deal they already owned. LPs have to take the time and focus to ensure that the management fee rate is the same, the headline percentage, the cost basis is unchanged, carry shouldn't be at a higher rate than you would have otherwise paid in the fund. Rolling into

• 20:18Speaker 00

  a new CV should not be paying more to own the same asset. That's not always an easy calculation to do. The owners should be on the GP to ensure rolling LPs are no worse off. We call this an economic status quo.

• 20:33Ted Seides?

  What are some of the ways that an LP might not fully understand they're going to be paying more rolling into a CV?

• 20:41Speaker 00

  Perfect example. Let's pretend we're in a fund, after the investment period, the management fee is 100 basis points, 1% on invested capital. Let's pretend the asset that they're going to sell to the CV they bought for $100. Us LPs would be paying 1% on $100 or $1 a year. The CV may have 70 basis points as a headline management fee rate. 70 basis points, that's good. That's less than 1%. However, the second component of the management fee is crucial, which is what is the cost basis? The GP maybe bought the asset originally at $100. They're going to sell it to the CV at $300. Your new cost

• 21:22Speaker 00

  basis is $300, but LP is now paying 70 basis points on $300, which is higher than 100 basis points on $100. That's on the management fee. On the carry, the market can differ. Oftentimes, there's tiered carry. We've seen structures such that carry can end up being higher than the original fund. The fifth one is more complex than a lot of realize. Many LPs don't have a choice to roll. While GPs present CVs as you make the call, stay or you can sell, it's your choice, LPs. A lot of LPs, for a variety of reasons, don't

• 22:01Speaker 00

  have that choice. They may have a board approval process that takes longer than the CV process allows for. They may have a legal review or no bandwidth from their legal team to do a legal review. The election windows oftentimes can be short, 20 to 30 business days. They might have a plate full of other priorities to get done. While it's presented as a choice, a lot of LPs don't have a choice. As a result, their only option is to sell. That's concerning. The sixth one, CVs can artificially enhance fund metrics. The original commingled fund, when it sells a CV to a new vehicle, it produces DPI and an IRR for that fund. Even

• 22:46Speaker 00

  though the asset is ongoing and the GP is still managing it, it has locked in DPI and IRR for the fund, even though the true value creation is not yet done. As a result, the GP's track record arguably is improved through this conflicted transaction. LPs can walk into our investment committee and present higher DPIs than perhaps our investment committee realizes will show up both ways. Actual DPI and DPI less, we call it synthetic DPI, when it's a CV or an NAV loan, will strip all of that out.

• 23:23Ted Seides?

  In an instance where you see a CV that you feel is a trophy asset, the classic asset that a GP wants to hold on for longer because it performs well and there's lots more to do. When you go to re-underwrite a manager, if you've stripped that out as part of synthetic DPI, how do you think about the difference between that CV versus another CV that you might not feel as strongly about the quality of the asset?

• 23:51Speaker 00

  We show full track record, which includes all the funds plus all the CVs. When we walk into our investment committee, it's almost a no-win when we show the CV track record. If you walk in with a CV track record that's too good, you would think they'd be excited because it is still an investment judgment and our investment committee is upset because they think if it did that well, they sold it for too cheap, therefore a fair process wasn't run. If you walk in with a bad CV track record, the investment committee says, what's wrong with this GP? They have bad investment judgment. Why did they continue to own this asset? There's not a CV track record that can win in terms of an investment

• 24:33Speaker 00

  committee. With that, by definition, CVs can't outperform too much. There are exceptions to the rule. The asset class as a whole, the subsector of CVs, if they start doing too well, LPs will stop allowing GPs to do these on the original fund. If they start doing too poorly, LPs will stop funding the CV buyers. There's a healthy tension such that CVs by their nature can't be structurally too good, also can't be structurally too bad. There's not much data on performance out there, but it's early. The data I've seen supports that that's the case.

