ADISA Video: Major Trends in Alternative Investments
In an interview with ADISA board member Greg Mausz, William Kelly, president and chief executive officer at CAIA, explains that mainstream investors and advisors should consider private markets since more companies are starting private and staying private for longer periods of time.
“I think the conversation’s got to be around where’s capital formation of value creation happening,” said Kelly. “It’s happening in the private market’s, full stop. And if you’re just becoming an exit mechanism for a Warby Parker who did a DPO, is that fair to you and what you’re trying to create, especially if you have responsibility for your own retirement and 401K plan? So, from that standpoint, if you’re thinking about wealth creation, you must be accessing the private markets.”
Video Transcript
Greg Mausz 00:10
Welcome to another edition of Focus on Alternatives, brought to you by ADISA, the Alternative and Direct Investment Securities Association. For more information about alternative investments, please visit adisa.org and check out the resource library where you’ll find lots of quality content. My name’s Greg Mausz. I’m your host today, I’m joined by Bill Kelly. He’s the CEO of CAIA. Thanks for joining us.
Bill Kelly 00:35
Thanks Greg. Pleasure to be here.
Greg Mausz 00:36
We are going to talk about alts and alt trends. But before we go there, I just want to hear your basic definition of an alternative investment.
Bill Kelly 00:45
So, it’s often easy to talk about what it’s not. So, I think most of folks think about investing is 60/40 models, 60% public equity, 40% debt, and that’s the traditional space. Alts can mean a lot of different things to a lot of different people, but it’s everything else. And it covers collectibles like wine and baseball cards. The institutional definition, what a sovereign wealth fund would own would be the private markets, private equity, private debt infrastructure, real estate, hedge funds, commodities, but even cryptocurrencies are considered an alternative. So, the definition keeps evolving, but I think it’s maybe easier to orient yourself about what it’s not, which is pub public equity, public debt.
Greg Mausz 01:23
So, you just covered a lot of different asset classes. Let’s go mainstream financial advisor, mainstream investor. How should they be thinking about allocating into alts?
Bill Kelly 01:35
Well, I think to not have a consideration for the private markets is a big mistake. You look at where capital formation of value creation is happening. It is in the private markets. During the course of my career, there’s a concept of the Wilshire 5,000 of, of misnomer right now, there’s only 3,500 publicly listed companies. More companies are starting private and staying private for longer periods of time. When they do go public, oftentimes it’s a DPO, direct public offering where the founding LPs and GPs are exiting. So, I think the very best value proposition, and I think our industry sometimes gets this wrong, we’re selling the investor on the concept that you can make higher returns in the private equity market than you can in the public equity market. May or may not be true given any specific company, but I think it’s fallacy. I think the conversation’s got to be around where’s capital formation of value creation happening. It’s happening in the private market’s, full stop. And if you’re just becoming an exit mechanism for a Warby Parker who did a DPO, is that fair to you? And what you’re trying to create, especially if you have responsibility for your own retirement and 401K plan. So, from that standpoint, if you’re thinking about wealth creation, you must be accessing the private markets.
Greg Mausz 02:45
Completely agree. And you just brought up retirement accounts. Talk more about retirement accounts and alts in retirement accounts, because it seems like they, there’d be a good fit for each other. There’s a long-time horizon on retirement accounts, and a lot of alts have, you know periods of illiquidity. So, touch on that for us.
Bill Kelly 03:03
So, I, I think as a headline, I absolutely believe the access should be there, but I heard of a fairly sophisticated GP proffer that why should the teacher in Texas have access to alts through a public pension plan? And yet the accountant doesn’t. And I think it’s, as a headline, it makes great sense, but the teacher has somebody else taking care of investment risk, inflation risk. We learned the impact of currency risk through these LDI arrangements in London just last week, and how poisonous that could be to wealth creation. If I’m the teacher in Texas, somebody else is taking care of all those risks for me and all I need to do when I’m 65 is walk down to the end of my driveway, open up a mailbox and a check is there a hundred cents in the dollar.
If we say to the accountant, all right, this seems unfair, you’re managing a retirement, have access to private equity, have access to private debt, who’s doing the due diligence for that poor accountant? And when that accountant goes down to the mailbox, there is no check there. It’s in his 401K plan. And he better have managed all of these risks, including longevity risk correctly and carefully. Otherwise, he or she’s going to have a very difficult golden year span. So that part of it, I think we get, we don’t pay enough attention to. So, the access is very, very important. But I think every one of these, quote unquote asset classes are no longer asset classes. They’ve gotten to be very, very complex industries where the median returns don’t look very attractive relative to the public market proxy. And then the dispersion, meaning what the, the medium return is versus what the top managers are delivering, you could drive a truck through it. So due diligence clearly, clearly important. But I think that if, if you or I are, are responsible for managing own retirement and we don’t have access to these tools, I think we’ve done ourselves a disservice.
Greg Mausz 04:50
Absolutely. And that’s why I’m so glad to see more and more people adapting alts in all different types from the private equity to the real estate to infrastructure. And speaking of infrastructure, I mean, that, that’s been a real hot button continues to grow. Can you talk more about infrastructure in alts?
