Listen: Private Markets 360° | Episode 15: Beyond the Mainstream: Understanding Unconventional Investments

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Presenters

ATTENDEES

Chris Sparenberg

Jeff Collins

Jocelyn Lewis

Presentation

Jocelyn Lewis

Hello, and welcome back to Private Markets 360, S&P Global's podcast dedicated to enlightening and educating our listeners about the world of private markets from vast vantage points. Your Private Markets 360 co-hosts both sit within Market Intelligence. I'll start off with introductions. I'm Jocelyn Lewis, Head of Private Debt Commercial Strategy.

Chris Sparenberg

And I'm Jocelyn's cohost, Chris Sparenberg, Head of Private Markets Commercial Strategy. I'm a super fan of our corner of the investment industry. We're thrilled to bring our listeners exciting guests every month for discussions about industry trends and other topics of interest here on the podcast.

Jocelyn Lewis

You sure are, Chris. And if you're interested in regular Private Markets content, hit subscribe and tune in. Ready to introduce our guest, Chris?

Chris Sparenberg

Let's do it.

Jocelyn Lewis

Our esteemed guest for today is Jeff Collins, a managing partner with Cloverlay, an independent asset management firm focused on investing in niche private market asset classes, also known as adjacent private markets or special assets. These special assets encompass a diverse range of investments, spanning both tangible and intangible asset segments, offering investors a unique portfolio diversification construct.

Examples of such investments include professional sports assets, Broadway theatrical touring rights, and stud bowls. We are delighted to have Jeff Collins join us on Private Markets 360. Jeff, thank you so much for joining us. Welcome. How are you doing?

Jeff Collins

Doing great, Jocelyn and Chris. Thanks very much for having me. Looking forward to the conversation.

Question and Answer

Chris Sparenberg

Great. To kick things off, Jeff, we've really enjoyed our preparation for this episode with you. I think our listeners are going to be impressed by the totally unique investment strategy at Cloverlay. Could you start us off with an overview of the business and how you define the concept of adjacent private markets?

Jeff Collins

Sure. So Cloverlay's mandate is to invest in the cracks between the traditional lines of strategies inside of private equity. So we don't invest in buyouts or growth equity or venture capital or real estate or real assets or private credit. It's really unique, uncorrelated assets that sit in between those definitions and are the building blocks upon which very large industries are built.

But for any variety of reasons, those assets themselves are either misunderstood or out of favor or in the hands of unnatural owners. And so our job is to assemble portfolios of those assets that provide institutional investors a single point of entry into a carefully architected portfolio of assets that are completely absent from the rest of their traditional private equity portfolios.

So they're additive from both a diversification standpoint and a return standpoint, and frankly, a volatility standpoint. That's our commercial license to provide institutional investors with a return stream that they otherwise don't have access to.

Jocelyn Lewis

Makes sense. So you help improve from the diversification standpoint.

Jeff Collins

Exactly. And we started the firm 9 years ago with that ethos. Roll forward to today, executing on exactly the same mandate. We only know how to do one thing. And what's interesting and fun to talk about in our spaces is that the areas of opportunity evolve constantly. And so the things that we were focused on 9 years ago or even 15 years ago in our prior lives are no longer interesting because the world changes.

Interesting opportunities attract lots and lots of capital. And our job is to find and invest in unique assets 3 or 4 years before a PPM hits the desk of one of our investors holding out the attributes of this brand new asset class. Meanwhile, we've had exposure to it for 3 or 4 years before most institutional capital is aware of the opportunity.

Chris Sparenberg

And could you share just a little bit behind the scenes of what the structuring and hold period associated with those assets typically is?

Jeff Collins

Sure. Structuring is spoke. We do want to get straight to the assets. You may accidentally create an operating business on top of the assets. We're typically unlevered at entry, and we want our domain expert partner on the ground to have the time and flexibility to reposition those assets in an interesting way. And so structure can vary and be appropriate for each situation.

