Transcript:

Ben Smith:

Welcome, everyone, to The Retirement Success in Maine Podcast. Joining me and co-hosting today's show, the Farnsworth Art Museum to my Colby College Museum of Art, Curtis Worcester. How are doing today, Curtis?

Curtis Worcester:

I'm doing well, Ben. I'm doing well. How are you?

Ben Smith:

Good, good. We're now back to school season. Pumpkin is everything right now.

Curtis Worcester:

That's right.

Ben Smith:

Everybody's got to go into apple and pumpkin, so we're going into fall and back to school and all that. So, hey, when it comes to back to school, of course, our show is a little bit of education here too. We dig into retirement. We dig into some life decisions and choices. As many of you know out there, we're investing advisors by day, podcast superheroes by night. One things we want to get into on the education side is we want to get into a little bit of a few things that our clients have heard about private equity and they're bringing that up to us. What's this private equity? I hear that in the Wall Street Journal or in the news, and I want to consider investing my own money in these sorts of things.

Curtis Worcester:

Sure.

Ben Smith:

Right. So, we're hearing that on a frequent basis. There's times when clients or friends are asking about it and they don't even really know what it is. So, the question is, "What is private equity? How does it work? Who can invest in it? But also how is this investment trend impacting the State of Maine?" So, one thing to quickly point out for a lot of Mainers is they might already have some of their retirement in private equity without even realizing it. We all know teachers, firefighters, police officers, Maine government employees, well, they all have a Maine public employee retirement system, otherwise MainePERS or MPERS. it's an $18.7 billion fund and it has over 15% of its fund investments in private equity. That was from a 2021 MPERS report.

So, if I'm doing some quick math, which we like to do math here, that's about $2.8 billion. So, private equity is also having other impacts in the state during the past few years as well. We've talked to many business owners in the state and New England that are receiving and sometimes accepting offers from private equity funds to buy their businesses and combine them with other national, regional, and/or local businesses. Is that a good trend or should we be suspicious of these pools of money coming into the state? So, all those things we want to cover in today's show.

Curtis Worcester:

Yeah, exactly Ben. I think while we have some exposure and knowledge in private equity here ourselves, just given the nature of our business, we obviously wanted to bring in an expert. So, today's guest is, I think, the perfect expert. He's the Head of Private Equity in Vanguard's Portfolio Review Department. So, his areas of expertise are investment strategies, including private equity, indexing, active and factor, as well as investment products including mutual funds, collective investment trust, and ETFs. In 2022, our guest became the Head of Private Equity, leading a team of experts responsible for the strategy, marketing and investment support of Vanguard's private equity offer. So, prior to this role, he led the ETF and index product management function at Vanguard.

So, leading a team of experts responsible for conducting surveillance of competitors' products and positioning, meeting with clients and prospective investors to discuss Vanguard's ETF lineup, publishing noteworthy developments in the ETF marketplace and Vanguard products, improving existing products, developing new products, and supporting ETF education initiatives. So, our guest joined Vanguard in 1999 and assumed an Investment Analyst role in the Portfolio Review Department in 2003.

So, for the majority of his tenure in the Portfolio Review Department, he served as a senior member of the oversight and manager search team, which was responsible for identifying advisory partners for Vanguard's actively managed funds lineup and monitoring the firm's people, processes, portfolios, and performance of all existing Vanguard funds on behalf of the firm's Global Investment Committee and the Board of Director. So, he's a frequent speaker at industry conferences. He's also widely quoted in the media and has made numerous national television appearances on the topic of ETFs. He earned a Bachelor's in Science Business Administration in Finance from Shippensburg University and an MBA in Investment Management from Drexel University.

So, with that wonderful background, please join me in welcoming Rich Powers to The Retirement Success in Maine Podcast. Rich, thank you so much for taking the time to come on our show today.

Rich Powers:

Hi, Curtis and Ben. Thanks for having me. Really thrilled to be here.

Ben Smith:

Rich, again with that background and looking at private equity is something we all want to learn about. In your role here with Vanguard, an industry leader here, and we're all really big Vanguard fans as well. So, really excited to have you on our show and talk a little private equity. Again, we're going to take the role of the public out there and our clients that are asking questions. We want to be asking questions from their perspective today to you. Rich, we always want to dig into our guests a little bit just to get to know you and your path towards your role today. So, love for you to just tell us a little bit about your upbringing and whether you were destined for a career in finance.

Rich Powers:

Well, sure, I'm not sure I was destined for career in finance, but there's certainly some seeds planted pretty early that led me on this path. But bit of my background, I'm actually born and bred in this area. I grew up just on the outskirts of Philadelphia, about five minutes from the international airport. My parents are actually still in the same house I was raised in. So, it's been longstanding place for our family. I'm one of four boys. I'm the oldest of the group and my parents definitely impressed upon us the importance of education and all the doors that that would open for us. So, what I didn't know was that Vanguard was not too far away from where I grew up, but about 30-minute drive from where I grew up.

Certainly, I didn't imagine that I would end up working at this organization for almost 24 years now, not having known it growing up. I think in terms of my path towards investing, I do remember early as a child watching the news with my parents and one of the things that always caught my eye was there would be a recap on what happened in the markets. The Dow was up, the Dow was down. for some reason, that was always something that I was paying attention to. Even though my family didn't really have any investments to speak of themselves, there was something about measuring what was happening in the economy of the markets that intrigued me.

