Transcription
Harvey, maybe I maybe I'll just start with you. You know, we're we're in this war and trying to figure out is there a ceasefire? Is there not a ceasefire? When does it end? How does it end? What does it look like? And what does the world look like after? But but I'm just curious, is is it changing anything about the way you guys are investing?
Well, first let me say it's great to be back here at Milkin and and on this panel with uh with friends and partners. the um I think you know we find ourselves at a particularly complex period in history where stepping away from the economic backdrop which is quite good. You see it in earnings results we have this geopolitical complexity and I think that the uncertainty premium associated around the war in the Middle East the war in the Ukraine uh remains quite high and I think it's very difficult for anyone to predict really how the ceasefire evolves. I think we remain optimistic that we're moving towards a sustained ceasefire. What does that really mean? How quickly can the straight be open? You've seen the announcements today on progress of uh getting ships escorted through the straight I think. But what we don't really know is what's the intermediate term impact of this oil shock which we're seeing around the world and you see the big differential between physical oil prices and financial oil prices.
From the getting back to your question from an investing perspective um what's really happening if you take a step back in the way we think about committing capital at Carlile for five years and 10 years is a rep prioritization of global priorities and so everywhere I travel in the world any part of the world national security is the single highest priority politically and in the economic engine of countries and what does that mean It's not just about national security in an already defined defense perspective. It's national security around energy security. It's national security around data security, critical infrastructure. Um how to think about supply chains. You know, we went from just in time inventory in the 90s then to a period of okay, we have to have much more elasticity in supply chains. Now it's how much do you need to really navigate a material disruption? So I would say the fabric underpinning what's really driven um markets in some respects for the last 50 years is changing real time and I think this will create enormous opportunities to invest. Uh we hope for a very quick resolution in the Middle East obviously uh very grateful for our servicemen and service women that are putting their lives at risk in the region and others and our friends. Um, but I do think this is again this is a process started in 2008 but the fabric of opportunity and prioritizations around the world is changing. This ultimately needs economic capital.
Mhm.
And so all of us on this stage in one variet will have to provide this capital. I think the demand for that capital is only going up because of all these factors.
Okay. So Ron I mean how many flows do you see every day?
You're the custodian of all of these people right?
Uh
And many more. They're they're great partners and yes we see about 11 12% of the world's flows but Harvey's making a really important point and if if you go back to the postcoid period and we actually Harvey you and I were on a panel last year where we talked about this in the context of tariffs um there's been a very significant reglobalization that's gone on firstly around supply chains coming out of co last year it was about tariffs and where were where were manufactured goods going to be sourced from. How is that going to change? Uh you asked a question about the Iran war and what that is triggering now I believe uh will be a a a big realignment of capital flows. There's 3.2 trillion that the Gulf states and the various sovereign wealth funds uh have deployed. now uh and that's been a an enormous uh export of capital to lots of people in this room uh really all over the world. If you think about the rep prioritization that Harvey's just talked about, um there's national defense that they need to be thinking about. There's a rebuilding that they need to be thinking about. And then there's building in resilience that uh we've they've all discovered, we've all discovered that they don't have and the straits of hormones is meant to be a red line that would never be crossed. It's been crossed. Uh to actually now lower the dependency on that is going to require a rep prioritization of capital and that will have long-term implications for the cost of capital.
Money going in instead of coming out from the
Uh money not coming out. Uh now potentially it'll also be money coming in because um it's actually doubtful nor would it be efficient for all that investing to be done internally. Um so there will be investment opportunities but the point being is is that on a net basis the amount of money coming out will certainly be lower.
Marcy, how are you how do you think about geopolitical risk and positioning your portfolio in a time like this?
Yeah, so we are a $630 billion portfolio. So it's really tough to turn that very quickly. Uh but I think what we try to do at least in our Kalpers context, we operate out of the state of California and what's most important to our board and our 2.4 million members is that they really understand what we're doing when we see these events happening. And so for the most part, we stay disciplined. It's really important that we're running some simulations on the portfolio so that when something unexpected happens, it really falls more into that expected category and we can build member communications. We can talk to our stakeholders. We can talk to our board because the most important part for us is we're long-term investors. We don't want to be making these dramatic shocks into the portfolio. And I would call dramatic shocks very much geopolitical risk. um you know devesting away from certain countries, devesting away from certain sectors. Uh we are center stage for much of that but I'm need to really be complimentary to the organization and to the board. I just am halfway through my 10th year. Uh we really did stop the devestments kind of the chiseling out of the portfolio being consistent and disciplined. So geopolitical risk uh something we pay a lot of attention to but it's typically around how do we communicate with the people who are paying into the system? How do we make sure that we have these simulations happening that we can give kind of a range of expected returns in the portfolio?
How much is US versus international for you?
So, we are um globally tilted as well, especially when you think about our sustainable investing plan, but we're in the major indices. Uh much of our private markets is in the US and uh globally, but we we are predominantly US, but we have a good tilt to uh global.
Global. Dan, what what about you? what are you seeing from big institutional investors, from your clients um around around these, you know, new risks around energy and geopolitics and the the reglobalization that Ron talks about.
