Bloomberg Audio Studios, podcasts, radio news Outside Hello, hedge funds, Venture Kappa, private equity, private credit. Allocating capital to alternatives has never been more popular or more challenging. How should investors approach these asset classes? I'm Barry Ridholts, and on today's edition of At the Money, we're going to discuss
how investors should think about alternative investments. To help us unpack all of this and what it means for your portfolio, Let's bring in Ted Sidies, who began his career at the Yale University Investments Office under the legendary David Swinson. He's founder and CIO of Capital Allocator, and since twenty seventeen has hosted a podcast by that same name. His latest book is Private Equity Deals Lessons in Investing, deal Making and Operations from Private Equity Professionals, is out now.
So Ted, let's start with the basics. What is the appeal of alternatives?
If you start with let's call it a traditional portfolio of stocks and bonds, the idea of adding alternatives is to improve the quality of your portfolio, meaning you're trying to get the highest turns you can with the similar level of risk or sometimes the same kind of returns with a reduced level of risk, and bringing in these other alternatives help you do that.
All right, So there I mentioned a run of different alternatives. How do you distinguish between private equity, private credit, hedge funds, venture capital? Lots of different types of alts. How do you think about these?
Each of them have their own different risk and reward characteristics. That's probably the easiest way to think about it. If you go from a spectrum private credit, think about it. It's the same as bonds, a little bit different. Hedge funds can be like bonds or stocks a little bit different. Then you get into private equity, which is kind of a little bit of juiced stock portfolio, and venture capital is the riskiest of them all.
So you're discussing risk there. Let's talk about reward. What sort of return expectations should investors have for these different asset classes?
Well, similarly, private credit, think about a bond portfolio with credit risk and a little bit of illiquidity. So that's bonds plus is it bonds plus two hundred basis points? Maybe something like that. Hedge funds generally have either bond like or stock like characteristics with less risk. Private equity you should expect a premium over stocks and venture capital a premium over that because of the early stage risk.
Huh, those are really kind of interesting. You mentioned illiquidity. Let's talk a little bit about the illiquidity pre What does that mean for investors? What's involved with that?
When you start with just traded stocks and bonds, you can get out instantaneously. So if you're going to commit your capital to any of these other categories, you have to embrace some illiquidity. Meaning if you want to get out in that moment, it's going to cost you. So to take on that risk, you need some type of extra return, otherwise it wouldn't make sense to do it.
So the concept of an illiquidity premium is that in order to pursue these strategies that prevent you from accessing your money instantaneously, you need to get paid for that.
So where does the illiquidity premium come from? My assumption was because this is so much smaller than public markets, with so many fewer investors, perhaps there are some inefficiencies that these managers can identify. Any truth of that.
It depends on the strategy. That would be the story with hedge funds. Sure, when you get into private equity venture capital, it's always in price. So if you're getting the same asset that's in the public markets or the private markets, in theory, you should want to buy it at a discount in the private markets because you can't get your money out quickly, and that's where you would see that premium.
And so, since we're talking about lockups and not being able to get liquid except at very specific times, how long should investors expect to lock up their capital in each of these alternatives.
It depends on the strategy and whether you're investing directly in these securities or let's just say you're in funds. So private credit can vary, but oftentimes you may not get the liquidity until the assets are liquidated.
So that could be anywhere from five to ten years.
It can be Hedge funds often are quarterly liquidity, depending on the underlying you get into a private equity or venture capital fund, now you're generally talking about ten to fifteen years.
Because you have to wait for that private company to have some liquidity of to free up the cash.
And on top of that, if you're investing in a fund, you have to wait for the fund manager to find the company. So you're committing your capital, they find the company, they might own it for say three to eight years, and then you're waiting to get the cash back.
Huh. That's really that's really kind of intriguing, all right. So when investors interested in alts, how much capital do they need before they can start seriously looking at the space? Is this for five million dollar portfolios or fifty million dollar portfolios?
It's changing a lot to move to smaller numbers. So if I go back to when I started in this, you didn't have kind of pooled alternatives. I think about fund of funds or all this movement of the democratization of alts, and a minimum might be a million dollars
for a single fund. If you want a diversification, and you wanted to say ten different funds, Now you're talking about ten million, and if that's only ten percent of your portfolio, you're looking at one hundred million dollars just to make it.
Those are big numbers.
Those are big numbers. That has changed a lot, and now you're starting to see more and more products available at you know, rather than a million dollar minimum, maybe it's fifty thousand dollars or even less. So it's a little bit less. What size I mean you do need to have, you know, is it five million, is a ten million? I don't really know.
The goal, but it's not five hundred thousand dollars.
It's not five hundred thousand dollars.
Right, So, and you were saying the goal is, well, the goal is.
To get access to some of these areas, hopefully in a very high quality way, and have some diversification within the strategy that you're pursuing, and that does take some capital.
So you just set something really interesting before ten different funds and a million dollars each out of one hundred million dollars. You're implying that investors should allocate a certain percentage. So let me rather than use that example, let me just ask that directly, how much in the alt and private space should investors think about allocating in order to generate potentially better returns and increase their diversification.
