Democratizing Growth with Irwin Loud, of Muller and Monroe. #4
Irwin Loud, co-founder of Chicago-based Muller and Monroe, fund of private equity funds, talks about the recent progress of directing capital to minority and women general partners.
Links:
NAIC Examining the Results
Cambridge Associates: Sector Specialists Outperform by nearly 5%
Cambridge Associates: Sector Specialists Outperformance
Cambridge Associates: Diverse Manager Investing
Brian Smiga: This is Brian Smiga, the Speedy VC at Alpha Partners. And I'm here with Irwin Loud of Muller & Monroe Investments. Irwin, welcome.
Irwin Loud: Thank you. It's my pleasure. After many years in dialogue, it's nice to do something more formal.
Brian Smiga: Yeah, it's great. We first met at Girl and the Goat in Chicago, at a nice dinner with Math Ventures. We’re here to talk about democratizing growth and how we might look at being proactive and moving capital to emerging managers, both minorities and women, because the statistics show they outperform, but they don't get the same capital. It's in single digits compared to others. What is Muller & Monroe doing in this area, Irwin? Can you describe the fund of funds approach that you have?
Irwin Loud: Sure. We are Chicago based minority owned and managed private equity fund of funds. 1.3 billion under management. My partner and I are African American. We're backed by wealthy families and private equity. We focus on smaller funds that invest in the lower middle market. Groups raising 250 to a billion dollars is the sweet spot. And we like growth equity, buyouts, and later stage strategies.
Irwin Loud: We started the firm because of our exposure to the realization that the lower middle market is the highest performing sector of private equity, and private equity is the highest performing asset class in an institutional and portfolio. I previously built a private equity portfolio at the Florida Pension Fund, and that's how I found this space after investing in big brand names and realizing that this end of the market is how they cut their teeth. Irwin Loud: Along the way, we ended up attracting minority and women managers as part of the emerging market manager space, and big public funds ended up putting us in business with mandates to do that. So while that's not our exclusive focus, we have built most of our franchise doing minority and women managers. And our recent performance is suggesting that our MWB mandates are killing our benchmarks, just extreme outperformance relative to historical.
Brian Smiga: That's great news, and I'm not surprised, but I wonder if we can pinpoint or discover what are some of the causes for that outperformance? Intuitively one says, well, it's grit, it's diversity of thought, it's empathy, it's diversity of access. Maybe there's other factors. Where do you see the drivers of outperformance?
Irwin Loud: Well, as a minority myself, I can tell you that your life experience makes you hungry and resilient and used to fighting an uphill battle. But that's really not the core, at the core of the outperformance is really the corporate finance of this sector of the market. It's that the lower middle market is much less efficient and companies have a lot of room to professionalize and grow. And we built our firm on the proposition that you invest in groups that are buying companies at four to six times cashflow.
Now at six to eight times cashflow, and you fire uncle Charlie, and then hire a world class CFO and a real professional sales group and give them access to channels that they never had, like Amazon and Whole Foods, and things like that. And you create value that enables: you get multiple arbitrage when you exit. So you exit in a full option at eight to 10 or 12 times cash flow, after already doubling or tripling the size of the company. And so that is the basic corporate finance model that we see evidenced in the space, whether it's minority managers or emerging non-minority managers.
Brian Smiga: Minority managers or women may have an advantage in sourcing companies, which are trading at good entry prices. And there's clear value that they can add. Do they have a sourcing advantage?
Irwin Loud: It depends on their space. And I think we could generalize, but the bottom line is every group has to be differentiated in some way. And what we look for is principal investment experience and relevant relationships evidenced in the team and how they've organized. So it could be that the team comes from an industry and has natural domain expertise in relationships, which enhances their sourcing, or could be they've partnered themselves with a collection of players, which may be someone who's an operator, used to run businesses in that space, and is fully wired.
Or they have contracted with a set of operating partners who extend their reach. And so we see a lot of creative ways in which people do that. But yes, being able to source on a proprietary basis, everyone says they have proprietary deal flow and are at the first quartile. The reality is everyone with a company, has someone advising them, and there's a process that they go through in evaluating partnering. It may be a full auction book, or a book put together by Houlihan Lokey, or with 150 others.
Brian Smiga: Here we are at the beginning of 2022, and you're investing 1.3 billion this way and outperforming with your fund of funds, how do we 10x that this decade? How is Muller & Monroe going to 10x that and how are others going to 10x that capital flow to minority managers who outperform in this decade?
Irwin Loud: Well, what's exciting is that the stars are aligned in several ways. When we first started the firm 22 years ago, there were very few emerging manager programs. And so finding money to invest in this space was an uphill battle.
Brian Smiga: Right.
