StepStone Group Inc. Q3 FY2022 Earnings Call

Greetings and welcome to the StepStone Fiscal Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Seth Weiss, Head of Investor Relations. Thank you, sir. You may begin.

Thank you and good afternoon, everyone. Joining me on the call today are Scott Hart, Chief Executive Officer; Jason Ment, President and Co-Chief Operating Officer; Mike McCabe, Head of Strategy; and Johnny Randel, Chief Financial Officer. During our prepared remarks, we will be referring to a presentation which is available on our Investor Relations website. Before we begin, I'd like to remind everyone that this conference call as well as the presentation contains certain forward-looking statements regarding the company's expected operating and financial performance for future periods. Forward-looking statements reflect management's current plans, estimates, and expectations, and are inherently uncertain and subject to various risks, uncertainties, and assumptions. Actual results for future periods may differ materially from those expressed or implied by these forward-looking statements due to a number of risks and other factors. Turning to our financial results, we reported GAAP net income of $126.3 million for the quarter ended December 31, 2021. GAAP net income attributable to StepStone Group Incorporated was $48.3 million. We generated fee-related earnings of $36.8 million, adjusted net income of $48.6 million, and adjusted net income per share of $0.42. The quarter reflected retroactive fees resulting from the final closing of StepStone’s Tactical Growth Fund III and additional closings of our private equity co-investment fund that contributed $1.2 million to revenue and $1.1 million to fee-related earnings. There were no material retroactive fees in the prior year's quarter. I now like to turn the call over to StepStone’s Chief Executive Officer, Scott Hart.

Thank you, Seth, and good afternoon, everyone. We delivered our strongest quarter to date on both an absolute and per share basis. We reported record results for fee-related earnings and adjusted net income, while growing our total assets under advisement and management to nearly $550 billion. Our private market solutions continue to demonstrate their value during a turbulent period for public markets, which are marked by recent volatility in stock prices, a more inflationary environment, and a rising interest rate outlook. Our breadth and scale across all four private market asset classes provide the full spectrum of tools to allow our clients to thrive in every environment. We construct balanced and customized portfolios that deliver attractive results to our clients, including consistent alpha generation from private equity, exposure to growth and the innovation economy through venture capital, income and yield enhancement from private debt, and natural inflation protection embedded in real estate and infrastructure. Furthermore, our business model is primed for steady growth and durable operating results that can withstand the peaks and valleys of cyclical economic patterns. We have deliberately invested in asset classes, strategies, and geographies benefiting from secular tailwinds, and the long-term nature of our client relationships, along with the diversity of our asset class and geographic footprint, provides stability to our fee-related earnings. Turning to our results, we generated $48.6 million in adjusted net income for the quarter, or $0.42 per share, up 50% from the prior fiscal year's third quarter on a per share basis. We generated fee-related earnings of $36.8 million, up 65% from the prior year quarter, as we produced strong organic growth and benefited from the Greenspring acquisition. Accounting for the increase in our share count, we grew fee-related earnings per share by 41%. This was our first full quarter with Greenspring, and the integration process is progressing well, with early results coming in ahead of expectations. The impact to our clients has been seamless, and we are seeing positive interest from both legacy StepStone and Greenspring LPs as they explore the added breadth of StepStone solutions. We produced another strong quarter of asset growth, finishing with $127 billion of assets under management and $71 billion of fee-earning AUM. Excluding acquired assets, we have organically grown fee-earning AUM by 28% over the last 12 months, with balanced growth across both asset class and structure. I'll now turn the call over to Mike McCabe to speak about our asset growth and fee-related revenue growth in more detail.

