New York City, July 20, 2023 / PR Newswire / – Parallaxes Capital, a premier investment firm that focuses exclusively on monetizing Tax Receivable Agreements (“TRAs”), is pleased to announce that its Founder and CIO, Andy Lee, recently appeared as a guest on the AAAIM (Association of Asian American Investment Managers) High ELI Podcast. Andy joined host Johnny Wu, alongside special guest host Nick Pon, to delve into the rapidly growing Tax Receivable Agreement market, his motivation for venturing into this space, and the challenges associated with this esoteric asset class.
The AAAIM High ELI Podcast is dedicated to amplifying the voices of emerging leaders aspiring to become pioneers in the investment management industry. Hosted by AAAIM, a leading organization committed to promoting diversity and inclusion, the podcast showcases the stories and insights of individuals who have made significant contributions to their respective industries.
During his appearance on the podcast, Andy shared his personal experiences, challenges, and triumphs as an investment manager. Listeners can expect to gain valuable insights into the strategies and principles that led Andy to explore the world of TRAs and establish Parallaxes Capital.
The episode featuring Andy Lee on the AAAIM High ELI Podcast was released on July 19, 2023. To listen to the interview, visit AAAIM’s website at https://aaaim.org/aaaim-high-eli-podcast/.
About AAAIM:
AAAIM is recognized as the national voice of AAPI investment managers and the only national organization dedicated to supporting the growth of AAPI investment managers. Our coalition of seasoned and rising investment managers is committed to mentorship, promoting access to capital, and educating the industry and public at large about prejudice experienced by AAPI. To learn more about AAAIM, please visit https://aaaim.org.
About Parallaxes Capital Management:
Parallaxes Capital (“Parallaxes”) is a premier investment firm that focuses exclusively on monetizing Tax Receivable Agreements (“TRAs”). We provide private equity sponsors, co-investors, and management team members with solutions to achieve liquidity, diversification, and optionality from their TRAs. Established in 2017, Parallaxes comprises experienced investment professionals from leading private equity and growth equity firms. To learn more about our services, please visit www.plxcap.com.
Media Contact:
Harrison Hsueh
media@plxcap.com
See below for a full transcript of the podcast:
| Johnny Wu | Hello! This is Johnny Wu and welcome to AAAIM High ELI, a podcast series brought to you by the Association of Asian American Investment Managers, better known as AAAIM. This podcast series is focused on raising the profile of emerging leaders that aspire to become the next generation of leaders in the investment management industry. AAAIM’s emerging leaders initiative, ELI, exists to help Asian American and Pacific Islanders, AAPIs, break the bamboo ceiling, analogous to the glass ceiling faced by women. Although Asians are well represented at the junior ranks across the industry, those statistics drop off precipitously at the senior ranks. We are grateful to our guests for spending time to support AAAIM High ELI, and we hope our efforts will make an impact over time. Support for this podcast was made possible by CIBC Capital Markets. CIBC Capital Markets partners with corporations, governments and institutional clients in key financial centers around the world to develop customized solutions that enable their clients to access capital, expand their operations, and actively invest. Their team of professionals around the world work in highly disciplined, cross functional teams, to provide the market intelligence and creative financial solutions you need to address your unique business challenges. With offices across the US, they have the expertise to provide organizations with the insights to turn opportunity into action. Our guest for today’s podcast is Andy Lee, Managing Partner of Parallaxes Capital, an investment firm he founded in 2017 at the age of 26. Previously, Andy was with Lone Star Funds and with Loan Star’s support, he spun off to form Parallaxes Capital to take advantage of an esoteric and growing asset class, Tax receivable agreements, TRAs. Andy is as smart and talented as they come, having entered college at 15, and earning his Bachelor in Finance and accountancy from the University of Illinois at Urbana Champaign. He went on to earn his Masters in Accountancy before joining Citigroup as an investment banker for his first job out of college. Andy has been featured in publications including Institutional Investor, NBC, Forbes as part of the 2020 class of 30 under 30, Reorg Radio, and Fitch’s LevFin insights. Joining me on the podcast as Co-host is Nicholas Pon, Investment Director at the YMCA Retirement Fund, where he is part of a team that manages over 8 ½ billion in assets under management. Nick’s expertise is on uncorrelated assets across public and private markets where he focuses much of his time on evaluating hedge fund strategies. Thanks to Nick for joining this podcast and taking the time to interview Andy. Without further ado, here is our conversation with Andy Lee. Well, I’m thrilled to welcome both of you to the AAAIM High ELI podcast series. Andy, you and I have known each other for some time now being introduced through AAAIM. You’re one of the prodigies, kind of, in the industry, right? Asian American Male who started his own firm at a very young age under 30 and you’re just a pro now. And then, Nick, thank you for agreeing to do this podcast. I’m more of a generalist in terms of – you know – I’m just very nosey. I love to ask questions about really smart people. But being on the allocator side and all the experience that you have in looking at, you not only mainstream hedge funds but esoteric assets. I thought you would be an asset in terms of interviewing Andy for this podcast here. So, first of all, welcome to both of you. Thank you for taking the time to join the podcast. |
| Andy Lee | Thank you. |
| Nick Pon | Yeah, happy to be here. I actually met Andy a few years ago. We didn’t know we were both in finance at the time. We actually met on the rooftop because we lived in the same building and our dogs are good friends. His dog’s named Taco and I have a dog named Donut. So, we kind of met there and then, even then, like, “Hey, what are you doing here?” So yeah, I’m really happy to be here today and happy to be an interviewer for Andy. |
| Johnny Wu | Yeah, small world here. So, we’re going to spend the bulk of the time obviously asking questions of Andy and Andy’s going to share a lot of insights. But before we get into that, Nick, for the benefit of the audience, talk a little bit about Nick Pon, like who you are, the YMCA, where you’re an allocator and your fiduciary for the defined benefit plan? |