Sometimes we participate in an SPD that holds nothing but, for example, intellectual property. And that sits independent from and beside an operating business that does something that we have nothing to do with. That's one example. Another example, like in our scotch whiskey platform, the reason we invested in that is because we were able to secure 6 million liters of liquid at 2.5-year-old pricing that was made specifically for us.

There is an operating business around that. That is the basis upon which we invested and sort of the holder of value. So structure varies. We never come into a B round or a C round if that sort of vernacular is familiar to some of the listeners in the venture world. Our capital, sometimes in a club, sometimes alone, our capital is at the point of inception galvanizing a situation, not coming into a platform that's been on its way for a period of years.

Jocelyn Lewis

Very fascinating. So Jeff, you mentioned the scotch whiskey platform. And during the prep call, you also mentioned that along with another investment that I found interesting, which was the ownership of the IP associated with the Care Bears. So these 2 investments, while you mentioned that you had to only do one thing, seem very different.

So could you just provide a high-level overview of how do you source these investments? Where do you find them? And what your investment thesis is around them and touch on some of the strategy that you used to achieve private equity-like returns.

Jeff Collins

The one thing we know how to do is invest in assets. Then you have to bifurcate into 2 different camps. There are tangible assets, like firefighting helicopters, and then there are intangible assets, like the Care Bears intellectual property. They share attributes, but admittedly are in different industry segments, and that's part of the diversification objective.

We want each of the line items in any of our portfolio to have nothing to do with the other. So firefighting helicopters are completely uncorrelated to the performance of the Care Bears intellectual property. And the way we source is more art than science, to be honest. There are no conferences to go to, to find these kinds of opportunities.

We're able to source because as a team of 16 people over our careers both at Cloverlay and in prior lives, we've lived in these niches. And so we have extensive network nodes inside any of these subsegments that are usually boring and not actionable from our standpoint, but then something happens and they become actionable. And we know we have an 80% running head start.

We know most of the participants either on the family office side or the strategic side or maybe sometimes the private equity side, but having a running head start when an opportunity emerges or an opportunity is created because of dislocation, the network needs to already have been in place.

So we have been individually and now, of course, as a firm, we have been known as a willing audience for the niche and the weird. We want to see all of it. You mentioned the stud bulls. We didn't actually invest in stud bulls, but we've seen stud bulls. We've seen thoroughbred horses. We've seen rare coins. We've seen the most expensive car collection in the world.

We've seen lots and lots of niche, asset-intensive strategies and are able as a team to pull apart the unit economics and figure out exactly what the correlations are that we would be stepping into, and exactly what the exit and repositioning, and then exit prospects really are because we are sellers. We are not perpetual holders of these assets.

We usually own things for about 5 years. In some cases, it could be intentionally longer or sometimes unintentionally longer. It's seldom shorter. So our investors are patient, private market investors, not looking for quick flips in any way.

Chris Sparenberg

And with that in mind, as you're underwriting all of these niche opportunities, staying in this uncorrelated segment of the market, can you give us a sense of the types of investments that you say no to? And then maybe why?

Jeff Collins

We say no almost all the time. We have to turn over a lot of rocks before we find something that is interesting enough to keep our attention for a 9-month or a 12-month diligence process. And we usually have that much time as I said earlier. If we don't decide to execute, this transaction is probably not getting done.

And I know a lot of investors in private equity hear about proprietary situations and GPs aren't in competitive processes. We've always found that to be difficult to understand and believe in regular way private equity. But when you're talking about these very small pockets and subsegments, it's absolutely the case, which is really unique.

The first and foremost reason that we turn things down is the profile of the assets and whether or not they may be found in sophisticated institutional portfolios. There are lots of assets that we love, but that our investors already have exposure to. Music publishing rights or regular way aviation, those are not secrets. Those industries have been around for many years and they are masters of the universe and both.

