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Welcome to the EY NextWave Private Equity podcast. Where industry leaders come together to discuss emerging opportunities and industry trends shaping the global private equity landscape.

Jenny Johnson

And then we said, for every 1% additional allocation that they add to the private markets, it is $130 million so just think of the scale of opportunity. 

Bridget Walsh

That's Jenny Johnson, CEO of Franklin Templeton, one of the world's largest asset managers. I’m Bridget Walsh, EY Global Head of Private Equity. In this episode, Jenny will be sharing her global perspectives on the future of the industry. Hi, Jenny, welcome to the podcast. Great to have you here today. 

Johnson

Thanks for having me, Bridget. 

Walsh

Jenny, Franklin Templeton has a fantastic heritage in the asset management space that actually tracks the evolution in the industry pretty well. You know when you look at the organizations’ move from brokerage to mutual funds and more recently to alternatives, maybe you can share with us the inside view on what drove those changes over time? 

Johnson

I mean, I think the market drives the changes. Last year, we celebrated 75 years as a firm.

Walsh

Wow, congratulations. 

Johnson

Thank you. And you know you don't thrive over 75 years if you're not evolving with the industry. And so, I think those trends that you talked about, going from your original brokerage where essentially the advisor was paid in the mutual fund vehicle, and over time I think in 2008, there was a lot of pressure from regulators to create more transparency around how people were paid. I think that's a good thing. That ended up with a much more fee-based advisers.

And then of course, alternatives. It's just, you know, we looked at the trend; companies aren't going public as early as they used to,  and banks aren't lending in the same way. And so, you created private credit, and we just felt like we needed to have those capabilities as a firm. 

Walsh

Yeah, and it's a trend we're seeing amongst a lot of the large multi-asset managers as well, which actually has proved to be great foresight in the current market.

Johnson

For sure. 

Walsh

You know when the traditional leverage roots have dried up, you've probably seen the same with your private credit business. 

Johnson

Oh definitely, no question. I mean, you know, you always question the kind of valuations. How is it that a public equivalent in a security is trading at a much lower than, say, an illiquid private? I think it's a combination of both. You know in these tough markets, when people need liquidity, the only place you can get it is in your public markets. And so they probably get oversold versus their valuation, and the private market is probably a little bit slower to mark down.

Walsh

And your recent move into alternatives, what drove that, Jenny, more specifically?

Johnson

Well, so we looked at it, you know, you have half the number of public equity companies that you had in 2000. You have something like five or six times the number of private equity backed companies, and so, just to put that in perspective, there are about 6,600 public companies, half of that, there were about 1,700 private companies that are now private equity backed companies, and there are now something like 11,000 or 12,000, right?

So, from investable universe, we couldn't be completely excluded from the private equity market. And then in the case of private credit, you see, you know that you had these regulations, Basel III in Europe and Dodd-Frank in the US, and they changed kind of the capital requirements for banks. And so banks are just not lending in the same way. So you've created this real proliferation of private credit managers, and we have 82 billion in private credit.

So, in looking at it, we just felt like, to be able to offer our clients the full spectrum of capabilities we really needed to be in, in the private markets and the alternative markets. And you see it with the institutional flows that have gone there, you know they're anywhere, pension funds or anywhere from 20 to 35% of their portfolios, and some are even talking about increasing that. 

And then in the retail space, that number is very low, probably less than 5% of portfolios, but with a real desire to see more. So you know it's about evolving with where the market is going.

Walsh

And I suppose part of that evolution as well, Jenny, is into the secondaries market, and my last podcast was with Mark Benedetti from Ardian; it was fascinating when we talked about that market. I mean what a market within a market in private equity. You know, a market that was 5 to 10 billion a decade ago is now roughly 100 billion. I see that trajectory going a lot more. 

Johnson

I couldn't agree more. I think that the time right now for secondary is an unbelievable time, and put that in perspective, there's been about $6 trillion deployed in private equity.

Johnson

And you mentioned 100, I say they are, you know, little, probably now there's been 110, 120 billion deployed in secondary PE with maybe another 100 billion raised. So 6 trillion to a couple hundred billion, and in markets like this, in 2022, in your pension fund, you may have seen your, on average, the equity portfolio was down 22%, your fixed income portfolio was down 15%. You needed to pay your pension years, so you were going to your liquid assets and pulling those out, which was driving that down to even a lower percentage of your portfolio. 