• 25:13Speaker 00

  Number seven, LPs are paying for an exit function that's no longer being performed. As LPs, we pay a GP by and large 2 and 20, to use the generic terms. What are we paying 2 and 24? There's three key judgment items that the GP does that we're paying for. The first is sourcing and evaluating investments. The second is creating value in those investments. The third is exiting those investments. If you take CVs to their logical extreme and a GP CVs every asset in its fund, it's thrown its hands up on the third and said, I'm conflicted.

• 25:56Speaker 00

  I can no longer make the exit determination. LP, it's your decision. That's fine, but I paid you GP to do three things. You're only doing two of those. That's frustrating because us limited partners are becoming less limited. We're not paying any less for taking the decision-making back within our own teams.

• 26:18Ted Seides?

  What's the potential to renegotiate that fee?

• 26:21Speaker 00

  This is one of those idealistic statements. I've yet to hear anyone say, that's unfair. It takes a long time to change markets. There is an entire infrastructure built around the 2 and 20 model. I'm not sitting here proposing that we're going to change that overnight. It's more highlighting to a GP, here's one of many reasons. It's a shifting of the discernment that an LP is paying a GP for.

• 26:50Ted Seides?

  How about the last three?

• 26:52Speaker 00

  Number eight, cannibalization of co-investment. Historically, if this asset had been sold to another GP, probably that other GP would have required some co-invest to do it. The market for buyout co-investment, at least in the US, is no fee, no carry. This has effectively been taken out of the co-invest pipeline. This is effectively cannibalizing fee-free co-invest because now it's fee-paying co-invest via a CV vehicle. LPs have built a lot of infrastructure up over the last couple of decades around building out co-invest teams. This is taking some of the deals out of the pipeline. Understandably, that's frustrating.

• 27:32Ted Seides?

  Have you seen that in practice, that the co-investment top of the funnel is less than you would have thought?

• 27:40Speaker 00

  I've seen a couple of things. First, deals that have gone into CVs, we know historically were not IPOs, were not strategic candidates. They would have been sold to another sponsor. They would have been too big for that sponsor. That is absolutely happening. Some co-investments that I've heard from LPs, when they're exiting alongside the fund, they might be allowed to reinvest, but it's via the CV at full fees. Even if you had a co-invest in the original and the GP is going to keep the asset through a CV, that fee-free co-invest option is being taken away. LPs are being forced to either exit what they had at no fee, no carry, or roll it into now a worse fee structure than they had before. Full fees, full carry.

• 28:24Speaker 00

  Number nine, reduction of right tail upside. These are often pitched as a GP's best assets. Oftentimes, we'll see CVs created when an asset has reached a 3X or a 5X, maybe even a 7 or a 10X multiple within the fund. The GP says, it's time to de-risk this fund and put it into a CV. That makes sense. However, most CVs I've seen are underwritten to at least another 2X. This is an asset that was sold at a 5X out of the fund, is being underwritten at a 2X in a CV. Had that stayed in the original fund, that would have been a 10X deal. That's the exact reason that LPs are in the private equity business is the ability

• 29:09Speaker 00

  to capture that right tail skew. When these best performing assets get moved out of the system, that can be frustrating for an LP who doesn't get to benefit from that.

• 29:18Ted Seides?

  The last on the list.

• 29:20Speaker 00

  The final one, number 10, is somewhat related to number nine. If you take that last philosophy and you apply it across the whole industry, CVs could have downward pressure on private equity returns industry-wide. These best assets are being systematically taken out of commingled funds and moved into standalone CVs before their final exit and before the full value creation story is over. The data suggests LPs are selling more than they're rolling. The LPs who are typically only exposed to the original fund.

• 29:54Speaker 00

  Are not getting the benefit of us higher outsized returns.

• 29:58Ted Seides?

  As you've laid out these 10, imagine some theoretical, most practical limitations of CVs. You're also actively managing this program that's going to have these CVs landing on all your desk all the time. Knowing what you know about this, how have you chosen to participate in the market?

