CONTRIBUTORS
Tony Davidow, CIMA®
Senior Alternatives Investment Strategist
Franklin Templeton Institute
In our most recent episode of the Alternative Allocation podcast series, I had the opportunity to sit down and discuss a range of issues with my good friend Scott Welch, from Certuity. Scott brings a unique perspective as a long-time CIO with a deep appreciation for alternative investments. We discussed the role of alternatives in client portfolios, evaluating funds, product evolution, and allocating enough capital to increase the likelihood of achieving goals.
Scott and I discussed the evolution from drawdown structures to evergreen structures, and how they can be used by investors. Scott stated that, “I think that the evergreen facility is a natural fit for private credit. The money gets right to work. There's no J curve.1 People start generating income right away. It's a 1099. Right, so there's a lot of positive aspects to the evergreen structure.”
Given Scott’s experience, I wanted to probe more into evaluating funds and managers. “So, as a point of view, I think you start with the basic four P's of due diligence—people, philosophy, process, and performance. If you don't like the people, stop there.” With respect to philosophy, Scott offered some insights regarding what advisors should be evaluating: “Do you believe the approach can work consistently over time?”
If the people, process, and philosophy make sense, then you can evaluate the performance of the manager and similar funds. Scott and I discussed the large dispersion of returns between the top and bottom private markets managers, and emphasized the importance of seeking to allocate capital to the best managers, and avoiding the bottom performers.
Private and Public Market Return Dispersion
As of June 30, 2024.
Source: MSCI Private Capital Solutions, Morningstar.
The returns for US Large and Mid Cap Active Equity Funds reflect the annualized returns for the period January 1, 2005 to June 30, 2024. The returns for Secondaries, Private Equity, Venture Capital (VC), and Private Debt are the Internal Rate of Return (IRR) of the funds with vintage years from 2005 to 2018, as of June 30, 2024. Past performance is not an indicator or a guarantee of future results. Important data provider notices and terms available at www.franklintempletondatasources.com.
Scott noted that, “. . . there is history that shows that the top quartile managers are consistently in the top quartile and those are the folks you need to get access to.” This makes intuitive sense since the top general partners are seeing all the deal flow.
I wanted to know where Scott thought the most attractive opportunities were today. He indicated they have made significant investments in private credit and are feeling more constructive on real estate as valuations have come down. We also discussed one of our highest conviction ideas—secondaries. “The traditional sources of liquidity for the private equity sponsors have not been there as much as they have been in the past. Mergers and acquisitions, strategic sales, and initial public offerings have not been as robust as in the past, and that's creating, significant discounts and opportunities within the secondaries market.”
Lastly, we closed out the interview by discussing how he allocates to alternative investments. While every client is different, and advisors should evaluate their client’s circumstances, it was instructive to hear Scott describe the way that he thinks about alternatives. He indicated that clients often have a 10% allocation to hedge fund strategies (macro, multi-strategy, etc.); and a 10%-15% allocation to private markets (private equity, private credit, and real estate). Depending upon what they are solving for, clients could have higher or lower allocations to private credit or private equity.
Scott was very generous with his time and his insights. He shared his experience in evaluating funds and allocating capital.
If you missed this, or any of the Alternative Allocation podcasts, don’t forget to subscribe wherever you get your podcast so you don’t miss future episodes, and remember to rate and review to help us improve.
If you missed this, or any of the Alternative Allocation podcasts, don’t forget to subscribe wherever you get your podcast so you don’t miss future episodes, and remember to rate and review to help us improve.
Endnote
- The “J-curve” is the term commonly used to describe the trajectory of a private equity fund’s cashflows and returns. An important liquidity implication of the J-curve is the need for investors to manage their own liquidity to ensure they can meet capital calls on the front-end of the J-curve.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Investments in many alternative investment strategies are complex and speculative, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative strategies may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. Diversification does not guarantee a profit or protect against a loss.
Risks of investing in real estate investments include but are not limited to fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by local, state, national or international economic conditions. Such conditions may be impacted by the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, and environmental laws. Furthermore, investments in real estate are also impacted by market disruptions caused by regional concerns, political upheaval, sovereign debt crises, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars). Investments in real estate related securities, such as asset-backed or mortgage-backed securities are subject to prepayment and extension risks
An investment in private securities (such as private equity or private credit) or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return. The value of and return on such investments will vary due to, among other things, changes in market rates of interest, general economic conditions, economic conditions in particular industries, the condition of financial markets and the financial condition of the issuers of the investments. There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor’s ability to dispose of them at a favorable time or price. Past performance does not guarantee future results.