Indexing private markets

Paul: [00:00:00] Welcome to Index Ideas from FTSE Russell. I'm Paul Amery, your podcast host. In this podcast, we explore index ideas that can help you address real-world investment themes and challenges. We look into how indices are built and why. 

As a reminder, you can't invest in an index, and the concepts that we discuss in this podcast are not investment advice. So any reference to potential investment strategies is intended for informational and educational purposes only. 

In this episode, I'm joined by two guests: Ali Zaidi, who is Head of Real Assets and Alternatives at FTSE Russell; and Tyler Johnson, Chief Technology Officer for StepStone Group. FTSE Russell and StepStone have recently collaborated to launch the FTSE StepStone Global Private Market indices. 

Ali and Tyler, welcome to Index Ideas.

Ali and Tyler: [00:00:47] Thank you. Glad to be here. Thank you.

Paul: [00:00:50] Ali, let me start with a question for you. Where did this index idea come from? Why did FTSE Russell work with StepStone to develop this index range?

Ali: [00:00:58] So, two questions there. FTSE is the leading benchmark provider on multi assets. And private assets is a growing allocation that we did not have a benchmark for. So that was a primary driver in developing a benchmark for this allocation. And why StepStone? Very clearly on the data strategy that the company has had. So it's the data that's built over continuous market participation over decades, something that wasn't put together, something that is not relying on survey-based or voluntary contribution. So it's the accuracy and the fidelity that got us very interested in building something on that data set.

Paul: [00:01:40] Thank you very much. Tyler, so what is the underlying data set for this index series?

Tyler: [00:01:45] So really at a high level, StepStone is a solutions provider focused on private markets. And in short, we deliver investment advisory and data solutions to investors globally. And we operate across all segments of private markets, including private equity, venture capital, infrastructure, real estate and private debt. And through our investment business, we have over $700 billion of total capital responsibility, and we deploy over $70 billion per year into new investments. And through all these activities, we end up sourcing and monitoring just an immense amount of data across private markets.

Paul: [00:02:18] Why is StepStone positioned to source this data compared to other private market data providers?

Tyler: [00:02:25] So as one of the largest allocators in this space, we're able to source the data directly from LPs that are in these funds. Effectively, we work on behalf of hundreds of institutional investors where we monitor their investment portfolios that are LPs in these private markets funds, and then we ingest and process all the cash flows and valuations of these funds that are sent out to LPs on a daily basis.

Paul: [00:02:52] Let me dig into that for a second. So the LPs, the limited partners are the investors, the institutional investors in private market funds, which are run by general partners or GPs. So does that mean that all the data that you collect to produce the indices comes from the LPs, or do you also get something from the GPs?

Tyler: [00:03:12] So the data for these indices, it's sourced exclusively from LPs that are getting accurate data on a daily basis from the GPs. So to be clear, these are not estimated cash flows that we are backing into from some sort of high-level data set that's publicly available. And these are also,  importantly, not sourced from GPs that may choose to contribute or not contribute data on any given quarter. This is effectively precise, penny-accurate data that's sourced directly from actual LPs in these funds.

Paul: [00:04:04] So how do you verify or validate the data to ensure that it's accurate?

Tyler: [00:04:09] Yes. So that's a very important question. So in terms of verification and accuracy, we're getting these values directly from the cash flow and valuation notices that are sent to LPs. Now this is a large amount of data that needs to be collected and organised each day. And while our data ingestion processes are certainly highly automated using AI and other technology and our “SPI by StepStone” platform, we also have a large team of individuals, right, as well that reviews the data coming in as well. So every data point that we log in our systems each day goes through multiple layers of both automated and human review, as well as an additional quarterly reconciliation process that we complete for each investment.

Paul: [00:04:54] Okay. Thank you for explaining that. Ali, let me turn to you. How can we be producing daily indices in an asset class, private equity or other private markets where fund valuations are typically reported quarterly and with a lag? So what is the meaning of a daily index in that kind of asset class?

Ali: [00:05:12] The daily index is essentially operationalising a lot of the practices that happen on the private equity investor side. So you may have a reported valuation, but during the two reporting periods, investors are accustomed to make mark-to-market and adjustments to get a sense of where they are. So what this index does is [it] operationalises those practices, those adjustments on the NAV level, and then it aggregates that. So even though you do not have daily NAV reporting or daily cash flow, there are industry accepted standards, for example on FX or looking at comparable public markets as to what the mark-to-market has for a specific fund or strategy. So we operationalise that through index rules. And that's how you create a daily marker in the absence of daily reporting.

Paul: [00:06:05] So effectively we're taking what are quarterly valuations and adjusting them to make them more reflective of what's happening between those quarterly reporting points.

Ali: [00:06:16] We're incorporating two sets of signals. One [set is] directly coming from those funds because intra-quarter there are cash flows in both directions. So those are adjustments, along with FX, that are coming from the funds. And then we're incorporating market signals—what the underlying public markets are doing. That, collectively, is the methodology.

Paul: [00:06:38] Okay great. We'll come on to those two different index types in a second. But I wanted to ask you, Ali, also to comment on—I know that some people refer to frozen and unfrozen private market indices. What type are we managing here. And can you explain what those concepts are?