Great. Thanks, Scott. Now turning to our growth in gross AUM inflows in the last 12 months, we generated nearly $16 billion, with about $4 billion coming from our commingled funds and roughly $12 billion in separately managed accounts. For the quarter, we grew fee-earning assets by $4.5 billion, with balanced growth across commercial solutions. Commingled funds contributed about $2 billion, driven primarily by interim closings of our private equity co-investment fund and our venture secondary fund. Commingled funds will continue to be a significant part of our growth engine, as the addition of the Greenspring platform expands our menu of fund offerings in the highly sought after but access-constrained venture capital and growth equity sectors. We've included additional details on our fund families in the appendix of our earnings presentation as a new disclosure. Separately managed accounts contributed the remaining $2.7 billion of this quarter's fee-earning asset growth, driven by a combination of re-ups and new client wins, as well as the successful deployment of fee-paying capital across asset classes and strategies. As Scott mentioned, the breadth of our diversified offerings is a significant competitive advantage, particularly evident this quarter across real assets. Real estate and infrastructure offer portfolio diversification, income, and inflation protection, and are seeing the benefit from increased client demand. We expect the positive backdrop for real assets specifically and multi-asset class solutions more broadly to continue for the foreseeable future. Looking over the last 12 months and excluding the impact from acquisitions, we have organically grown fee-earning assets by over $13 billion, or by 28%. While this is clearly an exceptional period of growth, it is consistent with the organic CAGR of 30% over the last four years. Being able to maintain our growth rate in fee-earning AUM, while at the same time monetizing investments for our clients is a point of pride for the entire organization. We continue to grow our evergreen products C-prime, our private markets fund for accredited investors. As of February 1, we have grown C-prime to $390 million in net asset value, a strong ramp-up since introducing the product less than a year and a half ago and we are making progress across all distribution channels. Our undeployed fee-earning capital stands at over $17 billion. This is down slightly quarter-over-quarter, given the strong deployment across asset classes, but remains near our all-time peak and provides visibility into growth driven by capital that has already been committed. Our undeployed balance also gives us considerable dry powder to tactically capitalize on market dislocations. Slide 9 shows the evolution of our management and advisory fees where we are generating greater than $3.30 per share in revenues over the last 12 months, representing a CAGR of 25% since fiscal year 2018. We generated our blended management fee rate of 52 basis points, which is stable compared to the last three years. Before turning the call over to Johnny, I'd like to take a moment to speak about expenses and long-term operating leverage. We remain disciplined in managing our spending while also steadily investing for growth. This approach has served us very well over our 15-year history, and we will continue to prioritize growth in what we view as a multi-decade opportunity for expansion within the private markets. Examples of just a few areas in which we have invested include the build-out of deep and experienced real estate, infrastructure, private debt, and venture capital teams to complement our original private equity capabilities. A broad geographic footprint with investment professionals operating in local markets where we invest and serve. The creation of a nearly 30-person dedicated retail team, and the development of proprietary technology that enables our clients and investment teams to optimize their investment decisions by accessing private market data through user-friendly SaaS-based software. We pride ourselves on a technology stack that is state-of-the-art. While many incumbent financial services peers are spending significant sums of money to update their systems, we have built an infrastructure that is modern, efficient, and flexible, creating a strong foundation that will serve both our company and our clients well into the future. Recognizing the durability and scalability of our platform, we remain committed to investing in our platform well ahead of growth. While this may result in a trade-off with margins in the near term, each of these areas is scalable and creates an environment for operating leverage over the longer term.