Yeah, it's interesting because I think there was talk about deglobalization, but what we're seeing is just heightened complexity. I think that's the word that Harvey mentioned. And in all three of these organizations are big uh they're not just clients. I think someone used the term they're all partners. I think we are a strategic partner with nomenclature across all three. Uh if beta is easy uh you know uh advice the value advice can be somewhat subdued right now with complexity uh the value of and we're a pretty simple firm at this point. We just help clients allocate capital across these three clients wealth managers sovereign wealth funds corporates uh the complexity is higher. I think it's not just geopolitical complexity but there's complexity across asset classes. And so as you go to these panels during the day, you know, there's equity influences that are influencing credit. Uh we still have a Parvy and I were speaking earlier, we have a big commodities business and so oil and then the second order effects into the economy will affect uh both micro and uh macro. And so that complexity goes up and in a world that we were talking about delization. It feels as global as I've ever felt it in 35 years. I mean we worry about and our clients are interested in the world every morning and the interconnectivity more than I've seen in 35 years and that you know our job is to sort of take some of that noise and try try to create uh an element around long-term investing and so I think there is near-term influences but if you look at our wealth management portfolios and our asset management portfolios which are now approaching 10 trillion and then the advice we give to institutions utional clients is to try to take a really hard and long look at the economic uh dynamics that are going on and probably the dominant one right now on the investment side and the potential productivity side is is AI.
AI which we'll get into in a little bit but just to follow up Dan where does the US rank right now in terms of deployment of capital and how attractive it is versus the rest of the world?
Well, I think the US is is is uh still the primary element and so I would I would I would say to Marcy's point uh being overweight US has been a good trade and it still is one you have to take extremely seriously and we'll get to the the aforementioned AI subject but that's where the capital is being deployed uh that's where innovation is and so in that context it still has to be important that being said we we see and we talked to Harvey about this and his team and others there is alpha around the world and so even in Europe where there could be GDP beta could be difficult whether it's in the private markets or in the public markets we see real alpha uh in those uh markets and then as a business matter we're following the equitization around the world so Japan is a real market for us I think we're partners with all three firms uh in Japan greater China uh is is attracting incremental capital versus two or three years and then pre-war certainly the Middle East uh was equitizing Brazil and then there's markets in front of us. Uh Germany doesn't really have a robust capital market but it could and if you look at the Japan example it probably should going forward to keep some of that innovation and capital in in region but right now I think you have to take the US and uh the great companies here and the capital that they are deploying in growth really seriously.
Yeah. I mean, part of it is the big part of it is the AI right where we're where Marcy how do you how do you think about how to make sure your portfolio is positioned for our AI revolution right now?
So that that is something we're you know I wouldn't say struggling but it is something that we're paying a lot of attention to our board has been asking a lot of questions around AI governance and the stewardship program that we have at Kalpers uh how are we making sure that the public companies are thinking about human capital disruption and retraining programs s uh you think about a public pension plan, you someone retires, the assumption is someone gets hired and if we see that uh ratio start to really drop down, then that has a real impact on public pensions across the nation. And so internally, we're taking it as human enabled and human in the loop, if you will. That's been our primary uh use cases. But for us, it's really trying to understand what our public companies and frankly our private companies as well. How are they looking at deploying AI for efficiency purposes, for innovation purposes, how do we make sure that we're in that communication flow, that we have the appropriate governance that you know that we can that we can ask a lot of questions around human capital disruption. I'd say that's the biggest concern that we would have about um the innovation related.
Are you is there a metric like what do you is there a metric where you track it? Is it margin? Is it so tied to AI.
Yeah. So that is under construction. When I said our stewardship program is really kind of grappling with the types of questions that we need to be asking these gentlemen on stage about how they're thinking about AI and not to the point that we are releasing any of their intellectual property. That's really important to us that we preserve that that we secure it. But we do have a strong need to have a better understanding. Um, the regulatory environment stills pretty loose on this. I I'll just say that. Um, so you know, innovation can be very helpful, but I do have pretty grave concerns about um disruption to people.
I mean, it's it's requires a huge amount of capital. That's one thing, Harvey, right? I mean, how how much of how much of what you're doing now is focused toward building this out and providing capital to do it?
So, we um, so for those who don't know Carlile, we're only 2500 employees at Carlile, but we have 750,000 employees across portfolio companies all around the world. locally in Japan, as Dan mentioned, across Europe, obviously here in the United States. Um, so we're one of the largest employers in the world. Um, we have a very strong belief, this won't surprise anybody, that we're clearly in the midst of a transformational change in technology. I do think you have to ask yourself whether you're a believer or not that we are a firm believer in that. The way we think about that is about really how to develop use cases that we can replicate both internally within the firm to make ourselves better investors. So when we're deploying capital for three years, 5 years, 10 years, obviously the most important decision we make is the moment that capital is deployed whether it's in our credit business, uh Carlile Alphinvest or in our private equity business or real estate business. So how do we use this next step in technology to inform that investment decision? both avoiding investments, enhancing investments and then really how do we work with CEOs of those companies who are really responsible along with those boards for driving that technological change and improving their performance. And so for us a big part of that is making sure that we have model fluency across the organization at Carlile you have every employee because there's only 25 has access to all the current models. We do a lot of internal training, but core to what we're doing is about harnessing our proprietary data. So, because we're one of the initial firms to do private capital and David Rubenstein, the founders, formed the firm back in 1987, we've amassed this massive cohort of proprietary data. And what we're really trying to unlock is how to use that proprietary data so that we make better investment decisions and also how do we use this technology to make the decisions faster. So Carl again at 200 employees, this is not a mission to see if we can run the company with 2400. This is a mission to see how do we run the company more productively with better outcomes and create marginal alpha using all the data we have and the tools we have. And it's pretty remarkable um when you have targeted use cases Sarah what you can reveal using these models which historically was not available. um you can unpack situations and the the steepness of the scientific evolution here um is incredibly important to what we do and it's going to change the way we think about investing the way we deploy capital uh and we want to be very much at the forefront of that.
I mean you're talking about it using it in a variety of ways through the portfolio companies in your own company for investing?
