E241: How Spirits Became a $1 Trillion Alternative Asset Class

0:00So you're the CIO of Invest. We'll get into that in a bit. You started your career as an OCIO at RVK. Tell me about your experience working at RVK. Yeah, that was a great experience. I worked with some really intelligent people who taught me a lot about investing. Really set the foundation for kind of how I thought about things as an investor. And one of the things that I thought RBK did a really good job of, especially the folks that I worked with, was thinking about things a little bit differently than the broader sort of institutional investment community, especially from the consultant side, where there was a lot of pressure to invest in big names.

0:36Pension plans want to align with what other pension plans have done simply because it didn't really put their neck out on the line. If you follow people's incentives, you'll see kind of what they do, right? And the consulting community oftentimes isn't incentivized to really search for the best and brightest. It's oftentimes reversed into the mean of the lowest common denominator of what others are going to do. And RBK was very different in that regard. Our team really wanted to differentiate ourselves by finding unique strategies that together created the diversification that maybe a go anywhere, do anything allocator.

1:13fund could do, but with more precision. And typically what we saw with experts and a specific focus is that you're sourcing better deals, you're adding more value throughout the deal, and you're exiting better. And that was a really important lesson that I thought was unique to the firm and the team that I was working with. And you hear a lot of people saying that consultants or even larger allocators are not incentivized to find these best and brightest. They're incentivized to go after the large brands. Can you double-click really granularly? Why is that incentive there? And maybe walk through that incentive structure from an individual at the consultant or an individual at a large asset allocation.

1:50For the consultant, you're proposing investment opportunities to typically an investment staff who then has to propose those to a board. And if you as a consultant, which are paid on a flat fee based arrangement, if you propose something new, unique and different, if it performs well, you get no compensation for that. And if it performs poorly, you're oftentimes could be considered the scapegoat there to the investment staff, who the investment staff, if they kind of get in line and believe the story that's being sold from the consultant, then they are responsible ultimately to the board as well.

2:26And so if they are recommending something to the board that is kind of out there a bit and it doesn't work out, that's really, that's putting their neck on the line. And they're oftentimes not compensated. And there are structures that some groups have implemented to kind of avoid this a bit, But they're oftentimes not compensated for overperformance. But if you do have something that's a bit of a slip up, then you're going to be judged against that. And all of these institutional groups are judging their performance relative to their peer set, relative to benchmarks. And so as long as you're meeting or exceeding the benchmark, really, you just don't want to be below the benchmark, right?

3:00And that's going to put you at risk for your role and for the individual who's making those recommendations. There's not a lot of incentive for either the consultant or the investment staff to take those risks. And you see that bear out in terms of the portfolios that you see a lot of money going to these big allocators that over time are just hard for them to really outperform. If I was dead set to raising from consultants, and let's say I was on a fund three or four, I wasn't KKR fund 17, what would I be looking for as a counterparty from a consultant, maybe individual or firm that would signal to me that they are looking for the best and brightest and that they are willing to take a risk on an emerging manager, maybe even a manager that just became an established manager, but it's still early on in their life cycle.

3:45What would be those one or two characteristics? One of them is that you could look at the track record of what they've already recommended, right? That would certainly be something that was a kind of telltale sign to the market for us that, hey, we were doing some more unique things. But I think that manager needs to think about how can I be a good partner here? How do I differentiate myself? And if you see a consultant that is open and interested in those things as a way of creating a customized relationship, whether that be fee reductions for first-time closings or co-investment rights, that consultant that's trying to find value-add pieces above and beyond the contract of the strategy, they're thinking a little bit more about how to add value to their underlying investor.

4:28because not only are you trying to be a good partner for this manager, but you're also trying to be a good partner for your underlying constituents, the staff and the board, by lowering the fee load and finding these additional opportunities to do co-investment. So those are just some simple ones. They're just thinking a little bit differently about allocations versus I know that pension plan ABC is in. We're already in this fund in a prior vintage. That seems pretty good. Nothing has really changed. Let's move forward with another allocation, which happens quite a bit. What percentage of the funds did you and your team source directly out in the market?

