"Zooming Out” with Ted Seides of Capital Allocators

Please stay tuned after the conclusion of the podcast for additional important information.

TED SEIDES: Probably the best quote I ever got, perhaps in the history of the podcast was from Karl Scheer, who's the CIO of the University of Cincinnati, who said, anyone who thinks that nothing lasts forever has never invested in a bad private equity fund.

GREG HALL: Hey everybody. Welcome to another episode of Accrued Interest, PIMCO's podcast, dedicated to serving financial advisors and their clients. This is Greg Hall. As always, I'll be your host. I lead the wealth management business for PIMCO here in the United States. Today I'm really excited to have with us Ted Seides. Ted's the founder of Capital Allocators. I probably don't need to introduce him to many of you 'cause I'm sure you're avid listeners to Ted's podcast.

It's one of the most popular, if not the most popular podcasts out there for allocators to alternative and traditional strategies. Ted and I have known each other for a very long time. I've watched the development of his business with a lot of interest over the last decade. And as we embarked on our podcast journey here at PIMCO, Ted was an inspiration to that process and somebody who gave me some pointers along the way. So it's really full circle, Ted, to have you here with us today.

TED SEIDES: Thanks, Greg. So fun to do it with you.

GREG HALL: It's fantastic. So I wanted to just maybe I really, I think your story is so interesting and so fascinating. I could get into your bio myself, but I'd like for you to do it. And I really think the advisors listening to this pod today will resonate with the entrepreneurialism that is sort of intrinsic to your story. So, I'm excited for them to hear it from your lips.

TED SEIDES: I'm gonna leave that entrepreneurialism comment aside. We can come back to that. Sometimes it's accidental, but I started, my first job out of college was working for David Swensen at the Yale Endowment in 1992. He had been there for seven years. The portfolio had been crafted in his image, but the world didn't know who he was. And I ended up working for him for five years as my formative years in the business, learning an incredible amount from a true master in the business. And then decided that I didn't want to spend my entire life in what felt like a dead-end job in New Haven, Connecticut. 'Cause again, nobody knew who he was.

And went to business school thinking I wanted to pick stocks. Tried my hand at that with a hedge fund that Yale had money with, didn't really find my footing in a summer job.

Went and worked at private equity for another firm that Yale had money with. That was an unmitigated disaster. Then moved to another firm, J. Whitney, that was a storied firm at the time, at a really interesting time alongside some incredible professionals who have done amazing things. But it was also right at the peak of the internet bubble.

And after a couple of false starts, decided to go back into fund manager selection, which turned into, had an opportunity to be the co-founder of a hedge fund of funds called Protege Partners. That was focused on, I would say, some similarities and some differences to how I invested in finding managers earlier in their careers. And then structurally, we did it both investing in funds and then trying to own pieces of new launches through seeding. And I did that for 14 years. That was when we crossed paths. I don't remember when, but a long time ago.

GREG HALL: It was. So yeah, you and I started to run across each other kind of in the, you know, the glory days, but also maybe the latter stages of the hedge fund boom in the early 2000s. So you'd been at it and were a veteran as I got more involved in the seeding side of the business. But we looked to Protege as the pioneer in that market.

TED SEIDES: I did that for 14 years. I left in 2015 and didn't really know what I would do next. I assumed I would stay in the investment business. I didn't want to stay just in the hedge fund space. And out of that, and a bunch of projects on the side, working in family office in one place, an asset manager, different things came up that I did kind of a date before you marry. I had been on a few podcasts relatively early on coming off of the first book I had written, which was a book about the lessons I had learned from startup hedge funds.

GREG HALL: So you want to be a hedge fund manager?

TED SEIDES: Yeah, I think it's called “So You Wanna Start a Hedge Fund”. So, You Think You Can Dance was popular at the time.

GREG HALL: Okay, gotcha.

TED SEIDES: As much a series of lessons that I had seen and that you had seen when you're around first-time hedge fund launches. People make mistakes, but it's not like a recurring entrepreneurship business, or somebody fails to start a hedge fund, they rarely start another one. Someone succeeds, they don't go on to start their next hedge fund.

They just run it. So you'd see these repeated patterns that someone trying to start for the first time didn't know, but we had seen over and over again. And I didn't want to do it anymore. I had been at the end of that chapter of my career, so I was like, I don't want to talk to these people, but let me write down all the lessons so that I don't have to talk to them.

GREG HALL: What we call that today is you were scaling your learnings.

TED SEIDES: I was scaling my learnings so that I didn't have to teach it anymore. And then I woke up one day and said, you know, it might be fun to run around and talk to my old endowment friends, because when you're just in the weeds focused on hedge funds all the time, some of them were clients, but a lot of them I hadn't really kept up with what had happened in the multi-asset investing business.