| Nick Pon | Technically, we’re not a defined benefit plan. We’re kind of a unique structure, but I can talk about that a little bit later. I work at the YMCA Retirement Fund. We’re an 8 1/2-billion-dollar pension fund based in downtown New York City. We managed the retirement assets of US based YMCA employees. We’ve actually been around for a hundred years and just do the way our plan is structured, it’s technically a DC structure but looks more like a DB in a few different ways. But do the way we’re kind of structured, we look morally an endowment or foundation and the way we invest in our asset allocation, because the draw on our fund is 2% to 3% per year and this gives a really long time horizon for investing and the ability to get really good long-term partners. Our investment team has about 15 people, led by our CEO, Hunter Reisner, who’s been here since 2010, I’ve been here about six and a half years now on the marketable side of portfolio and focused on uncorrelated investors, public and private markets, that spans a lot of different things, which makes my job really interesting. On the public side, it’s things like multi-strategy hedge funds, equity market neutral, and the private side, it’s really esoteric, things like insurance, reinsurance, life settlements, and we’ve looked at royalty strategies, and now spoken to Andy about tax receivables, definitely interesting asset class to be in. And prior to the YMCA, I worked at General Motors Asset Management in their absolute return strategies group, and part of that was at UBS and their hedge fund solutions group. |
| Johnny Wu | Got it. OK, so, being a veteran of the hedge fund industry and spanning your career at UBS hedge fund Solutions, GM asset management, and now YMCA, you’ve covered a lot of different strategies, Nick. What do you gravitate more toward today? Do you like the complexity or do you like, you know, you talked about multi-strategies. You don’t actually get to meet the individual portfolio managers, right? A lot of this little pod are like a lot of the large kind of platform shops say. What thrills you about the industry? Do you love meeting people like Andy that are running their own firms? |
| Nick Pon | Yeah, I love doing this on the multi-strategy platform work, just understanding how the processes work, see how the risk systems work and just the recruiting efforts over there. But then you know, a lot of the time I like spending on some uncorrelated strategies that are really unique and it kind of means like, in this world today, everything is investable from just artwork today to music royalties and buying YouTube royalties to things like tax receivables, but not as many people know about. So, spending time on that drilling in really understanding how different industries work is always really interesting. |
| Johnny Wu | OK, that’s good. One thing I found is that the people that you interact with in this industry – they’re just so smart and the more interactions you have, you just get smarter yourself, right? So, you’re in such an enviable seat, and I’m sure you’re a superstar in doing it. Thanks again for doing this podcast here. So, I will turn it over to you, Nick, to do all the tough questions. But before we do that, Andy, I’m going to ask you to give a little bit of background on yourself, right? And when I say background, take us back a little bit. Everyone has a story. Like, Asian Americans in this industry. I grew up on $5 a day. Nobody handed me stuff. I had to go out and kind of figure things out. And that’s why I love The Underdog. Talk to me a little bit about your background for the benefit of the audience here, Andy. |
| Andy Lee | Yeah, absolutely. And thank you for taking the time today. So real quick, my name is Andy Lee. I’m from Champaign, IL, so, the middle of nowhere, about two and a half hours South of Chicago land. I had the option to go to college a little early. I went to college when I was 15, and when I graduated, I was too young to sign my lease in New York City, and so my dad insisted on me pursuing a PhD. Being a rebellious kid, I wanted anything but to do a PhD. I want to be an Archaeologist but he was insistent. I couldn’t sign the paperwork, and so I did a Master’s in Accountancy with a focus on taxation. And, the only reason I did that, just to be frank, was primarily from two pieces that I prized. One, coursework with no classroom participation, and two an open book exam. And so, for the kid who was lazy, taxation was a godsend. Did that, I started my career at Citigroup where I worked in M&A. And there, I had the option to work on a TRA between the Rio Tinto and Cloud Peak, a coal producer. And I was like, this is fascinating, and someone should really provide third-party liquidity for it. Fast forward, I moved to a firm called Lone Star Fund down in Dallas, TX and there I was basically told, “Andy the only way for you to get promoted in this group is for you to create something.” And so, there were a number of things that I looked at, might that be, if you thought that drones were inevitable in our lifetimes, then you would buy all the air rights along the Hudson and charge Bezos a toll whenever he crossed that. Unfortunately, that was too much of an R&D in science project for the firm or to be investable. What got off the ground was in creation and monetization of tax receivable agreements. And several years ago, the firm said, “Andy, this opportunity set is too small for us given that they were encroaching on almost a hundred billion of assets.” But partners said, “Why don’t you go do it and we’ll give you money to go do it and at worst, you can come back in two years.” That was six years ago. We’ve now raised 4 funds we’re embarking on our fifth and have been partners with leading foundations and endowments and been thankful to be part of this journey. And AAAIMS been a big part of that, we’ve been incredibly thankful for the organization and the individuals and the support of those individuals over time. |
| Johnny Wu | So, if I were to do the math here, when you started Parallaxes Capital, you were on the 30 years old, right? So, you didn’t have the grace, per se, and then like leading a firm, starting a firm, hiring people, managing people, I’m sure those are all challenges, right? Nick, let me turn it over to you. Would you hear a story like that? Obviously, he’s very bright, right? Went to college at a very young age. Is it go getter, right? Like figure out how to get promoted. Starting something new and having the audacity to start his own firm. Amazing, right? From an allocator perspective, what questions do you have for Andy on that? |
| Nick Pon | Yeah, you know, I’d love to hear about how you went up building up your key team from the start, who you thought were key essential personnel to kind of start the firm from scratch. I want to hear about your challenges, let’s start with business especially, a non-standard area that other people kind of build businesses based on. |
