Chapter 1: What is the main topic discussed in this episode?
So Alex, you have one of the most prolific career backgrounds of any guests, having been at Morgan Creek, JP Morgan, Cleveland Clinic, and most recently CIO of Aberdeen Investments Ireland. You have a deeper pulse on the LP community than almost anybody that I know. Give me a sense for the biggest issues facing LPs today.
pensions, endowments, foundations, family offices, outsource CIO firms, consultant firms. We talk to a lot of allocators and we try to listen to them about what they're interested in, what they're worried about. And three big ones that have been coming up, two that we hear about a lot and one that we ask about a lot.
The two that we hear about a lot are the lack of distributions and the changing nature of distributions from private asset funds. Something that's really accelerated in the last... It's been happening for the last 10 years, but really the last five years. The second one is the absolute meteoric rise of AI tools generally.
And then specifically for allocators and investors, people who are assessing markets and funds, how can they use AI tools? And are AI tools going to replace us as investment professionals? And then the third one, factor model assessment of how their individual funds are doing.
Chapter 2: What are the biggest issues facing LPs today?
and how they can assess, importantly, the most important question in any fund evaluation process. Am I paying alpha fees for beta performance?
I do want to get into whether AI tools are going to replace the two of us as well as factor analysis. But first, let's start on the DPI question. Maybe set some context for where DPI was in 2024 and 2025 versus historically.
So that would be distribution as a percent of NAV. So that gives you distribution yield. So distribution yield for the portfolio for private assets has hovered very strongly at 20, 25%. This is data from MSCI Burgess. So Burgess put out this study to point it out. Yes, this distribution yield has historically hovered at around 25% or so.
So you invest $100 million, you're getting 25% of the invested amount on average on a yearly basis.
The distribution yield reflects the distributions that you're getting on an annual basis as a percent of the private asset NAV. For the last four years, that distribution yield, instead of averaging 25%, has averaged 12%. And the lowest it's been in the last four years has been 9%.
And that is incredibly important because what that means is that the models upon which deterministically allocators have used to evaluate their expectations of the size of the private portfolio relative to the public and how much they need to commit in private assets each year to maintain that exposure. Instead, what's happening is
is that private assets are getting to become a larger and larger and larger portion of the total portfolio. The university endowment, the foundation, the pension, they still need the distributions from that pool of assets. And so the only thing the allocator can do then is to sell the liquid assets which have been performing well.
So what happens is you get this denominator effect where the private assets become a larger and larger pool because you have to sell the public assets. And so in 2021 and in early 2022, we saw this huge kind of outlay of private equity funds or firms being sold to either strategic or financial sponsors.
There was a tiny little explosion of some IPOs that happened that had been kind of held up because of COVID-19. But then once we got past that, I wanted to share with you a critical number that we're seeing. So vintage 2020 and vintage 2021 funds, half of them, about half, 45%, have a DPI of less than 0.1%. So 50% less than 0.1. Yeah, of vintage 2020 and vintage 2021 funds.
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Chapter 3: How has the distribution yield changed in private markets?
If you are too positive when you push it into the continuation vehicle, it may help out in the short term, but it may hurt in the long term. The key for the allocators though, is that, and then I've seen this myself and I've participated in this, is that you trusted, you committed, you backed this private asset firm
And specifically this fund that you committed to because of the quality of the analysis, the capability of the team that's investing, that's picking these underlying private asset companies. And if they tell you, we think there is unrealized value that we want to hold on to. We think there's more we can do here. That's tough to argue with because you as an allocator are not a securities analysis.
There's a cognitive dissonance in that you go to your doctor who's a specialist in the area and now you're trying to outsmart your doctor.
It's a great analogy for it of we trust this fund, we trust this firm, we trust this team. They've done great before. The flip side, and this is where the love and hate for it is great. We trust that there's more value that you as a private asset firm can wring out of this company. And you're telling us what you sincerely believe is the reason for pushing it into this continuation vehicle.
But the other side of it is we could really use those distributions.
Maybe it's undervalued by 5%, 10%. Let's just pick a number out of there. It's still better than taking a 10%, 15%, 20% discount on the secondary. And there's no political issues with not committing to the CV.
That's the other thing too, is that some of the larger brand name firms may say, you know, commit to the CV vehicle because this is part of our firm ecosystem.
Right.
And you're either with the firm ecosystem and everything that we're doing, or you're not. And that can be very difficult when maybe the firm has a great brand and a great reputation, and they have that great reputation for a reason.
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Chapter 4: How does the lack of IPOs affect private equity investments?
And if your underlying investment portfolio already has some baked in leverage, adding more may be detrimental, may be adding a little bit more risk for quasi incremental return.
Is the lack of liquidity in private markets and allocators portfolios a moment in time, or is this a new normal?
It feels like we've moved to this new normal of large private companies with billions and billions of dollars in revenue, established companies with hundreds, if not thousands of employees. Think of a company like Stripe. Two Irish brothers moved to America, build one of the largest and most successful payment processing firms. They've been around forever, over 10 years.