And that turned into this podcast. And it wasn't, you know, I used to joke that it couldn't possibly be a business. It's like, okay, Greg, hop on a call and we'll just have a conversation and share it for free. You know, that doesn't sound like the kind of business model I learned at Harvard. But after a couple years…

GREG HALL: You might not have seeded that as a business proposition. Well, I mean, I think, you know, if I were to tell the story, I think, you know, maybe in modesty, you're leaving out a few aspects of it. You know, one, you studied under a legendary allocator, the late, great David Swensen, at a time, as you mentioned before, before people really were beginning to think about allocation as an art form or a science, really. And then, you know, while at Protege you had another brush with greatness or celebrity.

Scott Bessent, the Treasury Secretary, was one of your partners there, right? And so, you know, one of the things that you're certainly well known for is your famous bet with Warren Buffett about whether or not a group of hedge fund of funds would beat the S&P over a period of time.

A bet you lost, but I think it was well structured, well founded, and obviously brought a lot of attention to some of these issues that you care about. So, I guess what I'm saying is, you know, you weren't plucked from obscurity to host this podcast and talk to some of these impressive folks that you've had. But you've always been somebody who gathers smart people together. You've been a thought leader, and you've been a bit of a provocateur in an intellectual context. And I think that's why it's worked out as well as it has.

TED SEIDES: Yeah. Well, I appreciate that, Greg. I think that without planning it ahead of time, the podcast brought together everything I've sort of learned and everyone I've known for 30 years. It's incredible. But there are money managers I met in the first weeks of my career who were managing money from Yale. People like Jeremy Grantham and Tom Steyer, who I've known through that time, but at different, maybe a decade would go by, I had no reason to be in conversation with them, and then get to have them come on the podcast. And it's so much fun to be able to bring that together.

And unlike almost anything else in asset management, you can tangibly feel the benefit that you're bringing to somebody else when you have that large-scale audience. And it's a niche audience in this space. Almost a hundred percent of the time, I will tell a guest, you're not gonna believe how many people reach out to you. And when I tell you that it's gonna outperform that expectation, and then it does. Because it's just hard to imagine that you're having a conversation in front of a full Yankee Stadium crowd or wherever Chelsea plays in London. So, it's a pretty amazing thing to be able to deliver.

I used to call it the business of building goodwill on my personal balance sheet, but there wasn't really economics attached to it. But people would have just an incredible experience on both sides, the people listening and the people coming on the show. So it's a really fun way of bringing together all of the people, all the insights, and then continue to have access. Usually, you get great access to people if you're managing billions of dollars and they want your money. This is different. But I'm still able to have that kind of conversation with some of the best people in the business. So it's incredibly fun.

GREG HALL: Yeah. I think it's a testament to who you are, as well as the audience that you've constructed over the last decade. But let me ask you, you just think back on some of these conversations over the life of Capital Allocators, you've interviewed so many luminary minds in our profession. I'm curious, have you got a list? Have you arrived at conclusions as to what separates the truly great investors from the merely good?

TED SEIDES: Yeah. It's easy to walk through a list and I'm happy to share things like passion and great discipline and clear-minded thought and behavioral temperament. There's a lot of things that you would imagine would go into a great money manager. The problem is that many, many more people possess those traits than end up being really great at it. So there's always an intangible thing, but I think all of that is on the margin.

There are a lot of incredibly talented people in the business. On the margin, there are some that were born to do this, that they really would do it if they weren't paid for it. Many love it and are really good at it, but have lots of other things they'd rather do. That one person, luck willing, there's a lot of luck, and they have the skill, they're gonna win over time.

And that's true in any field. It's certainly true in investing. I think the biggest differentiator that's hard to tease out is that behavioral temperament. You have to have a sense of humor about yourself because it is humbling. And someone who is so serious, so passionate, but isn't fully prepared to have the temperament to deal with defeats isn't gonna do as well as the person who, you know, that can roll off their shoulders and they can move on, you know, the next trade, the next at bat, whatever.

It's and I think that's particularly true in the public markets. Private markets is a little bit of a different animal. But in the public markets, many more people that are talented, playing more competitive than it's ever been, and that's just continues, that's a directional error of progress. So that's what's interesting about it, I find, is that the more the information is ubiquitous, the more that people have great skill.

They understand, everybody understands how to do a DCF. Everybody understands what Warren Buffett thinks of investing. You know, when I started in the business, nobody knew who Warren Buffett was. The more that happens, the more it becomes about people. It really is what's differentiating one person from the next. It might not be the skill, it might not be the temperament. It might be where are they in their life for the next five years, and are they gonna be able to continue to create the mastery they had in the past as markets evolve.

And so it's just an endlessly fascinating combination of the intellectual side of what's happening in markets and companies and economies, and then the human side of how is an individual active manager gonna participate to try to win.