So, as I progressed to study business in undergrad, that became a little clear as to what that would look like and had a good fortune of having some friends who graduated from school a little earlier than me that also were from the Philly suburbs that had gotten jobs at Vanguard and knew that I was interested in coming back to the Philly area and knew my interest in investing and pointed me in that direction. I feel really fortunate for that having happened.

Curtis Worcester:

That's awesome. As you said, Rich, so you've been at Vanguard now for almost 24 years. What has it been about Vanguard that you think has been such a great fit for you in your career?

Rich Powers:

Certainly, I would love to say that I had it all mapped out and planned that Vanguard must be the perfect place, because of its mission orientation and what I was trying to do with my life, but that certainly would not be the case. It was good fortune that led me to Vanguard, but what's kept me to Vanguard is actually the mission orientation of who we are. We exist to serve our investors and that is it, right? There's no outside investors or owners of Vanguard. Our funds own the Vanguard group. Our clients own the funds, and therefore, those clients are effectively our owners as well. So, that creates a lot of clarity in terms of the ability to do the right thing for investors. We exist only to serve them. So, I think that mission orientation, I didn't appreciate that as a younger guy.

Certainly, as I got older and was able to interact with others in the industry and friends who were working elsewhere, it became pretty clear to me that where I had landed was pretty different and pretty special. I think more personally, the opportunity to grow and take on new responsibilities has been just incredibly compelling for me.

To think back, my initial job at Vanguard was working on our 1800 number for individuals who would call up and say, "Hey, I want to open up an IRA," or "I'm thinking about funding an account for my child. Can you help me figure out how to allocate capital or send me the right paperwork?" to over time becoming a senior member of our oversight search team that was responsible for working for our board and assessing our managers and making sure that the right people and processes are there. Then I led our ETF team who was responsible for helping us build out that lineup further, representing us in pretty high stakes engagements with clients and with the press, and then now leading our private equity team.

I just look at that as I've had probably four or five different careers in a 24-year period and never had to leave the company because Vanguard is involved in so many different things. They reward folks who work hard, who have talent, and have that longer term view. So, I've been a big beneficiary of that. So, I'm really appreciative that I happened to land here in a happenstance way right out of college, but it's been a wonderful experience for me for all this time.

Ben Smith:

Rich, I'll add it too, just again, watching Vanguard from afar, Maine to Pennsylvania here, is looking at what's been pretty neat about the evolution of Vanguard as a company is this idea of, "Look, we're starting with our clients first. when there's products that make sense for our clients, that's when we do it," not "Well, let's look at the profit we can get out of products and that's when we're going to start leading into it." So there's been other organizations that might be quicker in terms of getting something out, but when you go, "Hey, when does it make sense to do this for our clients? When is there demand? When is there a need to incorporate something on the investment side that we think our clients need and should have in their portfolios? Let's start with that as the demand."

I could see where that has caused the evolution of an organization but also to say, "Hey, here's Rich and we have somebody that's really great with talent and we can continue to put him in all these situations of growing with us and leading us." Retaining talent, I guess, is the point I want to say there. It's really important that when you develop talent and you develop this thinking and there's alignment and mission, I think it's a really important thing as our organization. So, inside and outside, neat to see that knowledge is what the story is to what we tell people on the Vanguard side, but also when you talk to folks like yourself, we work with Kelly Orr for a long period of time.

Kelly is so fantastic and really lives and breathes Vanguard. It's so synergistic across the way. So, I know from what we see as an investment advisor, independent, it's applauding that part, but I also want to ask another question, Rich, about you. We always ask the question of... The name of the show is Retirement Success in Maine. ... any connections to Maine at all?

Rich Powers:

No, I've only spent time in Maine for work actually. I visited Maine for meeting with clients before... Gosh, it's probably been at least 10 years now since I've been there. So, I don't have any family connections. It's not like a vacation spot for me but certainly is on the list of places for me to visit. A lot of it has to do with everyone around me seems to spend an incredible amount of time in Maine during the summer season or even during the winter. So, clearly, I'm missing something. So, it's on my short list of places to visit in the not so distant future.

Ben Smith:

Well, we'll get you that list of foods you must try when you come to the state, because there's a lot of really great experiences, but also food is, when you're this close to the ocean and you're getting all the best and freshest things, a must try. So, when you come up, give us a holler, we'll get you that list.

Rich Powers:

I'm holding you to a pen.

Ben Smith:

Yeah, please.

Curtis Worcester:

We're pretty easy to get to too, especially from you if you're right near Philly. Speaking of someone who flies out all the time, Philly's the spot. I feel like everywhere I connect, it's Philly.

Ben Smith:

Direct flight, right?

Curtis Worcester:

That's right. Straight up.

Rich Powers:

Yeah. Well, even the drive isn't that terrible. I mean actually plenty of the folks actually I work with have made the commute during the summer. Maybe the trip itself can be a little arduous at times, but on the other side of it, the benefits are very clear to that. Clearly, it's something to prioritize.

Curtis Worcester:

That's perfect. So, I want to keep moving, Rich, here and really dig into our topic today, obviously private equity and retirement. Really just what should people know. I think a great way to start all of our shows is we just like to start with definitions. So, the first question I want to ask you is can you just walk us through what exactly private equity is?