Through the life cycle of everything we do at Carile from capital deployment to exit all of it. So you what about the 750,000 employees that you peripherally?
Across the portfolio companies.
Like what is is the I mean, is it going to be 750 or more in five years?
I think that um that is a very difficult thing to predict. I think the early stage advances you're seeing are stories around oh employment dropping and I do think you'll see cases where you'll see efficiency. I think the real win is when you see companies delivering better outcomes, innovating faster, and actually being more productive. So, I'm a buyer of the productivity story. I tend to be a glass half full person anyway, but I'm a buyer of the productivity story that we're going to get better productivity. Uh, I'm not a buyer of the, you know, we have massive unemployment. I just I'm not I'm not a I'm not an advocate of that scenario.
Ron, how do you see it changing the markets and the economy?
For us, this is a really important question because we do two things. We invest money and we service uh those that invest money. That's the that's the relationship we have with uh with each one of our three partners here.
That's the custodian. I think of it as.
Custodian fund administrator. Um, but if you think about that, it's operationally intensive. Uh, it has to be uh it has to be managed to very very low error rates. Right? If there's an error made by us, every one of these people here uh get affected by it. So for us, it is about productivity. It's about the outcomes that Harvey talks about. Uh, but to really capture the value here, I don't think it's any more about the technology. I mean, the technology, even if it froze now, is pretty damn good. And it's not freezing, right? It's getting better and better and better. It's about how it gets deployed. And um in many other technological revolutions that we've seen in the past, it hasn't really changed the nature of the way work gets done. Um AI is really about operating models. And certainly for us, I mean, Harvey's got 200 people. We've got 48,000 people. Um, and it's how do you make those 48,000 people more productive? I think the role of the corporation as we've seen it for generations now, highly functionalized. uh the efficiency done within functions and you kind of deal with the inefficiency across functions. That won't be the case any longer. I think you'll start to see corporations, you'll start to see functions um kind of disagregate and reagregate around what they need and what the desired outcome is now. And that will take a lot of work. that will take people really thinking about oh gee it's not just about more efficiency and how can I do something with five people instead of eight it's about how can I do the work differently and really take advantage of the technology we have.
Can it be about growth too for you just because there's so much investment?
And I think it'll also um it'll um if you think about all the data that we all have we have in our firm uh Harvey's gotten his firm Dan's got in his firm Marcy has sitting amongst uh all the investing uh that they've done for decades now. It's it's harnessing that data and using it in a way to make better investment decisions to make proprietary investment decisions.
Where what are you guys thinking at Morgan Stanley Dan is the best way to capture the value of this? Is it the chips and the infrastructure? Is it the hyperscalers? Is it the enterprises that deploy it? I mean where where do you think is the best value?
So I I think similar to uh Harvey, we're big bulls on the TAM and in particular if you I interviewed Jensen a month ago at our conference and I think he's here today. Yes. I think our view is compute equals intelligence. He says intelligence equals revenue. I think it probably equals revenue and expenses. And so I think as a firm we're focused on a a couple of uh uh ways to execute on that. I think first as a firm to to the other comments it's around data optimization around our business you know we've been around a long time we're one of the largest traders of securities in the world and then we manage you know close to 10 trillion so there's a lot of data that to go optimize attached to that though is also you know we're in the trust advice and intermediation business and if if we can build productivity into our business you know we have uh close to 18,000 financial advisor izers and a few thousand investment bankers and then portfolio managers and traders. If we can build productivity there, there is an element around growth to uh to Ron's point which is we should be able to actually deliver more value to these three institutions but also if there are smaller ones that are existing uh which have been economically harder to get to we'll have the tools to go deploy in essence that IP that trust that advice to a broader set of either clients inside of Carlile and and Kalpers and and State Street also uh to uh some others. I think as it relates to where the value equation is uh you know we are uh certainly the infrastructure plays are a place that makes a lot of sense to be there but we would argue we're in the very earliest stages here. So if we look back at other mega technology trends and where we are in both capital deployment and where the ultimate alpha is generated we're still very very early. And so if you are a believer on it being transformative and you believe in some element of cycles being repeated, I think it's still worth uh creating uh some element of diversification around the potential winners. The one place I would say that we are getting a lot of traction is the firms that deploy. So not the nonlms or infrastructure players, but just the regular corporate including some of our own organizations. And we're starting to track that and build baskets. those who are viewed as optimal deployers versus nonoptimal deployers.
How do you tell the difference?
Uh margins, uh deployment, starting to get metrics where they are, CEO interviews, you can start to feel which firms are really embracing it, especially on CNBC, maybe only on CNBC.
Yeah. Right.
Um
And so in that context, we've been able to create baskets and see our performance. So that's margin uh that's ROE uh around where we've bucketed those and and so there is money to be made outside of the pure plays around uh infrastructure and I think that'll show up at our portfolios. It's it is a dominant uh theme.
When you say early cycle, what you're talking about the investment cycle?
Yes. And how early like in a 10ear cycle, in a 20ear cycle, what does that look like?
We're going to measure it in percentages because I would argue this is moving as fast as we've seen. You know, you're seeing revenue uh run rates around some of the companies deploying tools uh into the especially the enterprise but also the consumer which are some of the fastest uh revenue uh accelerations in the history of sort of the capital markets. But we would say we're only 10 or 15% through the deployment of capital. And as you deploy capital and it's as if it's as transformative as we think we there will be dispersion. And so there are going to be big winners and big losers. And then there is going to be a real big productivity gain upon the deployment. Uh and in that sense it's uh it's a dominant element and we could speak to just how it's being funded at some point. But it's pretty interesting how all of this investment is getting uh funded in the marketplace. It's being funded by a lot of you here and it's a lot of funding, right?