5:00And how many were referred to you by LPs that were basically sourcing them and sending them over to you for diligence? Oh, good question. I mean, I would say 90 plus percent were self-sourced by us. We really turned over the stones to find the new and interesting differentiated teams. so much in fact that we would even think about going as far as finding a great group of people who are at a larger firm. And we talked about this at times, do we see to spin out ourselves to create it? We are the C capital for this new firm, which would really incentivize that manager, obviously, to perform at their first time fund with us as the main LP source.

5:39And so we never went that far, but that was something that was bad about. So you went from working at an OCIO to investing in bourbon, quite the career arc. So tell me about that. And how did that come about? So my partner and the founder of Invespev, a guy named Brian Rosen, he and I have known each other for a long time. And we were out with our wives, who are good friends, out one night. And he started talking about his industry, which was alcohol. His family had been in the industry for nearly 100 years. It's a really fun story. They were actually the first liquor license in Chicago coming out of Prohibition.

6:13So his family has been in this space for a really long time. And under his stewardship, after running the business for a long time, he had exited the business to private equity with his own personal and family capital. He started investing in the Athol space again. And he came to me at that dinner and said, look, you know, Giuseppe, I'm seeing deal flow. I'm very ingrained in this space. I think there's some great opportunities to invest. I think, you know, my own capital can only go so far. I'm thinking about raising a fund. And I said, well, Brian, you know, I know this world a little bit. I'm happy to help any way I can.

6:44And kind of in a funny way, he said, well, why do you think I'm telling you about this? I want to do this together. And so that's really how it started. And so the next step was, okay, alcohol as a category, we all know it as a consumer. Let's talk about what you're actually doing. What's the strategy within the category? And you really leaned into this concept of whiskey aging. And I kept kind of leaning in further and further on this because as I heard about it, this aligns to some of the real assets kind of investing that I did at RBK, right? About real estate and infrastructure and all those things, timber as well.

7:18These barrels are this tangible real asset that really had a lot of the same attributes that some of those other real assets had, but they had a really distinct advantage relative to those other things where the good itself was actually getting better over time, We all can go to a liquor store and see 15-year-old McAllen is more expensive than 12-year-old and so on. Those types of things are kind of universally known that the maturation of whiskey, you get a better product as time goes on. So that really got me thinking that there's some attributes about this category that were really compelling.

7:54You spent a good half an hour going back and forth with ChatGPT. I even Googled, which is not something I do very often these days. I couldn't find the returns on bourbon. What are the historical returns on bourbon? The market by, some would say by design, is a bit opaque. But if you transact as much as we do, we have both our investment equity side and a credit side, which provides a lot of insights. You get a deep understanding of where pricing a barrel should be, finger on the pulse. and in our years of doing this nearly over 10 years now, we've had transactions and you've seen high times in the 40s, percent IRRs.

8:31You've seen some really, really outlandishly good returns when you think about this is a tangible asset. You compare it to the timbers of the world which are typically like a single digit type of a return. It's just no comparison. Now, I'd be remiss if I didn't mention that there are also times like in recent years where COVID has had an impact on our industry and so forth. And so returns have come down. The price of barrels have, that appreciation curve has come down slightly. And so returns in some of our vintages are going to be in the 20s, potentially even in the high teens. And so that's really the range that you can think about from a realistic outcome.

9:07What is the correlation to the market and how do you look at it? Is it also somehow correlated to equities? Does it have a beta? And how do you go about kind of ascertaining these numbers? We actually worked with the Kellogg School of Management here in Chicago, and just had them do a kind of a third-party correlation analysis. It kind of, it certainly mirrored what we might anecdotally say is that people drink in good times and bad, right? It's a non-correlated category. And the data bore that out. There was almost no correlation whatsoever with the S &P 500. There was no correlation with 30-year treasury, the unemployment, housing starts across the board.