Rich Powers:

Sure. So, I think a lot of the listeners will be familiar with public equity. So, these are companies that are publicly traded on exchanges like the New York Stock Exchange or the NASDAQ. These are many times large companies but often times can be small companies as well that you'll see quoted, just like I was alluding to earlier, on the nightly news talking about how did the market do. That's what you're seeing is, "What did the public markets do for a given day, for a given week, or a given year?" These companies have public shareholders. So, meaning they have probably insiders who own some of the company, but then Curtis or Rich or Ben could also be individual investors in those companies. Then they might also have owners who are mutual funds or other investment funds.

So, think of the Vanguard 500 Index or the Windsor Fund. They might own shares in that company. So, oftentimes when you think about public company, you think of them having a broad base of investors from employees and executives at the firm to individuals, mutual funds, pensions, what have you. In private equity, what you have is companies that are not quoted on an exchange like NASDAQ or New York Stock Exchange. They're not readily traded where you can easily exit a position that you hold in a private company and sell it to some other potential buyer like you could on any given second effectively for a public company. So, the ownership may tend to be relatively narrowly held.

There might be the founder who might own the company in its entirety or their family or the founder and some friends or there will be other investors along the way who would be, what would we call, general partners of private equity funds who are making infusions into that business for any number of reasons which we'll head into in a little bit. So, there's lots of similarities between public and private companies, but there's some key differences. I'd say just one other key similarity I want to point to before I break here is that we're really familiar with public companies that they come in all shapes and sizes and forms.

There's no monolithic public company. There's different sectors. There's different sizes of companies. There's different geographies which we operate. There's this idea that some companies are more value oriented, some are more growth oriented. Same holds true in private equity, though the ways you slice the different companies in private markets can be a little bit different. You can have really early stage companies. We call them two people in a garage with an idea.

You can have really mature businesses that are looking for additional funding to expand operations. Those companies can be here in the US. They can be elsewhere and they're going to cover different sectors as well. So, I just point to that there are lots of similarities to public companies that private companies have, but there are some key differences that I think we should probably dive into.

Curtis Worcester:

Yeah. That's great. You're teeing up my next question here. So, when someone chooses to invest in private equity, can you just talk about, again it may be something that's different than public equity, some unique things to private equity that they may not have encountered when they do invest in their publicly traded stocks?

Rich Powers:

Sure. I think there's a range of things that are pretty different but I'll hit on a couple that I think are really key and fundamental to the differences. Perhaps the most significant one is the illiquidity of a private company. So, going back to where we started earlier where if you owned the Microsoft and you wanted to sell that on a public exchange, you could easily do that within a second with a brokerage account. If you want a private company, there isn't an exchange, a marketplace, an option for you to easily transact in that type of ownership of a company. So, therefore, your time horizon when you're investing in private equity has to be materially different. In many cases, people are stunned at this as we've started to make a private equity option available.

The time horizon for private equity investing, as much as we have long term clients here at Vanguard, it's pretty lengthy. You're talking about 10 to 14-year time horizon when you're investing in these companies, because you want to give that company the opportunity to make the investments scale and evolve to realize its full potential and it may need a long period of time to do that. So, I think illiquidity is perhaps the most obvious difference between a public company. The second one I would point to is the potential for enhanced returns. If you are locking up your capital for 10 or 14 years, I think you're going to require a payment for that additional lockup.

Just like if you loan someone some money for a day versus loaning them something for 30 years, there's a lot of risk that goes in that 30-year time horizon you want to price in. So, there's an illiquidity premium that comes with investing in private companies because you're locking up your capital for a long period of time. That is generally translated into a return enhancement for private equity investments over public markets. Obviously, it comes with a bit of a lockup. Maybe the third thing I'll point to and then I'll pause is with private equity, it's not transparent. It goes back to public companies, they don't have to file the same type of regulatory documents that a public company has to in terms of disclosing operations, profitability.

They will have to share that with certain folks, but it's not like it's publicly available on the SEC website. Here, it's far more of a bit of opaque marketplace. So, that asymmetry actually translates into some things where an investor who might buy into a private equity fund actually doesn't know what's going to be held in that fund, because the manager's going to build that portfolio over the next couple of years. I contrast that with if you wanted to look at what was held in the Vanguard 500 ETF, you could pull that up on any given day exactly what you hold. Private equity, there's a bit of a blind pool that you're investing in that requires lots of due diligence and a little bit more faith in terms of the quality of the manager that you're hiring there.

Ben Smith:

Yeah, no, those are all three fantastic points, Rich, and I'm glad you broke each of those out the way you did. One last lump it into our foundational questions, obviously, we just talked in the intro, the State of Maine has some exposure in their public retirement system, if you will, to private equity that people may or may not know about. So, we just want to ask, can you just give us an example of a company that people might know and recognize that was whether recently or not recently purchased by a private equity fund and how it didn't change the company?

Rich Powers:

Yeah, I think folks would be pretty surprised to know that many companies that are really brand name and well-known, ubiquitous in the global marketplace had their start as a private equity investment that translated to public company. I should give you two because I think it'll be really important to draw a distinction in terms of the private equity is this umbrella term but takes many different forms.