Ali: [00:06:54] So the concept is an understood concept within private asset benchmarking: you receive a report on an NAV. Do you incorporate that on the index at the day of receiving that report? Or do you do this as of the effective date? So that involves restating every time you are receiving reports past the last reported index mark. Those are called unfrozen indexes. And the frozen indexes are that you are not restating anything that has been published. So you are incorporating information as and when it becomes available.

Paul: [00:07:28] And these indices that we've created jointly with StepStone are which type?

Ali: [00:07:32] So in our initial suite these are the frozen daily index. But in our product suite we have unfrozen indexes as part of the package.

Paul: [00:07:42] Okay. And Ali could you explain what the difference is between these types of index and private market indices that are built using listed equities as their components?

Ali: [00:07:56] So this is what I would call actual private asset fund performance that is generating what this index demonstrates as terms of what the returns are. The public market proxies have two purposes. One, to create some sort of an investable product with low access hurdles, so you can invest in public equities to get similar returns that could be weighted and positioned in some sort of a proxy of the private, but it's sort of the proxy to the actual private asset allocation. And the second is also sometimes used as an alternative to unfrozen or quarterly lagged benchmarks.

Paul: [00:08:40] Right. Okay. Thank you for explaining that. Tyler, could you explain what the likely use cases are of the two index types that we've developed jointly. One is called Daily Cash Adjusted and the other is called Daily Market. What are the use cases of these two versions?

Tyler: [00:08:58] Sure. So I can start off here. I think first off, it's worth mentioning that the private market space is currently evolving, right. We continue to see a lot of innovation in this space. New vehicles, new methods of access continue to be created, with effectively the goal number one, improving accessibility across a larger pool of investors. And number two, providing better liquidity for private markets investments. Now, we believe one of the use cases for the FTSE StepStone indices is effectively to help price, on a higher frequency, some of the portfolios of private markets assets. And we believe this is a very timely solution that addresses many of the needs of this new environment or really new phase that private markets is entering. Now to improve, again, accessibility and liquidity, we believe that many investment products will need to move away from quarterly valuations all the way down to daily. And these new indices are a means of doing that. And in fact, at StepStone for our private wealth business, we've used a very similar approach to the market methodology of the FTSE StepStone indices to provide daily pricing for those vehicles, which has effectively allowed us to tickerise those products and reduce some of the friction that comes from making investments in those products. So again, one of the use cases here is that these indices, the FTSE StepStone indices, can be used by others who are looking for those same benefits that come from having daily pricing.

Paul: [00:10:34] Right. Ali, any thoughts on that on the use cases?

Ali: [00:10:37] So to add to what Tyler said, you know, it really has to do with the macro shift. You know, there is a lot of focus on how can we make it more accessible. And the quarterly lagged benchmarks, they serve a purpose. They serve a purpose for maybe institutional with less frequent reporting. But when you think about mainstream investing, the discussions around 401k, those type of products, they need to be regulated in certain ways. And this is where the daily NAV estimation and the daily market valuation is highly relevant. So our contribution to this macro shift is facilitating that discussion that you can have an index that does that at an aggregate level across the thousands of funds to give you an idea where the market is going for that specific fund.

Paul: [00:11:24] And what are the respective responsibilities of FTSE Russell and StepStone? Ali, let me start with you.

Ali: [00:11:30] So our primary responsibility is to manage this benchmark with full transparency. We have published the ground rules and that demonstrates that FTSE does not apply any discretion as to which fund is going in and going out. So all the eligibility criteria are published and to make it compliant to various global regulations in terms of how we rebalance, how we publish the rules and how much transparency we offer for the wider market.

Paul: [00:12:01] Tyler?

Tyler: [00:12:02] Yeah. And for StepStone, our role is to continue to monitor and grow, you know, the thousands of private markets funds that we have in these indices. Now we have strong deal flow to support that. And annual deployment, like I mentioned, of $70 billion into new investments. So we fully expect the fund count that we have in these indices to grow over time. And for us to be able to expand the granularity of how close we can cut the underlying indices. And then lastly, our role here is really just to be a thought partner for private markets. You know, as one of the largest allocators across private markets, we're constantly talking to LPs, GPs, service providers all across the world. And in these different discussions, we end up naturally just hearing about the various pain points and opportunities that these different groups see in the space. I mean, really, at StepStone, our mission is to be the partner of choice in private market solutions globally. And we see these indices as a new tool in our tool belt that's used to address some of the needs that our partners are experiencing in this new phase of private markets that we're entering. So right, we are very excited about the initial use cases of these new indices that we have so far. And we certainly see the menu of indices and solutions in our partnership with FTSE expanding over time, so we're very excited about the road ahead.

Paul: [00:13:46] Well, thank you both very much for joining me and throwing light on this perhaps lesser-known area of the financial markets for many people. So it's been a very interesting discussion for me.

Paul: [00:13:56] That's it for this episode. And this brings season one of Index Ideas to a close. In this season, we've covered a range of topics, from asset allocation and concentration risk to the Russell US Indexes, sustainable investment, global bond markets, fixed income ETFs, digital assets and free cash flow. I hope you've enjoyed the content. Look out soon for new content in season two, starting shortly. If you've enjoyed this conversation, then please follow us and give us a rating or review on your podcast app of choice. And if you'd like to get in touch with the show, you can do that via the email fmt@lseg.com. But for now from me, Paul Amery goodbye.