E274:How LPs Miss Early Asymmetry by Waiting

0:00So for those unfamiliar, what is GlassFunds? And tell me how it fits into the alternatives ecosystem. Yeah, so GlassFunds is an infrastructure, an alternatives infrastructure platform. We work with about 150, 175 advisor firms to help them implement custom alternative platforms in scale. So they can allocate to hedge private capital across their plethora of ultra high net worth clients, fully customized portfolios, and easily implement that through the Glass Funds platform with minimal administrative input on their side. And we provide a number of efficiencies for them to do this. For example, it's a one-time subscription document.

0:41It's all electronic. And we also provide a number of workflow efficiencies, such as a single destination and source of cash flows to a single custodial bank, as well as aggregated reporting, including aggregated tax reporting. So an underlying investor can own 15 different positions and they'll receive a single federal K-1. So we exist to help the advisor firms implement their alternative programs in a way that they see fit. They can fully customize it client by client. They can allocate the funds programmatically. They can pick and choose their own funds or pick off our list or a mixture of the two.

1:13And this might sound like an esoteric question, but it is something that a lot of people that invest into startups and venture capital funds deal with K-1 management. In the early stage venture, you want to have really broad exposure into a lot of different funds and a lot of underlying startups. Is there a solution to solve this K-1 issue so that you don't have to deal with 200, 300 K-1s in order to get broad exposure? We think we've effectively solved for that. So it's through our legal structure. we manage two master evergreen investing entities in onshore and offshore, depending on the tax status of the client.

1:48And when a fund gets on our platform at a stroke of a pen, we create a new series. And given the legal structure, our auditor and tax partner, a big four firm that everyone's heard of, they can look at all of the series a client owns, which that series is an individual fund, and they can amalgamate the tax information from each underlying fund and put it together in a single K-1. And this is meaningful to advisor firms because some of our advisor firms have hundreds or thousands of qualified purchasers. So if each qualified purchaser ends up owning 10 to 20 funds, if there's not an efficiency there, they could be spending on an annual basis, tracking down thousands of K-1s.

2:30And also that ends up being an end cost to the end investor. We've heard some accounting firms charge$500 and up per K-1. So it is a meaningful time savings and just hard dollar cost savings to the end of the year. It's like one of those things. It's like, what does it matter? How many K-1s you have? Well, if the number of K-1s keeps you from investing into the asset class, then it matters a hell lot. In other words, it's almost more important than everything else because the number one rule of investing and the most underrated part of investing is you must be invested in the market. It's kind of one of these things that no one talks about, But if you're not invested in the market, it doesn't matter about your timing, all these things downstream of that don't matter.

3:10And if your K1s either keeps you from investing or keeps you from continuing to invest and get some of that alpha in the asset class, that's extremely important, extremely underrated. Yes, we agree. Alternative is evolving at a dizzying pace. Tell me about what a model portfolio looks like today for a$20 million client of one of your investors. If it's a mature client that's been allocating for a number of years, there can be some variations. But let's say the advisor firm allocates to hedge and private capital. This client will own a basket of hedge funds, maybe five to eight underlying funds, typically implemented through a model construct of which the advisor firm manages.

3:47And that hedge fund portfolio is typically funded through bonds. So that's a substitute for a bond allocation in that portfolio. them. Then the client will also own a diversified basket of private capital funds, typically across credit, buyout, growth or venture, real estate, and potentially some other real assets or esoteric strategies. But the core allocation is typically buyout, credit, and then the low-wesco growth venture and then smaller weightings on more of the satellite strategies. The overall alternatives portfolio typically ranges from 10 % to 20 % of the overall client's assets. And the advisor firm can take several different approaches on implementing that.

4:26They can be fully bespoke, meaning client A has a completely different mix to client B. Or if the advisor firm wants to get some scale or some consistent exposure, they can elect to implement the hedge or the product capital in baskets. So on the private capital side, our advisor firms typically use vintage series constructs. So their clients that participate in private capital, they're going to sign up for Advisor AA's 2026 private capital vintage series. And it could be a basket of three to seven funds diversified across strategy or the advisor can run dedicated vintage series and private credit or buyout, et cetera.