Irwin Loud: Now, there are a number of large public funds who got it early and created programs. And those are the programs that largely fund us. And we've been funded two and three times by them. And that has created an awareness, and their experience has been positive. Then you have the increased awareness in equality and justice. Equity and inclusion initiatives, the Black Lives Matter, conflicts and issues related to social justice more broadly has a much broader range of institutional investors bringing broader considerations.
ESG is a big part of that as well. So when you have endowments and foundations and corporate pension funds, who historically would not consider diverse managers and had never read any of the studies about the outperformance, and are never getting any pressure to do anything different than hire the same managers from the same old boy network, nothing changed. Now, all of that is a foot, and the consultant community is being pushed to broaden their exposure to managers. Irwin Loud: So they have been executing outreach to groups like us, and they had been trying to build their own networks and been much more forthright about how they look at the world, and how they can diligence the world so that it's really just helping to level the playing field. The field is not level, but it is clearly the most attractive environment that I've ever seen to raise money for emerging diverse management.
Brian Smiga: Yeah, I've always said that DEI is the fastest path to ESG, and that DEI is actually a more attractive and more urgent imperative. And I think it gets us to sustainability and better governance and fairness and equity by bestowing the capital to the diverse managers who represent the population. Now, not all institutions are created the same, who're the first movers here? Could name leaders? And who are the laggards just getting into the game?
Irwin Loud: Well, the big public funds were clearly first because they represent public constituencies and they're managed by high profile public individuals, often elected officials and so they had the early programs and that would be New York Common, CALSTERS and CalPERS. And Illinois had one of the first really comprehensive initiatives that was initiated by the Illinois Senate. After that, the Illinois Senate began having Senate hearings, with all of the public pension funds talking about diversity and inclusion. For years and years, pension funds were reporting 0, 0, 0, and then once they had public hearings, then the numbers began to change.
And there have been others who have been aggressive in building in this regard. I think the last people to the group have been the endowments, foundations and corporate pension funds that have not had a top down push to be open minded. And I think there was a set of players in the institutional universe across the board that had this flawed notion that if you are looking at emerging managers or diverse and emerging managers that you're compromising quality in order to create diversity. They did not review the studies that have shown otherwise, they just had this assumption that's not based on reality. I
So now, as they're getting pressed to defend their positions, and they realize there's a difference. Then it begins to dialogue toward change.
Brian Smiga: Yeah. So we're going to put some of those studies in the comments below this interview on democratizing growth. If you were in front of an endowment or an asset manager today, and you could say one or two things about opening their minds to minority managers, what would you say?
Irwin Loud: What I would say is that, number one, go to the NAIC website, National Association of Investment Companies, which is the private equity trade association focused on a minority, mainly African American, private equity managers. And they have assembled independent research of their user base that documents the outperformance. And it's done in a very thoughtful way with a big accounting firm auditing the numbers. I would send them to Cambridge Associates website to look at the article on sector specialist and growth equity sector focused funds which tend to outperform, have more upside and less downside. Irwin Loud: It's the first empirical work that we saw that validated the proposition that those in the lower middle market who are micro focused on something that they do extremely well, that gives them an operating advantage as they execute, which helps to get that multiple arbitrage of buying at six times cashflow and selling at 10 times cashflow.
That would be my response: to look at specific managers and look at how they're creating value and differentiating themselves and be open-minded about how you do the due diligence, instead of requiring them to have invested under two funded platforms, to be willing to look at their track record when they were inside of another organization, or when they were serial investors or operating under a pledge fund, or when two different people have been successful with track records in different organizations coming together. You have to manage the risk of the new organization, but you can validate that they are seasoned investors under a relatively new platform.
Brian Smiga: Great, there's some terrific resources. In closing when we think about democratizing growth and this movement and this change are there any single change agents or personalities that you might highlight as we close out this interview?
Irwin Loud: Well, the leaders of the funds who have launched the emerging manager programs are to be commended because they did things that were not comfortable. They have paved the way and their beneficiaries in their pension funds gained benefit. That would be Denise Lynn Nappier, who was a former treasurer, the first African American treasurer, in the State of Connecticut, who was very proactive. And Tom DiNapoli, the Comptroller of New York, who has been tremendously supportive of this space and Chris Ailman and the whole CALSTERS team who have been very proactive in this space.
Similarly, the Illinois public funds, all now have very strong outreach programs. And then the trade associations that have been in support, our organizations that people should reach out to, and also the general consultant community, I applaud their open-mindedness at recognizing deficiencies in the past and their openness to broaden their processes and broaden their consideration of the full universe. And they're going to benefit from the outperformance associated, by looking at the whole universe and not the subset of it.
Brian Smiga: Irwin Loud, Muller & Monroe, thank you so much. We're going to put the names and the organizations in the comments below for our readers. This has been a great session on democratizing growth in the 2020s. Thanks everyone for being with us.
To be in touch with Brian, DM @bsmiga.
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