And you know, I’ll give you a real transaction. We own Lexington Partners, which is about a $65 billion secondary PE firm, one of the state pension funds; called them and say, hey, we need a billion dollars off our portfolio in 30 days. Can you come in and do that?

And you know why is that? Well, it's because those liquid assets have been driven so far down as a percentage that they are now overallocated to their private market.

Walsh

The denominator effect really.

Johnson

And they get quarterly check-ins, right? And so you know at that quarterly, they need those assets off the books. Lexington Partners comes in and it'll say, you know, I want this vintage of this manager, this vintage of this manager, and they can take into consideration both valuations, as well as the current interest rate environment, which is really important. And they buy those assets at a discount, and they'll tell you that these are some of the best discounts they've ever seen in their career. 

So big fan of secondaries, there's no J curve. You get a diversified portfolio. So I think it's a really great asset class to have, and we're really excited with what we acquired.

Walsh

I share your excitement about this market. I think there's a lot more for us to see here, and I'm sure you'll be doing a lot more in that space, Jenny. 

Johnson

Yeah, no, because they're private equity, but we're talking about secondary PE and secondary private credit. I mean all, of any of these assets, private asset classes can have a secondary market in it.

Walsh

You mentioned Lexington; you've been so acquisitive of Central, Lexington and many others. You know from my own business, I know the skill it takes to embed acquisitions of people businesses.

I've heard you speak about the balance needed between retaining those great brands, but also getting the synergies from the back office and distribution. Maybe you can elaborate on how you've managed to deliver this? 

Johnson

Yes, so our first really big acquisition, we acquired Benefit Street Partners, which was, at the time, about a $26 billion private credit manager, they're now about 40 billion, and that was in 2018.

Johnson

And then we acquired Legg Mason. And Legg Mason, which was traditional managers with the exception of Clarion Partners, which is a real estate manager, they were one of the firms with Legg Mason. We were essentially acquiring eight independent investment teams. Martin Currie, folks in the UK know them well. Brandywine, Clearbridge. And so, you know, we had confidence that we could make it work, because we acquired Templeton back in 1992 and have always had the philosophy in the asset management business that what are you doing when you're acquiring an asset management company, you're acquiring investment talent and their investment process.

So the quickest way to destroy value is actually go in and mess with it. So we've been very comfortable leaving those teams independent and all of the supporting capabilities. So, you know, one of our investment teams will say, “It's really important that my trader sit on the desk with me and we put traders on the desk.” Others will say, “I prefer to have the trades executed in the local market, so we have a global trading system, so they'll leverage the centralized training.”

So you really, the CIO and the investment team gets to define what is part of that process. We leave it independent. You know, we have a lot of debates about how many brands we should have. We’ll probably still have those debates, but, on the traditional business, there's a lot of integration that happens in the back office. However, on alternatives, there’s actually very little. It's really at the distribution because, you know, take a private credit manager, they're doing a lot of their legal department are deal type of lawyers as opposed to a traditional asset manager, which might be 40, I can use it, type lawyers.

So you tend to leave the supporting team around, and the technology and everything alone in the alternatives managers so there’s actually a lot less integration. And then the key, as I said, is around distribution and making sure you’re delivering to clients, kinda the full firm, and really being efficient and effective in how you service those clients.  

Walsh

I love your point about “don’t go in and mess with it,” because you are retaining the culture that you have, which is effectively what you’re buying. 

Johnson

Yeah, and I would say, you know, the investment banker will tell you why it's a great price and why it's a great strategic fit. They never talk about culture. And I think the most important driver about whether or not a deal is going to work is if the two cultures can come together. And so we spend a lot of time with the people before an acquisition to make sure that it's a good cultural fit.

Walsh

Jenny, private equity is great at investing and raising capital from institutional investors as you know, but less experienced in managing large-scale distribution platforms, which Franklin Templeton does very well. I think that puts you in a really interesting position. How do you see that evolving?

Johnson

So I think it's true, we know, you know, you definitely have a big move by the large alternatives managers to try to move into the wealth space, and there's only been a few of them that have really figured it out. Having said that, it's one of my top three priorities, and it's difficult. 

It's difficult because, not only do you have to get your product in the right vehicle, which is different because these are, you know, really illiquid vehicles, and there’s not a lot of people in the retail channel that can withstand 10 years of locked-up assets. So you do things like interval funds. 

