Show V/O:
This is Alternative Allocations by Franklin Templeton, a monthly podcast where we share practical, relatable advice and discuss new investment ideas with leaders in the field. Please subscribe on Apple, Spotify, or wherever you get your podcast to make sure you don't miss an episode. Here is your host, Tony Davidow.
Tony Davidow:
Welcome to the latest episode of the Alternative Allocations podcast. I'm thrilled to be joined today by Wendy Li from Ivy Invest. Wendy, you have a unique background. Why don't you share maybe just a little bit of your background and what you're doing today.
Wendy Li:
Thank you so much, Tony, for having me on today. It's a real pleasure to be here. So my background is as a traditional endowment and foundation institutional investor. I have started my career at the Met Museum's investment office back in the mid-2000s. I spent roughly 17 and a half years at various endowments foundations here in New York prior to founding my now business called Ivy Invest, where we are a fintech investment platform, bringing endowment-style investing to everyday individual investors.
Tony:
We always love having people on who could kind of speak to lessons learned. And again, as you and I were talking about the endowments and foundations, I think have really kind of led the evolution of allocating capital, starting with David Swenson all the way down to all of his disciples along the way. So maybe if we can, what are some of the lessons learned from institutions broadly and endowments and foundations specifically?
Wendy:
It's interesting, David Swenson obviously has a very big presence over the way that endowments foundations broadly invest. And when I was starting back in the mid-2000s, I would say there was a lot of the professionally managed investment offices across the endowment space.
They were populated by former folks who worked in that Yale investment office, including the Metropolitan Museum's investment office. So when I had joined in the mid-2000s, that investment portfolio was already quite sophisticated. They had an investing in alternatives since the late ‘80s.
And so I was joining a really well-run, professionally managed, long running investment office. And Lauren Meserve, who is now the CIO, had actually at the time hired me. So she's been with that investment office now for quite some time. But she was previously at Yale's investment office under David Swenson. So we were part of that group of institutions where there was a lot of idea sharing, where there was a lot of due diligence and reference checks.
And going back to your question around sort of lessons learned, I think one of the aspects that really speaks to why the endowment foundation community does have a lot of, I would say, the benefits of having folks having been sort of cross populated across investment offices is that there is a oftentimes commonality in investment philosophy and how, as LPs, we regard our relationships with GPs and the types of interests that we advocate for as institutional LPs. And so the reason I mention all of that is, when it came to investing in GPs, a lot of the times that these LPs, these endowment foundation LPs, particularly the ones who perhaps especially back then in the mid-2000s at the Met Museum, why there was a lot of cross pollination of ideas across portfolios is because it really does matter who's invested alongside you in some of those alternative investments, private market investments, those GP investments. And so it may be, I would say, maybe less of a priority today given the number of institutional LPs that are out there, the huge variety of pools of capital that are invested into GPs.
But back when alternative markets were smaller, back when GPs themselves were smaller, back when the pool of institutional LP's was smaller, it really made a difference. And it mattered a lot that we as endowment foundation LPs were investing alongside other endowment foundation LPs. And there was this collective in terms of advocating for this set of interests alongside partnering with GPs.
Tony:
So I often cite that through much of David Swenson's tenure, he had a 70% to 80% allocation to alternatives. And he believed and espoused the values of the inefficient asset classes where the best opportunities are found. If everything's publicly available, there's not a lot of efficiencies, or there's a lot of efficiencies, there's not a lot of inefficiencies, the ability to pick up those incremental returns over time.
But as you and I were talking about earlier, that's great. And it's a yardstick to be out there. The reality is, individual investors are quite different.
Maybe we start that discussion a little bit. So what are some of the basic differences between individual investors where they may look at the Harvards and the Yales and the Calpers and the Calsters, but they're going to go a little bit slower as they get started. So what are maybe some of the things that they should think about?
Wendy:
I think you really pointed to one of the more, it's both obvious, but I think really underappreciated, which is just this depth of experience and the overall timeframe in which these institutional investors have been investing in these alternative markets. So with this multi-decade experience of having invested in alternative managers and alternative investment managers and alternative asset classes and private markets, there is a depth of expertise that is accrued over time to these institutions. There's a lot of institutional knowledge.
And with that, there's institutional knowledge about what are the particular risk and return profiles of different strategies within alternative markets, because I think as you and I both know, there is such a wide spectrum of what alternative investments encompasses, whether that's private equity and private markets, private equity growth, equity venture, which looks vastly different from private credit, where you have direct lending and asset-based lending and structured credit, which looks vastly different from natural resources and infrastructure, which also looks vastly different from distressed credit, right? So there's just all of these aspects to alternative markets, which because it's such a wide spectrum, the ability to have spent time in these markets, getting to understand these strategies, how do they perform in different market environments? What are the different downside profiles?