Love the assets, can't even remotely get their own pricing. The second reason that we typically pass is alignment with our partner. And that can mean a lot of different things. But pursuant to my earlier comment about not ever coming into a B round or a C round or something like that, we want to be hip to hip with all of the since-inception investors.

We want to have a shared vision for what we're trying to accomplish in the platform, how long we think that might take, and what kind of milestones we should be measuring our progress against. And when you have a small group of like-minded investors, that can be a really powerful thing because each of us has a network to bring to bear. We have experienced to bring to bear, both from an operational and a network and a governance perspective, it can be a really fulfilling and profitable marriage in those sorts of situations.

Jocelyn Lewis

You must have some very interesting investment committee meetings going through some of these unique assets and your investment strategy around them.

Jeff Collins

We certainly do. I literally just walked out of one. And we have a sort of midstream meeting, we would call it a Phase 2, which happens after Phase 1. And Phase 2 typically starts for the junior half of the organization. It typically starts with an industry teach-in. This is how the following industry works because even though you've seen a lot of things, you probably haven't seen this.

Then we start talking about the deal specifically and highlighting all of the still unanswered questions and trying to prioritize not only order of operations, what to get firm answers to first. But really, what are the potential deal killers? What are the potential fatal flaws in this model or this construct or this partnership or this industry that we have to completely understand, and we will take as long as we need to take before we execute.

We have to understand the entirety of the opportunity set inside that space. You can't see an interesting deal from an interesting partner and assume that is the best entry point into that particular segment. We need to know everything else that's going on.

And then from there, we'll never jeopardize our process for the sake of time pressure. We would rather pass in the second inning and save goodwill with a future potential partner rather than pretending we can get something done in 4 weeks or 6 weeks or something like that.

Jocelyn Lewis

I would imagine that might get tricky, if you see an investment, and think, oh, wow, the time makes sense. In your case, it doesn't seem like anything would trade away, so to speak. But I'm just wondering if at any instance, there would be a situation where some of these assets, if you waited might lose value.

So would that potentially become more interesting, less interesting, hard to say? But it would also reduce the potential purchase price or the potential investment you would be allocating in the deal.

Jeff Collins

I found that patience is almost always rewarded in this particular kind of investing, and due to the nature of the assets and how they behave in contrast to broader equity markets or fixed income market fluctuations. The longer you wait, there really shouldn't be much of a change in the value of the assets themselves. Instead, what you may see change, to your point, is a seller dynamic that evolves over time that can either move in your favor or maybe against you.

And they decide they don't want to sell or waste the time to sell these little tiny assets. They're just going to move on and keep them or they can become a more and more willing seller. But typically, it's really not about picking a pricing trough, it's about discovering assets and joining them with absolutely the best partner we can find to reposition those assets. And so time is not usually a factor.

Jocelyn Lewis

That makes sense. And your experience speaks for itself too in having seen these types of investments play out over your past 20 years or so. Jeff, I'm also curious about the data that you're looking at, what do you look at to really determine if a particular investment opportunity makes sense for you?

Jeff Collins

The data obviously varies from segment to segment. And the valuation metrics vary from segment to segment. There are almost never public comps for what we do. And so it's a very different exercise than most traditional private equity investment programs. So we really have to understand where the segment is in its evolution and in its cycles.

We have to understand the behavior of strategics, not only today, but the behavior of strategic players that might own these assets as a small percentage of their overall holdings. What's their behavior over time? Are they in an acquisitive mode? That would scare us off. Are they in divestment mode? That might be interesting, unless there's a flood of assets.

It's impossible to come up with any data that is consistent across all of our segments. But the data that we do gather both around the specific opportunity as well as what we believe the "market is" in that particular segment is all geared towards buying assets, tangible or intangible, below intrinsic or replacement value, not using leverage. That's how you contain downside.

And that's how you absolutely have exposure to the right-hand tail of equity, if the world behaves in a certain set of ways that we believe is possible. KPIs, if you want to call it that, not typically at the front end. There's lots and lots of data at the front end, but as far as KPIs go and what we're monitoring.