Marcy, how are you how do you determine who the winners and losers are?
Yeah. So, as I mentioned, we're kind of grappling with these CEO conversations to really have a better understanding of where we think the winners will be and people who might be a little bit later to the game or later in the cycle. And that is still very early for us as as well. Um, we think that there will be significant winners obviously uh as I was driving in today or riding in my car today, but think about technology as a disruption. So, I'm very optimistic around innovation um and disruption as long as we have a human capital plan associated with it. But just the abundance of Whimo on the roads and you know my Uber driver you know talking with us about disruption that depending on how concentrated that actually gets based on the trust of the consumer I think um wonderful wonderful technology but it will disrupt.
Sure, these entry-level positions and then are there really retraining programs for the gig economy uh probably not they would have to do that on their own as independent contractors and so these are the things that we are trying to get the information from our partners whether those are partners and CEOs and public companies and more importantly I think we actually get better deeper conversations with our general partners about the portfolio companies that they have in the book uh those are very rich discussions uh we do have protections in California that will protect uh the release of those uh discussions although there's a California state legislative bill um that would really infringe upon our ability to do that and would require us to look private equity in the book and whether we can actually get the managers that we prefer. Uh so there's just a lot happening. I agree it's early cycle and we're trying to get this data so that we can make better decisions. Uh we don't tilt the portfolio or pivot the portfolio very quickly. But on July 1, uh the board actually approved the implementation of the total portfolio approach for Kalpers, which means we have a little more delegated authority. We have a lot already, but we've got even more now. um where we need to be in this place where we're sitting around the table, we're challenging one another, the cost of capital, where should that check be written? Maybe it was written because it was siloed in equity before, but now we have to look at debt, we have to look at credit, we have to look at infrastructure very differently. So, we do think that AI will help us uh with all of the data as Ron indicated, all of the information or should say data that we have and really turn that into investment useful information that we can make decisions from. But it is early. It is early for us.
But when you think about who's vulnerable to disruption for instance and what the market's telling us now is software is in the in the crosshairs. Have you changed the way you think and your exposures around software for instance?
So we haven't changed our look too much. I think what we have said we need to do even more due diligence to really understand the the structures of these instruments. I think some of the more recent headlines around software and exposure in the debt markets was you know partially related to you know retail investors having access and were these instruments really set up for the liquidity requirements that would have been necessary. I would have the same concerns about retail investors accessing private equity in the same way. Do they fully understand is it appropriately disclosed that they understand that these is this is retirement savings and I might be 50 60 years old and I need liquidity now. Well, you're not going to get liquidity in these ill illlquid instruments. So, I think there's some work to do on disclosures. Um, you're getting into the retail market where you have a wide dispersion of investment sophistication. And so, I would worry about, you know, those that don't have the sophistication levels to really maneuver these complex tools.
Yeah. Yeah, I mean, Ron, how do we on the buildout and and just the tremendous amount of capital that's going there, the trillions of dollars, how do how do we know whether we're overbuilding like we've seen in previous tech cycles?
Yeah, it's a good question. Um, because if you go back to the the the late 90s, I mean, there was a clear build out in anticipation of the internet. It all was eventually absorbed. A bit of a difference here is uh the energy side of data centers certainly has a long life. It's not clear how long the the chip side of data data centers do. But I think that the buildout really will be a function uh of how quickly implementation takes place and that's really what we've been talking about here. You've got this tremendous technology and in my mind the incumbents ought to win here, right? They've got every right to win. The technology is available to them. They've got the data. It's whether or not they have the wherewithal to actually question the way they've done everything for years, if not decades, and say, "We're going to do it differently."
Who are the incumbents in your in your?
I'm talking about any incumbent company, whether, you know, in my case, it's the custodian banks. In Dan's case, right, it's the it's the broad-based investment banks. Um, there's always this point of, well, will the disruptors come in, take this technology, and, you know, make Carile and State Street and Morgan Stanley irrelevant. Um, I don't think that should be the case, but it does require a lot of change and change at a scale and at a pace that hasn't happened before in terms of managers being willing to actually question even how they've grown up in their own firm and that you know they've reached this point and that point may not matter anymore. We need to think about that differently. So uh to me the market is going to force a force a very rapid adoption of this because you're going to see these use cases that are taking off these success stories. Investors like Kalpers are going to say look what's happening here. Why aren't you State Street doing this? Why aren't you carile doing this? So I think the adoption will take place. I'm not that worried about the tremendous overbuilding because I think that there'll be a flywheel effect as institutions see the impact of this. But it really does come down to whether um the incumbent firms actually have the the wherewithal, the will and the skill to actually do this at the pace that's required.
I mean there questions about overbuilding Dan, but also questions you know about about how some of these deals are structured and financed just because such a tremendous amount of capital is being deployed and there's questions about circular deals and offbalance sheet deals. I'm curious what your view is around how all this is getting funded.
Yeah, I I wouldn't view offbalance sheet as necessarily scary. I think offbalance sheet is a recognition among the big players that they want diversification of funding. So I think if you start at the beginning and you feel like there's this enormous TAM around compute intelligence and then revenue, uh it's got to get financed unlike I guess the internet buildout uh which was building a connection. This is building a a platform on top of that connection. So that connection is built out everywhere in the world. So when we talk about the tools that are being developed, they can go into the retail market in India, the consumer market in India instantaneously. So that that that infrastructure has already been built. And so what you're seeing though is also the the core of the financing uh around this market is coming from the most the largest and most profitable companies in sort of world's history. So the big hyperscalers and Nvidia and the other big chip companies are generating, you know, big cash flows over the last decade and certainly over the last few years and they're redeploying that capital and then some of those hyperscalers and we're just seeing it in the marketplace are going to not rely on and Harvey and I actually have talked about this in the context of investment banks. You can't just rely on one financing market. And so what you're seeing just in the last couple of weeks, you're seeing big hyperscaler unsecured bonds.
