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At the Money: Lessons in Allocating to Alternative Asset Classes · Masters in Business

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  Speaker 1: Bloomberg Audio Studios, podcasts, radio news Outside Hello, hedge funds,
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  Speaker 1: Venture Kappa, private equity, private credit. Allocating capital to alternatives
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  Speaker 1: has never been more popular or more challenging. How should
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  Speaker 1: investors approach these asset classes? I'm Barry Ridholts, and on
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  Speaker 1: today's edition of At the Money, we're going to discuss
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  Speaker 1: how investors should think about alternative investments. To help us
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  Speaker 1: unpack all of this and what it means for your portfolio,
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  Speaker 1: Let's bring in Ted Sidies, who began his career at
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  Speaker 1: the Yale University Investments Office under the legendary David Swinson.
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  Speaker 1: He's founder and CIO of Capital Allocator, and since twenty
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  Speaker 1: seventeen has hosted a podcast by that same name. His
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  Speaker 1: latest book is Private Equity Deals Lessons in Investing, deal
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  Speaker 1: Making and Operations from Private Equity Professionals, is out now.
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  Speaker 1: So Ted, let's start with the basics. What is the
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  Speaker 1: appeal of alternatives?
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  Speaker 2: If you start with let's call it a traditional portfolio
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  Speaker 2: of stocks and bonds, the idea of adding alternatives is
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  Speaker 2: to improve the quality of your portfolio, meaning you're trying
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  Speaker 2: to get the highest turns you can with the similar
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  Speaker 2: level of risk or sometimes the same kind of returns
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  Speaker 2: with a reduced level of risk, and bringing in these
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  Speaker 2: other alternatives help you do that.
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  Speaker 1: All right, So there I mentioned a run of different alternatives.
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  Speaker 1: How do you distinguish between private equity, private credit, hedge funds,
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  Speaker 1: venture capital? Lots of different types of alts. How do
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  Speaker 1: you think about these?
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  Speaker 2: Each of them have their own different risk and reward characteristics.
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  Speaker 2: That's probably the easiest way to think about it. If
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  Speaker 2: you go from a spectrum private credit, think about it.
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  Speaker 2: It's the same as bonds, a little bit different. Hedge
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  Speaker 2: funds can be like bonds or stocks a little bit different.
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  Speaker 2: Then you get into private equity, which is kind of
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  Speaker 2: a little bit of juiced stock portfolio, and venture capital
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  Speaker 2: is the riskiest of them all.
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  Speaker 1: So you're discussing risk there. Let's talk about reward. What
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  Speaker 1: sort of return expectations should investors have for these different
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  Speaker 1: asset classes?
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  Speaker 2: Well, similarly, private credit, think about a bond portfolio with
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  Speaker 2: credit risk and a little bit of illiquidity. So that's
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  Speaker 2: bonds plus is it bonds plus two hundred basis points?
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  Speaker 2: Maybe something like that. Hedge funds generally have either bond
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  Speaker 2: like or stock like characteristics with less risk. Private equity
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  Speaker 2: you should expect a premium over stocks and venture capital
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  Speaker 2: a premium over that because of the early stage risk.
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  Speaker 1: Huh, those are really kind of interesting. You mentioned illiquidity.
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  Speaker 1: Let's talk a little bit about the illiquidity pre What
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  Speaker 1: does that mean for investors? What's involved with that?
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  Speaker 2: When you start with just traded stocks and bonds, you
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  Speaker 2: can get out instantaneously. So if you're going to commit
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  Speaker 2: your capital to any of these other categories, you have
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  Speaker 2: to embrace some illiquidity. Meaning if you want to get
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  Speaker 2: out in that moment, it's going to cost you. So
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  Speaker 2: to take on that risk, you need some type of
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  Speaker 2: extra return, otherwise it wouldn't make sense to do it.
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  Speaker 2: So the concept of an illiquidity premium is that in
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  Speaker 2: order to pursue these strategies that prevent you from accessing
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  Speaker 2: your money instantaneously, you need to get paid for that.
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  Speaker 1: So where does the illiquidity premium come from? My assumption
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  Speaker 1: was because this is so much smaller than public markets,
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  Speaker 1: with so many fewer investors, perhaps there are some inefficiencies
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  Speaker 1: that these managers can identify. Any truth of that.