| Andy Lee | Yeah, absolutely. We’ve had a ton of trials and tribulations, might that be personnel among others, unlike other asset classes, might that be private equity or credit, where you can go down the road and just pick up someone else’s number to recruit for your team because they have tried in through processes or go-to-market strategies. For us and our opportunity set, that was actually incredibly difficult on a number of fronts, primarily because we didn’t know what we didn’t know. And for what we did, that was a need for us to primarily recruit generalists, and then over time, as we scaled and these individuals scaled with us, moved them into more specialist roles. So, what might that describe? We primarily recruit it from the investment banking and private equity skill set, and overtime we have now moved towards more of an operating company model where individuals who have traditionally come from the deal world are now moving into more originations, as well as marketing oriented roles, roles that are not something that you typically find in a private equity skill set where the deal team is typically siloed into – or entirely embodied into a single person from the origination to the execution of the transaction. Overtime as we’ve learned more about our asset class and our underlying go-to-market, that has changed the kind of personnel that we’ve sought to recruit as well as the specialist skill sets that we’ve sought to refine among the existing personnel that we have at the firm. |
| Nick Pon | Yeah, I guess it would be good now to kind of talk about what tax receivable agreements really are. So, I assume a lot of the audience doesn’t really know about them, but love to hear you explain and highlight what they are, what factors kind of drive their returns and how big the addressable universe is? |
| Andy Lee | Yeah. I’ll start the last question. Look, we traffic in the largest asset class that no one’s ever heard of, tax. There are two things that are inevitable in life, one death, two taxes. You’ve invested in death; you should think about taxes. But it is pervasive in our society. Might that be the personal taxes, property taxes, or state taxes that each and every single one of us pay as responsible citizens. Taxes core into the fabric of our society, and it’s one of the things that actually has the ability to deliver what many allocators view to be the holy grail, uncorrelated returns. For what we do today, TRAs are the tip of the spear. They were created almost 30 years ago as an avenue to share tax benefits between sellers and buyers in a private equity framework. And over time, as there has been evolution of the asset class, it’s taken a number of formats primarily as a factoring arrangement, but the asset class today that we look at very specifically in the broader tax framework is a $40 billion opportunity set being monetized in investment grade, near investment grade credits primarily backed by private equity firms. So, there are five value props that we bring to bear, as investors. The first and foremost is an uncorrelated return. The 2nd is a cash-yielding investment, and the third is call optionality on potentially higher corporate tax rates. There are two other elements that are important for the taxables and that is a tax deferred investment and thereafter a tax efficient where we primarily pay cap gains. And so those are all avenues that are accretive and value added within the context of many investors portfolio that they find to be interesting. |
| Nick Pon | And I guess what type of companies simply issue TRAs? And I guess, what really drives the return for you that you’re trying to generate on the back of these when purchasing them? And are you kind of purchasing them directly from the companies or helping originate these or who the typical sellers you’re sourcing these from? |
| Andy Lee | Yeah, absolutely. So, the kind of companies that these TRAs are associated with are typically investment grade – near investment grade public companies. They run the gamut of the likes of a RE/MAX, a Shake Shack, and Duff and Phelps, names that people have heard of. And it pertains to some of these sellers and who are creating them that the likes of the mega funds where many of them have been beneficiaries of these tax receivables as a result of their management companies going public, that runs the gamut of the likes of the Blackstone, a Fortress, an Apollo. All of them have concreted this underlying structure that has allowed for this, otherwise, niche tax arrangements that facilitate the sharing between the previous pre-IPO holders as well as the current public shareholders. |
| Nick Pon | And I guess how are you sourcing these investments, like, how do you convince them to kind of sell to you and how is your cost of capital compared to theirs? |
| Andy Lee | Yeah, absolutely. From a go-to-market perspective, it’s a lot of brain damage. It’s a relatively knowable universe of these underlying asset given that there are, call it, 200 and change of these running around in the public markets. However, the underlying holders of these on average of 40 to 50 different holders, almost 10,000 and change holders out there that we need to get in front of. And so, the go-to-market associated with them reminds many of what venture capital or what growth equity looks like, where you are seeking idle warm introductions into these underlying holders or getting to them via cold emails or cold calls. And so, the primary reason for that is the size of each individual transaction is relatively small. Call it in the $10 to $15 million ZIP code, which as a result drives many away the broker community and makes that more challenging in order for us to facilitate transactions. That is an inefficient part of the market, and for us, we seek to have that direct outreach efforts in order to get in front of them and, thereafter, build a relationship with them and we’ve done that, through a number of methodologies, might that be sending things such as cameos to some of these holders, but also trying to find creative ways to get in front of them. I think a story that I’ve shared before is that I ran actually a 5K with an individual. When I understood that that individual was going to run this insofar that I could bump into him. And so those are not exactly scalable avenues through which we can get in front of holders, but we’ve sought to find avenues to at least touch them in some way shape form. |
| Johnny Wu | Let me jump in here, because I’m trying to be a bit more concrete for someone who’s not, you know, deep in the asset class, right? So, you talked about Shake Shack, right? So that’s a company that most people know, right? Amazing burgers, right? So, if I was a private equity investor, I was an early investor in Shake Shack, right? So presumably as they’re building up and scaling, they’re losing money. They’re not EBITDA profitable yet, that takes several years. And then at some point they become profitable. Early investors want to monetize. They need, you know, liquidity. It goes IPO and then it becomes a public company. Private equity investors that early on could cash out and sell their shares, but also what I think about what’s easier for me to digest is net operating losses. I know that’s not exactly what you do but let’s just take that as an example. Lose money for a while but in the future, you make money. But you don’t want to pay taxes on money that you make cause of all that money that you lost before. So, you get a credit for it. So, you could actually sell those net operating loss tax credits, if you will. Like, that’s how I think about it. Tell me, is that a good analogy for TRAs and it’s not NOLs that you’re focused on? I know it’s different? Can you just talk a little bit about that, Andy? |