That's usually post investment, and it's that milestone progress-based monitoring exercise, where we want the platforms to achieve the appropriate amount of growth, the appropriate amount of progress that fits with the profile of the assets. There are some assets that can become hyperbolic in their returns. You can look at certain segments of data communications infrastructure, wireless spectrum and dark fiber and things like that.

You can look at even Care Bears have a movie that's 1/10 of Barbie. But there are other assets that do not possess that potential. And so you have to get very comfortable with most of our portfolio, most of the assets we look at through the data. You have to get very comfortable with hitting doubles and triples because that's what this business is.

Chris Sparenberg

Jeff, shifting focus to the correlation of uncorrelated markets with broader private equity trends, can you talk to us about how big you estimate that this market is that you're investing in? And how does it correlate with broader trends that we see across private markets? We see things like reduced liquidity driven by high valuations and high cost of capital. How do those factors play for your team?

Jeff Collins

Total addressable market size is a very difficult question to answer just because of how broad the canvas is upon which we work. What's the size of the global gravel parking lot market? It's really big. I'm not sure anybody has put a number on it.

What's the total addressable market in all things, professional sports? What's the total addressable market in mass torts in litigation finance? It's really difficult, but needless to say, outrageously large relative to the quantum of capital that's dedicated to investing in those niches.

Chris Sparenberg

And when we think about some of the headwinds facing other aspects of maybe traditional private markets, are you seeing the same headwinds? Or how do you play alongside all those factors?

Jeff Collins

I think we're largely insulated but not completely insulated from some of the environmental factors that have more dramatically impacted traditional private equity, specifically buyouts and specifically venture. And the 2 main drivers in those worlds are the cost of leverage. We typically don't use leverage. So we escape that for the most part. And then the other is the exit environment.

So on the leverage point, the rise in interest rates has impacted our portfolio only on the margin around our exit environment. Because the acquirer of these assets that we've pulled together, a disparate collection of hundreds or even thousands of very similar assets into a coherent portfolio of scale that we are then handing on to another buyer.

That buyer is probably using leverage because we have assembled the portfolio. We have taken the time on an unlevered basis to do so and are rewarded with the valuation increase. They're now stabilized. So when there's uncertainty around the interest rate environment or that is more difficult to secure on the buyer side, that can impact us on exit, mostly in the form of a delay.

We're starting to see things open up in a very real way right now, but things were pretty quiet for about 12 months. On the exit side, unlike traditional private market, we've never had an IPO as an exit, just the nature of the assets that we invest in, nothing is going public. So when the IPO window is closed, no impact on us.

There's another feature to a lot of the investments that we make, which is effectively a self-liquidating exit. So instead of looking for one lumpy sale process, and I think sometimes in traditional private markets and in buyout specifically or maybe venture specifically, you've prepared a company for exit, and you're crossing your fingers that, that segment in public markets holds up while you run your 6-month process.

A lot of our investments and our assets naturally run off. We may buy things through the end of their useful life, but have made our return along the way and then there's nothing left to sell. Or in some of the structures that we have, it's much more complicated than a put option, but we are effectively derisked to 100% gradually over time and hand the assets back to the owner as opposed to a time-certain, valuation-certain put option that we put back.

It's more of a self-liquidation feature, and if that liquidation were to not happen, we're more than happy to continue to own the assets. So we are largely insulated from a lot of the headline risk factors that are impacting public equity markets and private equity markets that you hear about a lot today.

Jocelyn Lewis

And Jeff, when I hear you talk about these types of investments, it does seem like they are opportunistic, but they're certainly not opportunistic in the way of the more traditional sense. But still, even if you think of the special situations, there is a market for that. And I'm just curious, how do you define your market and what your outlook is for that market that you're targeting?