9:42In addition to that, alcohol sales had a dramatically less volatility Standard deviation was half in many instances and even less in others relative to these other categories. And so when you think about a category with an appreciating asset, tangible asset, limited volatility and limited correlation relative to the other things in your portfolio, that really became compelling to me. And I thought would be compelling to the investment community because that's one of the reasons why you invest in alternatives. At the end of the day is you want something that behaves differently and complementary and doesn't all zig when everything is zigging.

10:16You want it to, at the very least, not zig and potentially zag, but the alcohol industry just being so steady is a really compelling piece of this to me and to our investors. There's this whole asset allocation of diversifiers. Typically, it's hedge funds that are uncorrelated to the market. And typically, these have lower returns but add diversification to the portfolio because they are uncorrelated. Is this the bucket that it would fit in to an endowment or a pension fund? or where exactly, from first principles, where exactly should investors fit something like bourbon or alcohol in their portfolio?

10:49The one thing we talk about a lot with investors when we work at the institutional level is those that have really rigid buckets that they need to fill across their allocation struggle with, where do I put this, right? And I would argue that it does fit in a real asset bucket. That's certainly one opportunity or one way you can go if you have that. some folks have just an opportunistic bucket. I don't know if the risk profile of what we're doing is as high as what was typically in an opportunistic bucket, but we almost have to meet the investor where they are and say, what does your investment profile and portfolio look like?

11:25And how can we think about what we're doing and where it might fit? And honestly, it doesn't fit for a lot of folks, but those that are more nimble in their asset allocation and can be a little more open-minded because you don't start the day with an allocation to whiskey in your portfolio. We have to, as a firm, convince you that this is a category that is interesting and that it does fit, as opposed to finding where it was already preordained to fit. You know, there's only a handful, probably half a dozen funds that invest in this entire space. So a big part of your job is educating the market.

11:57How do you educate the LPs in a process? And how do you get that second and third meeting? Like, what's the art to that? you start with what is the what is the category right that we're talking about if it was real estate right they already have an allocation to real estate but you might have to be more specific and in a particular category so you need to get into the details of multi-family right you need to sell the category in and of itself what are the underlying dynamics and characteristics of the category that make it make it compelling and that's where we start with alcohol talk about the size of the category, you know, trillion dollar category.

12:33You talk about the correlation to other categories. We start with that to say, okay, this is big enough to really think about. This is compelling enough to dive a little bit deeper. And then the next step is kind of what is the strategy, right, with which you're capitalizing on the opportunity? Because first you got to sell them on the opportunity of the category. Then you got to sell, how do you capitalize on it? So that's when we get into the whiskey barrel specific characteristics, et cetera. And then from there, once they get a good grasp of this whiskey aging component, then you have to talk about why us, why are we the ones to do it, right?

13:05So it's a three-part journey in my mind. And to be honest, the first of those is honestly typically the most difficult. Once you get to now you've bought into this, I mean, you've been open to the concept, the strategy on the bourbon barrels is really compelling. And then you talk about us as a firm. To your point, there's very few people who do this aside from us. But our whole team, aside from me, comes from the beverage industry, right? aside from my partner who I mentioned, we have folks from Bacardi, Molson Coors, et cetera. And that really differentiates us from a relationship basis to buy and sell barrels differently.

13:36And to the point I made earlier about sourcing better, adding value, and then exiting better, if you have deep industry relationships in our category, which we do, that really sets us apart from, no offense from anybody who lives in New York, flying in from New York and just doing this as part of a larger hedge fund strategy or whatever the case may be, it's very different. and that's how we think about it. A lot of people, for whatever reason, don't think of asset managers as traditional businesses. I like to think of them as businesses. And the way I kind of think about it is you have to pick your heart.