Yep. You're seeing uh private credit around uh GPUs. You we launched our first public loan deal backed by GPUs. This week we're backing up uh some uh secured financing uh with TPUs out of Google and then contracts with anthropic. I I mean, we do need to understand the world is sort of sold out right now on compute and the value of some of the GPUs are hanging in there much longer and more durable than we think. So you're creating real diversification of debt financing uh as an example, but you're also seeing really enormous equity financing. I mean and some of it was done with strategic investors uh but some of it is is going to come o over time into the public markets. And so we feel those of us who live through fiber and selex this feels a lot more sturdy both in its demand profile because we're sort of sold out on compute and part of that is constraints in the energy market and others but we also feel underlying that is the investment from some of the most capized companies who are looking at diversification of funding.
So does any of it scare you?
Uh, I I think the social issues scare me the most. And so I I think I am certainly not, and I voted this way at dinner last night, I'm not in the 20% unemployment category, but I I would reflect back to a a private equity firm that we talked about, which is their companies are using it. But if you do have not 20% but an incremental x% of unemployment, where's the demand for the product that is actually being produced dramatically more effective? And then how does that filter through around society? And so I think it's the harder question because we're we're all great at building products and selling services. But the second order impact and how uh society works through and what are the economic and political elements of that uh that's where I think we're going to have to focus. But that is a much harder I think uh exercise than the power as Ron said the of the models that are coming out right now. And actually, I've been surprised at the ability for companies to start to deploy that. It's what's going to happen on the back end, you know, five, 10 years from now.
Harvey, just quickly at Carile, how how what role does does private capital provide in terms of building this all out? How focused are you guys on that?
Well, I think it gets to to Dan's point, which is anytime you have capital demanded on the scale we're talking about, and it's the capital directly, but it's also all the support capacity, the demands on energy right at a time when energy security is a topic that would be a priority topic notwithstanding the demand for data center buildout. I think what you need is exactly what Dan said. You need capital diversification and you need expertise. And so we participate in all parts of those capital stacks um across Carlile in parts of the world where we feel we have competitive value to offer. I think, you know, on the question of um you didn't ask me this but on the but I thought about on the things that um make me nervous is the exponential compounding effect of cyber.
Cyber. Cyber. And the speed of the technological innovation we're talking about. So, for example, like vibe coding sounds like a cool thing. Let me tell you something. I should not be coding. I'm 100% certain I should not be vibe coding. Like we and um some of the trend here is for adoption of skill sets that really historically were tightly controlled. And I think that's an area we need to really focus on especially with nation state actors. you know, the notion of um building large-scale data centers where again you have critical infrastructure in a geopolitically stressed environment around the world. These are all issues we're going to have to think about. You know, one of the big um platform aspects of Carlile is we're the largest scale player in aerospace defense. It's one of the first transactions ever done at Carile nearly 40 years ago. And I can tell you the dynamic nature around the convergence of the demand for national security everything happening in um this space large language model space and technology it's extraordinary the convergence around all these things. So it's moving very quickly but at the same time I agree with Dan it it feels early innings.
Yeah, I mean, Dan Ron, we have a sort of like public private thing going here and Dan mentioned private credit so I feel like we should talk about sort of elephant in the room. Um, because you see right private and and public right now. Do you think some of the the concerns and worries lately about private credit are are merit are merited? Are they justified? Is there a big problem here?
I think that there's a number of concerns that I would uh describe as important but not systemic or being conflated and now there's this narrative around systemic out there and and I I don't think that's right. I mean, I think that we're probably seeing uh a move into a different part of the credit cycle. Uh I would argue that that's healthy. We haven't had a proper credit cycle in a long time, but that's not private or bank. I mean, that's a credit cycle. Um, there is also an element of liquidity and Marcy alluded to this uh in in a very narrow part of private credit uh some of these semi-liquid funds and uh is is there the ability to redeem as much as you'd like? That's a different issue that I'm happy to come back to. But in terms of private credit, um, private credit in some ways is actually been a a a real real benefit to the system because if you go back to 2008, uh, why the system suffered was that there was u it was banks were at the center. Banks are concentrators of risk. All that risk was concentrated and a financial crisis turned into an economic crisis. Uh, private credit is exactly the opposite. It's a distributor of risk. uh the actual holders of the risk are widely distributed um not so much some of it's individual most of it's institutions and you know Kalpers has a little piece of a little piece uh is the way to think about it um and so from a systemic perspective if there is in fact a credit cycle and if there are uh elevated losses that's going to be widely distributed is that something that we should worry about?
Are we're in a credit cycle now?
It feels that way. It feels like we're getting to a different stage in the credit cycle which by the from an investor's perspective is probably a good thing, right? Because the balance of power will turn from those that are lending money as opposed to those that are borrowing money. Um, the what's getting all the news though is is this point around redemptions and liquidity. And there I think we all have to ask ourselves are these semi-liquid vehicles, are they the right thing for individuals? It's a really small piece, but should we say to individuals, you know what, there's a five-year term here. We're going to make it easy for you to be in it, but you're not actually not going to have quarterly redemption. So, I think that's actually the question that we ought to be asking ourselves, but it's a pretty pretty small problem.