And then next layer deep, who are the managers who have expertise in these markets? How do they execute their strategies? What is the history behind these managers? So there's both the sort of knowledge base, the institutionally accrued knowledge base, as well as then related to that is the access to these managers, having known them oftentimes from their earlier days or known them before they spun out from whatever large firm they came from previously. So there's the knowledge base, there's the access, and there's just overall, I think, institutions having been in these markets from some time, are then also keenly aware of what the different needs are for these markets.
And what I mean by that is I think the most obvious is the liquidity needs, right? So thinking about different liquidity profiles of investments that maybe are less familiar to individual investors. So I think for individual investors who are looking to approach alternative assets, looking to approach private markets, these are all really important considerations and questions to think about, which is, does my investment horizon, does that pair well with the investment horizon of these less liquid alternative investments?
Does my area of experience align with understanding and being able to understand what these alternative investments are from a risk standpoint, a risk and return opportunity standpoint? And then the one that will be perhaps most challenging, but also critically important, when we started the conversation with what are some lessons learned, the one that's really critically important and that actually is also quite challenging for an individual investor is that you're investing ultimately in the people. You're investing in these investment firms, the value of an investment firm, there are hard assets in that investment firm, right?
It's all people, it's talent, it's the experience and depth of knowledge of those individuals that are the investment managers at that firm. And so it matters very much, who are the people behind these strategies? And so that is one where as individuals look to dive further into alternatives, those are important considerations to keep in mind, because it is very different from investing in public markets, where publicly traded companies are required to share information broadly.
And it's very challenging, or I should say, inversely, it's a lot easier as an individual investor to access the same type of data the institutional investors are accessing in public markets. There's a massive asymmetry in private markets.
Tony:
I do want to go back on this notion of illiquidity. And it's something I often, when I'm speaking to advisors, just point out, illiquidity is just a feature. But I think, as you point out, the endowments and foundations, typically, their time horizon is substantially longer, some would argue perpetuity.
So, they clearly have the ability and the wherewithal to allocate significant amounts of capital, let it play out over an extended period of time, and then reap the benefits of it in the form of an illiquidity premium. But I think that is the biggest challenge for both advisors and investors. And again, I think it's some of the conditioning in the marketplace, they somehow believe that they need to be 100% liquid.
And I would argue that if you're 100% liquid, you might as well be in the stock market, which means you're going to get market-like returns. But if you want to get those excess returns, you have to be willing to allocate. And I always use the term patient capital, which is how I think family offices and endowments and foundations think about it.
But that is a hard one for advisors, again, because of the conditioning, it's giving up the control of the asset. But I do think that's one of the bigger challenges. So I like the idea of kind of framing it in the beginning, how much of your capital are you willing to commit to the long run, and almost kind of back into it.
And I call that an illiquidity bucket. And I find that advisors can gravitate, kind of get their arms around that a little bit, if it's a 10% illiquidity bucket, all of a sudden, when there's a bump in the road, and there's just shock to the market, they're not thinking about their private markets and moving in or out. They're saying, well, with my traditional investments, I can take some cash, buy a little bit more cash, or take some of my equity exposure down because the markets are volatile.
So, it seems to me that little by little, we need to condition them, recognize what's different about that long-term approach, and then speak to them in terms that they understand, because ultimately, the advisor needs to have that next level discussion with the individual investor. And again, these terms and these things can be a little daunting to them.
Wendy:
I couldn't agree with you more. I think there is this conditioning is a good way of putting it, where individual investors are accustomed to having daily liquidity through their ETFs, their mutual funds, their public equities investments, their bonds. And that daily liquidity is not available in many of these alternative asset private markets investments.
And that is very much by design, and it very much is meant to align the investor with the type of investments that that investment firm is making in these alternative assets. And I wholeheartedly agree with you. I think this is one of the premises behind why we built Ivy Invest, which is that individual investors are paying continuously for this daily liquidity option.
When their investment horizon, at least some portion of their portfolio, we think retirement assets in particular, especially for someone who is still of working age and will be many years away from retirement, those are dollars that are expected to stay invested for a multi-year horizon. And to not reap the benefits of that illiquidity premium within that, we think you're paying again for that liquidity option when you don't need it. And so it is a costly choice to make.
