Podcast Series
Lessons Learned from Bank Failures
Join Kali Jakobi, Tim Buchner & Paul Fleming as they discuss the importance of risk management, the fragile nature of trust, and the importance of diversification in light of recent bank collapses.
Transcription:
Kali Jakobi:
Welcome to Data Disruption, a podcast all about data problems, solutions and innovations disrupting the private markets. I’m your host, Kali Jakobi. Let’s talk data.
Kali Jakobi:
Hi everyone, and welcome back to Data Disruption. As always, I’m your host, Kali Jakobi, and today I have two very special guests with me to discuss some key themes and challenges that asset and investment managers face, specifically in light of recent events at SVB and in combination with the latest data from State Street’s most recent private markets survey. These themes and challenges include the importance of risk management, the fragile nature of trust, and the importance of diversification. We’ll also be talking about some key actions that investors should consider, such as being proactive, anticipating potential challenges and preparing for increased regulation. To help us explore these topics, we have Paul Fleming, Executive Vice President and Global Head of Alternative Investment Solutions at State Street, and Tim Buckner, COO of State Street Alpha for private markets with us today. Thank you both for joining me.
Paul Fleming:
Thanks, Kali. Great to be with you.
Tim Buchner:
Thanks, Kali.
Kali Jakobi:
So it’s been a few weeks since the Silicon Valley Bank collapse, but it’s worth talking about how this event highlighted a lot of important topics for investors to be thinking about. Talk to me about how you both saw clients react in the moment.
Paul Fleming:
Yeah, maybe I’ll start and then turn it over to you, Tim. It was really interesting. I think that one of the things I observed early on, and obviously for me, maybe not obvious, but for me, my mind, at the time, along with many other folks I think in the banking industry was going back to 2008, 2009, and one of my early observations is we went through the more recent situation was that I think that market participants, whether it be banks or investment managers or even investors, I think had a better understanding around what was happening and why earlier because there was just more transparency, certainly across the banking industry. There was a better understanding around what was happening specifically at SVB, and I think that that helped provide some amount of comfort that wasn’t there in 2008, 2009 when WaMu went down and it was just chaos and nobody knew what was on anyone’s balance sheet or how well capitalized folks were. And obviously we knew what happened after that.
Paul Fleming:
This was a little bit different and I think folks, certainly clients I spoke to, were worried about contagion, but I think they understood a lot better what was going on than they did back in 2008. And then I’d say one of the things that I found even more interesting and to some extent surprising was I had folks at our organization come to me and say, “What’s happening with clients? How can we help them? What can we do for them given the situation?” And really when I went out and talked to clients even in the moment, it wasn’t necessarily that they were looking for us to help support them because they expect to experience some type of counterparty risk or credit event directly. What I found was across the client base, certainly in alternatives, that many of our clients were really on the offensive as opposed to the defensive.
Paul Fleming:
Sure, we had some folks coming to us saying, “Hey, could we open up a DDA or custody account and move cash?” There was a little bit of that, but I would say there was much more of an interest in getting involved in either some of the specific issues like getting into SVB with regulators and looking at buying debt, looking at purchasing DDAs from founders at a discount, lots of interesting specific things that some of our clients were looking at. And then obviously at the more macro level, there was just a lot of activity and interest around trading in and out of what was happening. And so I found that clients were more on the offensive as opposed to looking for a shelter from the storm. Now that being said, if we saw the following week First Republic or somebody else collapsed and things start to snowball, it could have looked a lot different. But I’d say I’m pleasantly surprised that our clients seem to be relatively calm and more interested in looking for opportunities than looking for a safe harbor.
Tim Buchner:
And maybe not to repeat anything you said, Paul, but for me, coming from the Silicon Valley myself and having worked with SVB for over 14 years across three companies, their collapse was very close to home for me. On one hand, I saw many of my close friends or industry colleagues within private equity backed firms scrambling for their deposits, so that hit home. But I would say more importantly, and to maybe echo some of what you said, Paul, I saw alternative managers within our client base become very proactive, like you said, Paul, and we saw it like they were really treating the circumstances as an opportunity where you saw them immediately go on, as you called it, Paul, the offensive. And what was interesting is their websites were just completely flooded with reiteration to their market strengths of their investment process and diversification of their investment strategy. And you saw a lot of over-communication versus under, which I thought was great for the industry. It showed a lot of confidence.
