E313: Why the Endowment Model Doesn’t Work for Taxable Investors
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What investing challenges do taxable investors face?
What would most people be surprised about how you go about investing $15 billion in the market today?
You have to have a clear line of sight on asset allocation around things like cash flows, taxes, financial plan, objectives that are oriented around the family's own desires that may not be prescriptive, such as a 5% mandate.
This rise of the taxable investor is a new phenomenon.
It's a hugely important phenomenon going on. And it's, I think, the segue a little bit into the democratization of private markets and all of the different investment vehicles that we are saying come into markets. But this gets into a little bit of the, how do you take a institutional-like framework and apply it to private clients? So it's one thing to be able to say, hey, we treat you as a multi-generational client, the same way we treat you as a perpetual endowment or foundation. The reality is, in past, in history, it used to be very difficult to take and express the same investment ideas you would have for that institution and employ that for a private client. I think in this day and age now, if you set everything else aside, so all else equal, now we've solved that sourcing conundrum.
So we have the ability to bring our own internally sourced private market investments for all of our clients. And we do so using technology and a couple of different relationships we have to create a simplified investment structure for private clients. One of the nuances there is that perhaps didn't exist five, even maybe even 10 years ago, was being more tax aware in that process.
At the low end for coastal clients, then it could mean 35% difference in return. So you get a 15%, now you're 10%. At the high end, it could mean 15% to 8% if you're investing in hedge funds or private credit that have the short-term income.
Part of the response to that is not only different products and structures, but also being very thoughtful about how they're deploying those investments and generating returns, be that vis-a-vis capital gains or through the income lens. And to your point, if you don't appropriately asset allocate or asset locate those investments, you can lose 30% to 40% of your total return right off the bat.
What are some logging fruit and where taxable investors can use specific structures in order to maximize their after-tax return? Give me an example of that.
So infrastructure is a good example. So there's a couple of different strategies in the market right now where, again, these things didn't exist a handful of years ago where you're making infrastructure investments. And because of the joint venture structure of their line investments, they're able to deploy all of the income distribution as a return of capital. So if you're a private client, you think about that. After 10 years, you have eroded basis. And so now it's all long-term capital gain along the way. You've kind of clipped a coupon that's been tax efficient by having the ROC, return of capital benefit on there. And then if you're estate planning, you can use that to your advantage by having that asset flowing through an estate plan.
How does the endowment model apply to private clients?
Therefore, there's a step up in basis and then you defer that capital gain even further. So a little small myopic way of dealing with taxes from an income seeking agent.
And that seems to be a lot of the tax strategy, which is either defer for decades where the net present value of those taxes are essentially near zero, but you still technically pay the taxes or die. And then your kids get the stuff up in basis. Many private investors use the endowment model language when they talk about their portfolio, but they don't really apply the principles. What are most private investors missing when it comes to applying the endowment model to their own approach?
I'll give you three challenges. So one, what is the right number? What is the number in terms of asset allocation that you're willing to put towards private markets? The second is, okay, you've got the number. How do you source for it? How do you make sure that by locking up the liquidity, you're getting a better than public market outcome?
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Chapters
8 chapters
1
What investing challenges do taxable investors face?
0:00–2:39
2
How does the endowment model apply to private clients?
2:39–4:30
3
What role do taxes play in portfolio construction?
4:30–9:34
4
What are effective strategies for maximizing after-tax returns?
9:34–14:23
5
What challenges do private investors encounter with the endowment model?
14:23–19:22
6
How do governance and pacing impact investment decisions?
19:22–24:15
7
What are the emerging trends in private market investing?
24:15–29:15
8
How can families ensure wealth preservation across generations?
29:15–34:41
Speakers
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