GREG HALL: I think it's, well, one, it's just really gratifying in a people-driven industry to know that you think the AI overlords aren't going to take over for all of us, and that the human quotient still really matters in a world of ubiquitous information.

TED SEIDES: I don't know if that's gonna happen or not. So I'll give you an example from the podcast. Gavin Baker from Atreides came on the show. Everything I have learned about AI, I have learned from listening to Gavin. I happen to be an investor of his, I happen to be an advisor of his, which is something that came later just because I've so enjoyed learning from him.

And AI might be able to do a lot. He seems to be able to understand where AI is going far more than other people. I am never gonna figure that out, but I can figure out, I think, someone like Gavin has a much better chance than others of being able to be ahead of the curve with whatever AI brings.

And so for me, that's fun, 'cause it's a bet on a person who I feel like I know how to identify as an expert in an area I will never be able to understand and keep up with. But whether AI turns all this around, you know, it's revolutionary in the same way the internet was 20 years ago. But humans still drive lots and lots of outcomes, including what happens with AI.

GREG HALL: I want to, let's put a pin in this, 'cause I want to come back to this dynamic of the humans versus the machines, especially as it relates to indexing and kind of the state of modern public markets. But I want to go back to a couple of things that you just talked about.

One, I just want to underscore my total agreement that if you've got a choice between somebody who's a brilliant investor and somebody who loves it and just wants to do it every day, and it's the first thing they think about when they wake up and the last thing they think about when they go to sleep, and they're, you know, I remember back at the height of the hedge fund days, I had good friends who were waiting up until three in the morning because a credit card company was gonna drop its 10-K, and they thought they knew something and they were gonna get it.

Like that degree of commitment. I think that wins, you know, over time. And I want to cosign you on that point. The second thing that you mentioned and I wanted to ask about is whether private equity or private strategies and public strategies, you said different beast, and it just made me think, do we think they're a different beast? Or is the feedback loop more elongated?

TED SEIDES: Yeah. Depends what you're referring to. So in referring to the skill sets required to succeed, it's completely different. And I got that window at it in a granular way early in my career by spending time both at a hedge fund and inside private equity firms.

On the public side, the company doesn't care who owns their stock. The markets move. And there's a big behavioral aspect to it of that mark-to-market. What does that do to you when you're down? How do you respond to that? That doesn't really exist on the private side. The private side is about doing the analysis, winning a deal, and then operating the company to try to make it better.

So, the skill sets that are involved in deal-making and running businesses are very different than the skill sets that are involved in, let's say, a combination of the assessment, which might be similar, and then what happens when you own a stock, totally different from what happens when you own a company. So that's what I mean by different beasts. It's not so much, I mean, you can get into what are the drivers of return, how much does marking to market or not marking to market impact investor behavior. Those are all important questions, but that's different from what does it take to succeed in those two businesses.

GREG HALL: Yeah, that's fair. And of course, we should be, there's different styles of investing in both public and private companies. Some folks on the public side run models that screen for momentum. Some folks run technical models, some folks only buy high dividend distributions. You know, there's all sorts of ways to win. And then on the private equity side, you've got folks who specialize in financial engineering.

You've got guys who are turnaround specialists. So you're, I think you're right to point out the differing skill sets. My question was more, 'cause I just think we're at this moment in markets right now where a lot of advisors listening, it's not academic. They actually have to make a decision right now. Public versus private credit, particularly direct lending.

They're probably asking themselves the question, public equity with all of its pluses and minuses versus private equity, which is in a bit of an exit drought that you've referenced and hasn't wildly outperformed the public indices over the last decade or so. So I think it's really interesting, especially with you, 'cause you've seen all sides of this over the course of your career, to talk about what really separates public versus private and where they overlap.

TED SEIDES: Yeah, I think it's best to start with first principles of investing.

GREG HALL: Okay.

TED SEIDES: The main, so you start on either side, but say on the equity side, the main difference between public equity and private equity is just the liquidity. Private equity takes a while to get in. It takes a while to get out, and you can't change your mind. So that means that you should only want to invest if you're paid for that illiquidity.

That was easy to look at and say it was worthwhile in my early days investing when David Swensen wrote his book in 2000, because the risk premium to private equity was substantially higher than public equity. And you would know that just by entry price, where average buyout might be six times when the public market was trading at 12 times. And so you knew that you were buying a relatively comparable company much cheaper.

And that was how you could measure getting paid. As more and more money is coming into private equity, that assessment is much harder to determine. There are now other factors like, so for the very first time in my career, you hear very sophisticated allocators talking about private equity as diversification because the public markets have gotten more concentrated.

Said there's 3,000 listed companies in the US. There used to be 6,000. The index is highly concentrated, not that it hasn't been concentrated in the past, but it's concentrated today in a certain type of company that's been doing really well and is spending a lot on AI.