• 30:17Speaker 00

  We've chosen to participate in two ways. First, we sit on the advisory board of almost every fund that we invest in. We take a hands-on role as an advisory board member in terms of evaluating these CVs in order to waive the conflict. We've developed a scorecard internally that we fill out as a GP done X, as a GP done Y. If not, we vote no. The second then is when we have the opportunity to roll or sell ourselves when the election notice comes out. We've taken the view that as long as it's over a certain size threshold, we have a $250 billion plan at Texas Teachers. Some things are not enough capital to be a good use of time.

• 30:59Speaker 00

  When it's over a certain size threshold, we have to roll up our sleeves and dig in. We're evaluating the asset. We're evaluating the sponsor fit. All of that's the same work as a co-investment. We're also evaluating the alignment. That can be a lot harder to do. We have to effectively stop everything we're doing and evaluate it. We've also decided we have a large dedicated co-investment team. We've opened up the phone lines to be buyers of CVs that are beyond our roll sell decisions. We're actively out there sourcing new deals, evaluating those. They do have a higher bar because they have fees associated with them relative to most of our co-invest deal flow, which is no fee, no carry.

• 31:41Speaker 00

  We have a certain threshold upon which we might be willing to accept some fees in a CV if we like the asset. We've had to build on the resources, roll up our sleeves. We've found no other way around it.

• 31:52Ted Seides?

  To get a sense, within the CVs that come from your existing portfolio of managers that fit that minimum size threshold, what percentage of them would you say you end up investing or rolling in?

• 32:06Speaker 00

  It's a number that we track. It's not a number that we publicize publicly. However, of the actionable deals we see, we call it a hit rate. How many do we do versus how many do we exit or sell? Our hit rate is no different in CV roll versus sell decisions as it is in actionable co-investment decisions. If we do one out of 10 co-invest, we probably do one out of 10 rolls. We don't have a house view that CVs are inherently good or bad, a great buy or a great sell. Interesting opportunities can exist, but you have to do the work.

• 32:40Ted Seides?

  Should we take a step back from CVs as this fourth leg of a stool of how GPs are going to get liquidity? We're still facing this liquidity bottleneck that's been around the last four or five years. How do you think this is playing out over the next couple of years?

• 33:01Speaker 00

  It's something we spend a lot of time thinking about. It's something we're concerned about. It brings me to a topic we haven't covered, but probably should, which is zombie funds. A zombie fund is a fund that has stopped making new deals, also can't raise capital. It's neither dead because the fund still has assets in it. It's not alive either because they're not adding to those assets and they have no more dry powder. It's a zombie. We saw them a lot coming out of five years or so post-financial crisis. The industry data suggests other LPs have the same view that these zombie funds are going to become a real industry problem in the coming years.

• 33:40Speaker 00

  I saw a research report by Callar this summer come out and say that 54% of LPs expect the number of zombie funds in their portfolio two years from now to be higher. Two years ago, that number was 28%. There's a structural vintage problem. The 2018 to 2022 vintages deployed capital in a low rate, high multiple environment. They were not able to exit those deals in time. That environment no longer exists. The math doesn't work on exits. As a result, there's a structural DPI problem. That backlog is going to take years to work through the system. CVs are an interesting topic because you would think that they would solve the zombie problem.

• 34:24Speaker 00

  All CVs do is kick this can down the road. A CV can help an individual asset. It might help a single GP avoid being a zombie. There's far more stranded assets than there is capital for CVs. CVs alone will not solve the zombie problem. This cash becomes trapped, earning limited returns, if any. You can't exit without selling in the secondary market at a significant discount. All the while, the economics are misaligned. A GP is collecting fees on NAV or on their cost basis that hasn't converted to cash in years.

• 35:06Speaker 00

  There's little incentive for them to force a sale because they may not be in the carry. There may not be any more cash coming in when they sell. These funds are often amongst us LPs' worst performers. They become a huge drag on your time from a governance perspective. Lots of amendments come our way. I don't have an answer to your question, Ted, on how the liquidity drought gets solved. It's going to force some knock on effects such as zombie funds that are going to start taking the mind share of us LPs and start to become a real frustrating topic for us all to deal with.

• 35:43Ted Seides?

  What do you hear about the public markets, the IPO market as a potential exit path for private equity assets?