| Andy Lee | Yeah, absolutely. So, I think one piece that I failed to touch on earlier, and shame on me, was that we are secondary market purchasers of these assets. So, the creation of this opportunity is primarily on the back of the fact that public market investors ascribed little to no value to tax assets, and as such private equity firms and investors have started removing them from these companies that they subsequently taken public. That’s primarily because the public investor, given the flows towards mutual, are passive versus active. They have oriented these mutual passives or oriented towards revenue growth, EBITDA multiples, but less so free cash flow multiples. That’s more or so the domain of private assets or private equity who are very free cash flow sensitive. And as a result, when the private equity firms realize that public equity investors are not ascribing any value to it, they remove it. The problem for many private equity firms is that they have finite fund lives, 8 to 10 years fund lives, and they can’t hold a paper for another 10 plus years thereafter. And many of these tax assets, to your point, Johnny, have relatively long durations. And as a result, our job is to provide that upfront liquidity option, delivering dollars to them today in return for more dollars overtime. |
| Nick Pon | And I guess, it would be really fascinating to know what metrics you screen for when looking for TRAs, like, how do you kind of value a TRA for a different company and what’s the target company you kind of look for? Do they have to be profitable now to kind of offset, some of those net operating loss before they paid out for your TRA? And I guess, what’s the risk you take when you’re buying TRA for a company? |
| Andy Lee | There are effectively 3 forms of risk that we are manifesting in TRA. The first of which is around corporate tax rate risk. So, to the extent that corporate tax rates move down, we have a linear relationship with them. So, think about it as in that operating loss but $800 million of value. And today’s 21% tax rate as your price. A hundred by 21 gets you $21.00 of value. Should the tax rate move down to 15%, that 100 is multiplied by 15 so $15.00 of value. So, there’s a linear relationship on the way down, but correspondingly on the way up, that’s the first major risk that we’re taking. We’re effectively a call option on corporate the tax rates. The second option risk that we manifest is around credit risk. The majority of our portfolio that we seek to target to your question, is IG near IG businesses, so call it what over a 7-year migration according to rates methodologies, a triple B might move into junk bond ratings over 7 years. They’ll call it up 12 to 15% historically, and so that’s a big risk that we take. But the most pernicious risk is the final risk and that’s around extension risk. The one thing that I would highlight is that tax assets never get lost. They merely get deferred. So, to the extent you don’t use your net operating loss this year, you don’t lose it, you merely defer it. And so, your IRR sees some level of degradation, your MOIC remains the same. And so, the three risk, corporate rates, two credit risk, and then finally extension risk, that last one is the one that really kills us because it compounds the risk around credit risk as well as corporate tax rate risk cause you’re not able to bring down your basis over time. |
| Nick Pon | Gotcha! I guess it’s on the up front. How do you kind of screen, for like, what are you using as metrics to screen for with looking and evaluating TRAs? |
| Andy Lee | Almost all of these are bilateral transactions, and so we know the universe that we want to buy. So, of the 200 and change TRAs that are out there, we’ve sought to underwrite the entirety of the universe prior to actually seeking to originate against those opportunities. So, there are a number of TRAs out there that are challenging for us to necessarily get our heads around. And we’re all scars of our past, but some of them that make it challenging are one, the businesses where the unit economics are not proven just yet, or are relatively speculative, that are more so oriented with being venture backed, so more recently there was a space company that had a TRA in it, that’s challenging for us. Today you have minimal to no revenue and yes you have a very large equity value and not enterprise value, but you have no free cash flow. Forget taxable income, which is what we’re really oriented towards. And yes, you did generate a very large tax asset and it could be worth a lot in time, but until you demonstrate an ability to become profitable and then free cash flow positive, it’s an incredibly challenging story for us to be able to underwrite because we’re selling to our investors an uncorrelated return with IG, near IG businesses, making a call op – buying a call options associated with space business can be very challenging. And so that’s one thing that, yes, we may engage with a holder of a TRA associated with a business like that, but it’s not something that we would make core position within our portfolio. But in time, so, what’s an example of something like that? We made an investment in an oil and gas business in 2018. Obviously, oil prices went to -40 during the depths of COVID, and that was incredibly challenging for us. Ultimately, with that story, had a happy ending insofar that the company got taken private and we made a handsome return on that. TBD, if that was the necessarily the right call, insofar, that’s not exactly the uncorrelated return per se, albeit it was a relatively small part of our overall portfolio. |
| Nick Pon | Gotcha. I guess, other examples, you know, what’s a good typical example of a TRA that you kind of like – how you got to go through the metrics you screen, like you know, positive, and then you kind of like invest? Could you kindly walk me through an optimal case scenario where it’s worked out and maybe one where it hasn’t worked out so well, in terms of, you know, duration being extended or the company potentially going out of business, like, I just want to help others understand what really drives returns in this? Yeah, examples would be good. |
| Andy Lee | Yeah, happy to. So, an example of an investment that we made is RE/MAX, the real estate franchisor headquartered out of Denver. That’s a business that has been around and, well, was taken public by his former private equity firm Weston Presidio in 2013. We ultimately bought the TRA and as part of that, our beneficiaries of that cash flow stream overtime. The sources of those returns are among other things, credit risk that we inherited, that business is – to think about the uncorrelated nature of our asset class, think about it as a business with $100 million of EBITDA franchise revenue whereby it’s not subject to home price appreciation or transaction volume. It’s entirely focused on the broker remaining with RE/MAX overtime. For us, we held that investment for almost 6 years today and every year we get call almost 20% of our money in any given year. And so, almost – today, we’ve almost gotten 1x our money in that investment. Thereafter, we will get profit dollars from there, and so that’s an incredible source of value to us, given that the underlying credit today trades for, call it as 275. So as obviously it’s elevated