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  Speaker 2: It depends on the strategy. That would be the story
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  Speaker 2: with hedge funds. Sure, when you get into private equity
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  Speaker 2: venture capital, it's always in price. So if you're getting
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  Speaker 2: the same asset that's in the public markets or the
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  Speaker 2: private markets, in theory, you should want to buy it
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  Speaker 2: at a discount in the private markets because you can't
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  Speaker 2: get your money out quickly, and that's where you would
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  Speaker 2: see that premium.
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  Speaker 1: And so, since we're talking about lockups and not being
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  Speaker 1: able to get liquid except at very specific times, how
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  Speaker 1: long should investors expect to lock up their capital in
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  Speaker 1: each of these alternatives.
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  Speaker 2: It depends on the strategy and whether you're investing directly
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  Speaker 2: in these securities or let's just say you're in funds.
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  Speaker 2: So private credit can vary, but oftentimes you may not
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  Speaker 2: get the liquidity until the assets are liquidated.
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  Speaker 1: So that could be anywhere from five to ten years.
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  Speaker 2: It can be Hedge funds often are quarterly liquidity, depending
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  Speaker 2: on the underlying you get into a private equity or
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  Speaker 2: venture capital fund, now you're generally talking about ten to
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  Speaker 2: fifteen years.
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  Speaker 1: Because you have to wait for that private company to
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  Speaker 1: have some liquidity of to free up the cash.
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  Speaker 2: And on top of that, if you're investing in a fund,
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  Speaker 2: you have to wait for the fund manager to find
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  Speaker 2: the company. So you're committing your capital, they find the company,
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  Speaker 2: they might own it for say three to eight years,
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  Speaker 2: and then you're waiting to get the cash back.
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  Speaker 1: Huh. That's really that's really kind of intriguing, all right.
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  Speaker 1: So when investors interested in alts, how much capital do
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  Speaker 1: they need before they can start seriously looking at the space?
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  Speaker 1: Is this for five million dollar portfolios or fifty million
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  Speaker 1: dollar portfolios?
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  Speaker 2: It's changing a lot to move to smaller numbers. So
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  Speaker 2: if I go back to when I started in this,
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  Speaker 2: you didn't have kind of pooled alternatives. I think about
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  Speaker 2: fund of funds or all this movement of the democratization
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  Speaker 2: of alts, and a minimum might be a million dollars
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  Speaker 2: for a single fund. If you want a diversification, and
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  Speaker 2: you wanted to say ten different funds, Now you're talking
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  Speaker 2: about ten million, and if that's only ten percent of
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  Speaker 2: your portfolio, you're looking at one hundred million dollars just
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  Speaker 2: to make it.
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  Speaker 1: Those are big numbers.
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  Speaker 2: Those are big numbers. That has changed a lot, and
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  Speaker 2: now you're starting to see more and more products available
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  Speaker 2: at you know, rather than a million dollar minimum, maybe
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  Speaker 2: it's fifty thousand dollars or even less. So it's a
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  Speaker 2: little bit less. What size I mean you do need
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  Speaker 2: to have, you know, is it five million, is a
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  Speaker 2: ten million? I don't really know.
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  Speaker 1: The goal, but it's not five hundred thousand dollars.
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  Speaker 2: It's not five hundred thousand dollars.
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  Speaker 1: Right, So, and you were saying the goal is, well,
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  Speaker 1: the goal is.
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  Speaker 2: To get access to some of these areas, hopefully in
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  Speaker 2: a very high quality way, and have some diversification within
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  Speaker 2: the strategy that you're pursuing, and that does take some capital.
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  Speaker 1: So you just set something really interesting before ten different
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  Speaker 1: funds and a million dollars each out of one hundred
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  Speaker 1: million dollars. You're implying that investors should allocate a certain percentage.
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  Speaker 1: So let me rather than use that example, let me
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  Speaker 1: just ask that directly, how much in the alt and
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  Speaker 1: private space should investors think about allocating in order to
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  Speaker 1: generate potentially better returns and increase their diversification.
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  Speaker 2: It's entirely a function of let's say, a liquidity budget. So,
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  Speaker 2: as you mentioned it, you need to lock up your capital,
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  Speaker 2: particularly when you're getting into private equity and venture capital,
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  Speaker 2: and that means you can't access it. So if someone
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  Speaker 2: has enough money that they don't really need to access.