Now, understanding that for some folks, that peace of mind, it is what it is, and I can totally appreciate that. But for some subset of investors, it is just the natural conditioning or natural state of things that they're used to. And so, to point out, hey, there is this other option, there is this opportunity for you to capture the ability to generate that illiquidity premium if you are willing to stay invested for a longer period of time.
Because again, going back to why do endowments and foundations…why did Yale back in the day when it first started stepping into private market and alternative assets? It wasn't necessarily because there was a steep desire to lock up capital.
It was this understanding that if we have these assets that are longer horizon, we have this advantage we can use, then it would be a loss to us if we didn't take advantage and capture that. And so it was, if you are willing to put your capital into an investment and hold it there for some period of time, you enable that investment manager and these alternative investments in these private markets to execute strategies that require certainty of capital, that require that ability to stay invested, and where if they have that confidence, if they have that agreement with underlying investors, if they have that locked up capital, if you will, then they can execute these strategies that take time. They can execute strategies that take patient capital.
And in doing so, you're able to capture what I would describe as, you know, whether it's operational value add and private equity, you're able to capture the premium of working through a distressed situation at the other side, right? So there are these actual active premiums you're able to capture that that's what is embedded in that illiquidity premium, right, that we discussed.
Tony:
I did want to kind of pick up on that a little bit. And you and I were talking beforehand about evergreen or perpetual, these new structures that are coming to the market. And I always emphasize that even though the structure has more flexible features, lower minimums, they're evergreen, meaning they're on the shelf all the time. So I don't have to make a decision on a very tight window, you know, which is typically the case with a drawdown fund. I do always emphasize that these are long-term investments. If you want to capture the illiquidity premium, even though they do have liquidity provisions, you're not going to get it if you're in today and you're out tomorrow.
But I thought it was interesting. And more and more as we talk to institutional allocators of capital, we hear that institutional allocators of capital are actually using these structures because there's an advantage of it. Maybe just kind of share some of the thoughts that you shared with me.
Wendy:
I think these evergreen structures, because they are newer in the market, they are naturally viewed through a lens of a little bit of suspicion from institutional investors who have been…just stepping back for a second. The traditional way of investing into many private markets investments is through these 10-year life drawdown commitment vehicles where you as an investor, as a limited partner and LP, you are making a commitment of some dollar amount, you're agreeing to lock up your capital for the duration of this fund. There's something called an investment period where during that, typically three-to-five-year investment period, your capital is being drawn over time when the investment manager reaches out to you and makes a capital call and says, please send me X amount of dollars that you committed to me within a 14 day time frame.
There are these mechanical aspects of how these traditionally drawdown funds operate that I think would make an individual investor's head explode if they had to invest in private markets through these traditional drawdown structures. These traditional drawdown structures work beautifully for institutions because again, there's a familiarity, there's a length of experience in having built portfolios with these structures over time and where the great thing about these drawdown structures, it is perfect asset liability matching. It's locked up capital for locked up strategies with no optionality in between for liquidity, although setting aside the secondary markets, which as they develop, certainly do provide some capacity there, but that's sort of a separate conversation altogether.
I think the beauty of these evergreen structures, it's providing opportunity to access private markets investments, whether it's private equity or private credit, where there now actually is an opportunity for individual investors just mechanically to access them in a way that feels a lot more familiar. You're buying shares of a fund and when you exit, you're selling shares of that fund. So just mechanically, there is a familiarity.
And then beyond that, to your point, it is really important for folks to appreciate that while there is a liquidity feature, it's quarterly technically, there's a liquidity feature for a lot of these evergreen structures, whether they're interval funds or tender offer funds. I really like to describe it as “it's a break glass in case of emergency quarterly”.
Tony:
It's a liquidity valve if there's a change of circumstances. Yeah.
Wendy:
Exactly. But to enter into these investments, what that mindset is really doing a disservice to both you as an investor and the manager that you are, you should be thinking about as making a long-term partnership investment into because these investments, again, rely on some degree of certainty of capital in order to execute them to their fullest. And you as an investor, in order to maximize that allocation into a private market investment, in order to maximize your ability to capture the illiquidity premium, also have to think about it with that mindset, which is this is a long-term investment.
There is this valve, release valve in case things change because life happens and things change. And I think that is a really important consideration and I think should provide some degree of comfort to individual investors. But really, the going in mindset should be this is a long-term investment. This is not like my daily liquidity mutual funds and ETFs.
Tony:
And I think that's really so important because I think sometimes the market positions them as semi-liquid, which is a term I hate because I think what you're telling the advisor and the investor is that they're liquid. They're not. The underlying investment is still illiquid. It just has, you and I point out, a liquidity valve if there's a change of circumstances.