today, but when we did the transaction, that was a sub 4% piece of paper while we were doing the transaction in the mid to high 18s (26:25). And so, we were effectively capturing the spread for minimal incremental credit risk. So, that’s a transaction that would be more challenging, at least from our perspective. The company has done incredibly well. Let me just put it that way. Look at Shake Shack. Shake Shack is a phenomenal business. However, one thing that we didn’t fully appreciate about the investment was its ultimate reinvestment runway. As a result of COVID, the firm decided to expand beyond its core markets, our metros, the New York City, LA Metros of the world, and expand it into having drive-thrus. That’s something that’s incredibly capital intensive, though will ultimately be very long term beneficial to the firm given that they are a very creditworthy tent when most of retail has been retrenching in mass. And so, for us, that’s our investment story that elongates out the day that we receive our money, primarily because today, they have almost 100 million of EBITDA, but have been expanding about $150 to $200 million a year in Capex to build up their store base. That ultimately results in a deferral of our tax asset. We’ll get it back in time, but has a ultimately weighed on our investment internal rates of return associated with the underlying investment. |
| Nick Pon | Gotcha. And I guess you’ve been with Parallaxes for six years now. This leads to excitement like, you know, what lessons learned along the way and how is the environment changed in, like, the TRA world from when you started in 2017 to 2023, had a lot of volatility since then too? |
| Andy Lee | Absolutely, it’s been very challenging. One thing I would say is that we’re ultimately liquidity providers for non-core assets. And so, we almost have a counter cyclical investment orientation relative to most investment firms. So, just to frame it, between March and May of 2020, during the depths of COVID, we did 8 transactions and moved almost $60 million during that time. From May of 2020 to the end of 2021, we moved all $4 million. In 2022, we moved north of $100 million and to date we’re on pace to beat that year to date. That’s an incredibly challenging market, insofar that during 2021 and whatnot, people will focus on deployment and we could barely get any time on people’s calendar. Today, where challenged insofar that many are looking for liquidity and we struggle to prioritize accordingly the transactions that may make the most sense for us in the near term and it can get done. And so, it’s been an evolution whereby the go-to-market motion that we had employed when I first left, but we’ve had to refine overtime, whereby, historically, private equity has gone to market via the broker channel. We’ve had to ultimately look and feel a lot more like a venture capitalist in our go-to-market. And so, the personnel, and personalities associated with those personnel, make it incredibly challenging to find in a more – in someone who grew up in the private equity context. |
| Johnny Wu | Andy, I have a follow-up question. Because with interest rates rising so rapidly in 2022, how did that impact your overall business? And were you prepared for that? Did that require you to kind of hedge any interest rate risk that you have from, you know, some of your receivables as well too? |
| Andy Lee | That’s actually an interesting question on a number of fronts. So, there are two elements that I would highlight for discussion. The first of which is on our asset side of the balance sheet and then on the other side, the liability side of the balance sheet which also have interest rate risk. Interest rate risk for us, we are an absolute fixed income product and, in that regard, we typically originate, call it 1,000 and change point spread above the underlying senior secure a obligor. In that regard, we are originating in the mid to high teens and while credit spreads have expanded relative to some of those underlying names, we still trade at a comfortable margin relative to the senior for a marginal incremental amount of leverage. So, for now on our existing portfolio, because of the margin of safety that we effectively have, there hasn’t been a ton of movement on that front. One. Two, on new originations, obviously we have to earn our cost of capital from allocators such as NICs of the world, and so we have been expanding the credit spreads that we require in order to get transactions done. So, if we were originating once in the mid-teens, we’re now closer to the high teens low 20s, and that’s on the asset side of the balance sheet. We also have – more recently in 2021, we achieved a securitization across the entirety of our portfolio and so we have interest rate risk in there as well. We are in the process of refinancing that as a result of a number of factors including the potential to get a rating and that would migrate us to a different set of buyers, but in the interim we still have interest rate risk associated with our previous financing. |
| Nick Pon | And this is just, kind of, on that front, you know, who are the other competitors in the marketplace fitting to these assets? And is that kind of landscape evolved as well? |
| Andy Lee | Yeah! So, I would say that given the size and attractiveness of our space, competitors have had significant interest in this space. Think about them as your typical multitrack where they would love to originate this as part of a broader portfolio of assets to the extent that it was available to them. I would say that the underground number of challenges that make this asset class relatively difficult for competition. And let me be clear, competition is inevitable. My job is to make it as hard as possible to compete against us. And there are a number of avenues that we seek to deploy to facilitate that. But in the last five years that have only been a single transaction, that we are aware that we did not get that done away from us. And so – and why is that? I think that’s a number of challenges. Going back to our point on our challenges recruiting, it’s around the fact that private equity typically recruits the best and the brightest and the carry cost or the opportunity cost for someone leaving a firm where he might be a VP or director principle in order to start a competitor is significant, one. Two, to go-to-market challenges whereby direct e-mail direct outreach is a requisite in order for you to facilitate transactions. Make it very challenging for someone who has traditionally been going to market via the broker channel, that being hiring an investment bank among others to facilitate transactions, and ultimately the transaction sizes among others whereby doing a $10 million transaction. You need a lot of $10 million transactions in order to facilitate a fund. And so, those are some of the avenues that have precluded competition historically. We’ve actually had a number of competitors leave the space primarily because they were unable to get transactions done, and that’s not a good thing. Let me just be very clear. Having competition is important because there are inherent challenges to each individual firm. So, take for instance, there is a very large TRA that’s owned by a mega fund today that I’m a no bid for. It’s a beauty business that is very large, but it’s something that I can’t bet on and make an investment in, insofar that what happens if it goes the way of tanning salons? That’s not something that I have to wait 15 years to get my money versus an equity fund may wait three to five years to realize their return. That’s a very different underwrite and a very different perspective that I have to take and what lens I have to use in order to assess this investment. But someone who may have lived in consumer space before maybe a ton more comfortable with that investment than I ever might be. And so, to the extent that we are no bids for a deal, that’s going to result in firms no longer creating these underlying assets and make it incredibly challenging for ultimately deal formation and ultimately capital formation. |