5:01And the advisor firm can go out to the client or their group of clients one time a year, have them sign up for the vintage series. Then through the remaining of the year, they can deploy that capital. And at the time this client executes, they don't, the advisor firm don't even have to have the managers identified. Through our legal structuring and through the sub docs and client signs, they're signing up for a vintage series and then within that legal agreement allows the advisor firm to allocate that commitment as they see fit as they serve as the investment manager. So that's the typical construct we see for a$20 million client.

5:35Again, not rocket science, but you're creating these vintages. You're making these easy buttons for clients so that they don't have to get in the minutiae of this private credit fund versus this other private credit fund, which again, might get them in this analysis paralysis and not take any action. You solve that upstream and so much so that they could actually invest before you've even chosen the managers. Correct. Also, we also typically see where an advisor firm, they want to get scale and consistent exposure so that the clients can have the full benefit of the research process that they're running.

6:07But also from time to time, there are certain clients that need customized exposure or there are certain clients that want this, but they don't want that. So our construct allows fully programmatic exposure, but it also allows customization client by client. And we typically see that as the amount of client assets goes up or the net worth that the client goes up, typically there's a demand for the advisor firm to be able to customize those portfolios. I've gotten to know you a little bit, Brett. You're a great first principles thinker. You said that some of the underlying clients have 10 to 20 % exposure.

6:40I'm sure you know a lot of endowments have 40 % in alternatives. There's rumors that some IV endowments have over 50 % in alternatives. That's quite a gulf between 10 to 20 and 40 to 50%. Is that because you are trying to get your clients off of zero, so even 10 % to 20 % is a win? Or is there something fundamentally about high net worth individuals that should have different exposure to alternatives than, say, an endowment? The reason there's a difference is just when, on average, the core started allocating endowments and pensions and institutions. They've been allocating in some cases since the 1980s.

7:19Wealth management at a broad scale really started taking off late 2010s, early 2020s. So you're starting from zero. And for many wealth managers, this is a new endeavor. And when you're going into a new endeavor, there are a lot of considerations that need to be paid attention to. For example, no wealth manager wants to go through the implementation process, the education process, and then they make their first initial allocations and then they end up not going well. So there's a desire to start this process in more light-sized chunks. And also from a capital deployment perspective, if you're starting at zero, there's really not a need to set the target allocation up to 40%.

8:01It will take a number of years. Even if you had the target at 40%, it would take a number of years to get the portfolio fully exposed, the product capital strategies with that plan. So it's sensible maybe to start out at 10%, then reevaluate. If the client experience is going well, the returns are good, the receptivity is good, then maybe you consider going up to 15 or 20. But again, just given the nature of credit capital and that still a lot of the assets are being deployed through drawdown funds, there's just a natural time limit on how fast that money can be deployed. If we looked at some of those endowments that are currently allocating 40 to 50 to maybe 50 % of their portfolio, probably when they first started setting those allocations, those weren't the target allocations.

8:47There's a good chance those initial allocations were 10 to 15 % and they've worked up over time. I think we're just seeing that in the wealth management space, given that wealth management more recently started allocating. And there's two aspects to that. One is a behavioral, understanding your true risk tolerance, your true tolerance towards illiquidity. So on an individual basis, understanding, well, I put this in for 14 years. Yes, it sounds like I could handle that when I first put in my money, a.k.a. seed fund and venture capital. But as I've started to invest, I realized that's just too long for me.

9:18So I need to back up my liquidity. liquidity. And the second one is you want to deploy in a prudent way across vintages. So you don't want to put all of your venture or buyout in 2025, you want to do 2025, 26, 27, 28, and make sure that you have smoothed out exposure to the asset class in general. That's also a key consideration. Yes, it just simply takes time to wrap up. It also takes time to get educated on the plethora of strategies. You know, we talk about broad asset classes, hedge funds, product capital. But underneath the hood, there are vast differences. There's a very big difference between an absolute return hedge fund that has a target volatility of 4 % to 6 % versus a venture capital fund that is focusing on seed rounds.

