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:
Welcome to the latest episode of the Alternative Allocations podcast series. I'm thrilled to be joined today by Ben Webb of Balentine. Welcome, Ben.
Ben:
Thank you.
Tony:
Talk to us a little bit about your role at Balentine, and we'll delve into how you think about allocating to alternatives.
Ben:
Sure, yeah, I sit on our research team and really head up our manager due diligence process and my job is to scan the capital markets for Alternatives and private investments that can really help our clients reach their goals. What I love about it is no place is sacred.
We turn over every rock, look behind every tree and really finding what are the unique assets that we can deliver to our clients to help them reach their goal. And one of the things I've been saying is that if the advice around public markets and even first level financial planning is becoming commoditized, so to really be able to give our clients something that they can't get through their Schwab account is really what drives us into this alternative world.
Tony:
Yeah, I agree with you wholeheartedly. This is something that can't be commoditized. It's very specialized. How do you think about allocating to alternatives, and do you have a target allocation? I know not all clients are created equally, but certainly there must be some sort of target in mind.
Ben:
Yeah, we start at 20%, and what we do is we move it up and down based on two things.
What is your spending? And we have pretty strict policies to not let illiquidity creep up too high. The last thing we want to do is a client had to need to spend and pull from the portfolio but can't. And then it's also the need. And what we really look for alternatives to do in portfolios is to provide return enhancement.
We don't kid that private equity is different than public equity, or private debt is different than public debt. It's all, it's either the equity risk premium or the credit risk premium, but what's embedded in there is the active management. What companies are they finding? What sandboxes are they playing in?
Really, that's where we try to spend our active risk budget and going out and increasing the reach of our portfolios. Because at the end of the day, while they seem to diversify based on, they mark differently, it's just what we think is a better equity risk premium and better credit risk premium as well as inflation risk premium to really help our clients increase the chance of reaching their goals.
Tony:
There's a lot to unpack there and I really appreciate the way you describe how you think about alternatives because it's very much aligned with the way we think about it. You mentioned this illiquidity premium, the excess return that you get for tying up capital to private markets, private equity, private credit, private real estate.
How do you talk to your clients about that?
Ben:
The first thing that we've talked to them about, and a lesson learned, is this is money that you cannot touch. You have to have your spending set aside, whether it's two to three years, sometimes even five years, is you have to assume that this money is not going to be available.
And if there's any hesitation, then you have a conversation about not investing in alts, and like even if they're good investments, don't try to push them on your clients, because as soon as something happens that they don't understand, they're going to want to sell, and it's just a headache that could have been avoided.
And so the first thing we want people to understand is this is a different investment, don't think that it's going to price daily and you're going to be able to sell it. Once you get past that, it's really about telling a story and showing them that there's money to be made in the public markets, both equity and debt, but where the innovation is, where the, for lack of a better word, sizzle is, is in the private markets.
And whether it's investing in the next set of Apples, Amazons, and videos, or whether it's lending to companies that are just getting off the ground, it's really about telling a story. We, at Balentine, we focus a lot on entrepreneurs in transition. And one of the things that I didn't appreciate at first was, but entrepreneurs love to help entrepreneurs.
And so helping people who've made their money through private businesses, invest in the next generation of private businesses, it's really something that they enjoy. And we've come to appreciate that more and really tell the story around, “yes, here is what is called the illiquidity risk premium”, but what is it really?
It's unpacking it to saying that you're helping the next flight of entrepreneurs or you're lending to the next flight of entrepreneurs and getting paid a premium for that.
Tony:
I love the way you describe that. I want to talk a little bit about illiquidity because I think the way you described in the beginning is so important.
You need to make sure the client understands it and whether you call that an illiquidity bucket, you're targeting something, you're having that discussion with them that these are long term investments. I think it's such an important discussion and I think some advisors maybe gloss over that because it may feel uncomfortable, but I applaud you for leaning into it because I think it's a real big part of that secret sauce that we get in allocating to private markets.
I want to talk a little bit about products and allocation, just because I think when you talk about allocating to these investments, I sometimes cringe when I hear the term semi liquid when you talk about registered funds, because even though they have liquidity provisions, I still view those as long-term investments.
If you want to capture that illiquidity premium, you need to hold it from seven to ten years. You shouldn't think of it like a mutual fund – I'm in today and I'm out tomorrow. I wonder how you have that discussion around structure with your clients. And is that embedded in your illiquidity structure discussion early on?
Ben:
For sure, it is. It was a lesson learned. We were early allocators to interval funds. What I think the wealth channel didn't really appreciate is if it has a ticker and prices daily, everybody just assumes it's fully liquid. And we ended up rotating out of interval funds, and we really have a very barbelled approach in illiquidity.
It's either daily liquidity or seven years and beyond. And what I think is important in the wealth channel, it's getting the client to understand to match your investment horizon with the need for the horizon of your money. And a lot of our clients, they've beat the game. This is second, third generation wealth.
You have the opportunity to lock up their money. Go ahead and do it. It's really having that conversation of matching your time horizon with your investment liquidity, but then acknowledging that there are clients that they say, listen, I can't take a tenure fund. I don't even plan tenures in advance. And so we do have a couple investments on platform that, like you said, are those registered funds, they don't have a ticker that's monthly or quarterly in, quarterly out.
And what we say is, listen, if you're going to make this investment, You need to be at least have a five year time horizon because on day one, if you want your money back, worst case scenario, it can take you five years. And what we say is you will give up maybe a hundred, 200 basis points of excess return, but if this is what's going to help you get your toe into private capital, into the illiquidity markets, let's start there. And for some clients, they never go beyond it. And some are like, okay, wow, this is great. What else do you have? And so for those semi liquid funds, they can really be a gateway drug into full illiquidity. And so we just see them as a tool in our toolbox.