| Johnny Wu | So, Andy, you touched upon something that I think is pretty interesting in that. When there’s no competition, you can charge higher fees, right? You can underwrite the higher IRR? When I work with hedge funds, just like, if someone’s puking. If someone’s puking, then I’m willing to put a bid, right? Because you can just like, make more money, right? But Nick, I guess the question is for you as an allocator. Yeah, that’s great that Andy’s got pricing power and earned abnormal returns, but you also – that should attract like more people like from an allocator perspective. On one hand, it gives you comfort because it’s abnormal returns. On the other hand, it’s just like, “Oh, if he’s the only player in town, does that make me a little nervous?” What are your thoughts are on that? |
| Nick Pon | Yeah, I guess makes you question and plus I guess it makes sense that these are small transactions. You said they’re in the 10s of millions of dollars for, like, some of the transactions for you. I guess some other strategies, like some say music royalties, they’ll kind of create these portfolios, create these long duration assets, create these portfolios or buying these a lower earnings multiple than selling their IPO and at a higher multiple. But I guess if you’ve ever done that before, I guess you guys compile a portfolio and sell them off to another bigger bidder with the lower cost of capital, but want more scale inside this industry. |
| Andy Lee | Yeah. So, that is something that we have contemplated in the past. And to the extent that we are able to first scale up portfolio today, we own almost a Billion dollars of these assets. Our goal would be that we are able to find someone of a lower cost of capital or potentially similar to a firm royalty pharma in the drug space or a musical royalty firm like a Hypnosis, to ultimately take this vehicles public. Those are avenues that we’ve explored in the past and continue to explore given the potential for us to achieve the ratings, which are important for these, otherwise, return sensitive vehicles that are more ratings oriented. That is something that we’ve talked a little bit about in the past. But to Johnny, your point on – it is actually challenging on origination perspective, the lack of price discovery, whereby a seller of an asset, while the deal team may feel that we’ve appropriately educated them and shared with them our cost of capital among others. Where I think the inherent challenge is at the top of the house may desire several bids. And that makes it very challenging because what do I do? I can’t create competition for myself randomly, and so the lack of price discovery and depth of competition often results in what is the most pernicious of it, which is no trades. And that’s a very challenging place because the inability for there to be trades or the winning of a bid as spread ultimately results in the lack of formation around a market. |
| Johnny Wu | Look, what I think about your business, Warren Buffett always says, “What’s that natural mold?” You kind of have that mold or you have that expertise or, you know, you’re not the only smart person that’s in the business. But you gotta get the hustle. Someone from Goldman doesn’t like the cold call. Like, phone rings for them. Doing it the other way, it’s just not a skill set that they have. So, the combination of you being hungry, you having that craft, willing to take the risk, I think it’s really interesting. But talk to us a little bit about that, right? Knowing what you know now, would you have done what you did six years ago? Because if you say, I’m convinced, if you stay within a private equity firm, they pay is a billion, right? KKR, 25 years, go bang it out there, right? Like your path is kind of challenging and you gotta pivot. It’s you’re building your firm. There’s a lot of pride in it, right? But if you stayed within private equity, you’re on that path. So, talk to us a little bit about that. |
| Andy Lee | So, I think there’s one element that I always thought was incredibly challenging, but today I found to be an incredible blessing in many regards. The first of which is when I first was coming out of school, I needed a summer internship, but I was effectively a freshman trying to get a summer internship and all the recruiters were like, “We’re looking for juniors. We’re not looking for freshmen.” But I was like, “I’m graduating relatively soon. I need a job.” And what I found was who do these investment bankers listen to? That’s something called private equity. I have no idea what that is, but I’m going to cold call a couple of private equity guys and the private equity guys were like, “You’re a good kid. You went to my university. You live close to my hometown. Let me do you a favor and I’ll call banker on your behalf.” And as a result, the bankers were like, “I have no idea who you are but if a private equity guy calls me, I’m taking the call, and if he asked me to facilitate an interview for you, we’ll do that.” And that skill set was incredibly helpful because I came from a non-target. I went to the University of Illinois, that, while we have a very large alumni base, that alumni base did not necessarily extend well into Wall Street. But whenever those individuals that were on Wall Street heard my story, they were very willing to bend over backwards to help facilitate and help me throughout my career for which I’m incredibly thankful. So, that cold calling skills set that I hated when I was at Illinois- reaching out to alums- actually served me incredibly well for what I do today. And I’m incredibly thankful in that regard. As it pertains to going down the traditional path, it was very clear to me that I was never going to be able to compete against a blue blood, that is someone who went to then Ivy League like Johnny, who then subsequently went to Goldman, and then KRR or Apollo in that regard. And so, it was very clear to me that if you do what is average for a non-target, you’re going to end up with an average result, and that was something that I was unwilling to live with. And so, I knew that if I wanted to achieve what I believe my potential was, that I would need to expand extraordinary effort in order to get to an extraordinary outcome, and so I need to do something different. I didn’t know what that different was for a very long time. That Safe Harbor, that the Lone Star partners effectively afforded me was my call option. I mean, I could always go back, but I was very thankful that they were willing to give me, effectively, that safety net to make that jump. |