GREG HALL:  Sure.

TED SEIDES: So it's a hard determination because it's not a no-brainer that private equity will deliver higher enough returns than the public markets to justify accepting that illiquidity. The other piece of it comes down to manager selection, which is you tend to have a much wider dispersion of results in the private markets, certainly private equity, than the public markets.

So it still makes sense to allocate some capital to private equity if you're confident that you can get with, say, a top quartile manager, certainly a top half. If you're not confident, it used to make a lot of sense to do it. It's much less clear than it does today. So that's the private equity side.

GREG HALL: Talk to us about this. You published a, you call this series What Ted's Thinking. It's a great read. But not your latest one, but I guess one ago was all about the absence of exits in the private equity space. So tell us about what made you think about that and maybe describe for us some of the key points of the piece, 'cause it's a really interesting dynamic and it's having a huge influence over the industry right now.

TED SEIDES: It is. It's easy to think about it 'cause that's what everyone's talking about. And so then you go beyond that to say what could be happening. So what the data suggests is that you had this blip in 2021. A lot of money was coming in and then rates went up and things changed. And for the last four or five years, the exits, the distributions coming back to investors in private equity funds have been much less than they had been historically.

And so to put rough numbers on that, historically you generally saw about 25% of the capital that was invested in private equity funds in aggregate come back. So think about that as a 25% distribution yield, or another way of thinking about it as a four-year average hold for a private equity investment, which makes a lot of sense.

That number has dropped to below 15% for the last four years in a row. And the only time the industry has seen that was during the GFC. At 15%, you're at a six or seven year average holding period. And then if you look at the distribution of what's going on, there are lots and lots of companies that have been held for more than seven years by private equity firms. So something's going on.

And what's hard to know, start at the beginning of last year, 2025, everyone said this is the year that the distributions are gonna come back. And I wrote a piece then called When Will Private Markets Normalize? And my answer was not yet. Because the IPO market, you know, private companies don't really want to be public, sponsor-to-sponsor activity had this fairly wide bid-ask spread, which you could talk about.

And then Liberation Day hit. And everyone said, oh, that's why the private markets come back. By the end of the year, you had near historical high total dollar volume of distributions. There are plenty of exits. But the problem is that over the last 10 years, the dollars in the ground have tripled. So the denominator's tripled. And even though the exit activity is as high as it's ever been, it's still small as a percentage. So there's some significant implications of that.

One is that what happens if the historical institutional investor base doesn't get their money back in the same cadence they used to? Well then they can't continue to invest at the cadence they used to. Which means if you're a private equity firm, you can't necessarily go raise your next fund, you can't raise it bigger, you can't do the next deal.

So that's the biggest implication. Then the question is why is it happening, and will that just change? Oh, there's three times the number of companies, you're gonna have three times the number of exits, no problem. And that's what I broke down in this piece. And my conclusion was it's never gonna change. And the reason it's never gonna change is there's three exits for a private equity firm. One is an IPO, the second is to another private equity firm, sponsor-to-sponsor activity, and the third is strategics.

And the surprising fact that I didn't know is that historically strategics are 60% of all exit activity. And then there's more sponsor-to-sponsor, obviously less IPOs over the last 10 years. The volume of strategic purchases, or the exits from private equity, has basically been flat, a few hundred billion, maybe it's $150–$200 billion a year. So you say, okay, why is that the case? There's three times the number of dollar volume deals.

And I think it's because if you look at the demand from strategics, they don't care who owns the company. If you're a strategic, you don't care if you're buying it from private equity or a privately owned business or a public company. There's a certain natural demand that strategics in aggregate seem to have. And just because private equity firms now own three times the number of companies doesn't mean strategics have three times the demand for exits.

GREG HALL: Sure, yeah. Yeah. Of course.

TED SEIDES: And that's what's played out. The volume could go up three times, 'cause the public markets, as a proxy, have tripled over the last 10, 15 years. So you could say the dollar volume could be higher, but not the number of deals. And that's what we've seen. So I think it's a really interesting problem. I think it's more of a problem for the managers, the GPs, than the LPs. So unlike 2008, most of the LPs are not deeply over their skis in privates.

They might be 5% over allocated, they're not 20% over allocated. And they've seen this problem and they've been committing less. But for a GP, for the business model of we're gonna own companies for a finite period of time and sell them, and then we're gonna raise another fund and we're gonna buy bigger companies or more companies, that becomes problematic.

TED SEIDES: And it becomes problematic for their talent. It becomes problematic of what happens if they can't raise another fund. Probably the best quote I ever got, perhaps in the history of the podcast, and when I wrote a book during COVID about it, it was the number one quote from Carl Scherer, who's the CIO of the University of Cincinnati, who said, anyone who thinks that nothing lasts forever has never invested in a bad private equity fund.

