Hamilton Lane Inc. has an unusual perch in private markets. It advises on $860 billion in assets—screening, recommending and monitoring investments for institutions such as pension systems—and also manages $145 billion in funds and separate accounts. To that end, over three decades, Hamilton Lane has compiled metrics on more than 68,000 private equity, credit and other funds from more than 61 vintages, or starting years. And it has data on the operations of more than 178,000 portfolio companies.
As a result, co-Chief Executive Officer Erik Hirsch has a broad and deep view into buyouts and private credit—at a moment when many are worried about the growth of finance outside of public markets. He sat down to talk in a conference room on the 14th floor of Hamilton Lane’s headquarters in Conshohocken, Pennsylvania, a suburb of Philadelphia. The room is named for acoustic stringed instrument maker Martin & Co., part of a musical theme—also embodied in guitars and posters hanging on the walls throughout the office—that was started by Hirsch, a former CEO and others at the firm who are rock fans and musicians. Hirsch’s conversation with Investing & FFM Editor Jon Asmundsson has been edited for clarity and length.
JON ASMUNDSSON : There’s a lot of concern about what’s happening in private credit. It seems like part of the issue is that the market is opaque for most people.
ERIK HIRSCH : Yeah, I agree with that.
JA : Hamilton Lane, I would guess, has a view into what is happening in the market. Could you start by telling me about the firm and how it developed?
EH : Sure. It was founded in the early 1990s, about when institutional investors were starting to come into the asset class in full force. There were already fund-of-funds players around, and our founders had the idea of helping in a consultative capacity. The business was consulting to institutional investors to help them build out and manage their private markets portfolios. We first started working with states like Florida, New York, California—large pension funds that were just sticking a toe into the water.
That sort of fortuitous choice of starting as a consultant firm—which was less lucrative than a fund-of-funds model—I think instilled in the firm two things that are still hugely advantageous today. One was this client-centric culture. The second advantage is actually going to take us to credit, because it’s around data. We—a scrappy, small, not-super-profitable company doing consulting work—were quick to say to the customer, “We’re going to help you with everything.” And part of that was doing their back-office work for them. We were the ones who were coordinating the capital calls and dealing with the distribution notices and the annual reports and all of that sort of messy, not-always-fun stuff.
JA : That had to do with pension funds not being set up to handle that?
EH : Most people don’t want to handle that stuff, no matter who they are. We became quite efficient at it, such that we began selling it as a standalone service—meaning even if you weren’t having us manage money for you or be your adviser, we’re still happy to do your back office. Today there’s a heavy technology orientation around that—as opposed to years ago, it was an army of people literally processing paper. But we’ve been on the cutting edge of a lot of this tech and adopting data ingestion tools, processing tools, analytical tools. If you go back 10-plus years ago, we started taking balance sheet capital and investing directly in technology businesses that we thought were going to be strategic for us. We’re still doing that today.
The industry’s gotten very large, so there’s a lot more technology providers targeting it. But if we then wind this back around, being the back-office provider means that we’re getting direct detail on a huge number of fund managers.
We have a huge client base who’s invested in all kinds of different funds, and we’re getting directly fed that data from the fund manager: [We are able] to look into our database and see what companies are owned, what price was paid for them, how much leverage is on them, what’s happening with their revenue and their earnings. And since, for a lot of our back-office customers, we’re not managing their money, that database is not biased by our investment view. We might pick up a new pension to do their back office tomorrow. They’ve been in the industry, let’s say, 35 years, and they’re about to bring with them a database for us that’s another 275 funds spanning back 35 years.
JA : What’s the form of that?
EH : It comes to us in all kinds of formats. Usually people are housed in some independent third-party software. But then we sort of absorb it into our systems.
The business then migrated to where we began to do much more asset management ourselves. And rather than immediately go the fund-of-funds route, which was already crowded, we’re really one of the pioneers of doing customized separate accounts—like a fund-of-funds, but for a single LP. Most of the clients did not frankly want to build out a huge internal army to do it themselves. But they did want to have it customized. We have some people who only want to invest in credit. We have some clients who only want to do venture because they want high returns. We have clients who want a little bit of everything.
JA : So, then, what are you seeing in private credit?
EH : We can look into those databases, and we can see exposures, whether the company’s growing. We can see leverage levels. We can see equity coverage. What we’re seeing is defaults are sitting at sub-2%—which is historically their normal low—and dropping.
JA : It’s coming off a period of unusually low defaults?
EH : It’s been low, and it’s staying low. It’s actually dropping further. And leverage levels, if we put them in context, are actually not rising. They’re staying flat or dropping, which means equity coverage is also rising. All those data points are kind of flashing green.
The next thing I would look at is, what’s the portfolio mix on current payments versus payments in kind [in which interest payments are made by adding principal to the debt]? Are we seeing a huge rise in PIKing? There, it’s manager specific. The private credit space is very big. There are lots of providers. They’re not all the same. Some of them are better, and some are less good. Some of them are taking more risk, and some are taking less. They’re all building different portfolios.
