CONTRIBUTORS
Tony Davidow, CIMA®
Senior Alternatives Investment Strategist
Franklin Templeton Institute
In the latest episode of our Alternative Allocations podcast series, I spoke with Mercer Investment Consultant Will Dillard about lessons he’s learned from institutional allocators to alternatives. Having spent several years working with them, Will shared valuable insights about how institutions allocate capital, conduct due diligence and think about diversification across the alternative investment opportunity set.
We discussed the growing interest in private markets within the wealth channel. Will noted that “. . . the dispersion between top and bottom quartile managers, it's much wider than if you were to look at public market asset classes. So, I think aligning yourself with top GPs [General Partners1] who have management teams that have ultimately delivered success for portfolio companies—but also for their LPs [Limited Partners2] —is very important to success within the private wealth channel.”
We spoke about the importance of due diligence, and how it differs from evaluating traditional investments. Will noted that while there are similarities, there are also substantial differences, and advisors need to get comfortable with the firm and its offerings.
Will emphasized the importance of alignment of interests, and how he likes to see managers with “skin in the game.” Specifically, he noted evaluating the historical track record, how managers scale positions and construct portfolios, and their relative performance.
Will commented that “. . . having that depth of experience, having a track record and really going through multiple market cycles if possible is important.” He went on to share that “. . . typically you'll see the best-of-the best have some sort of competitive advantage in terms of sourcing relative to others.”
Will shared many great insights as advisors begin allocating more significant capital to the private markets, including evaluating funds, managing liquidity and managing expectations. We discussed the role of alternative investments in portfolios and the importance of diversification across alternatives.
Will and I went on to discuss our respective market outlooks. Will shared that “I do think secondaries3 are an attractive area of the market today, and with the institutions that we work with, a number of corporate pensions are looking to de-risk their plans.” And he noted that “You're not seeing distributions being able to fund new commitments. So, I do think there's going to be interesting secondary opportunities, both LP- and GP-led over the coming years.”
Will provided several valuable takeaways for advisors contemplating an allocation to alternatives, for those who are thinking about increasing their allocations to the asset class, and for those curious about where the best opportunities may be in today’s market environment.
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Endnote
- In the context of private equity (PE), the general partner, or GP, refers to the PE firm that manages a private equity fund. These funds are usually set up as general partnerships with the third-party investors being the limited partners and the PE firm acting as the GP.
- LPs are the investors into private equity funds which are managed by a General Partner (GP) Like shareholders in a corporation, LPs have limited liability to the extent of their investment and have no management authority.
- Secondary funds, commonly referred to as secondaries or continuation transactions, purchase existing interests or assets from primary private equity fund investors. For example, a primary private equity fund may purchase a stake in a private company, and then sell that interest to a secondary buyer. Sellers gain liquidity, while buyers may find the portfolio claim or asset(s) attractive.
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. An investment strategy focused primarily on privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity. Diversification does not guarantee a profit or protect against a loss.
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.