10:02And they all get lumped in under the alternative bucket, but it just takes time for the advisor firms as well as the underlying clients to truly understand the intricacies, the target risk returns, liquidity profiles of all these different strategies. When we last shouted, you mentioned that the term alternatives is overused. What did you mean by that? Alternatives is a catch-all. The term basically says it's alternative to what? Well, typically cash-tock bonds. But underneath this catch-all term are very disparate strategies, either from risk profile, return targets, liquidity, underlying return drivers.

10:41When we communicate internally, we don't use that term a lot. We're talking about specific strategies, specific risk targets, specific goals of strategies in a portfolio, liquidity characteristics, and it's all different. I'd also say alternative is a relative term. So as the market shifts, I also think the definition of alternative needs to shift as well. And I think allocators need to ask themselves, this particular strategy was alternative historically. But if it's grown either in popularity or size, is it still alternative? It doesn't make it a bad strategy. It's just when we talk about alternatives, typically they are differentiated exposures.

11:23They're harder to access and they charge higher fees. So as a strategy that becomes larger and more popular and more quote unquote beta like, allocators should ask themselves, is this really truly differentiated anymore? And two, should I be willing to pay fees that historically may have made sense, but do they still make sense? What's the right approach to building out your alternatives book as an individual investor? Investors should target a multi-year timeframe. I also think it needs to be reasonable in length. You know, there's no right answer, but I think three to four years can make some sense.

11:56I also think investors need to clearly define what their objective is. Are they looking to increase income? Are they more focused on capital appreciation? What are the tax sensitivities? What are the liquidity sensitivities? Are there certain areas of the market where you're not comfortable with, not necessarily from an economic standpoint, but more of a personal goals and values and what area of the market they want to target? But what does their other assets look like? Are they a business owner? Do they own a small business? Do they own a decent-sized real estate portfolio? These are all the types of questions that our advisor firms are asking when they decide to craft a portfolio of alternatives.

12:35Then it also can make some sense on picking certain parts of the market on where to start. On the equity side, we think a great area to start is either secondaries or GP stakes. There are a number of attractive attributes with these types of strategies. One is secondaries can provide instant diversification to hundreds of underlying funds, sometimes thousands, well over 10 vintage years, thousands of underlying private companies. It can be very capital efficient in terms of the cadence of capital calls and distributions. Limited J curve, which from a behavioral standpoint, is just easier to hold.

13:11So it can serve as a nice initial core allocation within a new private equity portfolio. We also think to a lesser extent, GP states firms can do this. A portfolio of growth-oriented structured investments in a private capital firm can have exposure to a number of underlying funds and either portfolio companies, loans, pieces of real estate that offers more cash flow efficient and diversified exposure. We also think private credit is a great place to start. We do think evergreen fund structures within private credit can make a lot of sense. To be clear, we always start out with manager conviction.

13:52We have to have a high-quality view of the manager. Then we look at the wrappers that the manager offers the strategies in and determine, does that wrapper make sense given the attributes of the strategy? We think in private credit, the evergreens can make sense. And from an initial allocation standpoint, this could be favorable because capital can be deployed into an existing diversified portfolio that you get pretty quick cash flows. Because the quarter after the fund has called your capital, you're eligible for income distributions, which can be attractive for new investors to see some more instant or not instant, but quicker cash flows from their private capital portfolio compared to a buyout fund or venture fund where it may be a number of years before you see their gains or cash flows.

