By Michael Oliver Weinberg, CFA.
Multiple prominent asset managers, particularly their ‘retail’ real estate funds, pro-rated, a euphemism for gated, redemptions. However, this was not during a market crisis, such as the Global Financial Crisis (GFC), the last time we recall gating. Post GFC, the lesson for institutional alternative managers was to match the liquidity of the assets to the liquidity of the structure, i.e., no illiquid real estate equity in a liquid fund. This begs the following questions: what precipitated the recent pro-ration, was it necessary, did the wealth management channel expect it, what could have prevented it, and most importantly, what could better align private wealth management and asset managers in ‘liquid’ alternatives?
The causal factor for the recent pro-ration was simple. Interest rates rose and consequently, so did capitalization rates, therefore publicly traded REIT valuations declined. Private market valuations typically lag, and investors needed or wanted their capital back, for exogenous reasons or fear that private market valuations would converge. Demand for liquidity was above the allowed supply per the documents, and funds were pro-rated – typically 2%/month and 5%/quarter. Worse, wealth managers are required to re-submit until they get the targeted capital out.
The funds are invested in illiquid real estate equity. Buildings can’t be sold at attractive prices on short notice, without ‘fire-sale’ prices, which would have harmed investors. To the question, was it necessary? Yes. The asset management industry asserts the wealth management channel should have expected pro-ration as it was in the documents and worked as expected to protect investors. We do not believe it was clear to the fund's investors, many of whom thought it was liquid exposure. Moreover, when clients need or want their capital back but have to wait multiple years, with constant redemptions re-submission, when they thought it would be accessible quarterly, it is sub-optimal. Though demand from wealth managers and clients is diminished in these structures in real estate, it is not yet in other asset classes, such as private equity, and we believe that is likely a future ‘shoe to drop.’
What could have prevented pro-ration? What the hedge fund industry did successfully post GFC, is match the liquidity of the assets to the funds. They didn't offer illiquid assets in a seemingly liquid structure. Why didn’t that happen? An appeal to the wealth management channel was the illiquidity premium of real estate without the illiquidity of the investment, the best of both worlds. Had the liquidity of the funds, matched the illiquidity of the real estate, commercial success would have diminished. It's easy to say to clients,” quarterly liquidity,” however, a ”10 (or 12) year private equity style lock-up” has very little ‘bid.’
What needs to be done to better align asset managers and private wealth management in these ‘liquid’ alternatives? Compromise. There needs to be more intensive education to clients and wealth managers, on the true liquidity in a left tail event; if there's a ‘run’ on the fund. Specifically, the liquidity is only quarterly when funds are net flowing in, and many investors don’t need or want to redeem. That in some circumstances, it is likely to take multiple years to exit the investment. Another solution is to better match the liquidity of the underlying assets to the underlying liquidity. Materially diminish the more illiquid, equity allocation, and increase the more liquid, credit allocation, as loans are paid off in a few years, whereas there is no maturity for an equity investment. Another solution is to better match the liquidity of the fund to the assets, i.e. semi-annual, or annual liquidity, or a multi-year gate. Though none of this would entirely solve the problem, it would at least mitigate the mismatch and create more alignment among asset managers, clients, and wealth managers. In summary, private wealth managers and investors need to determine if the benefits outweigh the costs.
About the Author:
For three decades Michael has invested directly at the security level and indirectly as an asset allocator in traditional and alternative asset classes. Most recently he was a Managing Director, on the Investment Committee and a board member at APG, a Dutch pension provider. Previously he was the Chief Investment Officer and Management Committee Member at MOV37 and Protege Partners. Michael is also an Adjunct Professor of Economics and Finance at Columbia Business School, where he teaches Institutional Investing, an advanced MBA course that he created. He was a portfolio manager, board member and global head of equities at FRM, a multi-strategy investment solutions provider. Prior to that, Michael was a portfolio manager at Soros, the macro fund, foundation, and family office, and at Credit Suisse. Before that he was a Real Estate analyst at Dean Witter.
His responsible investing career started as an investor for George Soros’s foundation, then continued at FRM, Protégé and APG, a world leader in Environmental, Social and Governance investing. Michael has taught ESG investing at business schools. He co-authored an academic paper on using machine learning to optimize allocation to the United Nation Sustainable Development Goals, published by The Journal of Impact and ESG Investing. Michael is a former co-founder of Project Punch Card, a not-for-profit organization, whose mission is to increase diversity by facilitating investment careers for under-represented groups.
Michael is a board member of AIMA. He is on the Milken Institute’s Global Capital Markets Advisory Council, the management advisory council for the Michael Price Student Investment Fund and a Special Advisor to The Tokyo University of Science’s Endowment. Michael is a former co-founder of The Artificial Intelligence in Finance Institute. He is a member of The Economic Club of New York. Michael is a former Chair at CFANY, where he has received multiple awards, including Volunteer of the Year. He has researched the impact of AI on Finance for The World Economic Forum. Michael also testifies as an expert witness in financial and technology litigation.
He is a published author, having written for The New York Times, international investment books and other publications. Michael has been interviewed by the Wall Street Journal, Financial Times, CNBC, Bloomberg, and Reuters. He is a frequent panelist, moderator and lecturer for investment banks, institutional and family office organizations and business schools. Michael has a BS from New York University and an MBA from Columbia Business School.