| Johnny Wu | So, this is, by the way, an AAAIM podcast. So, we’d be remiss if we didn’t touch upon being Asian American – being an Asian American GP. Some of the challenges that you face both good and bad – can you talk a little bit about that, Andy, from your perspective? Because, you know, a lot of our listeners are aspiring GPs, right? Asian American GPs that are thinking about hanging up their own shingle. What are kind of some of the observations that you would make, just having gone through that experience, raising assets, building a team, hiring folks looking as young as you do as well too? |
| Andy Lee | Yeah, absolutely. So, when I first launched – I was 26 when we started raising our first fund and it was incredibly challenging. Our first fund was actually a 21-year vehicle and there were many people who asked the question like, “Are you even 21?” Look, I’ll take that as a compliment, but our first fund took almost 800 meetings to get 16 tickets, that’s a 2% yield. That’s incredibly challenging. But it gave me a lot of lessons and I learned a ton from it. And I think this is the part that being Asian American was challenging relative to my underlying upbringing where, as many of you know, we are very much focused on putting your head down, being focused and excelling at the technical side of it. I think that was something that my dad really drilled into me. However, the one thing that, and the biggest lesson in life that I’ve taken away was actually for my mom that ultimately every senior job is a sales job, that in order for us to extend ourselves beyond the bamboo ceiling, like, we need to sell. And that is you’re going to need to sell your wife to marry you. You’re going to have to sell your kids on eating vegetables. You have to sell LPs that you’re going to be a steward of their capital. And you’re going to sell employees on your vision, sellers on why they should sell to you versus someone else. It’s all sales. Ultimately at the end of the day, while investing is a core skill set, everyone generally knows what a good deal looks like. It’s your ability to convince someone to partner with you and why you will be an appropriate steward of their assets, of their baby. That’s something that is not well understood from an Asian American perspective because so many of us have been focused on building that technical skill set and it’s incredibly important for us to build that skill set that the most senior levels require, and that’s just sales. And so, what I might say is, like, doing things that are flat out uncomfortable. Like being on a podcast like this in the public domain, that’s incredibly challenging and incredibly intimidating for both Nick and I. But it’s something that as we continue to grow our careers, we have to move up the learning curve. We have to be able, willing, and excel on smaller stages in order for us to excel being keynote speakers at conferences, being the headline among others. If we are ever going to reach the stages of the Joe Bayes, Rubenstein’s of the world, I think what’s incredibly encouraging is the fact that we already have role models, might that be the Tony Lees of the One Rocks, the Michael Chae’s of Blackstone. We have at the highest levels, Asian American leaders. They’ve already blazed a trail for us and have already overcome that hurdle. Our job is to follow and transcend that. We stand on the shoulders of giants, and we have that exact opportunity and communities, such as AAAIM, provide that exact avenue for us to build each other up, for us to take that next step as a culture. |
| Johnny Wu | Now, that’s amazing. You’re inspiring me, Andy. People like you, as well too, right? Not just, you know, the folks that you’ve named here. So, you’re in Fund 4 now, right? How many employees do you have? |
| Andy Lee | There are five of us today. |
| Johnny Wu | OK. So lean and mean, and efficient, already on your Fund 4. You’re raising your Fund 5, as well too, right? If you think about building out your firm, because there’s a lot of optionality as well, right? Now, you got a six-year track record, you’ve got good returns, do you think about bolting on kind of other businesses as well too? So, away from just TRAs, because you’re just a good investor. Like, how have you thought about that as you scale and build out? I can send you my resume, too. I’ll go get your coffee for you, but talk a little bit about that. |
| Andy Lee | Given what I shared about the asset class, it’s a significant opportunity set that lacks intellectual capital and commercial capabilities to go access. It’s one of the largest opportunities that are out there that has hidden in plain sight. We need to be stewards of the capital that we have raised and demonstrate a capacity to do exactly that. Once we do that, I believe that, as so long as we demonstrate that we are stewards of people’s capital, naturally opportunities to grow would arise from it, but I don’t want to put the cart before the horse. We’re very focused on doing and excelling at what we set up to do. And in the crawl, walk, run, to the extent that we are – will be afforded that opportunity to take that next leg of growth. |
| Johnny Wu | Nick, let me ask you a question. Because from an allocator perspective, you love uncorrelated returns, right? Sometimes that means that you have to go away from the mainstream. So, years ago, insurance link Securities, Litigation finance, healthcare royalties, music rights, right? Now you got this thing called Tax Receivable Agreements, TRAs. When you think about that category, and I know you have a private credit mandate as well too, how do you think about those different kind of investment opportunities and how TRA fits within that construct? |
| Nick Pon | I guess, you know, the main thing about the attractiveness of this asset class that is an uncorrelated asset with a five to seven year duration and pretty good yield too, is we kind of compared to other opportunities in a similar vein, you know, similar liquidity of like five to seven year fund life and just yield return there. I guess it’s different than a lot of the other things I have focused on in the past. It’s definitely a unique asset. For a lot of these asset classes, when we do them, we, like, a large track record of how they kind of performed over time, well the industry references. So, like we did a fair amount of reinsurance recently just of the overview of what’s going to happen in the industry, talked to insurance companies directly, people who run their insurance programs. We talked to brokers on the reinsurance side. We talked to multiple funds. And they talk to other investors to see, you know, what they’ve done overtime. So yes, something like this for new asset classes, it takes a lot to do something new in. We have to talk to a lot of different people in the marketplace. It’s really interesting that you guys are one of the few players in the space and, you know, I always wonder why personally, you kind of advertise yourself on these things. We have a great opportunity set. You’re kind of going out and cold calling these individuals to get these really attractive assets at a pretty good price. And so, in that context, it would probably fit within the diverse line portfolio. We have a – idiosyncratic bucket. We kind of bucket a lot of these more niche strategies that don’t really fit nicely anywhere else. But, you know, we can’t compare them on the merits of liquidity upside down. It’s like just really the range of returns, there are potential outcomes. And then there’s like the time horizon of them. |