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  Speaker 2: You know, if you have one hundred million dollars, you're
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  Speaker 2: probably not accessing most of that year to year. And
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  Speaker 2: you've seen in some of the most sophisticated institutions all
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  Speaker 2: these alts get up to fifty percent of their portfolio.
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  Speaker 2: If you're talking about maybe you have five million to invest,
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  Speaker 2: it's not clear you want to take half of that
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  Speaker 2: and put it away so that you can't access it
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  Speaker 2: in case you need the capital in between now and
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  Speaker 2: fifteen years from now.
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  Speaker 1: So a phrase I heard that kind of made me
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  Speaker 1: a giggle, but I want to share it with you.
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  Speaker 1: Sixty forty is now fifty thirty, twenty or some variation
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  Speaker 1: to that effect. What are your thoughts on that.
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  Speaker 2: I think about it a little bit differently, which is
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  Speaker 2: most of the time you want to think about the
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  Speaker 2: risk and return of the overall and you can break
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  Speaker 2: that down into stockbond risk. So whether that's sixty forty
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  Speaker 2: or seventy thirty, that's fine. The question with alts is
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  Speaker 2: how do you want to take that risk? So rather
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  Speaker 2: than in a seventy thirty having seventy percent in US stocks, yeah,
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  Speaker 2: you may want to say, hey, maybe twenty percent of
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  Speaker 2: that should be in private equity. You have similar risk,
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  Speaker 2: but you have a different type of return stream and
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  Speaker 2: hopefully a little more octane.
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  Speaker 1: That's kind of interesting. Let's talk about fees. It used
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  Speaker 1: to be that two and twenty two percent of the
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  Speaker 1: underlying investment plus twenty percent of the that gains was
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  Speaker 1: the standard. What are standard fees in the old space today?
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  Speaker 2: It is a function a little bit of that return characteristic.
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  Speaker 2: So if you get to the higher octane private equity,
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  Speaker 2: venture capital, you generally do still see two and twenty
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  Speaker 2: hedge funds and private credit it tends to be a
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  Speaker 2: little bit less than that. But make no mistake about it,
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  Speaker 2: the fees are higher in the alternatives than they are
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  Speaker 2: in the traditional world.
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  Speaker 1: How should investors go about finding alternative managers and evaluating
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  Speaker 1: their funds?
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  Speaker 2: So this is incredibly important because unlike in the stock
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  Speaker 2: and bond markets, the dispersion of returns and alts is
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  Speaker 2: much much wider, Meaning if you find a good manager
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  Speaker 2: it matters a lot more than if you find a
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  Speaker 2: good stock manager a good bond manager Cumbersely, if you
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  Speaker 2: find a bad one it hurts you much more. Than
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  Speaker 2: if you're hurt by stock and bond. So how do
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  Speaker 2: you do it? It does take a fair amount of
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  Speaker 2: research and either a trusted advisor or someone who knows
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  Speaker 2: the space. There's a lot of different ways to get
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  Speaker 2: involved in that. One of the ways you're seeing more
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  Speaker 2: and more as all to get democratized is the bigger
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  Speaker 2: brands are creating products. You can go to Blackstone and
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  Speaker 2: you'll be fine. I don't know if you'll get the
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  Speaker 2: best returns, but you're not going to get the worst returns.
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  Speaker 2: And so one way that people think about participating is
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  Speaker 2: you look at who these larger public alternative managers are.
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  Speaker 2: It's a Blackstone, Ares, Apollo, KKR, TPG. These are super
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  Speaker 2: high quality investment organizations.
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  Speaker 1: How do you gain entry to the best funds? A
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  Speaker 1: lot of you know, it's a little bit like the
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  Speaker 1: old Groucho Marx joke. I wouldn't want to be a
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  Speaker 1: member of any club that would have me. The funds
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  Speaker 1: you want to get into the most very often require
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  Speaker 1: giant minimums because they're working with foundations and endowments, and
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  Speaker 1: very often they're either closed or there's a giant queue
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  Speaker 1: to get into them. How does one go about establishing
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  Speaker 1: a relationship ps. All these questions come right from your book.
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  Speaker 1: But how do you go about establishing a relationship with
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  Speaker 1: the potential alternative funds that you might want to have
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  Speaker 1: exposure to?
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  Speaker 2: Yeah, it's really hard, particularly as an individual. If you think
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  Speaker 2: about it, you're competing with all of those very well
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  Speaker 2: resourced institutions and down its foundations, pension funds that have people,
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  Speaker 2: well compensated people that are out looking for these funds.