It's entirely a function of let's say, a liquidity budget. So, as you mentioned it, you need to lock up your capital, particularly when you're getting into private equity and venture capital, and that means you can't access it. So if someone has enough money that they don't really need to access. You know, if you have one hundred million dollars, you're
probably not accessing most of that year to year. And you've seen in some of the most sophisticated institutions all these alts get up to fifty percent of their portfolio. If you're talking about maybe you have five million to invest, it's not clear you want to take half of that and put it away so that you can't access it in case you need the capital in between now and fifteen years from now.
So a phrase I heard that kind of made me a giggle, but I want to share it with you. Sixty forty is now fifty thirty, twenty or some variation to that effect. What are your thoughts on that.
I think about it a little bit differently, which is most of the time you want to think about the risk and return of the overall and you can break that down into stockbond risk. So whether that's sixty forty or seventy thirty, that's fine. The question with alts is how do you want to take that risk? So rather than in a seventy thirty having seventy percent in US stocks, yeah, you may want to say, hey, maybe twenty percent of
that should be in private equity. You have similar risk, but you have a different type of return stream and hopefully a little more octane.
That's kind of interesting. Let's talk about fees. It used to be that two and twenty two percent of the underlying investment plus twenty percent of the that gains was the standard. What are standard fees in the old space today?
It is a function a little bit of that return characteristic. So if you get to the higher octane private equity, venture capital, you generally do still see two and twenty hedge funds and private credit it tends to be a little bit less than that. But make no mistake about it, the fees are higher in the alternatives than they are in the traditional world.
How should investors go about finding alternative managers and evaluating their funds?
So this is incredibly important because unlike in the stock and bond markets, the dispersion of returns and alts is much much wider, Meaning if you find a good manager it matters a lot more than if you find a good stock manager a good bond manager Cumbersely, if you find a bad one it hurts you much more. Than if you're hurt by stock and bond. So how do you do it? It does take a fair amount of research and either a trusted advisor or someone who knows
the space. There's a lot of different ways to get involved in that. One of the ways you're seeing more and more as all to get democratized is the bigger brands are creating products. You can go to Blackstone and you'll be fine. I don't know if you'll get the best returns, but you're not going to get the worst returns. And so one way that people think about participating is you look at who these larger public alternative managers are.
It's a Blackstone, Ares, Apollo, KKR, TPG. These are super high quality investment organizations.
How do you gain entry to the best funds? A lot of you know, it's a little bit like the old Groucho Marx joke. I wouldn't want to be a member of any club that would have me. The funds you want to get into the most very often require giant minimums because they're working with foundations and endowments, and very often they're either closed or there's a giant queue to get into them. How does one go about establishing a relationship ps. All these questions come right from your book.
But how do you go about establishing a relationship with the potential alternative funds that you might want to have exposure to?
Yeah, it's really hard, particularly as an individual. If you think about it, you're competing with all of those very well resourced institutions and down its foundations, pension funds that have people, well compensated people that are out looking for these funds. So the question you have to ask is what are
you trying to accomplish? And that can be different for different people, different organizations, but generally speaking, it does require working into networks where you start to learn who the players are and trying to figure out from that who are the better ones. It takes a lot of time to do that well.
So if someone wants some assistance in building out the alternative portion of their portfolios, where do they begin looking? How do they go find that sort of those sort of resources.
Usually the first step comes from the fund to funds world, and you could look at as a great example, Vanguard Now as part of their retirement package, did a deal with harbor Vest. Harbor Vest is one of the leading fund of funds to allow entry to get good quality exposure. So a harbor Vest, a Hamilton Lane, Stepstone, some of these are some of the bigger established, say private equity fund of funds. They do a very good job of getting people access to high quality exposure.
Huh So if you're a four to one k at Vanguard, do you have access to that or is that just broad portfolios?
I know it exists within their suite. I'm not sure if it's part of their target funds or you can directly access.
So what are some of the bigger challenges and misconceptions about investing in alternatives?
Well, the biggest misconceptions come from the public perception of it because most of the time in the news you only read about sensationalization. You read about huge returns and big failures in almost all the cases. Set a side venture capital, because venture capital is designed to have huge successes and failures. All the action happens in the middle. Like hedge funds generally speaking, are very boring, they're not newsworthy. They shouldn't make the news. Private credits the same way.
There will be a time in private credit where there are defaults, and you'll read about defaults but you probably won't read that the returns are just fine even with the defaults.
So how do investors go about doing some due diligence on the funds they're interested in? How do they make sure they're getting what they expect to get.
A lot of it starts with meeting the people and trying to understand what is their philosophy, what is their strategy, and how do they go about deal making. You then can get into the data. So any of these firms that's been around, they've done deals in the past, and you could try to figure out how do they add value? Do they buy well, do they run the companies well,
do they sell well? Is it financial leverage? And then trying to figure out what do you think works and is that a fit with how that firm pursues investing really interesting.
So to wrap up, investors who have a long time horizon, a substantial portfolio, the time effort and interest in exploring the alternative space may want to pull some modest percentage of their holdings aside and locking these up for an extended period with the hope of getting a better than average return on a diversified basis or an average return on a lower risk basis. Start out by looking at some of the bigger names in the space that Ted
had mentioned. Do your homework and your due diligence. Go into this with open eyes and make sure that you are not allocating too much capital to a space that might be locked up for five or ten years or more. Successful alternative investors have been rewarded with outstanding returns. Unsuccessful ones have underperformed the public markets. I'm Barry Ritholtz and this is Bloomberg's at the Money.
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