So, the first one will be Uber. So, Uber was founded in 2009. It's a ride hailing service. Obviously, it's involved in a variety of other different activities as well. It went public in 2019, but between 2009 and 2019, there was a series of investments that were made by angel investors, venture investors to help capitalize the business from this idea to actually operating company and then to allow it to grow and scale into this global platform. So, Uber is a relatively new conversion from a private company to a public company just about three years ago.

Another example would be Dell. So, Dell actually is an interesting history. Dell was founded in 1984 by Michael Dell. Home computer is the business they're involved with. They went public in 1988, a public company for about 25 years, and then in 2013, were taken private by Michael Dell and some private equity investors to help right size the business, rethink strategy, pull them out of the glare of the public marketplace, allow them to make some meaningful changes there. And then they IPO-ed about five years later. So, just an example of companies that started off as a really small idea that went from private to public and those that have gone from private to public to private and now that became public company.

Ben Smith:

Well, Rich, that's really awesome, especially again when we talked about now what private equity is and what it entails. One of the things that we were saying in our intro was, "Look, we're getting people that coming up and saying, 'Hey, I've heard about private equity and I hear you can make some money in it and I'm interested in learning about it and I want to maybe think about doing it myself.'" So I think that leads to a question of who can invest in private equity and who is it typically most appropriate for.

So, that's what I want to get into and maybe ask that question to you right now, because to your point, if I want to go buy a stock on the public stock exchange, if I find a stock that's $100 a share and I have $100, I could go just buy that and open up an account through Vanguard or whoever custodian and I could go do it. So, this is a little bit different. Can you explain what that is and who's eligible to invest in this?

Rich Powers:

Sure. All of this is a bit fluid here, but I'd say historically how to think about private equity is that private equity investments have been only available as private placements, where it's not a public fund that you go to a brokerage account. Rather you would work through a general partner or a fund of funds provider to access the private equity market. Private equity usually requires asset threshold that is necessary to meet in order for you to qualify. That's said actually from a regulatory standpoint. This is a rule that SEC requires. Let's say institutions need to have $25 million in investible assets to be eligible for private equity. For individuals, it's about $5 million. By the way, I'm just offering a shortcut interpretation of the regulatory. It's more nuanced than that.

But what that tells you is that by and large, private equity has historically only been available to large institutions and ultra-high net worth investors, because those $25 million asset test or $5 million asset for an individual, what that says is well, you probably need to have a lot more than that to start allocating to private equity, because you're not going to invest everything you have in private equity. Otherwise, you wouldn't have any liquidity. So, that's translated into endowments, foundations, sovereign wealth funds, pensions, largely being the historical owners of private equity and then ultra-high net worth investors owning it as well.

Ben Smith:

Rich, I'm not trying to put words in regulatory agencies' mouths here, but there's this influence or implied thought it feels like from regulatory agencies of like, "Hey, there's maybe greater risk," because of what you just said of illiquidity. Maybe I don't have access to it. Maybe there's more risk where I don't know the value on a day-to-day basis. Maybe there's more things I just don't know and there's more risk to these sorts of investments.

So, with that, we want the people that are investing to this to maybe be able to absorb more chance of a risk of loss it feels like. Again, if I only have $100, that's all I have to my name and I put it into one publicly traded stock, again, on a daily basis, I have a value on what's happening with that where it's a little less on the... I guess would you agree with that as a thought from a regulatory perspective?

Rich Powers:

Yeah, I think that's the right interpretation. First of all, I would say we and others believe that private equity isn't for everyone. I think there's a range of factors you have to consider in terms of need for liquidity, risk tolerance, time horizons. All that needs to be considered. So, even before you get to the wealth continuing, you could easily start lopping off a bunch of folks who are private equity is simply not going to be a fit. But even with that remaining population, I think what the regulators are simply saying is that the capacity absorbed and some of the challenges that come with the investing in private equity are probably better served by those individuals or institutions that have a larger balance sheet.

So, that if something goes wrong for those investments or it takes a lot longer to realize returns than expected, those folks are not going to be harmed in an irreparable manner from a financial situation. So, I think that's been a historical perspective. Certainly, we as an organization think that there is an opportunity and many others do as well, opportunity to bring private equity to more investors recognizing you still have to meet all this other suitability requirements that are so fundamental before you even get to the asset threshold.

Ben Smith:

So that's a really great, I think, definition of then the who. So, let's talk about, obviously, we mentioned in our intro about the Maine Public Employee Retirement System having 15% as a target of their money in private equity, but let's talk about them or Harvards or Yales or other public pensions. Why do they like private equity as an asset class so much? Because when you say 15% or maybe even more, that's a pretty significant chunk of any pool of money to say, "Hey, this is an asset class I'm putting into." Why is it that they've liked it so much maybe today or previously?

Rich Powers:

Yeah, I think one of the unique characteristics for those entities is that you classify them as perpetual. The Yales Harvards of the world, they will continue to be educating people for the foreseeable future. So, they have a time horizon that's as close to infinite as you probably can think of in terms of the relative to say an individual investor obviously that has a specific timeline. So, I think that allows them to think about investing in this manner in a much easier fashion than the average person would.