• 35:51Speaker 00

  Outside of a couple of large scale growth capital names, we haven't seen a lot of activity in the public markets. We're not encouraging our GPs to go and exit through the public markets because it can often be hard for them to fully exit. I call an IPO step one of a multi-step exit because rarely can you get full liquidity on day one.

• 36:13Ted Seides?

  The other big question in people's minds in private equity is what happens with private wealth, retail, retirement plan assets coming in? Wondering if you have any views of where we are today and where that might go in the future?

• 36:28Speaker 00

  This has been an emerging concern. Us LPs are watching it closely. A lot of the top 10 concerns we just walked through on CVs are the exact same concerns LPs have on private wealth and retail capital. Some of the same ones are dilution of the GP's time and attention, dilution of the alignment because of this new fee stream, co-invest cannibalization. What's interesting about retail capital, it's a unique wrinkle to this versus CVs. There's a saying out there that I like, which is private equity for the retail investor is the right strategy, but the wrong structure.

• 37:07Speaker 00

  Institutional investors, people like Texas Teachers and retail investors, people like myself, my parents' 401k plan. We have different risk profiles, liquidity needs, time horizons, performance expectations, level of expertise and resources. Yet a retail product, oftentimes those retail investors are being placed in the exact same assets side by side with an institutional investor. One of private equity's advantages over public markets was that companies can stay focused on the long term. Putting these into a semi-liquid quarterly redemption vehicle takes away that long-term horizon.

• 37:50Speaker 00

  Illiquidity is a feature, not a bug of the private equity asset class. You're taking away that feature, in my opinion, when you put it into a semi-liquid structure.

• 38:02Ted Seides?

  What are some of the other things you have your eyes on?

• 38:05Speaker 00

  Within retail, the things that we care about, in addition to some of the top 10 items, we're paying a lot of attention to hard caps and sharing percentage. How much can a commingled fund share with a retail vehicle alongside it? If I go into a $10 billion fund, I'm not paying attention to the LPA. If that LPA allows a retail vehicle to invest infinite amounts, then I've effectively signed up for an uncapped fund. Fund size is a key underwriting of us LPs. Knowing how much they can invest is a key care about. Another one is how does the investment timing work? Are both the retail and the institutional fund required to buy and sell at the same time? Can one buy and sell to the other?

• 38:49Speaker 00

  Can one sell before the other? There are inherent conflicts, different risk tolerances, liquidity needs between two different investors. Finally, is this cannibalizing our co-invest opportunity? We're spending a lot of time thinking about these things.

• 39:04Ted Seides?

  So far, most of the activity, to the extent there is activity on the retail side with private equity, has started with the large, mostly public, alternative asset managers. I'm curious if you've seen traction below that top tier of half a dozen firms?

• 39:20Speaker 00

  We haven't seen a lot start to raise products. When I talk with a lot of our GPs, if you catch them in a moment of truth and transparency, they would say they're certainly thinking about it. Met with a large publicly traded CEO recently, this individual said,

• 39:39Speaker 00

  Sure, I'm glad I'm CEO of a large firm and not a small firm right now because of the strength of consolidation that this large cap manager has. I'm not sure that it's coming immediately to the middle market. However, eventually, if it continues to grow, large cap players will want middle market offerings for their retail investors. They'll need distribution channels, a pipeline of assets to take advantage of the new capital coming in that has appetite for smaller deals. You may see joint ventures. You may see consolidation of GPs. You may see the big buying the smaller. So while it's not there now, there's a world in which it could be far more prevalent for

• 40:24Speaker 00

  middle market GPs down the road.

• 40:26Ted Seides?

  What's changed in the last few years in how you've gone about investing in the space?

• 40:32Speaker 00

  We're spending a lot more time now than we would have on a couple of areas. One is we are underwriting the unrealized portfolio more deeply than we had in the past. It was easy to assume when markets were up and to the right that a deal held at cost would get to 2X. That's harder to assume now. We're spending a lot of time understanding what was the multiple paid for this portfolio? How has EBITDA traded? How has revenue performed since entry? What is the actual versus budget on a year by year, asset by asset basis? Where does leverage sit today? We've even gone out and looked at where are the portfolios credits trading?