Wendy:
Although I will say just to distinguish here a little bit, we talked about how in general private markets and alternatives, there's such a variation. It's certainly not homogenous. But even there, I will say a lot of the private credit evergreen structures, there is going to be more natural liquidity within those vehicles.
So I do think that investing in those, it is a different investment time horizon perhaps than what we're seeing, which are these newer evergreen private equity structures. And those certainly, I think it's really important for folks to understand the underlying assets are truly illiquid with not a necessarily private credit. Yes, those are private loans, but there's a maturity date.
You can, depending on the manager, they're going to layer in different maturity dates of their underlying investments. And so there's ongoing liquidity that sort of arises naturally. There's nothing of that nature in a private equity evergreen structure.
Tony:
Wendy, I'd love to get your thoughts on, again, sitting here, where do we see the most attractive opportunities? And obviously, we all think that private markets are long-term oriented, but certainly there are pockets of the market that look more attractive than the others. Where are you seeing the most attractive opportunities to allocate capital today?
Wendy:
I think there's two areas that I find really interesting today. One is more structural. One is this growth of secondary markets and private equity.
Tony:
It's one of our highest conviction ideas too.
Wendy:
Secondary markets, they break down into two areas. There's LP secondaries, which are a much longer, more established market. And then there's this newer market of GP secondaries.
GP-led secondaries, I think, are one area where there is a significant mismatch of capital versus opportunity. And as an investor, you always want to be in markets where there's a mismatch, where there are more opportunities then there's capital available to take advantage of that, right. And that is the part of the secondary market, which I think today has a greater mismatch of capital versus opportunity set.
And there's also this interesting moment in time where when there's still a lot of uncertainty and something is developing, and you have some subset of investors that has been able to reach clarity earlier than others, then again, it goes back to there's an opportunity to capture moments in the market. There's an opportunity to capture here this inefficiency of information that is being conveyed in these GP-led secondaries right now. So there's an opportunity to capture, I think, greater returns because the market is not efficient really in any way just yet there.
And I think that's structural. So that's a structural opportunity that I'm excited about. I think there's also a moment of, I won't call it a moment in time because I think it could be more than just a quick moment, but something that I think is a little bit more opportunistic that we happen to be having this conversation today of all days, shortly after some geopolitical flare-ups that are impacting markets more broadly.
I think there is likely to be ongoing opportunities for dislocation in markets, particularly in credit markets, where spreads have been tight, where I think we have seen that there has been a lot of willingness to extend capital into credit markets across public and private. And so I think on the flip side of that, that should we continue to see opportunities that could lead to stress, and we've seen some obviously already in credit markets where they have been more fraud related, but I don't make macro calls, so I don't want to describe it as anything of that nature. But I think from an opportunistic standpoint that that is one area where I want to be talking to managers today who are looking in stressed and distressed and have that experience managing stress and distressed credit strategies through cycles.
Tony:
So Wendy, one of the things that I always think about, our highest conviction idea is secondaries, and we agree with you in just this mismatch of kind of liquidity, but also with the GP-led, it's these longer duration assets because now the assets are staying private longer. But it's really primarily been in the equity markets, even though there is a secondary market for private credit, private real estate, private infrastructure, they're still relatively new and inefficient. I'm curious if you have any visibility on how and when you think those markets will mature and be as vital to the overall ecosystem as private equity secondaries, which we now kind of take for granted.
Wendy:
I think that one may be a little above my pay grade. I certainly see it developing. I find it really interesting that you're seeing this, and it makes sense.
The private equity primary market is just a more mature market that has been operating. It's deeper. It has been a longer history.
I think it's perhaps no surprise that as direct lending is private lending and private credit continues to evolve and mature, that there naturally would be this evolution of a secondary market that is appearing alongside it. I have no prediction in terms of timing, but I think this is a very natural evolution of markets.
Tony:
And that's kind of the way that I look at it. I don't know when it's going to be, but I definitely see it happening, and it just seems to be the natural evolution as markets get mature, they get a little bit more big and efficient, and all of a sudden, you see this really robust secondary market. Wendy, this has been fantastic.
Thank you so much for coming in, sharing your experience. As always, for all of our guests out there, please rate, let us know what you like, what other topics you'd like to hear, but thank you so much. I think this is very timely, and again, a lot of great lessons learned from sitting in the seat of an endowment and foundation.
Thank you so much, Wendy Li.
Wendy:
Thank you so much for having me.
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