I think the other factors you would point to would be returns. These organizations are doing this not because they simply can, they have to have access, but rather because there is a return profile historically for private equity that is demonstrated outperformance over public markets. Depending about the time period, you can come up with different measuring points, but hundreds of bases of points of outperformance over public markets by top private equity first. That's an attractive aspect of private equity investing. That has been one of the reasons why endowments like Harvard and Yale have invested in that matter. I think you also have to remember, they have large pools of capital.

So, going back to our point earlier that you actually need large dollars to invest, those entities have billions of dollars of capital to invest in. So, I think those are the reasons why you get there. I'd also throw in maybe the last one, which is I think there's some debate about the value of this, though I certainly can see it, it's diversification. The reason why there's a little bit of debate is some folks will point to you, part of the reason why private equity offers diversification benefits is because you only value the assets every quarter while public market's being valued every day. Perhaps that's the driver of the diversification. I can see that.

But even if you assumed that was normalized everything and everything was on the same time horizon, you would still have some benefits from a diversification standpoint in terms of returns, zigging and zagging at different times. I think diversification also comes in the form of simply accessing a segment of the market that is growing in size that you can't access through the public markets.

I think the figure that I saw recently is if you looked at the global market cap, about 10% of the global equity market cap is comprised of private companies today. That number's growing rather rapidly, about a half a point or so per year. So, as investors, diversification is the only free lunch we have access to. So, that is, I think, part of the selling point that I think organizations like those consider when making private equity allocations.

Curtis Worcester:

That's great. So, I want to keep going on the fundamentals of private equity funds. So, typically, they have a life cycle on how they invest for their clients. So, can you just talk about the typical stages of how a private equity fund works and maybe get into what is a J Curve?

Rich Powers:

Sure, sure. I think there's really, I'll call, three phases of private equity investing. So, maybe I'll just take a little diversion here and say there's really a couple different ways that an investor can access private equity. They can go and hire a general partner who's going to go out and select 30 companies for their portfolio. So, that'll be a direct investment into a general partner's fund or they can hire a fund to funds manager who's demonstrated some expertise in selecting great general partners and building a diversified portfolio of 20 or 30 different general partners. So, you have a more spread out portfolio. But let's just assume that we're talking about a conventional direct investment in a general partner's fund. There's three phases.

One is the fundraising phase. So, this is where the general partner is going to the marketplace and saying, "We're raising X amount of capital for the next year or so." They're engaging with institutions, financial advisors, and high net worth individuals to say, "Here's what we're going to attempt to do." But what they're doing that with is simply using their historical track record and a broad description of their investment approach. There's no portfolio companies that they're doing that fundraising on, but they're able to do that, particularly the firms that have been around for a while, because they can point to their history as investing in this company or that company that realized great value. So, there's fundraising. We'll call that phase one.

Phase two would be the investing stage. So, this is where the general partner has raised a billion dollars in capital and now they've decided, "Well, I've got this billion dollars in capital. Now, I'm going to go look in the marketplace for companies that need investment, require investment that are attracted to them from a return perspective and decide over that two to four years, two through four, where they're going to invest the portfolio." So let's just say they've arrived at 30 companies, they're going to spread that billion dollars out over. In years, call it 4 through 10 and maybe even longer is what we call the phase where the actual underlying companies are calling for capital to make those operational improvements or to expand their footprint from a geographic standpoint.

So, there's money that's leaving the general partner, going to the underlying companies. Some of those companies are going to realize that return's pretty quickly because they might be able to take that capital, make the investments they need, and it turns out that they can actually go public. So, all of a sudden, the capital starts flowing back to the general partners and ultimately to the limited partners who are the investors. So, that's the three phases. There's the fundraising, the investing, and then call it the harvesting, if you will, of the underlying investments.

Why the J Curve is a shorthanded way to describe that is as the underlying investors, the limited partner, you're experiencing effectively calls on your capital in that first couple of years, which means that relative to what you invested, you're a bit underwater, right? You're not making any return on that money at that point, but come years, call it 4 through 10, that's when you expect to realize gains through those investments as those companies either merge with others or go public and you experience the upward slope of returns that are available. Thus, that's the shorthanded way of describing what happens in private equity investing, the J Curve.

Ben Smith:

When I think of the J Curve, I got a third grader right now, so I always think of the penmanship lines where you got the line and the J is going underneath it, the bottom of the belly there. So, that's how I think of it as all the dotted lines back to third grade when they start doing the J curve thought. I want to hear a little bit about when you hear the term private equity, I think there's a lot of assumptions out there. So, we'd like to myth bust a little bit.

So, there's assumptions that this type of investment, somebody invests in it, and many of these businesses, they just go bankrupt. Because I know we're talking umbrella private equity and how people can invest, but there's different types of private equity investing out there. Can you talk a little bit about just compare and contrast angel investing and buyout and venture, those sorts of labels and how they maybe differentiate in terms of when maybe in a company's life cycle we might be investing in them?

Rich Powers:

Sure. I think bankruptcy is an occurrence that happens across companies of different maturities, of different areas of the market, of being private or public. So, it's not an experience that's endemic to private equity, but I think maybe we talked a little bit about the types of private equity, it probably provides a little bit more color where that risk probably exists the most, right? So you made the point around angel investing and started off talking about what angel investing looks like. It's two people in a garage with an idea. There's capital that shows up there that thinks this idea is good and what can you do with that idea that translated into a real company. That's probably a higher risk type of investment.