You have to do a lot of education and, you know, obviously convince the gatekeepers in firms. And then you have to educate, you have to help that firm educate their salesforce on how it makes sense to fit in. You know, how some private assets can fit into a broader portfolio.

And you know, many of the large alternatives managers are used to walking into a pension fund and it's a one-sell. You know, you're either in or out. Here, maybe you get a financial advisor who says, “Yeah, I think this is great, I can see how it fits in my portfolio,” but then that financial advisor, it's the tip of the spear that becomes the really complicated part. They have to decide which of their clients can actually withstand that illiquidity nature of the vehicle and to make sure that it's suitable for those clients. 

So it's an individual decision at every client for that advisor to make. So it's just a lot more complicated. It takes longer. They are smaller tickets. But I also feel like we're at a bit of a crossroads. I say, you know, my grandfather got into the mutual fund business because the average person couldn't get the upside return in the equity markets until somebody came up with this idea of a pooled investment vehicle where you can get diversification, expert management for a reasonable price and liquidity.

We're at that same crossroads today in private markets because there are excess returns, because companies are waiting so long to go public, you're seeing higher returns by the good private equity managers. And right now, we're leaving out the average consumer. I think you know retirement plans are a great place for it. But again, we have to have the right vehicle, and we have to make sure it's a suitable investment for the end client. 

Walsh

And accessing those retail investors, the real opportunity isn't there when you look at the scale of money sitting with private investors; I mean, it's astronomical.

Johnson

I think we did a calculation this was based in the US, but we looked at the four largest distributors, and we said, and I think that, on average, they're about 5% allocation. And we said for every 1% additional allocation that they add to the private markets, it's $130 billion, right? So just think of the scale of opportunity.

Walsh

In that vein, you know, I've heard you speak passionately about technology, tokenization, blockchain and using that to more effectively reach those retail consumers. 

Johnson

The technology because it's so efficient, you're going to start to see two things. One is it's going to allow us because it drives down the cost of a transaction, it's going to allow us to fractionalize a lot of those illiquid assets and create liquidity in there. 

Walsh

Which I think is going to be the trigger event in private equity. 

Johnson

Definitely. Definitely going to be important. And then the second thing is if you think about what blockchain does: it does three things. It allows a payment mechanism.  Right now, everybody goes, yeah, but it's not dollars, but over time that will fix itself. Number two, it has the ability to create smart contracts, and I'll talk about why that's important in a second. And three, it's a general ledger. 

So the general ledger component is when the transaction settles; it means you don't have this batch system and wait overnight; the New York Stock Exchange closes at 4 so you don't have to do that. 

Walsh

It's instantaneous. 

Johnson

It's instantaneous. There's no latency, and so you could imagine a 24 by 7:00. Whether that's good or not is another thing, but you can imagine that because technology enables it.

So here's an example of where you take those three things to unlock kind of a unique asset. Rihanna, the singer, was performing at the half-time of the Super Bowl, the US’s largest watched sporting event, and she issued right before it 300 NFTs, nonfungible tokens. They cost $210, and each of them basically had the rights to the royalties of one of her songs, and it was a .0033% right to a song. So how can she do that? 

Well, she could do that because the token can get embedded through the smart contract in places like Spotify and Apple Music. So when her song is played, there are no intermediaries that need to go settle that transaction. So you have confidence that, when you hold that token, you're going to get paid. 

Johnson

In addition to that, she has the benefit of probably making more in the economics, because who's buying it? It's the Rihanna fans, right? So there's probably the economic value of the token, but then the culture and the excitement. Now you could imagine the same thing can happen with sporting athletes. Here you get a baseball player or an NBA star, you know, who signs a couple $100 million contract and says, hey, I'm going to sell it off to my fans, 10% of it off to my fans. You know, how much would somebody pay for a premium to be able to own a piece of their favorite athlete’s revenue stream and income stream?

And for the athlete, they get a portion of that money right up front. So I think the key is that, because it takes a lot of the friction out of a transaction, you're going to start to see new types of investments that are unlocked and then old types where, you know, there's, I think, it's a Four Seasons or St Regis in Aspen, Colorado, that's been tokenized, and so if you own a piece of it or the smart contract can pay you your share of whatever the profits are.

But when you check in, they say, “Oh, you're an owner, let me upgrade your room.” So it combines a kind of loyalty with the investment. And I just think it's going to be really interesting to see how this all unfolds. 