14:06So it's very hard to be in a hyper-competitive market and it's also very hard to educate a market, to go through all that. But there are these huge rewards for people that start a market. Support for today's episode comes from Square, the all-in-one way for business owners to take payments, book appointments, manage staff, and keep everything running in one place. Whether you're selling lattes, cutting hair, running a boutique, or managing a service business, Square helps you run your business without running yourself into the ground. I was actually thinking about this the other day when I stopped by a local cafe here.

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15:08Square gives you fast access to your earnings through Square checking. They also have built-in tools like loyalty and marketing to your best customers keep coming back. And right now you can get up to$200 off Square hardware when you sign up at square.com slash go slash how I invest. That's S-Q-U-A-R-E dot com slash go slash how I invest. With Square, you get all the tools to run your business with none of the contracts or complexity. Run your business smarter with Square. Get started today. It's two funds that come to mind. Arctos started the first sports fund in 2020. I believe they're today at about$9.9 billion.

15:45as of January 2025. Blue Owl, which was named DAL at the time, started GP Stakes for the first few years. It was incredibly difficult for them. Today, they're a part of Blue Owl, which is roughly$284 billion. So some of these businesses, it's the education, the first mover advantage, although it's very difficult. That's what leads to these unique asset classes. Same could be said in venture. Andreessen Horowitz had to popularize this idea of founder-friendly. We're going to give feedback to founders. We're not going to treat founders poorly. and it took a while to kind of scale up for them. I think their first fund, if I'm not mistaken, was roughly two to$300 million.

16:21So I think you pick your heart and there's different dynamics, but there is no free lunch. Same to your execution sourcing. Like that is your alpha. The reason that's sustainable alpha over several vintages is because you can't just come in. It's not just financial trade. Everybody wants that financial trade, but they don't want to capture a beta. They want to capture alpha. So I think you have to think about alpha not only as today, but how do you sustain that alpha over several vintages? It's an incredible way of thinking about it, right? Pick your heart. there. And I certainly, we've experienced that over time.

16:49There's certain people that immediately get it. And there's certain that just, you know, a lot of convincing and some people never convince, right, to do something different until they see, you know, decades of experience. And then, not to say it will be too late, but you'll certainly be behind the curve of getting exposure to categories that really could generate, you know, returns that you're not getting in other places with managers that you want to be aligned with, right? Adres and Horowitz, for instance, right? If you passed on that years ago and you said, okay, now I'm bought in, I'd love to, have an allocation there, well, good luck, right?

17:17It's one of those things that they're only working with existing investors typically. And so, you know, you don't want to say folks are going to miss the boat, but there's, you will certainly from a return perspective and you may just, you know, not be able to get access to that manager. You see that with others in venture, Sequoia and so forth, like it just becomes difficult and very sought after once everyone's bought in. Going back to that point we talked about earlier, right? Once there's comfort in the masses from others investing, you start getting a snowball of commitments. Do you find that the early adopters, the Clay Christensen innovators dilemma, the early adopters and going back to the laggers and the conservative investors, do you find that that's on organizational level when it comes to LPs or on an individual level or is it some combination of both?

17:59And if both, then how would you allocate kind of 100 points across the individual versus organization? ultimately find at the end of the day that the individuals who think that way gravitate to the organizations that think that way right because if you were if you were that have that entrepreneurial mindset and want to do things that are new and different you're going to get stifled over time at an organization that doesn't doesn't think that way and you're going to either go start your own thing or you're going to find an organization that that does accept that uh mentality so it's certainly driven by the individual um at the end of the day but i think the individual drives the organization and they have to ultimately be aligned for anything to get done.

18:37Tell me about the economics of alcohol production. What does that look like? We'll use spirits here, right? Because it's different across different categories in alcohol when you think about beer and wine and so forth. And I'm going to use rough numbers here just in terms of these costs and they vary. But if you think about a whiskey, right? A barrel, the wood itself is going to cost roughly 250 bucks. And then you think about the grain and the labor and all those things, another 200,$200. So then you have a roughly 450 cost basis as a distillery. If we as a firm buy that barrel for 750 bucks and we bought barrels for more expensive or less expensive than that, less expensive today, which is great, but that's roughly a 40 % margin, right?