Tim Buchner:
But as you also talked about, Paul, for a quick second, private credit was really interesting in this. So these circumstances also served as a really interesting catalyst for growth, especially within that private market asset class where there was heavy re-emphasis on their dry powder. And you saw companies quickly extending direct loans to replace banks, including SVB, and this is the trend that we really see continuing to accelerate. So it’s not just what happened previous, it’s now how will the market be reshaped? And we see this effective supercharging what already was an exploding private credit market.
Kali Jakobi:
So talk to me a little bit about how events like SVB and other recent bank implosions highlight the importance of risk management for asset and investment managers today.
Tim Buchner:
Risk management, specifically, we work really closely with a lot of our clients and really have a front row seat to how many of them are at their best or, in some cases, at their worst. And we see a lot of the stronger firms with very well-established risk management teams with well-documented and followed rule sets and processes that are really aspirational for a lot of the newer companies and all have a really keen emphasis whether publicly or internally around protecting shareholder value. And you can see that really play out as they’re building systems or building processes that we obviously can see a lot of. And I would also say that when you think back to the SVB side, proper risk management clearly show that they can break down. In their case, there was clearly a big breakdown in scenario analysis that happened on an adequate basis and examining of repeatable key risks.
Tim Buchner:
And we found this really to be a mission-critical piece, especially during uncertain times. And clearly we’ve been in that for the last five or so years. So because this was a lacking, we saw that as a clear factor in their downfall. And so I think it’s worth highlighting for many clients we serve, we find that the best run firms are constantly running those exercises to be really strong at risk modeling and to really have full teams associated with that and to best understand sensitivities across their portfolio’s risk profile, we see that as mission-critical.
Paul Fleming:
Tim, well said. Maybe a couple things I’d add to your points. Number one, I think this served as a good reminder to the whole industry to understand our exposures. And as I said before, I think we’ve come a long way as an industry both on the buy side and the sales side from that 2008, 2009 time period in terms of understanding our exposures. Certainly that was driven by the industry, but also our regulators as well. So I think we’re much better positioned there and that helped, as I said before, contribute to some of the calmness that we saw relative to what we saw in the last crisis.
Paul Fleming:
And then the other thing I would say is that when we talked to managers and investors, as we did in our most recent private markets survey where we interviewed 480 managers and investors, one of the things we heard from investors in particular was that one of their top areas of focus in terms of improvement in private markets investing, in particular, was enhanced due diligence and data access around deal quality and deal risk. It’s very important to them. And so when we talk about exposures, I think there’s a continued interest particularly on the part of investors to get better access to data, to understand the due diligence process and the quality of the due diligence process that goes into deals and deal risk. And so that’s going to be a continued focus around advancing the ball there. And we know that from talking to investors directly.
Tim Buchner:
And a key challenge from the recent downfall was really due to the fact that SVB was far too concentrated in a single segment private equity venture capital. This clearly had its advantages when interest rates were low and deposits were high. When we really think about it, now working with some of the largest most diversified asset managers in the world, we’re finding a lot more resiliency in those that have diversified investment strategies because it really prevents a lot of that concentration risk that we see by certain players today. And so what we find really interesting now is if you look at the global private markets industry, total AUM is about 12 trillion, 60% of the market still is dominated by PE, while real assets is 22% and private credit is about 11%. But wow, if you look back five years ago, what a different environment it was for private credit and what a difference it was even for infrastructure.
Tim Buchner:
And so today, if you look a little closer about where the growth is going and how quickly private credit and infrastructure and even residential real estate are growing very quickly, you’d see that the other side of the market is down about 15% to 25%. And so the key that hopefully that listeners will have as a takeaway is that for those that have been really dominantly focused on one segment, it’s going to prove to be harder to get consistent returns for your investors. And to us, we’re really emphasizing the importance of diversification and probably equally importance, the emphasis on really being flexible as a platform. And when we think of platform, it’s both platform from the businesses that in segments that you’re going after, but also platform and how you’re actually able to manage data and how flexibility in driving that data is going to be extremely important to be able to really give the kind of returns you’re looking for long-term.
Paul Fleming:
I think about diversity from a couple of different angles. One is just what Tim is talking about, the opportunity set, the investment opportunity set, and it’s really interesting. Tim, you talked a little bit about the evolution you’ve witnessed over time and I’ve seen that as well. And I do think that the industry needs to continue to push to diversify the opportunity set because one of the other things we hear from investors when they talk about concerns around investing in this space or allocating more capital to this space is overcrowding and competition for deals. And maybe that has a little bit to do with what you said, Tim, the big folks who dominate some of these sub-asset classes. But we already know, and again, we hear from managers and investors that things will continue to rotate into different types of assets. We hear a lot about rotation into infrastructure and natural resources as an example that we haven’t quite seen yet, but we do hear a lot of talk about that. So I think that will be good for investors.
Paul Fleming:
The other angle to look at is on the investor side in diversification there as well, if you think about the retail investor, 50% of all wealth globally comes from retail investors and that’s going to change this industry too over time as that capital has opportunities to move into some of these asset classes. And so that’s another way I think about diversity in this area as well is from the investor side.
Kali Jakobi:
With all factors in mind here from recent events and the recent State Street survey, what insights can you all provide about the criticality of investor confidence and trust and maybe what steps can be taken to proactively maintain that from the investor’s side?
Paul Fleming:
It goes a little bit back to what I was saying before in terms of that feedback we got from investors as part of our survey. I do think that access to due diligence and data around deals and deal risk is really important. And then I think on the manager side, being able to do a really good job managing data and analytics is important. We found as part of that survey, Kali, as you know, 60% of our managers reported that having really strong data management and analytics around their investment process was a key competitive advantage for their firm. And I think that’s going to be even more important going forward.
Tim Buchner:
Yeah, I love that. When we think about trust in customers losing trust, clearly that’s been a big trigger of the recent collapses, but it really highlights how important trust is with both customers and investor bases. And as I think back to the friends that I had and PE back firmed like gaining access to funds and quickly establishing new relationships with rival banks, fast moving, their balance is over, especially with those that can support them, that’s not easy to do. Taking an entrepreneur and having them move that over, that distracts them for a whole lot of things, so having the client have to quickly react to losing trust. Gaining that trust back is not so easy.
Tim Buchner:
And so I think that trust on the investor front will have to be reassured by companies reiterating that they are following strong investment principles, processes, strong management of data, just like you said, Paul, and strong risk management diversification, much of that was out the door with SVB. So making sure that we really get back to the basics in a lot of ways. I’ll probably talk about a little bit later, just this importance of getting much more proactive in the space so that you are trying to drive that proactivity.
Kali Jakobi:
We have a key theme highlighting here that there is a need for clients to be proactive and anticipate potential challenges. What are some of those proactive steps in that asset and investment managers can take to prepare for these potential market challenges?
Tim Buchner:
There’s a couple of key areas we’re seeing consistently across some of the best run alternative managers that are worth noting, right? Number one is there’s this relentless focus on being proactive. And there are some really, really good examples in the space when you do look at some of the best run firms and what we find as some of the big testaments are this regular cadence to stress testing portfolios and having a technology platform capable of driving those scalable scenarios. It’s not something that’s uber common in this space because so much of the private markets is driven out of Excel, but having ways in which the industry can have repeatability around driving valuations at scale, when you have much of the industry relying on manual silo-based systems, thinking about how that interconnects is going to be keenly important.
Tim Buchner:
Also, I would say considering continuous improvement plans to risk, management is going to be really important. We talked about risk management earlier, but I would say most of the departments, I think, are constantly thinking about how they improve, but risk management’s one we’ve seen you set it and forget it. Those teams get established, they invent their processes, but what they don’t commonly do is as things are missed or as learnings Zurich applied, you don’t see best practices coming back into the firm. So I would say really making sure best practices are that you’re getting from the market or that you’re getting from your own experience and that you’re constantly looking at that, getting embedded back into your processes, I think is critical.