Thank you, Mike. I'd like to turn your attention to a few of our financial highlights. We are reporting strong organic top-line and bottom-line growth and have benefited from a full quarter of the Greenspring acquisition. We generated record results for management and advisory fees, adjusted revenues, fee-related earnings, adjusted net income, and ANI per share. Our FRE margin for the quarter was 35%, up 300 basis points year-over-year. We benefited from retroactive fees in the quarter, which contributed 70 basis points to the FRE margin. We also benefited from variations related to year-end bonus accruals that favorably impacted this quarter's compensation expense and margin. As Mike mentioned, we see a significant pathway for continued growth, and we will invest appropriately to pursue that growth. For the near term, that likely means increases in compensation expense as we grow the team and fill open positions. Additionally, we expect a higher level of T&E as we move through the coming year. G&A expense trending higher still remains at levels below what we would consider normal. We continue to view near-term FRE margin of about 30% as a reasonable expectation, with some variability quarter-to-quarter based on the timing of expenses and the cadence of large commingled fund closings. Over the long term, we continue to expect our margins to migrate to the mid '30s as we balance profitability with sustainable growth. Gross realized performance fees were $66.6 million for the quarter, our highest period ever, reflecting a continued elevated level of realization activity driven by a positive market environment for exits and strong underlying investment performance. Shifting to our profitability, we have grown fiscal year-to-date fee-related earnings per share by 17%. As a reminder, we earned an unusually high level of retroactive fees in fiscal 2021, so our fiscal 2022 year-to-date growth comes against a high comparison. Looking over the longer term, we have achieved a CAGR of 48% in fee-related earnings per share since our fiscal 2018 period. We have grown our adjusted net income per share by 98% for the year-to-date period and by 46% over the longer term, reflecting continued increases in FRE and strong realized net performance fees. Moving to the balance sheet, gross accrued carry continues to increase, driven by strong underlying investment performance, and in the quarter, totaled over $1.3 billion. This is up 11% from the prior quarter and up 112% over the last 12 months, despite a high level of realizations. On the bottom chart, our own investment portfolio ended the quarter at $99 million, up 9% from the prior quarter and 56% over the same quarter in the prior year, reflecting market appreciation and net contributions. Unfunded commitments to these programs were $73 million as of quarter-end. We manage a large pool of over $51 billion or performance fee eligible capital; this capital is widely diversified across multiple vintage years and approximately 150 programs. Lastly, we view the outstanding $65 million on our revolver as a relatively small amount of debt, considering our earnings and cash generation. This line of credit gives us flexibility to support growth initiatives, including future GP commitments.

We will now be conducting a question-and-answer session. Our first question is from Ken Worthington with JPMorgan. Please proceed with your question.

Hi. Good afternoon. And I guess Happy New Year, if we can still say that. For Scott and Mike, as we start the new calendar year, I was hoping you could reflect on management's top goals for growing the business in calendar 2022 and to the extent that you're focusing more resources in one element or aspect of the business versus another. What are you most excited about for StepStone when thinking about the growth outlook ahead?

Sure. Thanks, Ken. For the question and a belated Happy New Year to you as well. As we look ahead to ‘22 and fiscal ‘23 for us, it is, to some extent, business as usual. I think back to the first six quarters out of the gate that we've had as a public company. One of the things that really highlights the strength and diversity of the platforms is that each quarter it's been a different part of the business driving our outperformance. Starting initially with the final closing of our real estate commingled fund followed by a couple of quarters of strength specifically in the private equity and private debt asset classes; and more recently, looking at the last couple of quarters, there is real strength from the infrastructure side. Various factors have been driving our growth and success, setting up a platform to capitalize on continued growth opportunities. We are also focusing on commingled funds, as confirmed by new disclosures on our historic commingled funds, and that will be a priority in the year ahead. Re-ups will continue to be high priority as investment activity has picked up. Lastly, the retail opportunity remains a key focus for us.

Okay. Great. Thank you for that. And then just maybe a bit more on Greenspring now that you've been sort of an owner of the business and have probably a better feel than you did when you were buying it. How are you progressing and thinking about their growing their offering in the coming year?

Sure. I think you're indeed getting to know the team even better than during the due diligence process. We've been spending a tremendous amount of time with the Greenspring team, including myself. Things are going well, and some of that is anecdotal based on what we're hearing from the team, as well as some expectations playing out in real-time. Whether that is gaining access to investment opportunities or due diligence insights that would not have been possible previously. Part of this is driven by data points suggesting the venture-focused secondaries fund recently surpassed $2 billion and is performing well, ahead of our expectations and timelines for some other funds in the market seem to be outperforming as well. We want to ensure that we capitalize on the combined strength of the platform by continuing to listen to our clients.

Okay. Great. Thank you very much.

Thank you. Our next question comes from Alex Folstein with Goldman Sachs. Please proceed with your question.

Hey. Good afternoon, guys. Thanks for taking the question as well. First question, maybe a little bit more industry-focused, given the benefit you have looking and speaking with so many LPs around the world. I heard your comments about appetite for real assets, given the inflationary outlook. What about private equity, given the significant amount of deployment the industry has seen over the last couple of years relative to maybe a slower pace of realizations? How are people thinking about tactically allocating to private equity as an asset class over the next 12 to 18 months?

