By William (Bill) J. Kelly, CAIA, the President & CEO of the CAIA Association.
BREIT gated last week, and management was baffled about the attendant narrative. They certainly have a right to feel that way. Afterall a word search of the 469 page prospectus for certain terms (number of occurrences in parenthesis) such as risk (413), liquidity (75), suspension (25), and illiquidity (21) would seem to meet a reasonable standard of caveat emptor, even if the true guts of this gating risk don’t really get wholesomely addressed until page 89. Regardless of whether anyone even reads these offering documents, individual investor behavior and the party-line the media adopts have become so very predictable.
Like the theater fire narrative — somebody thinks they smell smoke, and they get out as quickly as they can. Others, maybe not even knowing what, if anything, is wrong quickly follow as they reason it is better to act first and ask questions later when they are standing at a safe distance. The assumption back in investment land follows this same corollary, the underlying might have a problem and I want out, too. A prospectus is stickered while a gate is put up and talking heads shift into overdrive. To really stretch this narrative, we have seen this movie so many times before that we can recite every next-line and we know how it will end. So, what really baffles me is …
Why we sell liquidity (or illiquidity) as a benefit when it really is simply a product feature. The liquid alt product is the poster child for this peeve. As a general matter, hedged equity offerings, strategies promising access to a macro investment approach, or providing commodity exposure via a CTA structure are differentiated investment strategies. Packaging them into daily liquidity vehicles with limits on leverage, illiquidity, and position concentration clearly will rinse out a (significant) part of what said investor should get in a private fund offering.
Why private fund valuations have become a punching bag. A link to a recent Howard Marks memo can be found further on in this essay, and therein he raises some excellent points on this debate. “Mightn’t it be fair for GPs to decline to mark down private investments in companies that have experienced short-term weakness but whose long-term prospects remain bright? Should the private market pricing emulate the public market prices that so often reflect excessive psychological swings?” To that, I would add my own additional question - Would it be fair to test and realize those values (in the short-term) to meet the demands of an exiting shareholder who have a short(er) term orientation than the remaining shareholders who will suffer an interim (excessive?) markdown that they didn’t want nor anticipate? The truth is somewhere in the middle between public and private markets, but making the assumption that either represents the truth is a fallacy. Fellow CAIA Charterholder Chris Schelling argues that the “lag” of private valuations may be more of a feature than a bug in this thoughtful new Institutional Investor article.
Why we debate the veracity of the 60/40 model. The very essence of better risk adjusted returns is the ability to allocate across a wide aperture of uncorrelated risk premia. Three, four or five options will always be better than two. It should never be a debate of traditional vs. alts rather a focus on differentiated ALLternatives that can be accessed and understood through a finely tuned due diligence prism.
Why we don’t talk about risk as an asset. Risk can be avoided or transferred but never eliminated from the system. Most (smart) investors opt to own it but responsibly manage it and mitigate it through diversification. The most recent Howard Marks Memo so eloquently drives this point home: “Develop the mindset that you don’t make money on what you buy and sell; you make money (hopefully) on what you hold. Think more. Trade less.”
Why we talk about the illiquidity premium when accessing private markets. As we learned last week, most individual investors don’t understand what an illiquidity premium really is, but they absolutely understand the illiquidity discount and will always seek to minimize it by rushing to the redemption window. A recent report by Hamilton Lane on the private markets (see page 7) so elegantly captures the very best reason to be thinking about the private markets where we see that 87% of the companies in the US earning over $100M in revenue are privately held. That is where capital formation and value creation are happening and with the right IDD/ODD, alpha can be sourced in that deeper sea of inefficiencies and opportunities.
Why we talk about ESG as if it were a single risk factor. No need to repeat what my friend and colleague John Bowman has so eloquently articulated recently in Barron’s.
Why we don’t invest enough in ‘Educational Alpha’. CAIA’s March 2023 exam window is open, and we are running at a record setting cycle for new Candidates and that is a good thing for the client and the prospect. We are the only pure-play credential focused on alternative investments and have been at this for over two decades. Alternatives are less than 20% of the global AUM pie yet represent about 50% of the revenue at a time where the majority investor is no longer the institution. We urge Ameriprise, and anyone else, who has not taken the time to understand what we do, to talk with us, embrace the role we play, and proudly allow your fiduciaries to carry our marks. Your client needs and deserves the highest standards of professionalism.
Seek education, diversity of both your portfolio and people, and know your risk tolerance. Investing is for the long term.
About the Author:
William (Bill) J. Kelly, CAIA is the President & CEO of the CAIA Association. Bill has been a frequent industry speaker, writer, and commentator on alternative investment topics around the world since taking the leadership role at the CAIA Association in January, 2014.
Previously, Bill was the CEO of Boston Partners and one of seven founding partners of the predecessor firm, Boston Partners Asset Management which, prior to a majority interest being sold to Robeco Group in Rotterdam in 2002, was an employee-owned firm. Bill’s career in the institutional asset management space spans over 30 years where he gained extensive managerial experience through successive CFO, COO and CEO roles. In addition to his current role, Bill is a tireless advocate for shareholder protection and investor education and is currently the Chairman and lead independent director for the Boston Partners Trust Company. He has previously served as an independent director and audit committee chair for ’40 Act Mutual Funds and other financial services firms. He is also currently an Advisory Board Member of the Certified Investment Fund Director Institute which strives to bring the highest levels of professionalism and governance to independent fund directors around the world. A member of the board of the CAIA Association, Bill also represents CAIA in similar capacities via their global partnerships with other associations and global regulators. Bill began his career as an accountant with PwC and is a designated Audit Committee Financial Expert in accordance with SEC rules. Follow Bill Kelly on Twitter @CAIA_BillKelly