Now Franklin Templeton has a regulated money market fund. We worked really hard with the SEC to get approval on it. You know, we're big believers that this should be regulated, and it will drive much of the back office in financial services firms. It's going to take some time to do that. But we believe that this market will be regulated, and it'll be really interesting to see the kind of creativity that comes out of it.

Walsh

If you were to predict sort of a time arising when we will really start to see this coming to fruition, Jenny, what would you say? 

Johnson

So it's really hard to know that because one is, I do think regulation is going to be a big component about whether or not you know the pace of that change. So that's one. And I do think that there are, you know, Hong Kong regulators who are very focused on this. The UAE is focused on this. Singapore's focused and is moving probably faster than, say, developed market regulators. So I think, in those markets, you'll start to see more of a convergence of traditional asset management and the blockchain and tokenization. 

But you also, every big financial institution is probably experimenting with parts of their business in their back office. Like when we did the money market fund, we built a transfer agency, a shelter servicing system in blockchain.

Johnson

We were astonished by how efficient it is. So I think there are a lot of those types of projects going on, and what will happen is, over time, they'll start to link up with each other. It's a classic hockey stick where everybody is sort of stumbling along, and then suddenly things are going to link together, and you're going to shoot up and people are going to say, “How did that happen so quickly?” And yet, it will have been years in the making. 

Walsh

Exactly. You just need that inflection point to go back in. I love your passion around this. And you know, I hear you're speaking at Consensus, the world's largest crypto conference. How did that come about, Jenny?

Johnson

I spoke at another crypto conference; I said, “You’ve got to come to Consensus.” So no, I think you know, I'm fortunate that, at Franklin Templeton, we have a real team of folks that are very, very passionate on digital assets, and so I mentioned the money market fund. We also do node validation. We have active strategies where we recommend coins. Our team that does research on this, does this thorough research; if you read a researcher report, it would be as thorough as any fixed income or equity write-up that you'd see from our traditional analysts. 

We have a venture capital fund. So you know, it's a space that we think is important. For me, you know, I'm third generation at Franklin Templeton, and I say what's my big fear is, you know, some technological disruption happens, and we miss kind of the key moment. And so it's always keeping one eye on things that could be disruptive. And I think this is a space that is going to be hugely disruptive.

Walsh

Jenny, you've a great global perspective. You’ve been traveling a lot. I know you've been in the Middle East recently; you obviously know the US market, and just any observations from what you're seeing out there at the moment?

Johnson

I went with my executive committee to the Middle East, and actually, my executive committee is made up of some real, well, they're all world travelers, and several of them are emerging market investors. And one of the comments about Saudi Arabia is that they had never seen, because many of them hadn’t been there since pre-COVID-19, They've never seen a society shift so much with what's going on. You know, women driving, but not just women driving, we would meet with pension funds and customers ,and you had women in the CEO position. 

So you know, I think that was pretty fascinating, and I think unlocking that talent there, you're going to see tremendous growth there. 

Johnson

I think a lot of the innovation that's going on, you're going to see some real innovation around green energy. You know, many people think, oh, the fossil fuel companies, you know, they're going to be protecting themselves. But they also want to make it over the long run, and so they recognize the change. And so I think that the focus on an innovation there is pretty interesting. 

I think Hong Kong is really positioning itself as the gateway to China. It's opened up a lot. It was interesting to see that. Japan is, you know, talking about inflation. Japan has had inflation in 20 years, right? Like it's amazing to start hearing about those sort of things. 

Walsh

Yeah, and we're actually seeing, you know, the 

de-conglomeratization actually starting to happen. Private equity really coming in, huge, huge amount of activity in Japan.

Johnson

Yes, yes, definitely.  

Walsh

Sometimes I come back from my travels and draw spider diagrams, you know.  I'll have a sovereign wealth fund investing directly and co-investing with another GP, investing in the GP. It is a very small world at the same time in our industry.

Johnson

There is no question that we are very interconnected as a world, despite a lot of the rhetoric. I always say China and the US need each other. So, you know, and as you travel around, you realize how interconnected we are. 

Walsh

Thank you so much. This has been a fantastic discussion. 

Johnson

Well, thank you for having me here; it's great. 

Walsh

That's it for this podcast. Please do subscribe for more insights from the PE industry's top professionals.

From me, Bridget Walsh, and Jenny Johnson, thank you for listening, and goodbye. 

Thanks for joining the EY NextWave Private Equity podcast. For more insights and perspectives, visit ey.com/privateequity

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