Talk Your Book: Alt Goes Mainstream with Michael Sidgmore

0:04Welcome to Animal Spirits, a show about markets, life and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:34Welcome to Animal Spirits with Michael and Ben. On today's show, we talk to Michael Sijmore. Michael is a partner and co-founder at Broadhaven Ventress. He also has a really cool podcast called Alts Go Mainstream. So Michael and I wanted to talk to him about alternative investments, how that world has changed since I first started investing in alts back in the day in my endowment and foundation, former life, and why Financial Advisors and RA channel is such a huge opportunity for alternative investments. So here is our conversation with Michael Sijmore.

1:13Michael, welcome to the show. It's good to see you. Good to see you too, Michael and Ben. Thanks for having me. You're welcome. All goes mainstream. Today, the topic of the show is going to be alternative investments. You've had a front row seat to the broadening out of alternative investments that traditionally started in the institutional space, pensions, foundations, endowments, giant pools of money. And over the decades and years, it's gone downstream to wealth managers, RAs. People are able to get access with the much smaller dollar amount. And you had a front receipt of that at iCapital.

1:52Talk to us about the evolution of alternative investing from the institutions down to the individuals over the last, I don't know, 30, 40 years? Sure. Yes, alts indeed feel like they're going mainstream. I actually don't love the term downstreaming of alts, and I'll tell you why. And that'll be a good jumping off point into this evolution of private markets. But I don't love the term because on one hand, yes, you're providing investors who have smaller dollar amounts to invest in private markets. You're giving them access to private markets. So it's downstream in that sense. But if you think about the size of the opportunity in the wealth channel, it's roughly equivalent to the size of opportunity in the institutional channel.

2:38There's about 145 trillion or so assets in the wealth channel, yet, you know, 2%, 3%, 4 % is allocated to private markets. Rounds to zero. Exactly. Relative to some of the largest institutions in the world, think the largest pension plans, the Yale endowment, et cetera, sovereign wealth funds, 20, 30 plus percent allocation to alts. I had the CIO of Calcers on my podcast. They're 300 billion or so. They're like 35, 40 percent allocated to alts. So when you think about that delta, there's just such an opportunity to enable the wealth channel investor to access alts. And iCapital, amongst many other technology innovations that are happening in this space, are really creating the infrastructure to enable that to happen.

3:22There's also the investment and focus from the GPs, knowing that working with the Wealth Channel is, I consider, their next institutional LP in terms of size and scale now. Different in terms of how you have to manage it, different in terms of how you have to productize for it. But I do think that the Wealth Channel is really the next quote-unquote institutional LP. Well, all the juice has been squeezed from institutions for the most part. If you're at 30%, how high are you going to go? And let me ask you this, why is that number so high? Like before, is it just because of the success that Swenson had with the Yale model and the alpha that they were able to generate?

3:57Like what was, I don't know he's been doing, well, he's not around anymore. But I know that he had been doing that for decades. What was the institutional space like before he came along? Was it mostly public markets? So look, I think when it comes to like the evolution of alts and private markets, I mean, Blackstone's 39 years old. They're a trillion of AUM. They joined the S &P last year, $150-ish billion market cap company, not small, but they're only 39 years old. And when you think about the evolution of all these alternatives managers, many of them started out as private equity firms doing buyouts.

4:36So that was a small portion of the universe. And then that grew and scaled, and then they became multi-strategy. So Blackstone now does credit. they do real estate, they do growth, they do infrastructure, etc. They do head fund investing, fund of funds, effectively, secondaries. So when you think about the evolution of these firms, they've become these massive platforms, and they service institutions and individuals now, but by providing a whole platform. And prior to kind of the initial start of the alts world being a part of an investor's portfolio. Yeah, it was really, I mean, people had a 60-40 portfolio.