The probability of translating an idea into a business is lower than say if you already have an existing business in place. So, perhaps that's where this notion that more bankruptcies occur, it'd probably take place, and I think that's pretty reasonable. The next stage, there will be venture investing. So, you've transitioned from being two people in the garage with an idea to actually having a business and building out an operation. So, now there's a little bit more maturity. Again, I think that risk exists as well, but you're closer to having something like a product to actually sell, at this point, to business to be a viable long term offering. From there, you move into growth.

So, these are companies that have gone from the idea to a business to actually selling meaningful product. These growth investments, these tend to be companies that are trying to scale their operation in some way. Maybe they're regional in nature, but now they're ready to take a more national approach to making their product available in the marketplace. They need the capital infusion there. Again, it's a more mature organization, more breadth to it. The probability of bankruptcy probably declines there.

And then maybe the last group that I'll talk about would be buyout. So, think of buyout really as companies that either public or private, but I'll go back to the Dell example, a public company where perhaps there is an opportunity to right size the operations, refocus the strategy of the organization, recapitalize the balance sheet in some way, shape, or form. These companies are usually larger in size.

Again, I'd say the risk around bankruptcy probably declines there. So, I think what has to be pretty clear to the audience would be that bankruptcies are a possibility, but just like in the public markets, it depends upon where you are in the life cycle and a maturity of an idea of a business where it's actually going to show up. So, I wouldn't paint with a broad brush on that topic just like I wouldn't paint private equity with a broad brush as a single monolithic idea.

Curtis Worcester:

No, that's good. I'm glad you broke those out that way. So, I want to talk about trends in finding capital to grow companies. So, I think people probably traditionally are more familiar with large companies. They would go borrow money from investors, issue bonds for example, or they sell their stock to the public through IPOs to get capital to grow. So, one thing that we read and we've heard that stuck out to us and this came from Investopedia.

So, the Wilshire 5,000 index, it tries to capture 100% of the investible US market. It typically contains more than 5,000 stocks to do so. Recently, it only contains 3,687 stocks. So, I just want to ask your reaction in how does private equity fit into that statistic and how is it in impacting investors' ability to capture the growth of investible companies today?

Rich Powers:

Sure. It's a topic actually, I used to spend a lot of time on my old job in the ETF world as the pool of investible companies continue to shrink. Listen, I think if you look from an overall count standpoint, the trend is inarguable. Fewer and fewer companies are public. The market capitalization of the public equity marketplace though is inarguably materially larger. You just simply look at the largest companies and their market cap relative to say 10 years ago, the largest company, 4 or 5 or maybe even 10 times larger in terms of size. So, there's a variety of factors that are happening there. I think a couple things that are driving why I say companies are staying private for longer.

One, there's a regulatory burden of going public. There's additional audit requirements and filings. There's certainly a meaningful more scrutiny from a regulatory, even from a public marketplace perspective. So, I think that is the reason why companies are staying private for longer. The availability of capital would be another reason. The underlying pool of capital to finance companies who are in the angel venture growth stages of their maturity is larger today. So, a company can stay private for longer, build out the business to a maturity level where perhaps at a later stage in their life, they can become a public company.

So, that I think is part of the reason why we see a smaller public market in terms of account and a growing private market in terms of account. It's hard to imagine that trend changing materially. I mentioned earlier that about 10% of the global equity market cap is in private companies. Twenty years ago if we were talking, certainly, we wouldn't have been on this platform because it didn't exist, but number was closer to 1 or 2% of the equity market cap. So, I think there's some of those trends that are drivers of it and there's reason to believe that it'll continue, at least for the foreseeable future.

Ben Smith:

So, Rich, you did a great job of painting where we are today and why companies are choosing private versus going public and also where we have been the last 20 years, but let's look in the crystal ball in the future. So, in the future, how is it changing today and do you see time in the future where an everyday investor will be able to easily access PE?

Rich Powers:

Yeah, I really like the point you made earlier, which is that a lot of investors, individuals already have access to PE through a pension investment that they have. So, in many ways, it's reached the masses in a less obvious but nonetheless powerful way. So, I think that exists. I think there's been some talk from a regulatory standpoint, it really depends upon different regimes that are in place from a regulatory standpoint as to who's enthusiastic about making PE more available to investors or not. It's difficult to say where things are today, but I think what's inevitable is that more individual investors will have access to PE in the future than have in the past. And then I say that for a variety of reasons.

One, the firms who have historically been PE firms, who have gone to endowments and foundations and other institutions for capital, they're now branching into the retail space. So, they are either developing products and partnership with a financial advisory firm or a broker dealer. They're making listed products available for individuals to purchase. So, they are looking at the individual investor as underserved really in accessing the private markets. I think there is reason to look at that with the skeptical eye in some ways, because you'd say, "Well, are these firms coming to the individual investor market with the best of intentions?" It's simply a cash grab and a capital raise.

I think what that means is that as an individual investor, aligning yourself with a financial advisor or a firm who can do the type of research to vet the really great PE firms from the very average ones is going to be really, really important, because the average PE fund probably gives you about public market returns. Is that worth the effort if you have to tie up your capital for all this time? So that's why working with a professional who can do the due diligence and make those decisions on your behalf is going to be really powerful.