Should should we have those things? I think you have those things, right?
Sorry, what? I didn't hear you, sir.
You know, these kind of these kind of funds, right, that for retail investors that make it?
I'm happy to comment on that. So, you know, the evolution of this um has really come about over the last five or seven years.
And um in terms of semi-quid, you know, when I first started a car three years ago, I went out and I just met with advisers because I really wanted to understand the phenomenon and the first thing I said is wow, I'm not sure the industry should have called these semi-liquid. Maybe we should just call them sometimes not liquid at all because really just to drive home that. But I will say my experience dealing with advisors is that they are some of the most sophisticated people I've worked with as sophisticated all the institutional investors. Um, I'm talking about Dan's people and others and they're managing billions of dollars. So I'd be surprised if advisors had any misunderstanding about how various vehicles work. I think what we've had here is something Ron described very well which ties in with software. We've had a unique and disruptive entrance into software and software was also part of private credit which has created some anxiousness and so you've seen some heightened withdrawals but I think if you take a big step back sir I think the numbers are 2% of all the global wealth in the world in terms of the wealth wallet is allocated to private capital. Um, and so there's no doubt that if you think about the returns available to investors around the world, whether it be institutional or wealth, and the benefit they can get from long-term diversification across all forms of asset classes. Um, I mean, Kalpers has been managing retirement assets for employees for how long now?
93 years.
Yeah. Successfully with a large portion of the portfolio in private capital. I think there's clearly a role to play. It's just incumbent upon everyone to make sure the right individuals have access to the vehicles they want, the diversification they want. Um, but again, as you know, you and I have chatted about it. I'm with Ra. I don't see this as a systemic feature. I do think it is sort of the early part of the process of solution adoption and inevitably it'll go through. But at Carlile, we if someone wants to have a feeder fund where they can get drawowns or they want to be in an interval fund where they can flexibly add capital from time to time. um we just want to make sure we give them as much choice as they want. Um, but uh, but my experience has been that the advisers are super sophisticated as are the end users uh in terms of the people that are participating in these.
Marcy, how much of the portfolio is in privates at this point versus public and is that changing are you shrinking that?
Yeah, so uh specifically to credit we have uh 4% of the portfolio so as Ron indicated pretty small percentage overall private uh equity more significant uh currently about 20% of the portfolio Uh we also have infrastructure and real estate. So I would say for the three-year, you know, not getting into a lot of the the secrets that are going to be told to our board in close session, but we don't see the portfolio changing that dramatically in the next three-year look forward. Uh we think that private markets are going to be extremely important to getting that 6.8% return. Um, but we have gotten a lot better at manager selection. We've gotten a lot better at saying yes quickly. But equally important I think to our partners is saying no quickly as well. Um, we had a time and we fondly refer to it as the last decade. You probably saw that. I think maybe CNBC covered that as well. Um, but we just did not pace private markets appropriately. We were in we got scared you know 089 we got scared we came out and when we came out it was the worst time to come out. Those were the best performing ventages. And so what we're trying to do again is be consistent, have the discipline, uh stick to the allocations when we can, but again, under a TPA model, you're sitting at a table and you're kind of duking it out with your fellow asset class leads about where's the best place to write that check. So even though we may have a 17% target, uh there might be times that we'll be above it and there could be times that we'll be below it just depending on market. So you know, on the software issue, you know, concentration is great when it's performing well. concentration is a real problem when things start to cool down. And that's why the diversification and why we even brought private credit into the portfolio in the first place is to make sure that all of these assets are well diversified because we're not moving the portfolio very quickly.
You know, to Ron's point, Sarah, on the credit cycle, you know, the economy is still quite strong. The consumer's been amazingly resilient. We have been in this credit boom for a long period of time. So, we're starting to see some price adjustment. There was a transaction we looked at for example two months ago which is you know shifted in pricing in two months as Ron says pro probably healthy but you know we do have an expression that
We use at Carile just to remind ourselves. We say credit is credit. And you know, if you look at the, I guess, three more high-profile alleged fraud situations with Tricula, First Brands, you know, there were private alternative asset managers and banks all involved in the credit. And so I don't really know that you can splice the world between bank credit and private credit. You just need really good underwriting, thoughtful processes. Fraud is always going to be difficult to detect for anyone.
But I agree with Ron. It's been a long cycle, but the economic engine feels quite good. We're seeing as many opportunities to deploy credit today as we've seen, and actually more, and increasing institutional interest.
>> Immediately on the back. >> So, but you're pushing back. You don't think we're on a credit cycle? Sorry. >> So, we're not in a credit cycle. >> No, we we will inevitably will be, but I do think it has to correlate with the economic engine. You know, we just haven't had a recession in a very long time, thankfully. And the we have successfully navigated tariffs, war, um, and geopolitical splintering quite successfully. >> Inflation, high rates, >> just really been a remarkably resilient market. Um, but I just think we need, look, we're all partners on this stage. Like, we we need Morgan Stanley to do well. We need our bank partners to do well. So, we just want the world to have as much capital available as can be needed at a thoughtfully priced uh marginal return.
>> Yeah, >> Dan, I'm Are you guys a changing approach or doing anything differently around private capital?