GREG HALL: Oh. That, I mean.

TED SEIDES: So these things just take a long time to play out.

GREG HALL: Yeah. I mean, there's, oh, there's so much great stuff here. So, you know, I think one of the questions I wanted to ask you, 'cause I read that piece, I really enjoyed it, how is it that we keep hitting record highs in the S&P and we can't create an IPO exit window for the last vintage of private equity deals?

TED SEIDES: It's not a question of can't, it's desire. And I think that's as much regulatory as anything else. So when we were growing up in the business, if I had been wealthy enough growing up, which I wasn't, or successful enough early, which I wasn't, to be a member of a country club, the guy at the country club wanted to brag about being a public company CEO. It was a very prestigious thing to do.

Nobody cares about that anymore. People brag about being a private equity-owned CEO who has a big option plan, or a tech entrepreneur. So part of it is that the private companies don't want to be public. They don't want to deal with the quarterly scrutiny. There is, since Sarbanes-Oxley came, there's a higher cost to being public. There are benefits to being public.

The accessibility of credit in particular, much, much bigger than despite what we hear about the private credit markets. Sure. It's much bigger. Sure, sure. Just come inside PIMCO, you know, that's the case. So there are benefits to being public, but most, you know, your average middle market company that is a $2 to $5 billion enterprise value business, they just, they don't want to be a public company.

And so I think that's a big driver. No one's forced them to, because there's been so much demand for private market assets that there's plenty of capital. If you're a venture-backed business, you can get to profitability just being private. And if you're private equity-owned and you generate cash and you're good on your own, there's just no interest in being a public company. And so, unless that changes, there's no reason to think that we're gonna have a thousand new public companies in the US in the next five years.

GREG HALL: Do you think, I mean, it's one thing for an entrepreneur who's built a private company to not want to go public, and they've got the option of raising private capital. It's another thing for a portfolio company of a big PE firm that the PE firm owns and controls and needs to get money back to its LPs.

So in that instance, who cares what the management thinks, right? Like you're going public. So it strikes me that what we might also be seeing is a divergence between what the private equity firms want in terms of exit valuation and what they think they can achieve, even in a very constructive, a very resilient market like we've seen.

TED SEIDES: That would be a welcome solution for everyone. I think there were 70 IPOs in the US last year. You're talking about a need of a few thousand companies. The order of magnitude for that mindset shift is just massive.

I can't remember the last time a traditional middle market leveraged buyout company filed for an IPO, went public, not a fast-growing tech business. And hopefully we'll see a bunch of those this year. But just a traditional LBO, maybe it was once public and then taken private, you see a few of them, but not even in the tens, let alone hundreds or thousands.

GREG HALL: So you think this problem sort of writes itself at the LP level where an LP just says, okay, my holding period on this stuff is now seven years instead of four. I'm gonna change my flow, my ongoing allocations to accommodate that, and then things naturally sort of right-size themselves to the right level.

TED SEIDES: Yeah. So in aggregate, that's how you would expect. Right. Maybe GPs that were coming back generally every three years and then every two years, maybe it's every four years. That's not what'll happen in practice. It'll get, like any industry, like hedge funds, it'll get very bifurcated.

So you'll have, and you see this, you have larger, in some cases some very, very successful in-demand firms can do whatever they want. They come back for their next fund, they're oversubscribed, and you'll have a long tail of funds that really struggle to get at or even to their next fundraise. And that's where there's a lot of focus about what's gonna happen with all of those businesses that become zombie funds.

There's a huge incentive for the manager to stay in business. Are they gonna do right by the LPs? You have this whole movement of continuation vehicles, and there's some really good practices and some one-off pretty bad practices that come out in that space. So that's what people are sort of focused on. It's not this average. I mean, I could look at it and say, on average, I think this is a problem, but in the weeds, for some people it will be messy. It's gonna be messy.

GREG HALL: Yeah. I mean, we saw that with hedge funds, right? The overall industry size, I'm a little dated on the figures, but I think it peaked at 3 trillion and kind of stayed at 3 trillion. It's probably bigger now, but around the time of the financial crisis. But the composition of the industry went from thousands of meaningful funds.

I joke sometimes it's like four, you know, there's, and of course that's not true. But, you know, so it really consolidated very acutely and then has gone on to deliver, I think, nice results for a lot of its underlying LPs. What do you think of some of, 'cause of course, yeah, the other way to solve this sort of buildup in unexited positions is what you mentioned.

There's continuation vehicles. We've seen a huge increase in interest in secondary strategies, and the lines between those sometimes blur a little bit. I would say private credit itself has played a role in doing NAV loans and things like that to private equity portfolios. And then you've also, and advisors will be familiar with this, of course, you've got firms out there where the fund vehicle now offers quarterly liquidity up to a gate or a threshold.