14:35Yeah, I want to double click on a couple of things that you're highlighting, which are very smart. One is you're essentially advocating without saying it for a beta or market average, so that you make sure that you're within a certain band of returns for that vintage. Without using numbers, you're not going to heavily outperform or underperform a specific vintage year. And two is from a behavioral aspect, you're making sure that, like my previous example, you're not waiting till year 14 to get your first distribution. You're getting at least those markups earlier on. You have a minimized J-curve, which, again, from a behavioral aspect encourages you to continue investing to the asset class.

15:13Those are excellent points. When we look at intercourtile spreads of private credit and secondaries, it is materially more narrow than venture capital. Venture capital of intercourtile spread can be over 30 percentage points. In secondaries and private credit, in some instances, it's less than 10 percentage points, and sometimes it's even smaller. So when an advisor firm is new into private capital, it's important to show early wins and to really limit the downside. So if we can find sort of the core evergreen, the core middle to fairway type strategies that will deliver attractive returns, maybe in a narrower band, you have a higher floor but a lower ceiling, that can be initially attractive for new allocators to private capital.

15:54I've been speaking to a lot of secondary private credit funds and strategies. And it emerges two of the things that you were talking about, secondaries and private credit. What are your thoughts about this space and why do you think it's been evolving at such a fast pace? With the liquidity struggles of primary strategies, I think the answer or the personal answer has been the secondary markets and providing long holding LPs with liquidity and creating that demand for secondary capital. How we've looked at private credit secondaries, we prefer primaries on more middle of the fairway private credit.

16:36I think where secondaries can make sense is in more opportunistic type debt. And we've been able to identify some structural reasons for that. One is opportunistic private capital is a smaller strategy within the broad ecosystem. Two, when these large institutional portfolios go out to market, many of the secondary firms do not want the opportunistic debt exposure. Therefore, to a certain extent, these can be orphaned assets, allowing dedicated players to come in and scoop up these orphaned assets at a much favorable price compared to some other areas of the market. And it's because of this dynamic of the supply and demand of secondary capital and where that secondary capital wants to go.

17:26We think on more of the optimistic debt, either mezzanine debt, maybe structured preferred equity, those types of funds can be acquired pretty attractively on the secondary market. On more of the direct lending type strategies, you know, we prefer our approach is finding areas in the direct lending market outside of large middle market spotter back that is targeting on certain niches and has better supply demand dynamics from capital flows perspective, where the underwriters can get more attractive pricing, covenants, risk perfections, collateral protections, etc. Let's be honest. Subscriptions out of fast.

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18:43Get started with Experian app today. Results will vary. Not all bills or subscriptions are eligible. Savings not guaranteed. Paid memberships with a connected payment account required. See Experian.com for details. I had the CIO of CalSTRS, Scott Chan. And because they're so big,$350 billion, they move markets. So they have to be very purposeful about where they go in with supply and demand dynamics. But I would actually argue that everybody should be looking at supply and demand dynamics of every market because they're an actor in that market. Whether or not they move the market to a new equilibrium or not, there is an existing equilibrium.

19:18And there's an existing risk and return spread for that entire asset class, not just the manager. Everybody's focused on the manager, but also knowing what asset class to go after, I think is a highly underrated aspect of investing. 100 % agree. I think the one advantage that I think is the most underutilized in wealth management alternative investing is wealth managers don't have to write big tickets. Wealth managers as a firm level, depending on the size of the firm, could write a$5 million ticket and that's meaningful to them. So really at that level, the world is your oyster. You can go into a number of different strategies and a number of different funds and areas that have lower capacity.

20:00I think if you look at where the wealth management capital flows are, I think they're over-indexing to the very large product capital managers. And I understand why. I understand why that can make sense. If you're doing something new, you want to go with a brand name, it can be safer, it can have lower perceived risk. I'd also venture to say that probably if you did some correlation analysis, there's probably a pretty strong relationship to the number of – if you calculate how big a private capital firm's wealth distribution team is relative to how much capital flows are getting from the wealth management channel, I think there's a pretty strong relationship there.