Sure, Alex. I'll start, and others may want to jump in as well. One of the biggest challenges we've heard from LPs looking at allocating to the private equity market is the pace at which managers have been returning to market. Many LPs have had their hands full working through existing managers' pipelines, leading to a focus on how do we selectively re-up with those managers while also freeing up capital to allocate elsewhere. We're seeing tremendous interest in the venture and growth space. Clearly, secondaries had an active year in 2021, and we expect some continuation into 2022, but navigating the active pipelines is key. Recent market volatility has raised concerns around valuations, but the hope is that the decline in public markets may create buying opportunities, even if that takes some time for buyer and seller expectations to align.

Got it. Great. Helpful. And then a follow-up question, Johnny, probably for you around FRE margin. The near-term FRE margin of 30% is meaningfully lower than what you guys have done recently. How should we think about this over the next several quarters? Is 30% the right number for 2022, and should we expect a positive margin expansion trajectory thereafter?

Thanks for the question. We think of retro fees as helping the FRE margin, so we're focusing on core operations rather than relying on retroactive fees. The timing of our performance may shift above or below that 30% mark, driven by the timing of fund closings and the filling of positions. Around 30% is a reasonable expectation for the next few quarters, and if fundraising on our commingled funds picks up sooner, we could see a lift. The challenge lies in timing.

Thank you. Our next question comes from Michael Cyprys with Morgan Stanley. Please proceed with your question.

Hey. Good afternoon. Thanks for taking the question. Scott, I wanted to come back to your earlier comments around investing in the platform for growth. Could you expand a bit on how much you're planning to expand headcount by over the next 12 months? What are the top areas across the firm for adding headcount and some of the top initiatives you'd like to expand on?

Sure. I think Mike touched on several investment areas during the prepared remarks. We're continuing to grow our asset class teams and geographic footprint. We are expanding our asset class teams, with significant growth in our retail team, which you heard us reference earlier. Additionally, we are enhancing our human resources team to attract, retain, and develop talent, given the competitive market. Further, we will focus on expanding sourcing and deployment opportunities in areas like infrastructure and private debt, in line with the trends we are observing.

Great. If I could just squeeze one last question in here about the retail C-prime product. Given the exceptional investment performance, can you discuss the steps you're taking to accelerate flows into that product? Where do you see the size of the team 12 to 24 months from now, and what's the progress on platforms for distribution?

Thanks, Mike. We are approved on over 100 platforms now, including RAs, IVDs, and a few international platforms. A number of others are preparing to launch, with progress being made on several U.S. wires. As for headcount growth, we're looking to add more individuals in the U.S. while also beginning to pivot toward building out our non-U.S. sales force.

Thank you. Our final question comes from Adam Beatty with UBS. Please proceed with your question.

Hi. Good afternoon. Thank you for taking the question. Firstly on the management fee rate, given the mix shift toward a higher percentage of commingled funds, what should we expect moving ahead? Should we expect some fee rate accretion as a result?

Sure, Adam. As you pointed out, with the addition of the Greenspring platform, which is more heavily weighted toward commingled funds, there is definitely a mix shift happening. Given that the Greenspring platform had a higher overall fee rate, we will continue to see a shift toward commingled funds that may help our overall blended rate slightly. However, you may have also seen a lower commingled fee rate for this quarter, so it will fluctuate as business levels change.

When looking at fiscal ‘21, there was some elevation in fees driven by retro fees; as the portfolio grows we expect that margins may vary from quarter to quarter based on the timing of new business.

Great. Thank you for those nuances. I wanted to inquire about the environment you’re seeing among the GP managers you work with, particularly in light of the market dislocation and rate hikes. Are you noticing any disturbances or shifts in GP dynamics that you’re keeping an eye on?

We haven't noticed any specific disturbances in the GP community. Rather, we see an active fundraising environment that has resulted in rapid pace and interest across several categories. The recent trends in asset allocation from LPs suggest there are shifts in focus, especially towards real assets, as they prepare for rising interest rates and inflation. However, our relationships with GPs remain strong, and we continue to see high demand and numerous managers in the market.

Great. Thank you.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Scott Hart for any closing comments.

Great. We appreciate your time and your interest in StepStone, and we look forward to updating you as we move ahead. Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.