So, I do think more and more individuals are going to have access to PE, but just simply blindly buying PE is not going to be a strategy that's going to lead up lots of happy outcomes. I think having a discerning eye, having a professional that's working for you is going to make a world of difference there.

Curtis Worcester:

Yeah, that's great. I want to keep going here, Rich. Back in our intro, we talked about how there might be a level of skepticism that many communities and speaking where Ben and I are located, smaller communities have when investors are coming in and purchasing local businesses. Private equity is then finding ways to save costs, grow revenue to create returns for those investors.

I think in some cases, again, speaking specifically to our lovely rural state, in some cases, the management decisions of the private equity fund might be at odds with the goals of the communities, even on the ground level of sponsoring a little league team or having local jobs or cutting jobs that affect people in the local community. So, can you just talk about is that a fair critique or is it an unfair label that's being applied to the whole industry of private equity?

Rich Powers:

I'll go back to the bankruptcy example we talked about before. I think again, painting with too broad of brush, I think, is a dangerous thing here, right? Certainly, there are instances where a private equity firm requires a company and the decisions they make is to take costs out of the system. It could mean laying off workers, shutting down operations. It's painful for everyone involved and that certainly does happen. But I would say that that's not necessarily the majority of actions that we tend to see here. And then oftentimes that could be in places where perhaps capitalism being used in its best service and again, hard for the individuals who are impacted by that, but there could be an economic rationale in that case.

But I would say the majority actually of private equity falls into that bucket, where there's job creation and formation, because those angel investments, those venture investments, those growth investments, they're allowing companies that didn't exist to exist, for companies that do exist to grow their footprint, grow their job creation capabilities and their economic output. So, I look at it as yes, it happens, but there are also many great aspects of private equity investing, just like you would characterize on the public equity side of things.

Ben Smith:

To that point, I know there's a lot of great things happening around the State of Maine as well. There's a really passionate group of Maine citizens that are Maine Angels and they do investing. So, it's just creating this ecosystem of getting capital across every size of business. I think that's what I think the State of Maine is really trying to do and using all the levels of access to capital so that we can continue to track businesses and grow and create jobs.

So, Rich, I think you did a great job touching on that, because I think that's really important to highlight is yes, there's good and bad with everything that's out there, but it's really easy to just look at this and say, "Hey, there's an example that my friend or my buddy lost their job, that they had been there for 20 years because management accepted some private equity money, got consulting, and decided long-term to grow the business. They had to shrink in the near term."

So again, sometimes it's a little tough to judge what the decision is until you get little more of the facts. Obviously, Rich, in terms of your role as Head of Private Equity, very new in 2022, and obviously, private equity is not something that Vanguard's known for. So, I'd like to hear a little bit about how Vanguard is positioning your clients with private equity. So, what initiatives are you working on or is there anything that you can share with us there?

Rich Powers:

Yeah, I can say that really the entirety of my time here at Vanguard that we have been looking at private equity in some way, shape, or form for almost that entire period, perhaps even before and nobody's told me that, but certainly during the 20 years that I've been here. We decided to enter private equity in 2020. We offer a private product that's only available to our endowments and foundations that where the advisor... The shorthand for this is called outsourced CIO, where Vanguard manages the pool of assets for small endowment or our foundation.

And then we also offer it to our ultra-high net worth investors who qualify from a suitability as well as a regulatory standpoint from an asset standpoint and through our personal advisor services organization, which is our version of a hybrid device where you have an advisor you interact with, but also high level of technology which you interact in. So, that's where our current PE offer extends. It's a private offer. We're a couple years in. Certainly, we're pretty thrilled with the adoption along the way. The reason why we're doing this, again, I'll come back to where we started, which is we exist to serve our investors.

So, our conclusion as we were thinking about entering this marketplace was, Is this going to be valuable to investors and add to their diversification and to their potential for maybe realizing their investment outcomes and enhancing their returns?" Our conclusion unequally was yes, it will. Certainly, there's risk with this, but we believe we can add value to client portfolios. So, we're making it available to those investors. Uptick has been good, of course, feedback and questions. I think we've spent probably the last couple of years educating a lot of folks.

I think the endowments and foundations that we serve, pretty familiar with PE, but maybe couldn't access the quality of PE that we're bringing to market through HarbourVest, who is our partner on this. And then for the retail investors, some of them are familiar with PE and so this is allowing them to access PE through the Vanguard platform that they know and trust. But for a bunch of folks, PEs is brand new. So, explaining, much like we've talked about today, some of the differences and similarities to what they're familiar with already has been where we've spent the lion's share of our time.

Curtis Worcester:

Yeah, that's great. Obviously, it's exciting and new and I think you hit the nail on the head with the educational, which is what we're trying to do here with this conversation is bring education to private equity in our clients and our listeners. So, I do have a wrap up question for you, Rich, before we let you go. So, obviously the name of our show is Retirement Success in Maine Podcast. So, we'd like to ask all of our guests, how are you personally going to find your retirement success when you get there?

Rich Powers:

Yeah, I think for me, hopefully, it starts with good health. I think second that I'd be comfortable enough from a financial perspective that you'll be able to spend time with those that I love as much time and support them in any ways that I can. I think the third thing that comes to mind for me would be the ability to travel. I've had a benefit of traveling for work and also personally. So, I appreciate that. If I can mix in some music, that would be great. I'm a big music fan.