5:17The institutions were the first to allocate to private markets because they saw this as an inefficient market where people could get higher returns. Obviously, there was a smaller market than it is today, right? There's$14 trillion or so in private markets. About$6 to$7 trillion of that is in private equity. So that has become a more efficient market. And that plays out in the data too, right? The large buyout firms, the interquartile spread between first quartile performing funds and fourth quartile funds is a smaller interquartile spread than lower middle market buyout, where it's obviously, it's a much more fragmented market, but the interquartile spread between first and fourth quartile is larger.

5:57Same with venture. The case, best performing venture funds are much, much better than the lowest performing venture funds. So I think the market has evolved to become more efficient, will probably continue to become more efficient, that gets to an interesting kind of next phase of evolution of alts, which is, is it as much about alpha? I still think it's about alpha in many cases, but it's also about diversification because it diversifies you away from public markets. And if we think about like, to me, the big story in alts is you think about a few different trends. One, there's private companies staying private longer.

6:31The number of companies that have, that are in public markets has basically halved in the last 10 to 15 years. So there are about 4 ,000 or so companies that investors can access if they want to invest in equities of a company. Private companies are staying private longer. You have a move to passive, you have indexation, and you have concentration in the MAG-7 and a certain number of stocks that are driving returns in public markets. 87 % of private companies, 87 % companies in the US with 100 million revenue or more are private companies. Wild. So how do you give people access to all these businesses as equity owners?

7:13That becomes, one, private markets, and two, you've got to provide the infrastructure to enable them to do that. So the institutional to retail to wealth management thing is interesting because I came from the institutional side where there was like this hierarchy of people who thought they were better than other people. So you had endowments at the top, right? And they thumbed their nose at the pension funds. and the pension funds thumbed their nose at the wealth managers and the wealth managers thumbed their nose at the retail. And that was kind of the hierarchy from when I was in there. And the thinking was always like, well, the endowments, we get the best, we get access to the best managers and pensions kind of get the also ran.

7:47And then once it gets down to the wealth manager channel or the retail, they get like the table scraps, right? They're eating with the dogs or whatever. They're getting the bones. So how do you get over that stigma of by the time it makes it to retail, all the good stuff has been picked through and good luck finding a top quartile manager that can actually outperform. Has that sentiment changed? Yeah, I'm sure this was a while ago, obviously, that I was kind of more involved in that space. So I'm talking, you know, like a decade ago. But it obviously has. But I'm curious to hear your version of how that how that sentiment has changed and how wealth managers are thinking about it.

8:25No, it's a great question. I say that a little bit tongue in cheek. So I think a few things there. There were some trends that played into this. So one is as all these alternatives managers got larger and the large institutional investors wanted to have big relationships with them, they started to do things like co-invest. And the Maple 8 were real pioneers of that, as well as some other sovereign wealth funds where they'd want to get co-invest access to blend down their fees from 2 and 20. I don't think we're at 2 in 20 anymore, even with the Wealth Channel. And we're seeing that play out with evergreen structures, which are not 2 in 20 structures.

8:58But as they grow in AUM in size and scale, the GPs can make up for the fact that there's not 2 in 20 fee structures anymore, but they're still generating large amounts of fee-paying AUM from that. But I actually think because the Wealth Channel is such a big opportunity for these GPs, I think what you said was the case 10 years ago, that the GPs would go to the Wealth Channel and they would – whatever funds they had allocations to that were left open, they would give access to the Wealth Channel. Now, I think this, and this really kind of explains, in my view, why alts are going mainstream, is the GPs are now providing access to private investors in this different product construction, but the same types of products.

9:52A lot of these evergreen structures have co-investments where people can access these evergreen structures and invest alongside the flagship private equity fund of a large GP into a deal. So they're now getting, it's not always the case, but in many cases, they're now getting access to the same or similar type investments that institutions got access to. And I think that's going to change the industry too. I mean, you think about what things like evergreen structures do to the potential dollars of co-invest for large institutions. I think that's a really interesting question too. You mentioned the dispersion between top quartile and bottom quartile performers going, compressing in certain spaces.