And so in some respects, they're, depending on your perspective, right, they're letting the investor make the decision about how much they want allocated at any given time, rather than having to make that decision at the portfolio level. And I'm, that's a big question to ask you, but I'm just

TED SEIDES: Yeah, there's a lot. There's a lot in that. Each of the, I think the broad way of thinking about it is that the leaders of private equity firms, are particularly the ones who have built the established successful ones, they are entrepreneurs, they're incredibly bright business people and investors, and they're being creative about what is a problem that is in need of a solution.

My sense is that the sponsor-to-sponsor activity as an exit channel, which includes all of that, a continuation vehicle is just instead of selling to another private equity firm, you're effectively selling it to yourself or a different pool. That still needs, that is and will grow as a percentage of the exit pie, but it's never come close to being as big as the strategics and the IPOs together.

So it's not that much in the same way you said hedge funds, like we were in the hedge fund space when it was, you know, 2011, 2016, just maximum scrutiny. And people would catastrophize about it's all going away, and now it's bigger than it's ever been. Composition's changed. Same thing for private markets. Private markets aren't going away.

Private credit isn't going away despite every negative headline this week in the newspapers. But the structure and composition will change. And so as we've discussed, private equity, if the assumption needs to be that holding periods are longer, that changes a lot of things. It changes commitment pacing for the LPs, it changes how GPs think about their businesses, and that will happen. It'll just happen slowly.

Those vehicles are mostly band-aids. They're not really the long-term solution. If the problem is the private equity model of buying the business and selling it, so you can go buy a new business, if that sale used to be outside of private equity, say exogenous to private equity, all of these solutions are still endogenous to private equity.

So continuation vehicle is, I'm selling, but they're still private equity-owned, or a sponsor-to-sponsor, I'm selling it to another private equity, it's still private equity-owned. So that's the recalibration that has to take place. It's this realization that, wow, over 15 years, there's been so much more money that's come into private equity.

It's now a permanent part of the landscape, and much in the same way you saw in public markets, that has implications for the ability of managers to really drive value. The low-hanging fruit is mostly gone now.

You're not just a bunch of entrepreneurs buying a business from a founder who didn't know their business should trade at eight times, and you're buying it at four, and there's all this low-hanging fruit you can do in operations, right? If you're going from a private equity sponsor to another, someone smart has owned that business for a while and tried to make things happen.

GREG HALL: Yeah. No, it's a far more efficient pricing mechanism than when you were plucking these companies from obscurity in the eighties and nineties, just introducing either a more aggressive capital structure or operational fixes later on. Obviously using scale and volume and the size of your overall holdings to influence outcomes, you know, it just becomes a little bit of a tougher sled.

I think the overlying theme that we've referenced a couple of times here, whether we're talking about hedge funds, public markets, or private equity, is just how much money chasing how many opportunities. And the need for that to find an equilibrium where everybody gets what they want.

We have not talked, it's been 30 minutes that we've been chatting here, and we have yet to talk about private credit, which is a record for me at least. But so let, I'm just, how would you interpret what's going on in private credit right now? Kind of viewed through this supply-demand lens that we've applied to other asset classes?

TED SEIDES: Yeah. So I feel like this is a super interesting potential inflection point. Right? The private credit in the hands of asset managers. I don't need to retell the story of why it was needed, coming out of the financial crisis for better asset liability matching. And that worked for a while. And now you have a period of time where you've had ballooning demand for private credit, fundamental strength of the companies.

So whether people are complaining that the default rates aren't reported as high as they are because of PIKs, it's still somewhere in the realm of normal default rates for high-yield companies. And so you've had all these things happen without a bad economy, and now you have this liquidity question of, is the box that some of these private credit assets have been put in an appropriate box?

I mean, the interval fund with a quarterly redemption and a 5% gate, and now those numbers are exceeding the 5% gate. Well, is that happening because people are playing game theory and they're saying, well, you better get out, you better get more than you want out because you're gonna get cut back?

And you and I have seen this play out in hedge funds. So there's a structural issue of like, where's that box sitting? And then there's also the question that I don't think people have an answer to yet, which is, when you have that much new volume of activity over a relatively short period of time, what's the quality of the marginal underwriting?

So the worst-case scenario is what happened with subprime mortgages going into the financial crisis where there was such demand for these structured products, there were no people to write the new mortgage for, so they would go out and find them.

I don't think that's happened in corporate credit, but what you don't know is that next loan, was it underwritten with the same scrutiny as the one from five years ago, that, you know, was that same level of discipline at the investment committee playing out? And it's really hard to know because again, it's become a concentrated industry. Most of the private credit is in the hands of a few mostly public alternative asset managers who are really, really smart.