Tony:
I love that. I want to talk a little bit about due diligence.
You talked about in the beginning that your value to the organization is evaluating all these strategies coming to the market. And certainly over the last couple of years, we've seen a plethora of products coming to the marketplace. How are you evaluating one strategy versus the other? How are you conducting your due diligence?
Ben:
No secret here. It's the four P's at the end of the day, but really focused first on the people. I enjoy working with long tenured managers that have the right alignment with my clients. At the end of the day, that's really what it boils down to is, show me how you're aligned with my client's outcome and show me that you know what you're doing.
We tend to stay away from fund one fund twos. Again, we don't have to extract the value from a fund one. We're happy to be there in fund threes and fours, but just show me that you know how to invest, show me, you know, how to run a business. A lot of people, they'd be great investors, but they can't run a business and so their platform doesn't stay around.
And then also show me succession. A lot of these funds are 12-, 15-year investments, and half the people in your fund are going to retire by the time this is through, but I want a multi-fund relationship. So show me the next generation. And then from there, it's “What is your philosophy?”, “What is your process?” And there's no right answer to what the right philosophy or right process, but I just need to be able to see that your philosophy makes sense and that you're applying your process and correcting your process along the ways. The other reason I love fund threes is it's like show me the lessons learned in fund 1 and fund 2 and how you've applied it in fund three and fund four. And that just increases the confidence that I can have in the manager. And if you have the people, the philosophy and process all right, the performance should be there. We're not going to fire a manager because they had a fund that's in the third quartile, but we want to understand why did this fund underperform?
A perfect example is our buyout manager is industrial focused. They were a third quartile in their 2014 fund. Well, that made sense because all the buyout funds were all about the craze in technology. And so we said, okay, we understand why you do that. And so just making sure that you can tell that story.
Because if you get that and you get the alignment and you get that strategy in the right vehicle, very high confidence that that can fit on our platform and help our clients reach their goals.
Tony:
So I'm curious as you're looking at the alternative landscape today and private markets in particular, whether there are things that you're looking for that you're not finding, or are there certain areas that you find the most attractive?
Ben:
I've been saying for about a year now that I believe over the next cycle that debt is going to eat equity’s lunch. And what I have a hard time finding is if you're expecting 15ish from equities, 12 from your private debt, why would you take that risk? Just let's be higher in the capital stack. And so I do think that what we'll see is that maybe manager will use less debt, maybe they’ll be more thoughtful with how they're building their capital stack.
But I think that's a very interesting point for credit right now. And that is maybe we're getting too close to, the what people would call, in the golden age of credit. But I just think that we have a lot of runway there. And the other thing we're looking at is where is the real estate market going to go. And sitting here in early 2024 after the price of money went up the way it did, what is that going to do to cap rates? What is that going to do to specific sectors of it. And as we've all seen, it never affects everything uniform. And so maybe office will have a different experience than multifamily, just being able to be opportunistic and there for when those opportunities come and being ready to be part of any type of thematic play in real estate.
I love the concept of picks and shovels for AI, data centers, fabrication centers. It's a different way to play this AI theme that you're not really betting on, okay, this is the technology that's going to play. And so credit and real estate is where we're really focused. And then just keeping an eye on how is the venture market going to evolve after this free money craze that we've had for the past 13 years. I think there's opportunities developing there. So we want to keep an eye on that as well.
Tony:
Yeah, so we're aligned with you. We definitely think private credit looks very attractive here up and down the cap stack, whether it be direct lending or distressed or even real estate debt. I love the discussion around real estate because that's the way that we look at it. Not all real estate sectors are created equally. Office has clearly some headwinds, which we think will persist, but industrials, multifamily, life sciences make sense. I'm curious, on the private equity side, you didn't mention secondaries, and I'm curious if that's something where you're dipping your toe in and looking at secondaries.
Ben:
Yes. We're big fans of secondaries for all the reasons you know. Shortens the J curve, gets money back in quickly, it's not a blind pool. And what we've been doing more and more is, instead of asking our clients to subscribe to a fund directly, is we've been building our internal partnerships to where we then allocate to a number of funds.
And so we’re not trying to make any money on that, but just have an access point for our clients to keep the minimums low to keep the access high. And part of each of those programs is a program to secondaries. And so we like private equity secondaries, we like real asset secondaries, but we're also really liking private credit secondaries.
I think one of the biggest indicators of a fruitful secondary market is fundraising in the primary markets. It's been said a lot, just the amount of money that's been raised in private credit. I think that is going to lead to a very interesting secondaries market. We're fans of it. We try to get it where we can and really pairing it with the primary funds because we acknowledge that, yes, it's going to be higher IRR, quicker capital, but you're going to have a lower multiple. So pair that with a primary funds and a co investment program that can really have a better offering all around for that asset class.
Tony:
Ben, thanks so much. I feel like we've covered a lot and I know that our audience will appreciate your perspective as you're thinking about allocating capital and maybe more importantly, how you're having those discussions with clients.
Because I think that transmission issue is so important that our clients understand beforehand how they work, the features and benefits of the structure, the merits of the underlying asset class. And thank you for helping us think through how we should evaluate the various opportunities out there, even looking forward where opportunities exist with private credit, select real estate, and secondaries.
Thank you so much, Ben.
Ben:
It's my pleasure. Thank you.
Show V/O:
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