Normally, back in the 80s and the 90s, early 2000s, they would have already had an IPO. But there's a lot of commitments when you have an IPO, a lot of new governance structures you have to put in place, a lot of new governance requirements. And so this whole conundrum of private is the new public seems to have taken hold. And there don't seem to be any material forces pushing back against that.
Do you know the origin of the four-year investing schedule for startup employees?
The numbers are easy. 25% a year over four years.
Four years used to be the expected timeline to go from private to going public. I wish that we could see more of that today. To give you a sense for how much we've drifted from the original assumptions, really going back to the 90s, We've went from four years to now really 14 years. This kind of feels like a new normal.
I remember in 2012 when Facebook went public and I was working at JP Morgan, we were part of the desk that was distributing shares to ultra high net worth and high net worth individuals, institutions that were looking for shares of this IPO. And it was a big deal. It had taken a while for them. They've done so well. And we were so grateful to be part of the team that was leading that IPO.
But yeah, I don't know what changes because the benefits are so diffuse in terms of the allocators asking for it that it's hard to get them together as a group and advocate for it. Whereas the benefits to the private firms and the private funds that are managing this are so tight that it may continue like this for a long time.
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Chapter 5: What does the rise of continuation vehicles mean for allocators?
And that seems to be sticking to history. So for the last 25 years or so, it's had approximately a decent, you know, 24% distribution yield. And for the last couple of years, it's still around 22, 24%. This is in stark contrast to private equity buyouts and to venture capital, where the distribution yield has dropped to low double digits, if not high single digits.
So number one, for all allocators, adjust the models to acknowledge the fact that the illiquid part of your portfolio is going to remain illiquid for longer than you thought.
A lot of people are looking towards 2026 liquidity via IPOs almost as the savior in their portfolio. And although it might help minimize some of the issues in the short term, I think you have to take a step back and look at what are the incentives that are driving private marks and private assets to stay private longer. I think the incentives are
obviously on the asset level, these assets want to stay private longer. It's only become more and more difficult to become a public company. You have to deal with a quarter by quarter scrutiny, which in my opinion is value destructive. Um, and two is you have to look at these other factors like CVS. I think CVS have now reached a hundred billion dollars.
I think CVS are here to stay for many of the reasons that we talked about. Um, And a great IPO run may even solve issues for one to two years. But if you're starting to deploy in the next vintage for the next 10 to 15 years, You should not rely on a hot bowl IPO market.
I think you really have to look at the decisions of this new normal and of all these players and how their incentives are aligning. Because in many ways, allocators are at the mercy of the incentives of GPs and GPs are at the mercy and incentives of the portfolio companies. Obviously, everybody has leverage and everybody has some power in the market.
But ultimately, the decision lies with the underlying asset.
100%. And I would just summarize that to something you hinted at, which is why? Why go public? In the past, private firms would go public to raise capital, to help with their expansion needs, to help recognize the entrepreneurs that started the company financially.
But if you can get that in a secondaries market, because you're doing another series round for your private investment firm or your private company, and you can raise the capital and all the capital that you need on the private markets, then why deal with the hassle publicly?
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Chapter 6: What are the implications of prolonged illiquidity for allocators?
It will take meeting minutes. It will draft emails. It will sort all of the incoming files that come in. So it's allowed you to not have to do a lot of the drudgery work. The key phrase that we had at the Cleveland Clinic when I worked there was maximum value per unit of effort, max view.
So max view in terms of operational efficiency for an office means that a managing director, for example, should always, for the most part, be doing managing director work. And if there's something that the managing director or the CIO is doing that could be done by an analyst or an intern or could be offloaded to a third party tool, then we should go for that. And AI tools really help with that.
So before we started recording today, you said that the five factor analysis could be completed in under a minute. How can investor very quickly ascertain the factors in their investment?
The first thing I tell you, and this is, I just want to reference a great white paper that all allocators should take a look at, which is from Barber, Huang, and Odeon, 2019. And one of the key things they found- That's it for today's episode of How I Invest.
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Thank you for your continued support. But we're ignoring every other factor research, every other factor insight that's come out since then. And this white paper that I mentioned Barber 2019, they noted that almost all allocators, almost all investors, they pay attention to beta, cap M, first factor, but they ignore every other factor.
And Fama French came out with a three-factor model, and then they expanded it with a five-factor model. And there are tools, PortfolioVisualizer.com, FinPilot.ai, Excel. where you can run this five-factor model research. You can get all the data for free. Fama French still put it on their website for free. You can run it within minutes for a given fund.
The key insight, though, from this white paper was that nobody's doing this. They are not running this research, and they are relying just on the CAPM beta and attenuating to alpha what is actually beta, what is actually factor exposures from the other four factors.
On that note, Alex, it's been an absolute masterclass. Thanks so much for jumping on. Looking forward to doing this again soon. Thanks so much for coming on.
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