10:33And that's a natural product of so much money coming in. And the days of these outsized returns where there was just a few dollars have massive inefficiencies. In my opinion, that's over. It just can't persist. Also, valuations were way lower and all that good stuff. But you mentioned something that's interesting is that maybe, and I guess my word's not yours, the alpha is not going to be what it was in the 80s and 90s. Like just, in my opinion, just full stop. It's just not going to happen. However, access to different areas of the market. You mentioned the company staying private for longer.

11:07So if you're trying to get access to like the micro caps or the small caps of the world, that jives. And I like that you use the word diversification because public equity and private equity, they're both equity, right? And one gets marked daily and one doesn't. And so ultimately these are both businesses And so they should be correlated, but that doesn't mean that you can't get diversification. I wholeheartedly agree. I think we've moved from a conceptual framework in terms of asset allocation or portfolio construction from 60-40 to something other than 60-40. Now, the way I like to think of it is instead of being pieces of a pie and alternatives being a piece of that asset allocation pie, you now have buckets and spectrums.

11:52So there's an equities bucket, but equities end up being public equities and private equities. And to your point, that's still equity risk, but you're just taking different type of illiquidity, hopefully generating a different type of return for taking on that illiquidity. So different risk profile, but you're going to have people think about the spectrum of liquidity when it comes to equity, when it comes to fixed income or credit, public, public credit or public fixed income, private credit, private fixed income effectively, right? So I think that's going to change the way that people think about asset allocation.

12:27And liquidity, I think, for the wealth channel is really going to be the big question. Evergreens are trying to address some of that by having these structures that provide for some level of liquidity. They're not, I don't think they're semi-liquid. That's a term that some use in the space, because they're not terribly liquid, right? And the fund can decide how much liquidity they want to offer to investors on a quarterly basis. But there is some level of liquidity versus a traditional closed-end fund, private equity, right? You commit dollars over a number of years, the capital's called, but you can't take the capital out unless there's an exit and there's capital return.

13:07So I think liquidity is going to become the really big question. But I think the diversification piece is interesting. Mark Rowan said that at the Nordris Bank Investment Conference a few months ago, he talked about diversification being an important piece of private markets. And I almost look at that in two contexts. One, I think there's truth to that. And I think it does provide diversification away from public equities if you're doing private equity. So you get diversification away from the MAG-7 into other growth areas of a market or a region or a sector. The cynical way to look at that, though, is that he's trying to future-proof both his firm in the industry from the fact that there might be lower returns, like you say.

13:52So that, I think, is an interesting concept to unpack, which is, okay, now private markets investors are starting to talk about diversification. But are they doing that because they know there's more capital coming into the space and returns might be lower than they have been in the past? Well, let me ask you this. So I was about to say, anytime you democratize an asset class, returns have to go lower. And I do believe that. I guess a counterpoint would be, well, the index fund didn't lower returns. Yeah. Yeah. I mean, I think one stat that has stood out to me, KKR recently released a report talking about the growth in evergreen structures, and they obviously have their own evergreen funds.

14:31And for the audience, what's an evergreen structure fund? An evergreen structure is a, it's different than a closed-end fund. It's a structure where investors allocate, but the fund is always open, but there's no end date of the fund. So there will be exits, and that can return capital to an investor. But unlike a closed-end fund, which is a defined fund life, so closed-end private equity fund will be a 10-year fund. The fund manager has to return capital in 10 years or maybe with a few extensions, 12 years or so, roughly speaking. Maybe, again, they can ask for more extensions. But they have to return capital and exit the companies they've invested in.

15:10An evergreen structure does not have that. So they've created a different way of enabling people to access private markets, which is they can invest in these structures. There's no end date of the fund, but they can get liquidity on a quarterly basis. They can take some capital out. But the concept and idea is that there will be compounding of capital. So if you leave it in and you're generating 10%, 12 % return a year, over time that compounding adds up. And that was really the point of KKR's report, which was if you're compounding that capital at 11%, 12 % a year, you're returning 3x over 10 years roughly, which is – that would be in many cases and in many vintages close to top quartile private equity returns, right?