We’ve seen a handful of very public, big credit problems. I will note that if you look at who the lenders were in those cases, it was primarily the banks, not the private credit fund managers. I would say that the banks might have their own set of different issues. But I think the market reaction was, “Uh-oh, we saw these big headlines.” You saw a couple of very senior people come out and say there might be cockroaches. To me it was a little bit of: Well, I know we made bad loans, but I’m sure everyone else did too.
The data just isn’t suggesting that. Not to say that we won’t have some credit managers who’ve made bad choices. But painting right now with this very broad brush to say there’s a problem with private credit, I think, is untrue. The opaqueness is what is concerning to people. And that I understand. It’s that you don’t have the ability to look in our database today to see what’s happening in there. But I think there is enough data available around the big points of average lending levels, equity coverage, default rates, etc., that I think are just not showing you that there’s some big crisis on the horizon.
JA : Isn’t your private markets database Cobalt available for investors to subscribe to?
EH : We don’t think of Cobalt as a data repository. We think of Cobalt as an analytics engine. It does harness a lot of Hamilton Lane data for doing analysis, but what most of the customers are using it for is portfolio construction, benchmarking, manager evaluation, risk calculators. And then they’re using a series of benchmarks that come with it.
JA : Could I get you to talk a bit about the taxonomy of private credit? You mentioned there being good and bad managers, but could you talk about, say, origination versus specialty finance? Do you see a lot of difference in performance across the categories?
EH : Across all parts of the private markets, you see meaningful dispersion from top to bottom in terms of performance.
JA : Within any category?
EH : Within anything, yeah. The bands might narrow and shrink depending on kind of how risky the strategy. Early-stage venture, you’re going to see a dispersion that’s really big, because the top could be extraordinarily high. Someone has, you know, a 2,000% internal rate of return, and someone loses everything. As the strategies get riskier, the dispersion widens out. But in each of them, you’re still going to see noticeable dispersion.
On the credit side, that’s what you’re seeing. Again, lower risk, smaller dispersion, but you see dispersion across it. Part of it is, how much risk are they taking? What kind of underwriting standards do they have? How good are they at doing that? And if there is a problem, how good are they at working alongside the equity provider to try to fix the problem?
I go back to skill sets. One of the things that is kind of the elephant in the room that needs to be talked about: Lending has taken a sort of huge shift. It wasn’t that long ago when we talked about lending to private companies as being a fully bank-driven thing. That’s who did the lending, the banks. If you owned a business in Nebraska, and you were the CEO of that big business in that town and you wanted to add an expansion to your factory, you went to the bank who knew you. You walked in and saw your banker—I’m making a very generic example—but that’s where lending occurred. Lending has shifted away from the banks. While the banking piece has been shrinking for regulatory reasons and merger reasons and consolidation, we’ve seen a rise in private credit.
Where is their talent coming from? The banks. When you go and ask private credit managers—as we recently did in a poll—“Over the last five years, what percentage of the hiring that you’ve done has been pulling people from banks?” The answer is, a substantial portion. We’re not acknowledging that. I would argue that there’s been a bit of a shift in talent.
JA : It seems intuitive—where else would they come from?
EH : We didn’t hatch them, right? Some of it is certainly private credit to private credit, people shifting firms. I’m not suggesting it’s 100%. But when we formally went off and surveyed a bunch of credit managers, it obviously varied by firm, but 60%, 55%, 70%, it’s not insignificant. That to me is sort of elephant in the room, part one. And elephant in the room, part two, is how people are compensated. Bankers get paid bonuses, and a lot of times you get paid your bonus based on, “Hey, you originated that deal and we got the loan.” Well, over here in private credit world, most of these people are investing their own money in the fund as part of the GP commitment. And they’re deriving some portion of compensation from profits that are only occurring when there’s a successful exit. It’s just fundamentally a different alignment mechanism. This to me feels like a much better alignment mechanism.
JA : Could I get you to talk a little bit about private equity and the lack of exits lately?
EH : It looks challenging and has looked challenged for the last couple of years. One of the things that was always great as a private equity person was you’re like, “We always beat the public markets.”
But that hasn’t been true for the last few years. Private equity has been lagging. On a one-, two-, three-year basis and on an individual year basis for the last couple of years, they’re lagging. Why is that? A few reasons. The public markets have been on fire. It’s hard to keep up with the public market when it’s on this meteoric rise. That is not to say that there’s no blame on the private equity side. Covid caused people to get a little nutty. Dollars were deployed very quickly, pricing got very high.
JA : When did that happen? At the beginning of the pandemic?
EH : Back end. Coming out of the pandemic, we put all the stimulus into the system—the markets were on fire. Again, dollars deployed very quickly in a very concentrated period. That’s never a great thing for private equity—high prices paid. Now it’s taking time to work through those businesses.
We’re not seeing—back to our debt issue—we’re not seeing tons of bankruptcies, but we are seeing elongated holding periods. If we look at holding periods on average over a 20-year period, it’s generally around four, four and a half years from the time I buy it to the time I sell it. Today, we’re sitting at over five. It’s just taking longer to grow your way out of that purchase price.
Asmundsson is Investing & FFM editor of Bloomberg Markets.