• 41:17Speaker 00

  What do the public credit investors think about the quality of this portfolio? Where are the secondary bids for the LP interest trading? There's a lot less liquidity, a lot less distributions. There's a lot larger unrealized portfolio to get your arms around. In addition to a deeper analysis of the unrealized portfolio, we're spending a lot of time evaluating the partnership. This is hard to do. We're assessing, is this a partnership that is going to stick together when the going gets tough? It's easy for the partners to work well, look past shortcomings, not get on each other's nerves when all is going great and carry is getting paid. All that our GPs really have as assets are the people.

• 42:02Speaker 00

  And the cracks in those partnerships start to come through when someone's deal starts to underperform, or maybe they're not going to get carry, or maybe the next fund isn't going to be quite as big as they thought it was going to be, or they have to start letting some people go. Hard to do, but we're spending a lot of time thinking through partnership dynamics. A lot of these partnerships haven't been tested. The last 10, 15 years have been good times for the private equity industry. A lot of these firms were started over that time. Hard to do, but important part of our underwriting.

• 42:35Ted Seides?

  How do you go about getting underneath? No one has an incentive on the GP side to let you know that there's a fracture underneath.

• 42:44Speaker 00

  It's much more an art than a science. It's one of the reasons I love being an LP. I like to say LPs have both quantitative tools and qualitative tools that they have to bring to bear. Because at the end of the day, all we're doing is assessing, is this a person that I can trust with the Teachers of Texas money? Do I think they'll make good decisions? It's almost a psychoanalysis exam. You have to dig in. How did that person show up in the diligence session? Did you see any body language that was a little concerning? Had there been departures? How do you talk to those departures? So more reference calls than we've ever done before.

• 43:28Speaker 00

  The importance of an onsite, visiting them in their office, in their element. Anyone can fly to Texas and look great in our office for a couple of hours. Maybe it's a different story if we show up in their office and spend an entire day, plus maybe a dinner. There's lots of little tricks and little tools, but it's a culmination of all of the soft stuff. The quantitative is still important, but we're spending a time coming up with that art project of how do we assess the qualitative side of these partnerships?

• 43:59Ted Seides?

  How do you get conviction if you detect something doesn't feel great, but you're not sure and it is qualitative?

• 44:08Speaker 00

  That's what I love. That's investing. It's easy when there's no hair. It's an easy story. Track record's been great. We teach our team all the time, trust your gut. If there's one tool that we have, it's a matrix where on the X axis is attractiveness of return. On the Y axis is risk. If I have a manager where there's a high level of risk because of complexity, turnover, change in strategy, high growth in fund size, et cetera, but they're an N of one type manager that I've been trying to get access to, that's the top right quadrant. We have long discussions about those.

• 44:52Speaker 00

  We may be more willing to lean in to that risk because there's nowhere else that we can replicate that potential return. If it's a manager that we feel is a little lower in our conviction, maybe is similarly situated with a couple of other managers in our portfolio, they're a little lower down the return side of the spectrum, but they're high on the risk side. That's where we typically say we can recreate this return stream somewhere else with less risk.

• 45:22Ted Seides?

  As you've built this portfolio over 16 years to where it is today in the 30 billions, where do you think it goes the next couple of years?

• 45:31Speaker 00

  We certainly don't think growth of our team is going to happen as fast as it has. Maybe we continue to grow a little bit. We have a London presence that was a large growth area. I'm not sure there's any new geographic offices on our horizon. We've studied secondaries and while we might do a little bit here and there, it's not a area of focus for us in terms of a new team build out. In the past, we were creating alpha by entering into new markets, whether that be co-invest, large strategic partnerships, better fee savings. Our CIO likes to say it's now all about craftsmanship alpha, which is fine tuning

• 46:11Speaker 00

  the processes we've developed, making small changes to try to produce better results. The alpha is coming through a larger team that can go source more transactions, build deeper relationships, have more knowledge, try to deploy more on the AI front, use all the tools that we've developed in our toolkit. I'm not sure that it's going to be revolutionary, probably more evolutionary.