| Johnny Wu | Andy, back over to you in terms of if you think about this as a baseball analogy, where’s TRA in that life cycle? Are we still in the first inning? Ohh, not even first inning yet. It’s pre-game right now. |
| Andy Lee | Look, this is a relatively nascent opportunity. And for many regards, like, we’ve done a ton from a standardization perspective, working with a lot of the underlying stakeholders, primarily because there’s a ton of technical debt. It has been a cottage industry, even though it’s called early years and change in the making, there are unfortunately a bunch of documents that are basically non-transferable or non-salable. So, to advance this, Moelis, the investment bank. Unless you’re an employee of the firm and you’re a natural person, you can’t transfer the document. That creates an inefficiency in the underlying markets because the only buyer of it is either the company itself or a current employee of the firm. And God forbid, someone gets hit by a bus. You no longer have the ability to own that asset and so there are a bunch of technical debt that exists within our industry that we have been working to clean up alongside some of the accounting firms, as well as law firms to help standardize and help people understand the ramifications, cause when they wrote those underlying documents 15 years ago, no one had contemplated some of the outcomes that have arisen over the years. And so naturally, until you standardize, you can’t grow and scale as an industry. |
| Johnny Wu | Andy, from your experience, you talked about banging it out. We have first fund, meet 800 people, get 16 investors, and then you obviously you’ve had fund two, fund three, fund four, if you think about the investor where TRAs and your strategy resonates, what does that investor typically look like? Is it more family office type, more independent endowment and foundations? Like, I don’t need to know that Harvard invested in for me to invest. I make my own independent decision. What does that look like? |
| Andy Lee | I think it’s someone who’s really sitting on the cutting edge for the longest time. Pharmaceutical royalties were backwater today. There are number of companies publicly listed and traded that were previously ENF or family office back in the past. Same for the likes of musical royalties, they were not things that were well trafficked or well, and a number of leading E&Fs and investors have really pioneered the institutionalization of that asset class. And so, our job is to find a few independent, fiercely independent thinkers, like the Nick [Pons] of the world, in order to bring our asset class into the mainstream. It’s something that is inevitable in my mind, and it’s just a matter of when not yet. |
| Johnny Wu | Got it. OK, awesome. Well, this has been very enlightening for me, being able to spend time with two awesome dudes in terms of just learning from you, Andy, and then, Nick, just hearing kind of your perspective, and some of the questions that an allocator might ask someone like Andy. In closing here, we’re just about an hour in, right? Andy, away from your experience, like, starting your own firm, etcetera, talk a bit about the investor community. You guys know I’m always on the high horse trying to wave the flag for the Asian American being included, right? We just want to be included, right? Have you been able to kind of get into like emerging manager programs and being viewed by whether some of the public pensions or some of the other progressive allocators that have diversity and equity and inclusion programs, then, from your perspective? |
| Andy Lee | We have not, historically, primarily, because of our asset class. But to be clear, Asian Americans, I suggest are incredibly bashful. We want to sit behind and stand out on our merits of our investment. We have an incredible story to tell as a community. We have so much to bring to bear, like we have talented individuals of the world, we have the NICs of the world, Johnnys of the world. Like, we need to do – if I think about a tech startup, you have product and then you have go-to-market. Even a great product, unless it’s a product like growth and enterprise and has adopted that go-to-market strategy, no one dies because of too much revenue. And so, we have not done a great job of sharing our accomplishments, making sure it’s well understood by the investing community and really building out our brands. Like, that’s something that I feel like as an Asian American, we’ve unfortunately done ourselves a disservice despite the incredible product that we bring to the investment community at large. |
| Johnny Wu | Yeah, I think one of the themes that the AAAIM community needs to lean on a bit more is uplifting the AAPI community, right? And I even had a friend who was an allocator, and the person was basically asking for specific help and I was like, “Oh, OK, that’s fine. You can come and you can lean on the network.” I was like, “Well, I need some help from you.” and said, “What do you need help with?” I said, “Can you just do more meetings with AAPI managers?” It’s because, look, it’s safe to hire the Bridgewaters, the PIMCOs, and the G Sams of the world, right? It’s less safe to hire a startup or an emerging manager and such. There’s more career risk around for that. But as an allocator, what I was impressing about him, I was like, “Can you just do the work?” And folks are just incredibly busy people, right? But as a community, I think the more kind of shots on goal that you get, I think that’s just kind of really important. And that’s one thing I’ve been really impressed with the AAPI community is. Of course, you want to give everyone a shot, but you still have the time of the day, just do it all. But, folks, that kind of lean in and work harder at that, it does uplift the community. I think that’s really important as well too. |
| Andy Lee | Yeah, absolutely. The fact that Nick had this discussion with us, I’m extremely thankful for. Amidst his busy schedule. Like, that’s something that has an avenue to give back, might that be to young emerging managers that are few years behind us. We try to find avenues to do exactly that, and we’re thankful for the people ahead of us who have done the Tony Lees of the world, who have afforded us their time. So, to Nick and his brethren and the LP community, we’re very thankful. |
| Johnny Wu | Yeah, definitely. Any closing comments from you, Nick? |
| Nick Pon | No, really appreciate the time today guys. It’s really interesting to talk about such a unique strategy and uncorrelated format, which is what I focus on. So, really appreciate the time today, guys. |
| Johnny Wu | Well, let’s leave it there. Thank you and have a great weekend, guys. |