And then the last thing would just be I found a passion over the years for education. So, in some way, shape, or form, staying connected to that and either helping a local community or be involved in teaching in some way, shape, or form. I think that would be a really nice way to put a bell on what retirement would look like for me.

Curtis Worcester:

That's awesome.

Ben Smith:

Rich, that's a fantastic answer. We really can't thank you enough for our show today, lending your expertise to our audience around private equity, what it is, what it isn't, how it's working, and where it's going. So, thank you so much. We can't wait to hear a little bit more maybe down the road from you about where things are going, but thank you and catch you next time.

Rich Powers:

Thanks much guys. Really appreciate the time.

Ben Smith:

So episode 71.

Curtis Worcester:

Seventy-one.

Ben Smith:

Yeah. Private equity in your retirement, what should you know. Again, good to have. We're trying to swing for the fences here. We said, "Well, hey, let's ask the Head of Private Equity at Vanguard and see if they would come on our show." We were very fortunate and we're extremely blessed that we got to talk to Rich today and be able to share him with you, because I think hearing from somebody that, again, explaining it in a way, here's a very complex topic and explaining it a way that we all can consume it and we all get where we're going.

I know we could expand probably another eight hours on what this is and how it works and all that, but yeah, I think hitting some highlights was the goal. I think Rich really did that in spades. So, again, we always like to wrap up our show with things that we learned or we wanted to take away from today's show.

Curtis Worcester:

Sure.

Ben Smith:

So Curtis, what was something that you took away from our conversation with Rich today?

Curtis Worcester:

Yeah, it came up a couple times, I think, in our conversation. It was about painting that broad brush, if you will. It probably could apply to things more than private equity. I think we could all hear this, but specifically today and the piece about the local communities, it was the conversation we were having. I think more and more specifically in Maine, I know we're seeing it recently in these companies that have been longstanding family or locally operated owned businesses here are being acquired by private equity funds. I think it's happening more and more and I get the reaction that people have. If the little league team can't get sponsored, if someone loses a job, it's terrible. I get it, but I think it's important and Rich pointed this out to really think about the goal here.

They're not sitting there saying, "Let's go into Bangor, Maine and just destroy their lives." The goal is growth. They're trying to grow the company. It is an investment. They're trying to make a return on that investment, but they're not coming here just to put people out of business. I think it's important to remember that and in the short term pain that it may or may not cause. I get it, but I think it's just to remember the bigger picture and the goal of these funds. I think that's a good takeaway. Again, private equity or not, I think sometimes it's good to just look at the big picture in all of aspects of life. So, there's my spiel.

Ben Smith:

Okay. No, I like that. I think that's something we're going through and understanding, well, again, what it is out there in the community. We talked about how a lot of us maybe have public equity in our lives, in our investible savings somehow. Even in an indirect way, it very much touches a lot of our future in terms of our income through MPERS and things of that nature. But I wanted to talk a little bit about, again, one thing that we didn't touch on a whole lot today, but in terms of we talked about who can access it and what. How is something we touched on a little bit.

One of the things that Rich was talking a little bit about was getting access to a fund to fund, somebody that just says, "Hey, here's who the best ones are out there of private equity and they help make those picks for you versus you and I walk up to some private equity manager and say, 'We have money we'd like to give you.'" When you have the Harvards and Yales out there that they just choose the best managers, then what's left over for the Guidance Points of the world to go and get access to? Because they get all the money they really need from these really large endowments and foundations-

Curtis Worcester:

That's right.

Ben Smith:

... and pensions. So, I think that's something where to realize, as Rich said, but also a lot of them are, as Rich was talking about, these 10 to 14-year windows. I view this as planting a vineyard. You plant your grapes and you don't know based on water over that timeframe how good the grapes are going to be. There's years that there might be volcanic ash in the air and the trees suck up volcanic ash with the water from the rain. All of a sudden, you can have a crop that might not be great. You could have the next year that's pretty good.

That's what private equity is too. It is meant to be on a year by year basis and rotated through a portfolio. Why I'm bringing this up is if I'm in retirement, I'm retiring at 62 and I make an investment that might be 10 to 14 years down the road and I have to do this year by year by year to really realize all the benefits of these sorts of funds, getting your money back and having the ability to lock up your money for that period of time is not really attractive for a lot of people.

Curtis Worcester:

Sure.

Ben Smith:

That's I think why you've seen certain investors' profiles work and some not. Some people want to access it and they have enough money for maybe one vintage of a fund, and what we don't want to do is do that and it'd be the one that maybe had the bad yield or the bad crop that year, that thing. So, I think there's lots of things to go through as we talked about suitability. Are you right for it? But also how can we do it? You want to make sure you're doing it right. I think those are things to consider and work through and as Rich said, working with your advisor. If it's not us, that's okay. But working through those things together of, "Is this right for me and what are the things I should know?"

Maybe this is a good foundation for you to hear and maybe hear twice to go through and then have those conversations with your advisor and figure that out. So, yeah, hopefully, that did that for you today. We will have a little bit more on our website. You can go to blog.guidancepointllc.com/71, because this is episode 71 of Retirement Success in Maine. So, you can go there, check that out. We really appreciate you tuning in today. We're really excited about the direction where we're going and we'll catch you next time.