19:15So now we're talking about a margin of 40%. We hold it for four years, let's just say on average, and we sell it to a brand for$2 ,000. And again, we've sold four-year-old barrels for more than that and at times even less than that. But if you think about those numbers, if we bought it for 750 and sell it for 2000 in a few years is a 27 % return, which is kind of in line with what our fund is projecting. So now you have a$2 ,000 barrel of whiskey and you're going to get anywhere from 250 to 300 bottles out of that barrel. And so now you're talking about$7 a bottle. So then you take$7 a bottle and you add that into, you add in the bottle itself, the label, and all those things, you call it$10 for cost of goods to the brand.

19:59that that brand is going to sell it to the distributor for let's call it$25 so they're getting they're getting their margin then that distributor is going to have to sell it to the retailer and they're getting their margin and then that retailer has to sell it to you as the consumer and they're getting their margin and so all in that that liquid that costs$7 a bottle is probably ending up on the shelf for$50 all in when you when you layer in all those those those pieces of the ecosystem in the alcohol industry. So that's a lot of middlemen. A lot of middlemen. And the whole three-tiered system, and we could have a whole conversation around that.

20:34It came out of Prohibition, but there's pros and cons for that. But for those who can navigate it well, it creates advantages for scale. And for those that can't, it creates hindrances and really blocks the ability to grow a brand. And so the fact that we have a team that knows that space very, very well and decades of experience there is incredibly helpful for us as a group. You started your first fund in 2015. you're on your fifth fund what have been some of the lessons that you've learned over the last decade on how to start and scale a fund manager people are important in every business and having the right people on our team has or or early in the early days just not having as many people or or the you know it's just like really my partner in the early days i think that can limit your ability to to execute and to scale and so if you if we had a crystal ball and kind of knew where the world would go and knew how investors would, how this would resonate with investors.

21:28I think we would have invested even more upfront. We would have built a bigger team. We would have built bigger, more resources, and we would raise more money earlier. Would probably be one of the lessons that I see because one thing that we really found ourselves thinking about is our first institutional fund was our fund two. the first fund was really Friends and Family Capital that predated that. When we came in the market in the middle of COVID in 2020, we didn't know how the market would react to an alcohol-specific fund, etc. And so we came up with a pretty small fund, and we ended up being oversubscribed, which was great, right, for the fund.

22:06But then you find yourself in that dilemma of, now I have to go sell my second fund, and I think about my consulting hat, putting that back on. You don't want to see a fund make too big a jump between fund one and fund two, fund two and fund three. So now we sort of anchor to the smaller fund size that we've been building on over the years. And now we're to our fund five, which still relatively small comparatively to some of the names we've talked about. But now we're big enough to really be on the radar of some of the larger. Let's assume that a fund one is 100 million. What's an acceptable fund two, fund three?

22:39And what's tolerable, for lack of a better word, by institutional investors? And what do they like to see in terms of fund size over time? I mean, how much is that impacted by the strategy itself? We've been doubling that. That's palatable to folks, even though it's a bit of a, not a bit of a stretch, but a slight stretch. You don't want to see this dramatic increase. But a doubling has been what we've done from Fund 2 each time. So we're at about a 250 million target here for our Fund 5. So still on the really small end of the spectrum. But now you think about from the institutional perspective, there's a couple of things that have historically been limiting factors.

23:15for the very large institutions to be, to look at us. And really we've gotten past now, which is great, is that if you're writing a very large check, now we're to the point where in the most recent fund, we have an anchor that's a$100 million check, which is great. And we have a couple of others that are$15,$20 million checks. And so that snowball is starting to really roll, which is great. Going back and putting on your RVK hat, I've heard of this kind of doubling as an acceptable kind of speed limit, but you do see some people that triple or even quadruple. What are some leading indicators of a fund that's allowed by their investors to grow faster?