15:56And can you get that in public markets? I assume most of these companies are willing to do the evergreen fund because they know, I mean, a lot of them have the thing where they say, listen, we do 5%, we'll let you take out 5 % because they know that it's going to be an ever churning of clients, not churning, but new clients are going to be coming with more capital. Some clients will be taking out. So that's the idea where they're more willing to do that structure because operationally it's easier for them and easier for the advisor. Yes. So I think there's a few points of evergreens. There's I'll hit on the why it's good for the GP from a deal perspective, why it's good for an LP from the structure perspective, and why it's good for the GP from a business perspective.

16:37I think it's great from the company so they don't have to exit in 10 years. But say more on that. So that's a really important point. If a GP, Blackstone, can go to a family-owned business and say, hey, we'll invest in you, but we don't have to exit our investment and sell your business in 10 years, the family's going to love that because they can hold it for multiple generations. So it's great for the GP, and it can help the GP win a deal potentially. So there's benefits from structure in that perspective. And it means that a GP doesn't have to sell either, right? So say they want to hold that business for 20 years because it's a nice cash-flowing business.

17:12They don't have to exit and return capital to investors because they can just keep holding it in an evergreen structure and let it compound. There's benefits there. I think, Ben, you hit on a really important point for the Wealth Channel. And this is one of the biggest learnings I had from iCapital, which is the largest platform that enables the Wealth Channel to access private markets, which is that you need to figure out how to meet advisors where they are. Different advisors have different types of clients. They have different types of needs when it comes to reporting, when it comes to liquidity, when it comes to client size, how to put minimum investments, how to put investors in alternative products.

17:46So, Evergreen solved for some of that. There's no K-1s. There's one capital call, so you don't have to worry about cash flow planning. If you're investing in a closed-end fund, you might have a number of capital calls over three years. And then you have to hope that capital comes back in 10 years, and then you recycle that. But you don't necessarily know when it's going to come back or when they're going to exit. And that can change cash flow planning, liquidity needs for the client, etc. So that can be a challenge. Evergreen abstracts a lot of those challenges away. So from a structural perspective, it makes it a lot easier for reporting, for enabling investors to access funds, right?

18:23I mean, as a wealth manager, too, they might have some clients who get onboarded, and you can get investors invested right away. You don't have to wait until the next vintage. Say a fund isn't raising until a year from now. You have some clients in XYZ private equity fund, Evergreen. you can just put the new clients in that same fund, obviously, at potentially a different nav, because it's been a year and the investments have been marked at a different price. But you can just put those clients in there rather than have to wait until the next vintage. So I think there's a lot of structural reasons why it makes sense.

18:55And then the third reason why it's a really interesting development for the market is really from the GP's business building perspective. So So alternative asset managers, and this kind of gets back to our earlier conversation about the evolution of private markets, a number of these businesses are now public companies. They are big businesses that are, in many cases, valued on fee-related earnings. So management fee. Yes, there's an incentive fee, but the markets are looking at how stable and predictable is their fee-related earnings, management fees on the funds that they run and manage and the capital that they raise.

19:35And AUM growth ends up being a big driver of whether or not investors like what those businesses look like. So why do GP staking when you could just buy Blackstone? It's a good question. Is that the best way to access private markets is just all these companies? I think the answer is both. So I think you can do GP staking and you can buy the publicly traded firms. I mean, some of these publicly traded firms will grow in size and scale. I think scale does matter in private markets. You look at the largest firms, they, A, will continue to benefit from being the biggest. They have the brand. They can invest in their brand.

20:13They can invest in distribution professionals on the ground. Blackstone has 300 plus people focused on wealth channel distribution. Not every firm can do that, but the firms that can do that, the other publicly traded firms are also investing heavily in distribution to work with the wealth channel, the big wire houses. There's plenty of people who need to be covered there. The RIA channel, completely fragmented, hard to cover, so you need people and boots on the ground. You need to build relationships. You need to build trust. You need to build brand. Those firms will do well in growing AUM, and scale does matter there.