Jeff Collins

Within the vast majority of our segments, eventually competition arrives. Eventually, the segment becomes more and more professionalized. Institutional investors realize that this is actionable for their kind of capital and we end up moving on. Because increased competition is, in our view, sort of the enemy of returns for sure.

But I think the way we define our collection of subsegments into a "Cloverlay market", I think is the ownership of assets that most institutional investors don't realize you can own. A lot of people didn't know 8 years ago that you could actually participate in a wireless spectrum auction run by the FCC and own real estate in the sky in certain ZIP codes across the country.

They thought AT&T and Verizon owned all of the airwaves. They don't. That was an actionable niche. There will be no more FCC auctions for 5 years. that's pretty interesting. No more real estate in the sky. So we look for the subsegments that have interesting assets, of course, but also haven't commanded the attention of institutional capital for whatever reason.

Chris Sparenberg

So interesting. But that can come back around, for instance, where saturated niche segments have second and third order derivative opportunities that Cloverlay is uniquely able to capitalize on. Can you tell us more about those?

Jeff Collins

The world changes over time. And previously uninteresting segments suddenly become interesting. Previously interesting segments become less interesting because of macro factors or increased competition. Our commercial license is to hang around the hoop in each of these segments and to monitor them as closely as we can to identify the changes as they occur.

And that's what presents the second and third order opportunities, being very close to music royalty catalogs, which everyone has heard of, music publishing rights. Love the asset, super, super competitive space where we can't get there on pricing or returns. However, there are certain genres that are absent from those very large institutional portfolios.

That is an interesting second order actionable segment of an otherwise pretty broadly trafficked space inside of private equity. You can say the same thing for litigation finance, which the complex commercial world has gone through 15 years of fairly rapid evolution and remains a hypercompetitive cottage industry.

Everyone fighting over relatively small deals and returns used to look like a multiple of capital and now you look more like mezzanine on top of a firm's entire caseload. We're not interested in the latter. We would be interested in the former if it existed.

But you look at the 75 different opportunities we've seen in litigation finance, and the one largest issue in litigation finance broadly is duration. And even the most conservative estimates of how long it will take to reach resolution of these 5 cases or these 9 cases, they've been wrong and they've been wrong by a lot of years.

What about litigation finance secondaries? That is a second order, very interesting, very compelling, uncompetitive second order opportunity inside a much larger segment that everybody knows about. So there can be regulatory changes that can change certain segments geographically around the world.

They're the nonperforming loan pools is a theme that we've been following, the royal we, including my partner Cory, going back to the early 1990s, following the opportunity around the world as laws change. What sort of collateral can we go after in different places depending on what kinds of debt you buy? South Africa was off limits for 25 of those years. And then because of regulatory changes, South Africa is a vibrant nonperforming loan pool opportunity.

Same in Brazil. So there are lots of things you can do. You have to stay around, be in the conversation even when things aren't interesting, and that takes proactive effort. It takes an oversized team to have all of those conversations, most of which are just ho-hum updates, but then you find something that's changed, and that's when we like to take advantage...

Jocelyn Lewis

It's fascinating. Thank you, Jeff. We appreciate you joining us today to dive into the niche adjacent private market strategy. It's fascinating to learn about the types of investments your team is working on, how you source them, how you navigate each opportunity. Also so interesting to hear you talk about how you work with partners to set KPIs, track performance and achieve your targeted returns. We wish you continued success with your strategy, and thank you again for joining us today.

Jeff Collins

Thanks, Chris. Thanks, Jocelyn. Really enjoyed it. Thank you.

Jocelyn Lewis

Thanks, Jeff.

Chris Sparenberg

Thank you again to our wonderful guest for a great chat today. We really appreciate everyone listening in. If you're looking for more Private Markets content, hit subscribe to catch future episodes and listen to our earlier episodes wherever you listen to podcasts. Cheers everyone.

Jocelyn Lewis

Thank you so much. You can also subscribe to our monthly Private Markets 360 newsletter. The link is in each episode bio or connect with us on LinkedIn. Have a great day.