• 46:38Ted Seides?

  Scott, I want to make sure I get a chance to ask you a couple of closing questions. What was your first paid job and what did you learn from it?

• 46:46Speaker 00

  My first paid job, I was probably 13 years old. I'm not even sure if that's a legal working age. I was a day camp counselor for a kid's summer camp in my neighborhood. I have the benefit of having excellent role models in my parents who both had full-time jobs. I learned at an early age during my summers, during my winter breaks, I could be productive and earn a paycheck. My mom always had me working. I learned all the things you learn around executive functioning. I had to get myself to work on time. I had to get myself home from work. I rode my bike. I had to learn, do I need a lunch today? Is this a swim day? How do I pack the appropriate items?

• 47:26Speaker 00

  I also learned that small acts of initiative go a long way to impressing a boss, especially amongst 13-year-olds. All it took was showing up a little early, offering to set up the cones for the soccer game, staying a little late and picking up the balls, looking around and saying, how can I be helpful? Small acts went a long way.

• 47:47Ted Seides?

  Which two people had the biggest impact on your professional life?

• 47:50Speaker 00

  Maybe instead of two people, I'll cop out a little and say which two organizations? It's Alpinvest and Texas Teachers, the two LPs that I've worked for. I started my LP career at Alpinvest. It was an incredible place to learn. I invested across a full cycle, both the peak and the trough, worked with an incredible group of people, a lot of whom have gone on to be true leaders in the LP private equity space. It's an incredible network that I developed and incredible skills. It was a special place to be in a special time in my life. The second organization is the one I'm at now, Texas Teachers. I never would have imagined when I moved back to Austin to work for Texas Teachers that here we sit 16 and a half years later, never would have imagined what it had turned

• 48:34Speaker 00

  into, never would have imagined the life that my wife and I were able to create in Texas. It gave me not just a job, but a career. I'm eternally grateful for that opportunity.

• 48:46Ted Seides?

  What's the best advice you've ever received?

• 48:49Speaker 00

  There's two pieces of advice that I've received that are in slight tension with each other, and I've had to be okay with that. The first is my dad would always say, anything worth doing is worth doing right. I'll never forget as a high schooler, know-it-all, wanting to cut corners, wanting to take shortcuts. Every time I would try to say, it's okay, I can cut the corner here, I'd hear my dad's voice pop up in my head, anything worth doing, son, is worth doing right. And I would do it fully and wholly as I knew I was supposed to, as my dad taught me. And an old boss of mine used to say, don't let perfect get in the way of good enough. That conflicted with anything worth doing is worth doing right. I've had to come to terms that both of those can be true.

• 49:34Ted Seides?

  You want to talk about how you reconcile that conflict?

• 49:37Speaker 00

  Life is about knowing when you need to be perfect and when you need to be good enough. That's been a lesson that I've had to learn over my years, which is when does the incremental effort produce no incremental return? When is that incremental effort the most important effort you put out to produce the full return? That's not easy.

• 50:00Ted Seides?

  Scott, last one. What life lesson have you learned that you wish you knew a lot earlier in life?

• 50:04Speaker 00

  One of my favorite analogies of life is that life is just the juggling of balls. In my life, I think of having five main balls that I'm juggling at all time. Work, family, friends, faith, and health. Some of those balls are rubber balls. If you drop them, they bounce right back up, no problem. Some of those balls are glass balls. You drop them, they're shattered, they're ruined and irreconcilable. Life is all about knowing what balls are you juggling at what time and which ones are rubber and which ones are glass.

• 50:39Ted Seides?

  Scott, thanks so much for sharing your insight. I appreciate it.

• 50:43Speaker 00

  Great to be here with you, Ted.

• 50:45Ted Seides?

  Thanks for listening all the way to the end. If you made it this far, how about one ask for me? Tell one friend about the show. It's the best way to keep growing this incredible community. Thanks so much. And until the next one, stay curious and keep compounding knowledge, relationships, and capital a little bit at a time.

• 51:09Speaker 02

  All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast.