StepStone Cofounder and Booth Alum Tom Keck Talks Investment Trends, Industry Evolution

Cofounded by University of Chicago Booth School of Business alumnus, Tom Keck, MBA ’97, the StepStone Group is a global private markets investment firm that last year went public with an IPO totaling more than $362 million.

Keck is StepStone’s head of research and portfolio management, and also is involved in the firm’s responsible investing and risk management initiatives.

Following the close of the IPO and the start of the New Year, we caught up with Keck to discuss industry trends, how the firm has responded, and what he expects from the next five years.

Polsky Center: How has the industry evolved over the last five, ten years? 

Tom Keck: In the past decade, private markets have grown, and become more global. The amount of capital available to invest (“dry powder”) in Private Equity (including Venture Capital and Growth Equity) has risen from just under US$800 billion in 2010 to over US$2 trillion in 2021. At the same time, Private Real Estate, Private Infrastructure and Real Assets, and Private Debt have all increased at similar rates. Much of this growth has happened outside of the US. This means that private investors have about US$3 trillion of capital to invest in assets in private companies in a much wider array of economies than was available ten years ago.

At the same time, the number and size of available publicly-traded companies has changed substantially, despite the recent spate of IPOs and SPAC activity: in the US alone, from just over 8,000 in the mid-90s to just over 6,000 today. The smallest company in the S&P 500 has over US$8 billion in market capitalization—but most people in the US work for companies that are much smaller by comparison. Investors have recognized that to get broad exposure to the global economy, in both developed and emerging markets, they need to have exposure to private assets.

What this means is that the role of private markets assets in an investment portfolio has changed. Investors used to focus on “outperformance” as the rationale for incurring the lack of liquidity in private assets. Steve Kaplan and Antoinette Schoar wrote a seminal paper in 2005 talking about the persistence of outperformance in private equity, and the pursuit of “top quartile” managers became a mantra for investors. We have much more data available today than we have ever had; this has allowed us to focus more on risk and correlation of private assets, because we can now demonstrate the diversification benefits of private assets.

The globalization and expansion of return profiles in private markets are evident in the number of opportunities available to investors today: the number of managers has doubled in the past 10 years, with over 6,000 general partners offering a wide array of strategies. Almost half of the increase has occurred outside the US, and in asset classes other than Private Equity.

The result of this is that investing in private markets has gotten more challenging. There is greater competition for assets and capital amongst general partners; limited partners face more variety and a much greater amount of data to evaluate performance and risk. The persistence that Steve and Antoinette found in pre-2000 private equity is now elusive. There are even more methods for gaining exposure to private assets, as more institutions utilize the secondary market, co-investments, and direct investments. As a result, private investors are looking to assemble “optimal” portfolios of private assets, rather than just assembling a list of the usual suspects. This customization of private markets portfolios has really gained momentum in the past 10 years.

Polsky: What are some of the biggest trends you’ve seen? And what is the impact?

Keck: Globalization, customization, and the expansion of asset classes outside of Private Equity are three significant trends, of course. This means that there are a wider array of investors getting involved in the asset classes. We expect to see this continue. For example, retail investors have had difficulty gaining access to private markets. Some of the barrier was regulatory, some was the practicality of servicing thousands (or more) investors, and some was illiquidity. Technology, and changes in regulation, are allowing us to overcome these barriers. We expect that in the next 10 years private markets will be “democratized” as more and more individuals gain exposure to private markets in their retirement and other investment accounts.

Insurance companies have also historically underinvested in private markets, even though their longer time horizons are perfectly suited to private markets’ lengthier duration profile. Greater understanding of both market and liquidity risk in private markets is allowing more and more insurance companies to find appropriate roles for private assets in their portfolios while minimizing the risk-based capital charges that previously had hindered the attractiveness of these asset classes.

ESG is another key area of focus. Ten years ago, ESG was considered a segment of the investment world. Today it is a framework for understanding risk factors in any investment. Going forward, it may also be a framework for identifying opportunities. As outlined in our paper “Responsible Investing: Internalizing the Externality,” we believe that data and technology are enabling greater transparency and pricing of historic externalities. This will transform markets and business models across the entire economy. Investors that can accelerate this transformation will be able to realize an arbitrage between the market-clearing price today, and the market with these externalities priced.

Private markets offer a preferred method for realizing this arbitrage by accelerating the transformation. Much of this activity today is being marketed as “impact investing,” but we increasingly believe that understanding issues like climate change and how it affects a whole range of businesses is just “investing.”

Risk management is another big trend we have been seeing. It was rarely discussed in the context of private markets, because “risk” was not well understood, or even thought to be measurable. This has changed, in part because we have more data to try and characterize risk, and in part as a result of the fallout from scandals in other asset classes, such as the Madoff scandal. With respect to market and liquidity risk, data science and technology have greatly enhanced our ability to model the behavior of private assets, both in terms of valuation, as well as the timing of capital draws and returns. This understanding allows us to tailor the correlation and liquidity profiles of a portfolio of private assets in a way that wasn’t possible 10 years ago.

In addition, as an industry, we have gotten better about understanding operational risks involved in different strategies. Finally, the focus on ESG has allowed us to spend more time understanding the governance structures that private markets investments entail, and to do a better job of designing structures that minimize misalignment of interests between general partners and limited partners.

Polsky: How has the firm responded to these trends? And what has your role been?

Keck: We saw some of these trends when we started StepStone in 2007, but the speed and extent of the changes have been greater than we anticipated—at least in part due to the Global Financial Crisis. For example, customization was a core principle of the firm when we started. But the move away from funds-of-funds was accelerated by the GFC. We have responded to the globalization of private markets by becoming a global firm; as of December 31, 2020, 69% of our clients and approximately 40% of our employees were based outside the US. We brought in local teams to provide specific expertise investing in a given region, but have equipped those teams with a common global perspective, mindset, and culture, to ensure a consistently high standard of execution.

Similarly, we have responded to the expansion of asset classes outside of Private Equity by building out teams with the specific domain expertise required in each of these areas – Real Estate, Infrastructure and Real Assets, and Private Debt. Though they all have similar structures and liquidity options, each asset class has distinctive qualities. Each of these teams has taken the basic operating model we pioneered in Private Equity, and tailored it to fit the requirements of their specific environment. Even so, our clients can still recognize the basic StepStone model across each of these areas— as of December 31, 2020, 34% of our clients had exposure to more than one asset class.

My Booth background has been critical to my role over the years. StepStone has always fostered a culture of spirited, evidence-driven debate regarding our investment theses and portfolio construction. As a founder and board member, I have tried to support this ethic, which I learned in Hyde Park. Chicago also engendered a thirst for data—I started our original data collection efforts, and have worked closely with the team that has developed a suite of technology solutions that gathers information, increases operational efficiency, and provides industry insight that no other firm has. While I have been involved in all the different sectors we invest in, I am happy to report that we have been able to quickly bring in highly motivated, infinitely more-qualified professionals. “Replace Keck with someone more qualified” has probably been one of the secrets to our success.

Polsky: What do you expect from the next five years?

Keck: I think we will see our competitors pick up the pace on data and technology, and push us to keep getting better with our systems, analyses, and tools. Investors will increase focus on portfolio construction, and will have a deeper understanding of the variety of roles private assets can play in an investment portfolio. This will lead to innovations that will extend the “democratization” of private markets.

ESG and Impact will become more mainstream, and we will see private markets investors leading the charge for greater transparency in disclosure of risk exposures to things like climate change and corporate governance. Companies will face dramatically different cost of capital depending on how they respond to these changes. I think the financial services industry will become a career choice for a more diverse segment of the workforce, and the quality of the decision-making at firms like StepStone will benefit as a result.

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