20:44And I think going public is part of that brand building exercise. People will know who they are. Blackstone has a TV commercial now. People are going to look at that and say, oh, this is Blackstone. And I want to invest in that just like I invest in an iShares ETF. So I'm seeing a lot of LinkedIn ads for these private companies. And there's been a lot of articles written in the recent months. Are private markets in a bubble? Is there too much money in there? So anytime - Sorry, let me set this up a little bit better. Sure. I mentioned that anytime you democratize an asset class, returns have to come down.

21:15Index funds are free-riding the market. They're owning the market. But for something like private credit, for example, which is the hottest private investment in my career that I can remember. They're raising money, right? These GPs are raising money. They have to then go deploy the money. There's so much money coming into the space. How are the GPs literally finding companies to give the money to? Where is all this demand for the borrowing coming from? No, it's a great question. And I think there's two sides to the coin. So one is anytime there's massive growth in a market, you have to stop and take stock of that and say, okay, is this going too fast?

21:57And is too much capital coming into a space? You have to just step back and look. And as bullish as I am on private markets in general and private markets becoming a bigger part of the investing universe, which I think they are, right? It went from sub a trillion of AUM in 2006, 2007 to now over 14 trillion. Prequin expects it to be anywhere from 18 to 20 plus trillion by 2027, 2028. So we're talking about this is not a small part of the universe. Relative to public markets, it's still a small fraction of assets. How does that money find a home that treats its investors well? Sure. So I think that's one side of it.

22:39The other side is specific to private credit. You have the largest firm. So Apollo has said anything that's on a bank balance sheet is really private credit. And we can actually help remove some risk from the system and deleverage some of these banks by some of these assets actually going into the private credit universe, whether it be direct lending, asset-based finance, consumer loans, things like that, where you could take some of that off bank balance sheet. Apollo calls that market$40 trillion, private credits at$1.7 trillion. Even if you take Aries, who's another large manager, they call it$20 trillion.

23:20Blackstone calls it$25 trillion. No matter if it's any one of those three, I think they would argue that it's a very large market, that there's still plenty of room to run, and there's plenty of companies to finance. And I think banks have kind of, due to regulations. They've retrenched a little bit from lending and private credit. They're now trying to find ways to get back into it. But Jamie Dimon spoke about this recently on this call. He's like, hey, wait a minute. We could do this too. Sure. And they actually looked at buying Monroe Capital, which is a$19 billion private credit firm. So, you know, I think banks are both understanding of the fact that private credit and these alternative asset managers are eating into their lunch.

24:05But they're also trying to do this too. I mean, Goldman raised$20 billion in their private credit fund recently. So I think banks understand that they can do this themselves. They also understand the competitive pressure from these alternative asset managers who are encroaching on their territory. I mean, Blackstone at$150 billion market cap is bigger than— It's roughly the same size, depending on the day, as Goldman Sachs market cap, maybe even a little bigger. So, like, that's not a small business. What does the recession do to private credit? That's, like, the big question. I think that's a really valid question to ask.

24:39And also, what do lower rates do to private credit? In a higher rate environment, most private credit instruments are done on floating rate. So in a higher rate environment, it's actually generally a good thing for private credit in a sense. I'm surprised that there's been so much interest in private credit given that you can get 5 % risk-free. Like I understand 12 % is attractive. Yeah. But I - People love yields though. Yeah. That's why, Michael, your point about private credit being a bigger opportunity, I actually agree with that because the whole thing about endowments and foundations taking on long-term illiquidity risk, that makes sense because they have their maybe 5 % bogey to hit.

25:15But those are perpetual funds. They can last forever. A lot of these clients for advisors have goals they have to reach in maybe the near intermediate term. So the whole private credit being a bigger piece of this for the Wealth Channel makes way more sense to me in terms of advisors wanting to sell it. And because it's not like the yield is a guaranteed return, but showing that to clients makes them feel a little bit better than, oh, well, this VC or private equity fund could give you this, but we don't know, versus here's the yield now that you're going to get. So I think the selling point of it, not saying private credit is going to automatically do awesome, but from a sales perspective, it makes way more sense to me from the advisor side of the aisle.