>> I look, we've been um I would say investing alpha is hard. Asset allocation is hard. I think what you're seeing is just that that can be challenging. Uh we would agree with the commentary. It's not systemic. Uh I think in the in the case of private credit, you had uh I would say private equity got skewed a little bit to software and then private credit skewed a little bit more to private uh uh to software as well. And so you have an asset allocation issue against as we talked about really transformational changes around AI but not all software is going to die and some of it's going to return and so you have to go through all those dynamics in the in the marketplace and it'll find equilibrium. The other thing to Harvey's or maybe Ron's point um the total of direct lending market is maybe $1.7 or $2 trillion. The semi-liquid piece is about $200 billion. That's about 2% of the market cap of Google and Nvidia combined. Uh those two companies, by the way, can move $200 billion in an afternoon. And so when we think about context, I think that's important. And on the vehicles, uh and and Harvey deserves a lot of credit. He literally goes to our branches a lot. He talks to the advisors. We've been doing private markets, uh with the high end of our wealth management uh clients for like 30 years. You have to start with investor education. The back end of investor education is a liquidity budget. The liquidity budget rules. It has to rule above risk and reward in these clients. And I'm not talking about 401ks. I'm talking about, you know, the the brokerage and advisory accounts that we have. And and we've lived through we lived through '08 uh in this marketplace. Importantly, we lived through COVID. And it wasn't that long ago that real estate firms had semi-liquid and they managed through that and and they managed through it through uh actually the advisors do what they were getting uh and then through the education around that. And so I I think in in that context this is just asset management is hard. You'll have some people who who underwrote better. You'll have some who asset allocated better within sectors and and and then flows and performance will drive off of that. uh but uh it seems like the institutional bid uh for credit and we we're big believers at Morgan Stanley it's credit uh and to a degree there's there's an element where that sits in the banks uh and then it sits in the asset management community but where we're most focused is asset management.
>> Public credit, private credit, it's just deploying. And we're seeing in the transactions that I talked about earlier a lot of gray and a lot of blending. And uh we can start uh around innovation and it might start in the private credit market and then it ends with a CQIP and and everything in between. And I think you are seeing among asset owners around the world an interest in uh trying to figure out where they can play in the credit market. If you go back 15 years ago, uh endowments, sovereign wealth funds, the sort of uh most sophisticated um pension funds were not as exposed to credit. Banks have now pulled out, asset managers are doing more with insurance capital. It's just a much bigger and broader and I would argue more sophisticated market today.
>> And this is all beneficial to the capital markets. I mean, if you go back to '08, it's uh and and think about how the world locked up as a result of of what was happening there. Um that probably wouldn't happen today simply because uh the the world actually looks at uh at credit the way Dan is talking about it that credit is credit whether it's private or bank provided. uh and what vehicle it's in is you're almost indifferent to that. It's a very efficient allocation of of capital and credit that we've never seen before.
>> I also want to hit private equity because I think it's been alluded to a few times on the stage. Harvey, and you did this like very complicated, interestingly, creatively structured fund raise, right, with a with a new fund that you're launching. And so I just wanted to give you a chance to talk about it and explain what it says about the environment we're in either for fundraising or for for private equity in general.
>> Sure. So uh what Sarah's uh referring to uh and maybe I'll take a step back. So we have basically three large businesses at Carlyle. We have the private equity business. We have our credit business and then we have a business Carlyle Alpine Invest uh which the firm acquired in 2012. And for 25 years is one of the large hyperscalers in both secondaries, co-invest, and solutions. And the solutions business um is a business that as this business grows very dramatically uh in totality, the solutions business is one where we work with all of our partners and partners around the world to help them reallocate their portfolios. So I'll often be in a room with a CEO or a CIO of a large plan or a sovereign wealth fund. Part of the conversation will be look, we want to access the private credit. And then it might be look, we want to modify this part of our portfolio. Who do we work with to change the portfolio? And it became very clear to us having this internal IQ that we could work with partners, clients who wanted a liquidity solution at the same time exposure to our next US bio fund. And so we created this solution which uh is innovative, not particularly complicated but innovative um and effectively raised $5 billion in advance of any formal fundraising uh at full fees. But I think uh the most important thing about this is this is kind of the direction of travel for this industry. When you hear, you know, Dan talk about the efficiency of the capital markets and and Ron and Marcy's discussions about how she thinks about her portfolio, it's all going to be about in this world, how can you be as dynamic as possible, whether you're in liquid markets or less liquid markets and think about this portfolio allocation and the efficient use of capital. And this is really what this is for us. We run a balance sheet light firm. I think if we were a big balance sheet heavy firm, um we wouldn't have come up with something innovative like this because we just would have used a lot of our own capital perhaps. But in this particular case, we're able to solve uh a client priority and obviously uh create this seed capital uh prior to our formal fundraising. So, it's a good outcome for everybody.
>> So, you're blazing a trail here, you think, when it comes to how these funds are going to get raised. I think that there will be uh thoughtful ways of fundraising but really what drives this is about portfolio allocation in terms of how our uh a set of LPs want to think about allocating their capital and I think you'll see this evolve. I think you know um there have been discussions from time to time about how do you create tradable underlying assets like almost trying to merge the go to the ETF world. Um, I think that we're very very far long way from doing that for a whole bunch of reasons, but I think more liquidity in all markets is better because we want less friction because it reduces cost in in how you create portfolio dynamics. And so, yeah, I think we're at the early phases of a more thoughtful way of thinking about portfolio allocation.
>> Okay, in the final minutes we have left, I'm going to ask everyone a same similar version of the same question. Ron, which is if you have $50 billion to allocate today, where do you go? A AI deployment and and how >> AI >> Yeah. And how AI into our own firm and how we work with each of our clients because uh is as I think about how what we need to do as a firm and what we need to do to serve our clients both from an investment perspective and an investment servicing perspective. It's about how we operate and it's about how we operate with them. Marcy.