And then there's a long tail of other funds that might not be as smart. So I don't know what's gonna happen. I don't think it's quite as bad as the world thinks it is this week, and it's certainly not as good as the world thought it was six months ago.

GREG HALL: Yeah. Look, I think reasonable people could disagree about where it all heads from a fundamental credit perspective. I think you're right to point out the potential for deteriorating underwriting. It's just a natural consequence of a lot of money chasing relatively few deals and an incentive structure that was built off of deployment for a period of time.

And in credit, you can only make par back, right? So it's a little different than real estate or private equity where you can have huge winners that pay for when you make some bad decisions.

It's a little tougher in credit to do that. But even just putting the fundamentals aside, the liability structure and the ability of folks to just decide they don't want to be allocated to an illiquid asset class any longer, that's, I think, gonna be the test. That's what we're gonna see probably over the next year or so.

TED SEIDES: Yeah.

GREG HALL: And like we analogized with hedge funds and your predictions for private equity, my sense is that when an asset class, when people have expected perfection and then you encounter disappointment, the averages are gonna look, actually might look pretty smooth in terms of how we get right-sized, but at the individual investor level or by the GP level, the averages will belie a fair amount of volatility and diffusion of returns, right?

TED SEIDES: Yeah. A lot of the boom started coming off of 2021 and into 2022. Rates spiked, and you had a very, very brief period of time where you could underwrite a pretty good loan in double digits. Now companies and the capitalist economy probably doesn't sustain itself at like a 15% debt cost of capital. So that couldn't last forever.

But now the expected returns on private credit portfolios should probably be mid-single digits. And that's where I think if people didn't fully appreciate that, that's what they were gonna be getting, the combination of all the noise in the press and the reality of this isn't something you said, this isn't something with unbounded upside because it's a credit instrument, it's not an equity instrument, you could potentially see a fallout. But it's also very Soros reflexive.

If the press is bad, there'll be more redemptions and it'll cause problems. If it somehow dies down, maybe it's okay. It's really hard to know.

No, it is. It's, somebody said to me the other day, you know, we have credit cycles when people decide we're gonna have a credit cycle. Right? That it's oftentimes about the removal of funding as much as it is about the existence of credit problems. And you know, one of the things that happens for lending businesses, of course, is you have some credit fears, then you have redemptions.

And so your PIK rate and your loss rate and all the stats that you look at to evaluate credit, by definition, they all pick up. If you have 10% redemptions, all your stats go up by 10%, and then the next guy looks at it and says, oh my gosh, losses went up 10%, they're going up. Yeah. And that's why oftentimes when lending businesses just kind of slow down, it actually looks a lot worse than slowing down would imply.

GREG HALL: So we'll have to see how that plays out. I think a balanced view of things is the right way to approach it. I think they're really highly mindful that they were dealing with an area of risky credit and that losses are to be expected.

The issue has just been that the economy has been so benign and the growth has been so fast that those losses haven't materialized. And sometimes no matter how much you caution that they will or they might, when the track record piles up the way that it has so positively, then expectations follow even if everybody's behaved correctly.

So one of the things that we touched on very, very briefly earlier on was behavioral attributes of good portfolio managers. And I'm really curious, just given how little volatility we've experienced economically, big picture, folks who've only invested in private markets and kind of haven't had the humbling benefit of a market telling you you're completely wrong about something? How do you think that influences the way that they think themselves about investing?

TED SEIDES: The feedback loop that comes from the market telling you you're wrong is just much faster in public markets than private markets. And that happens for two reasons. One is that a public market investor generally takes many, many more swings. So even if you have a portfolio that's only 20 names and 25% turnover, you got four or five new ideas a year.

And a private equity fund might do 10 deals over a, you know, they might do three or four deals a year at most, if it's a very large firm. So part of it is the mark to market. I mean, they could look at the comps. Certainly if you're a SaaS investor in the private markets, you're looking at the comps and saying, ooh, something's changed. But I think it's more that owning businesses is very different from trading businesses.

And it's just by design. There aren't as many reps and lessons that happen year over year in the private markets than the public markets. It does happen over a career. You certainly see lots of situations and lots of deals. But it's a very different, right. This whole mark to market issue, is it a feature, a bug in the private markets is kind of a fascinating one. And there's not one that I think there's a clear answer to.

GREG HALL: Yeah. No, I completely agree. I mean, on the one hand, I think you and I, and many others in the marketplace would argue that we as PA investors probably pay way too much attention to daily moves and markets relative to our time horizons. So taking some of that input away from us could be very healthy.

On the other hand, not knowing when something's gone very wrong. And then the other thing, and you talk about this in your private equity piece or adjacent to it, but the absence of price discovery. So, and that brings us kind of to what we're experiencing today in direct lending, where you can only transact at NAV, at par, if you will, which means big supply-demand imbalances build up.