Bill Kelly 05:08
So, it’s one of these, again, I’ll use the word asset class for simplicity purposes here, Greg, but it’s, it’s one of the asset classes that doesn’t get the attention it deserves. And if you look at the emerging middle class in sub-Sahara Africa, parts of India, it is enormous. And the population in these countries are enormous. They don’t have the basic infrastructure around just around tow roads and airports and a whole host of things like that. The ability to invest with a secured asset with a return that is probably better than you can get in the public debt markets for a long period of time, I think exceedingly attractive. The amount of capital need in that space is enormous. The risks are there too. You’ve got a public-private partnership, so your investment partner might be the sovereign itself. What does that mean? If you don’t know, you better figure that out before you make the investment in the first place. But I think there are many, many opportunities beyond the garden variety 60/40 model we have in front of us. And I think infrastructure’s just one of those that I would point out had that conversation with your advisor, because that could be a very interesting substitute for what is a very unattractive fixed income market in the public space.
Greg Mausz 06:14
So, speaking of infrastructure, there’s now more closed in funds, non-traded vehicles, interval funds that are accessing the global infrastructure investing. So, it’s great tools for advisors to be able to access for those in individual investors. Next topic that’s a trend is impact investing. So, what’s happening at the intersection of impact and alts?
Bill Kelly 06:39
So, I, and I think your point a moment ago, very much plays into that because the wrapper matters. And if we’re going to take very sophisticated product and drop it into a 40 ACT fund or an ETF, where next day liquidity, have we given the investor what they want or what they absolutely need. And I think even interval funds a better movement, a quarterly liquidity subject to a tender. But I think we’ve got to look at the investors’ wants and needs and being more impactful. Clearly this next generation much more so than the baby boomers, but can we accomplish that in the public markets? Short answer is, I think so, but a lot more difficult to do. And I think this label of ESG seems to dominate the discussion in the public equity markets as if ESG was a single risk factor. There were so many risk factors tucked inside and see, it seems almost foolish to be talking about it.
I saw an article recently in the Economist that talked about the rating agencies that, that track these ratings in the public sector. They’re looking at over 700 metrics across 64 verticals, only 10 of which are in common. And that people say, wow, I’m surprised that one to the other only correlate 0.5, I’m surprised they correlate it all. So, getting back now to your question about impact, impact is like so many things in life, a long-term play. But if I’ve got a very narrow opportunity around housing or water or something that’s very, very specific, that’s a lot easier to measure. And when I think about the concept of net profit, what is my net profit after the impact that I brought forward? And hopefully it’s an additive, not a deduction. So, I, I think that this can be done much more so in the private markets because you’ve got a concentrated shareholder base, very, very patient capital metrics that a GP could work on with the underlying portfolio company to say this is important to you, important to you, to us, and certainly important to the end investor we’re serving.
Let’s find a way of measuring. In the public markets if we try to do that. Every lobbyist has a lobbyist, and every special interest group is saying, no, no, no, you can’t do this. You’re swinging too far to the right and nothing gets done. So, I think there’s not only the concept of patient capital, but the smaller eyeballs on it, I think for allow for a much better value proposition. And I look at this next generation of millennials and the transfer of wealth and the baby boomers down, it’s measured in the tens of trillions of dollars. I saw a number of 80 trillion recently. So, the amount of money moving into the hands of this more sophisticated impact investor, I think could be enormous. And I think we’re just scratching the surface. I saw recently the impact space is maybe a trillion dollars. I think we’re poised to see a tremendous amount of growth there.
Greg Mausz 09:18
And in your opinion, making an impact investment does not mean you have to get lower returns. Is that right?
Bill Kelly 09:23
It’s, I think if that is an accepted truism, then as a fiduciary either to yourself or to somebody else, if you’re the GP that should not be part of the mix. If you’re trying to capture it short term, you may have to give something up on a long-term horizon. It should be a double bottom line. Full stop.
Greg Mausz 09:41
Okay. So, as we wrap up, what are some best practices about allocating portfolios to alts?
Bill Kelly 09:48
I go back and I know that we’re dealing with more of a retail-oriented audience here, Greg, but I go back to a David Swenson at Yale. He died last year way too young. But you think about how Yale allocates to endowments; they don’t think about traditional versus alternative. They think about how much is Yale going to poll each year. And it’s usually 5 to 6%. And then I look at other liabilities and responsibilities and the duration of those. And if I say, well, a fair amount of this capital is not going to be called upon for, for years and maybe in some cases decades, why can’t I lock that up longer? Not to capture an illiquidity premium, to capture complexity premium, to get involved in early-stage VC and growth equity where the action is happening. And that’s how the endowment model is built.
Now, if it comes down to you or I, we’re wired differently because we want liquidity on demand, but if I’m 25 years old and I’m saving for retirement, or I have a three month old and I’m saving for college, is liquidity a page one risk for me? It shouldn’t be. But I think time and time again, our industry takes very complex offerings, put them into that 40 Act wrapper because that’s what the client wants. But having that conversation about what they need and think about the very best risk adjusted portfolio you can put forward. And we’ve seen a lot of contagion in the marketplace so far this year. The All-Country world index is drawn down 20% through the end of August. That if I had hedge funds in there, and I know that maybe that’s a scary term, the average hedge fund drew down four. So, if I had some hedge fund exposure rather than being down 20, maybe I’m only down 10. And that’s a much shallow hole to get back out of and get back up. So, I think ultimately, it’s not time in the market. It’s time in the market. And if you can have a diversified portfolio with some of those sharp movements sort of winnowed out because of diversification, I think you’re going to sleep better at night and have better risk adjusted returns over time.
Greg Mausz 11:42
I completely agree. Bill, thanks so much for sharing your wisdom and perspective with us.
Bill Kelly 11:46
It is a pleasure. Thanks Greg.
Greg Mausz 11:47
And thank you for watching another episode of Focus on Alternatives. Again, for more information about trends and alts, please visit adisa.org. Thank you.
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