>> Yeah, I mean I I don't think my answer is going to be a lot different than Ron's both from an internal perspective again trying to understand how our partners are really thinking about AI. So deploying to AI but in particular for us we got 400 bips of active risk that we have to deploy related to our reference portfolio and that's going into private markets. So private equity uh helps us secure the 2.4 million uh members that we support. So a lot of that will be in the private markets. We think infrastructure with AI for certain. Um, but most of that will be in the private markets. AI would certainly be a sector.
>> Wherever Marcy wants us to go, we're going to go. Um, >> yeah, we're all going to go. >> No, as a fiduciary, >> forget it. You're all partners and you all love each other. >> We are. Um, Dan's clients do. Uh, as a fiduciary, we really Sarah, we don't avoid risk. We just want to price that marginal risk unit >> for the reward that we can get. Again, I go back to what I was saying earlier, big big macro trends which I think will define the next 10 years. Um, which feel very durable in the fact that they're trends. There's obviously going to be a lot of activity around it, but aerospace defense, evolution of healthcare, the reindustrialization of industry with the deployment of technology, um, energy. I think there's going to be some really fascinating things that happen around the world in terms of economic growth. You know, we again, we were one of the first firms to go to Japan and stay in Japan with a dedicated Japan business. As you travel the world, I think there going to be a lot of different ways to deploy capital and obviously all influenced by what's happening in data science and AI.
>> Yeah, >> I think um I said it earlier, I think European alpha versus European beta would be one place that we think there's real opportunity. I think uh >> what does that mean? >> Meaning I if the economy doesn't need to do well, but out of that economy and out of some of the stress uh politically, you're going to see either companies that need capital or will take advantage of weakness in their either home market or be global winners and adapt. And I think both private equity firms as well as active equity managers in particular, whether they be hedge funds or private equity, can can deploy and still generate alpha. I think uh clearly in our view uh Japan, Korea, even greater China around the technology of Asia and the demographics of Asia is quite attractive to us. I would say we think the noise is overdone in private credit, but that will create an opportunity. There is an M&A wave coming. The financing of that M&A wave especially given some of the noise is going to enable some alpha to be generated by being the financier uh into uh into that M&A market and then I think you want to be both uh long uh the uh your best view on the winners on AI infrastructure and all the way through chips through hyperscalers to LLMs but also really work through a portfolio around where are the deployers and and not every incumbent's going to win, but some will win really big and there and be uh agile enough to go early with some companies that disrupt in in certain sectors.
>> Okay, now is the hard one. Where do you not want to allocate?
>> Oh, I had one more. I forgot. >> Okay, go ahead. >> You did a lot. Morgan Stanley, obviously. >> Yeah. >> Where do you not want to be, Ron? My gosh, >> I I it's a hard question because I actually think this is a great time to be an investor with all the change that's going on and disruption usually leads to opportunity. Um, I mean there's probably some places that are a little bit overdone that you wouldn't want to be. >> Like what? >> I don't know that I I don't know that personally I'd want to be deploying more into data center development >> overdone. >> Marcy, where do you not want to be?
>> Well, we are uh pretty much everywhere, but I think where we have we get a lot more noise. I'll just call it noise. um whether that's political noise or stakeholders coming in. Um some of the developing markets are pretty challenging for us. Some of the early developing markets would be challenging. We do have some fixed income instruments that are there. They're probably some of our noises, but they're also some of our best performing, frankly. So, I wouldn't say there's no place really we want to be as long as it's legal to be invested there. Um but when you are underfunded, we're still only 84% funded. we have to really keep everything on the table and just understand again the cost of that capital and the risks associated with deploying there. Uh so there's nothing specifically but we do have to be really thoughtful and make sure we've got the return expectation in place u deploying in some of the emerging markets.
>> Yeah. So I think um you know Ron said something earlier about reflecting back on 2008 the evolution of these markets or maybe it was Dan. I do think what we're seeing is again a persistent trend for the next forever is just high deficits everywhere in the world and that is going to create the demand for the services of everyone on this panel particularly private capital, public capital because there's no there's no state capital that's going to be able to support all this drive for economic growth and all the priorities we've talked about. I worry a little bit about the developing world as a backdrop against that. That's not a area where we deploy employ a lot of capital. But I do worry that as technology and the advancements and the investments and all the things we're talking about in a world where the leading economies will compete for capital and we'll have access and the innovation that happens here and other places in the world. How that extends to the developing rest of the world I think is a concern particularly as again deficits are so large and the world geopolitically splinters for sure there's going to be winners. Winners around commodities, winners around policy, winners around certain things, but I worry generically over the next 10 or 20 years about it's again it's not an area we redeploy capital uh generally but um but I I could be a little bit concerned about that.
>> High-indebted, high-debt emerging countries. What about you, Dan? Final word.
>> And again I said we're a big fan of being very active in Europe. The counter to that is is being a little wary. It's a it's there's a multiple debates at Morgan Stanley because the price may be right in Europe. European beta but certainly uh it's a place where we think there's some economic challenges relative to the US and relative to the uh Asia. I think the other thing we would be wary of is being too short-term oriented uh in that you know there are some very big trends there's some big uh there's some big longer term positive economically and and not to get in too wrapped up in a trading mentality. Uh this is our advice to investors. you know, we have to manage a balance sheet at Morgan Stanley and there's certain funds that are set up to be very trading oriented, but we would be very much focused on long-term investing right now and and that's sort of the way we think about the advice we give.
>> So, don't be short-term, >> try not to hard, but >> and you hate and love Europe. >> Um, okay. Well, we we're out of time, but thank you all for being so candid and um I thought that was a really great discussion on money in motion, capital in motion. Thank you all for joining us.
>> Thanks, Eric. Thank you. >> Thank you.