Because if you don't believe NAV, you don't believe the fund's worth NAV, well, you sell, right? And there's no buyer on the other side of that. And so I don't know how you square that circle, but I think what we're witnessing in the market right now is kind of a messy resolution of the balance of that.

TED SEIDES: I mean, the easiest way to look at that is today in the private credit markets, if you have, there are some of these, a manager that has a side-by-side non-traded BDC with a publicly traded BDC. And the private BDC, you can redeem at par, and the public BDC trades at a 20% discount.

That probably structurally shouldn't last, but it's certainly rational if you're an investor in the private funds to redeem and buy the public one at a discount. And you would expect capital to flow from the private funds to the public funds until that discount narrows. There aren't that many opportunities, certainly in private equity where you see that.

And for years, the lack of mark didn't really matter because you knew you were stuck for a long time, you're expecting to get paid upon the exit. It's really a combination of so much money coming in and the increasing volume of secondary activity where there's some feeling of price discovery. And I think Cliff Asness says this incredibly well, which is he said, it's not the case that public market mark to market is good and private market, call it mark to model is bad, but it is the case that you shouldn't be playing by two separate sets of rules.

GREG HALL: Yeah. I think that's another inflection point or a point of introspection for the industry we're probably going through right now. Right. Which is, in order to get access to a lot of these strategies on the wealth side of the business, you effectively have to play by two sets of rules, right?

You need to own either a public market instrument that owns illiquid products, or you're locked into a NAV pricing schematic and a private instrument. And then it's your liquidity that reacts to perceptions of price, not the price itself. But either way, you're sort of trying to have your cake and eat it too.

TED SEIDES: Yeah. I mean, this has always been a problem for institutions in multi-asset allocation investing, where you have some of your assets are liquid. Yes. And some of your assets are illiquid and don't get marked. And so when you go through a big public market sell-off, all of a sudden your private market exposures look like they're higher.

And that gets complicated. And I think the wealth channel will now experience this by, when generally when you invest in a drawdown structured fund, you commit a certain dollar amount. I'm gonna put $20 million into this fund that's gonna get drawn down over a couple of years. But that dollar amount represents a percentage of a total portfolio that's fluctuating every day.

And when you have extreme moves, that $20 million, if it's an extreme move to the upside over a couple of years, that $20 million might be undersized. If you have a big move to the downside in markets, that $20 million gets oversized. And it's really hard to balance a nominal dollar commitment at one moment in time with a denominator that's moving around with markets.

GREG HALL: Yeah. And that's sometimes where I think, you know, I hear a lot of folks, I'll say, kind of blithely apply an endowment alts allocation or a pension alts allocation to the wealth space as just an inevitability.

Every individual in the country is gonna go to 20% or 30% because that's what Yale did. And it's just the differing time horizons and the predictability of cash needs across an individual's life versus a 300-year-old university with a forever horizon. Right? Like, we shouldn't make light of those things. Those are fundamental differences. That's before you get to taxes and other key considerations.

TED SEIDES: Yeah, absolutely.

GREG HALL: Yeah. Ted, I could do this for hours. It's been so nice to sit with you and just talk about things that maybe aren't ripped from this morning's headlines and do a little bit of a big think on some of these trends that have defined our universe.

I want to congratulate you on all the success you've had with Capital Allocators. I'm an avid listener, I don't care who knows it. And it's been nice of you to share some time with us as we look to follow in your footsteps with our podcast and get a listenership that's as large and engaged as yours. But thanks for taking the time to spend with us.

TED SEIDES: Thanks, Greg. And I'm gonna flip that before we cut it off. It's been incredibly fun to see you go from a box similar to the one that I've been in, to having such a bigger impact on so many people with the knowledge that you bring.

GREG HALL: Ted, that's really nice of you. That is objectively too kind, but thank you.

TED SEIDES: You're welcome.

GREG HALL: Alright, Ted, well, thanks so much again. Hey, for those of you listening, I really hope you enjoyed this conversation with Ted Seides. We'll absolutely have him back on the show. I'd encourage all of you to avidly consume the Capital Allocators podcast and Ted's writings and thoughts on the investment industry.

If anything that you've heard us talk about today sparks your interest and you want to go a little bit deeper, do feel free to visit us at pimco.com in the United States or your country's local website. If you identify yourself as a financial advisor, you'll be taken to Advisor Forum, which is your one-stop destination to get what you want from PIMCO quickly and efficiently so that you can be well prepared for your client meetings throughout the day.

Please do push the like and subscribe button. That's how we know you're out there, and we can continue to devote the time and energy necessary to make this a great experience for you and a good listen. Good luck in the markets, and we'll talk to you next time.