20:38And again, we think some of these strategies offered by the big private capital managers are high quality. We're not opposed to them. But I also would urge wealth management allocators to really utilize the one benefit that they clearly have over institutional investors is that they are not capacity constrained. there's this chicken egg there similar to what we were talking before which the biggest mistake that you can make as a private investor investing in alternatives is not to invest at all in alternatives the second biggest mistake is not to invest in a certain space so sometimes going with a blackstone kkr could be the gateway drug to actually investing in that space and maybe they have slightly lower returns i'm not saying that's the case or maybe they have the average returns maybe technically you might be getting another 100 200 basis points also going in a lower middle market.

21:24But the fact that you started that decision or you started that decision five years ahead of when you would have typically have made that decision, maybe that is actually the behavioral alpha that is available to platforms like that, to investors that invest in platforms like that. Yes, that makes a lot of sense. And again, for example, we look at a lot of large cap buyout, and we think some of them are really good. And if they are really good, it makes a ton of sense. If I could offer something to an investor that they've heard of, it's a brand name, and it's good, that's a win-win. What I would encourage wealth managers to do is just broaden what you're looking at.

21:58And over time, if you do have hard and fast rules that the manager needs to be of this size or have X amount of years, maybe as you come up to speed in the marketplace, your knowledge grows, your experience grows, you become more comfortable, is just to expand what you're looking at so that you can fully do the comparable analysis. So I only historically, if, for example, you only looked historically at large cap buyout, now I'm looking at smaller managers. Once you broaden your horizon, maybe you can find better pockets to allocate to. Yeah, taking the extreme, one advisor might have 100 out of 100 trusts with a client where they don't even ask the asset class.

22:34They're just like, just invest. I trust you. I'm not even gonna, you don't even have to do it on the asset class basis. On the other extreme, you have somebody that looks at their advisor purely as somebody that's giving them products and they want to know every single thing. So it's all about having the right products for the right solution. Our more long-tenured advisors have been doing this for a number of years. They do gravitate typically down market over time. Not always. There's still a mix of some very high-quality strategies offered by large managers that have been able to deploy capital in larger size and still generate attractive returns.

23:06But the general trend is as advisors become more experienced in this space, they do tend to shift towards smaller, more targeted managers. At GlassFunds, you've invested in over 150 funds. What are some general principles that you look for in terms of GPs that you want to put on your platform? Year to date, we've onboarded over 150 funds. Now, a little nuance there. The vast majority of those funds have been sourced by our advisor firms. For the funds that we underwrite, we really take a bottom-up approach. We don't make top-down calls. I don't have the expertise to say, you know, this sector in real estate is better than this sector, so that's where I'm going to allocate to.

23:45We leave that up to the managers. Now, in the extremes, we are macro and sector aware. For example, several years ago, the bar would have been very high for a central business district office type real estate strategy. Not because I'm the office expert, just that the trend seems severe enough where it just probably wasn't worth the risk. So we care less about the raw materials that managers are working with. We care more about how they're using those raw materials and how, if they have competitive advantages that are durable and that we can underwrite and can they generate attractive returns at a specified risk level going forward.

24:20And that's what we focus on. To put a little more granularity on it in hedge funds, we focus on funds that generate most of their returns through stocks, either security selection or specifically idiosyncratic exposure versus common risk factors. So we tend to shy away from long short equity or long bias managers to have a material beta exposure to the market. We want to, you know, we believe that if investors are going to pay hedge fund fees, that we want those fees to be going towards security selection versus just repackaged beta exposures. For private capital, you know, we look at transactional level data.

24:58For example, for a buyout vertical, we want to look at all the transactions that the team has done, and we want to understand how they traded value. We favor strategies that create value through EBITDA growth, either by preferably top-line growth or margin improvement, and we discount multiple expansion and leverage or financial engineering. Not that we have a negative view on those, we just don't think that the manager has a competitive advantage in trying to time multiple expansion or tidying the debt market. We do think managers can have an advantage on buying companies, creating value through top line growth or internal efficiencies at the platform company.