Tim Buchner:
And the last thing I’d probably say is just really accelerating teams away from this constant thought about they have to have bottoms up data strategies from just asset to asset ways in which you’re managing data to really moving toward a much more top-down centralized approach. In private markets, in particular, much of the data management is ruled by Excel, as we’ve talked about. And different teams are running off different point solutions. And so most of the industry is in a constant struggle around operating models that embed data, strong data governance, and we think that’s going to be critical.
Paul Fleming:
Yeah, Tim, I think that’s a good commentary on the manager side. Maybe I’ll bring the investors back in again. I think one of the things that’s going to be important going forward for the industry to do is help the investors understand how they navigate some choppy waters. I think that’s important, and particularly as we start to see a broader, as we like to call, democratization of investors or investing in some of these asset classes, particularly in products that can be more liquid, we have to help investors understand how we navigate these choppy waters because we saw last year, even in some of the high profile funds that our clients manage, as things got choppy in the markets broadly and investors pull capital out or not allocate capital as planned to the space. And that was a little bit of a head scratcher for us because the returns were good and the risk was well managed in my view.
Paul Fleming:
And I think the thing for investors to know is that even before SVB in the second half of last year, deal volumes were down, valuations were down, and performance in some cases suffered a bit, but private markets on the whole continued to outperform public markets on the way down, even when there was a dip. So I think we have to help investors understand how this industry performs in choppier waters, and not only how it performs but how managers manage risk.
Kali Jakobi:
As we wrap up with our Data Disruption episode today, our loyal followers know that we always end on a question that has nothing to do with our topic, and I affectionately call them our personality questions. So Tim, Paul, my question to you is what movie inspires you most?
Paul Fleming:
I’m a big action movie guy, and I would say that for me, I really love the Jason Bourne series and the reason I like it and find it inspiring is you basically have one guy who’s up against every police force, intelligence agency, army, whatever in the world, and he just continues to fight for what’s right and get to the truth and persevere. And I find that to be inspiring. So that’s me, but I’m a big action movie guy.
Tim Buchner:
Much like Paul. I would say that I always look for themes in movies or themes across what I’m dealing with in my own personal life and my personal, one of my best, is the Pursuit of Happiness.
Kali Jakobi:
Oh, so good.
Tim Buchner:
Yeah, I’m always looking for those stories where someone had to come from really hard life challenges and had to get ready in a bathroom that was in a subway station or had to take their kid and make it happen and live wherever to work there. And having come from my own startup journey for 14 years and being down in the bank account to very few thousands and having many, many tens of people working for you and at the end over a hundred people, you have to be scrappy and you have to be good at taking no for an answer and turning it into a yes. And that movie, it pulls my heartstrings, I should say, as he was able to get his job as a stockbroker at the end. Boy, oh boy, does that sound like how we ended up at State Street? And I’m very proud to be here.
Kali Jakobi:
Oh, both great movies. I’d have to say mine is the movie Warrior. I don’t know if you guys have seen that. It’s a boxing movie of the two brothers that ultimately have to fight against each other and the brother story just gets me, but it’s also action and big boxing fan. So that’s a movie that definitely inspires me.
Kali Jakobi:
Well, what an incredible discussion we had today here on the challenges and opportunities facing asset and investment managers. We covered a lot of ground, including the importance of risk management, trust and diversification, as well as the need to be proactive and prepared for the unknown. Check out the link in our podcast description to view the 2023 State Street private market survey highlights, and be sure to sign up to receive the full copy of the report when it’s available at the end of this month. As always, Paul, Tim, you guys have been great guests. Thank you all for sharing your insights with us today. Until next time.
Paul Fleming:
Thanks, Kelly. Thanks, Tim.
Tim Buchner:
Thanks so much.
Kali Jakobi:
Thanks for listening to this episode of Data Disruption by Charles River. If you like what you heard, share and leave us a review. It helps others discover the show, and I thank you for it. And if you like additional insights related to this conversation or others, go to our website at www.crd.com. Till next time.
Information Classification: General
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The material discussed is for informational purposes only. The views expressed in this material are the views of the author and are subject to change based on market and other conditions and factors, moreover, they do not necessarily represent the official views of Mercatus and/or State Street Corporation and its affiliates.