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  Speaker 2: So the question you have to ask is what are
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  Speaker 2: you trying to accomplish? And that can be different for
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  Speaker 2: different people, different organizations, but generally speaking, it does require
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  Speaker 2: working into networks where you start to learn who the
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  Speaker 2: players are and trying to figure out from that who
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  Speaker 2: are the better ones. It takes a lot of time
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  Speaker 2: to do that well.
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  Speaker 1: So if someone wants some assistance in building out the
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  Speaker 1: alternative portion of their portfolios, where do they begin looking?
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  Speaker 1: How do they go find that sort of those sort
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  Speaker 1: of resources.
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  Speaker 2: Usually the first step comes from the fund to funds world,
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  Speaker 2: and you could look at as a great example, Vanguard
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  Speaker 2: Now as part of their retirement package, did a deal
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  Speaker 2: with harbor Vest. Harbor Vest is one of the leading
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  Speaker 2: fund of funds to allow entry to get good quality exposure.
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  Speaker 2: So a harbor Vest, a Hamilton Lane, Stepstone, some of
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  Speaker 2: these are some of the bigger established, say private equity
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  Speaker 2: fund of funds. They do a very good job of
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  Speaker 2: getting people access to high quality exposure.
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  Speaker 1: Huh So if you're a four to one k at Vanguard,
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  Speaker 1: do you have access to that or is that just
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  Speaker 1: broad portfolios?
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  Speaker 2: I know it exists within their suite. I'm not sure
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  Speaker 2: if it's part of their target funds or you can
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  Speaker 2: directly access.
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  Speaker 1: So what are some of the bigger challenges and misconceptions
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  Speaker 1: about investing in alternatives?
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  Speaker 2: Well, the biggest misconceptions come from the public perception of
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  Speaker 2: it because most of the time in the news you
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  Speaker 2: only read about sensationalization. You read about huge returns and
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  Speaker 2: big failures in almost all the cases. Set a side
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  Speaker 2: venture capital, because venture capital is designed to have huge
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  Speaker 2: successes and failures. All the action happens in the middle.
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  Speaker 2: Like hedge funds generally speaking, are very boring, they're not newsworthy.
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  Speaker 2: They shouldn't make the news. Private credits the same way.
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  Speaker 2: There will be a time in private credit where there
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  Speaker 2: are defaults, and you'll read about defaults but you probably
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  Speaker 2: won't read that the returns are just fine even with
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  Speaker 2: the defaults.
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  Speaker 1: So how do investors go about doing some due diligence
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  Speaker 1: on the funds they're interested in? How do they make
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  Speaker 1: sure they're getting what they expect to get.
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  Speaker 2: A lot of it starts with meeting the people and
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  Speaker 2: trying to understand what is their philosophy, what is their strategy,
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  Speaker 2: and how do they go about deal making. You then
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  Speaker 2: can get into the data. So any of these firms
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  Speaker 2: that's been around, they've done deals in the past, and
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  Speaker 2: you could try to figure out how do they add value?
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  Speaker 2: Do they buy well, do they run the companies well,
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  Speaker 2: do they sell well? Is it financial leverage? And then
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  Speaker 2: trying to figure out what do you think works and
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  Speaker 2: is that a fit with how that firm pursues investing
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  Speaker 2: really interesting.
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  Speaker 1: So to wrap up, investors who have a long time horizon,
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  Speaker 1: a substantial portfolio, the time effort and interest in exploring
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  Speaker 1: the alternative space may want to pull some modest percentage
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  Speaker 1: of their holdings aside and locking these up for an
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  Speaker 1: extended period with the hope of getting a better than
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  Speaker 1: average return on a diversified basis or an average return
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  Speaker 1: on a lower risk basis. Start out by looking at
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  Speaker 1: some of the bigger names in the space that Ted
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  Speaker 1: had mentioned. Do your homework and your due diligence. Go
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  Speaker 1: into this with open eyes and make sure that you
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  Speaker 1: are not allocating too much capital to a space that
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  Speaker 1: might be locked up for five or ten years or more.
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  Speaker 1: Successful alternative investors have been rewarded with outstanding returns. Unsuccessful
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  Speaker 1: ones have underperformed the public markets. I'm Barry Ritholtz and
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  Speaker 1: this is Bloomberg's at the Money.
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  Speaker 2: Arm outside of Girl Grown Russ