Blackstone's King of Hedge Funds on Alt Investing Right Now

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1:09Bloomberg Audio Studios. Podcasts. Radio. News.

1:25Hello and welcome to another episode of the All Thoughts Podcast. I'm Traci Allaway. And I'm Joe Weisenthal. So, Joe, you know what I realized? Two months ago, just two months ago, we were still getting a bunch of headlines about how private credit was the hot new thing on Wall Street and how multi-strategy hedge funds, pod shops were huge and growing. And we've done quite a few episodes on these respective topics. But, you know, just a couple months later, the headlines are starting to look very different. And there's concern that if we get a substantial economic slowdown, you're going to get some sort of big blow up in private assets and things like private credit, private equity.

2:08You know, a lot of people have been predicting that might happen for a while. And then when it comes to multistrats, we've already seen a lot of a lot of talk about pain at the pod shops, given all the recent market volatility. So everything is feeling a little different right now. Well, we are recording this on April 22nd and we got a headline. This has been in the news for a few days, but I guess it's just been confirmed. So speaking of the asset allocators, where's the real money come in from, right? And they're wealthy families and wealthy. But the real big money is in these huge pots of money, whether we're talking about teachers, which if those in the know, the Ontario Teachers Pension or, of course, university endowments.

2:52We got a headline today. Again, it's been out in the news for a few days. Yale considering selling in the secondary market some of its private equity stakes. So these huge pools of money that are really upstream from the private credits of the world and upstream from the hedge fund multistrats of the world, they're in a new era for all kinds of different reasons. And so to even understand these various alts, we have to understand how the people who fund the alts are thinking right now. I am so glad that you mentioned all of that because that was a perfect intro, but also Yale specifically, because we all know that the emphasis on alts was pioneered by David Swenson over at Yale.

3:36And since then, you know, alts have been a big thing, not just in university endowments, but in lots of different types of institutional investing. So I'm very pleased to say that we do, in fact, have the perfect guest to talk about all of this. We're going to be speaking with Joe Dowling, Blackstone's global head of multi-asset investing. He previously ran Brown University's endowment, and this was one of the best performing endowments at that time. He did that for a decade before he joined Blackstone about four years ago. He's been called the king of hedge funds in some of our own Bloomberg coverage.

4:13So really, who better to talk about things like alternative investing, university endowments, and what's going on right now in private assets than Joe. So Joe, Joe D, welcome to the show. Thank you, Tracy and Joe. Thanks for having me. Can we make this a four hour episode? I already have so many questions. Anyway, go, Tracy. OK, so first off, I'm going to have to be very careful in how I address each Joe respectively. But other than that, OK, so one of the things, you know, Joe and I have kind of nibbled at the edges of the university endowment model. And one of the things that we know for sure right now is that they are very large pools of capital, you know, worth billions and billions of dollars.

4:56And for that reason, we often see them compared to things like pension funds, maybe sovereign wealth funds. In your experience, are there differences between running a university endowment, investing for an endowment versus investing for traditional large institutional funds? Absolutely. But let's set the table with just how big the universe is, because I think that'll help us. Please. There's 650 U.S. endowments with a combined assets of$875 billion. That's from Nakubo. I'm using Nakubo data. But the average endowment is only$1.3 billion in assets under management. And the median is$235 million.

5:45I appreciate that you came prepared with numbers. When you see a headline, Yale considering a private equity stake amid its funding turmoil, some reports have said it's up to$6 billion. How big of a deal is this? Like how much of an earthquake is that this entity which we associate with long term willingness to hold on to illiquid stakes, timber, so forth? How big of a deal is this? I think it's a big deal because it's showing stress in the system. And the$6 billion number is also a number that I've heard from outside investors who are actually looking at the portfolio. And what it signals to me is that Yale, who's been a pioneer, is being proactive.

6:29They have a new CIO. Remember, David Swenson, who you quoted in the beginning, was the person who really pioneered the endowment model, but they have a new CIO. And I think it's a sign that he's going to put his own stamp on the Yale endowment. Not surprising with what's happening in the political environment with the endowment tax, which is currently at 1.4%, being considered to go to up to 20%. So that's a big, big number. So with regards to taxes, you might remember during Trump's first administration, under the Tax Cuts and Jobs Act of 2017, they introduced the first endowment tax. And it was a 1.4 % excise tax on net investment income for really the wealthiest endowments.

7:25And how did they define that? What they did was they took the total value of the endowment and divided it by the number of students. and if it was over$500 ,000, then you were subject to that tax. And now what's been proposed is an increase from 1.4 % to 21%. Now, what that would result in is$70 billion of extra revenue over 10 years. And I'm assuming there the average endowment return is 7.5 % to get to those figures. So call it$7 billion a year of additional taxes. And it's going to change really the way endowments are managed. They're going to need to be more tax conscious. They're going to need to target higher rates of return.

8:14And I think they're going to have to continue to use the private markets. So talk to us about how important was that special tax status to returns over the years? Because also, if I look at returns, you know, recently, over the past three years or so, they've already been lackluster. So I imagine with the additional tax pressure, that's going to be pretty painful. And then when you say endowments are going to have to be more tax conscious, what does that actually mean? Is that like investing in munis? I guess you already mentioned private credit, but what can endowments actually do here? Yep. So a couple of things.

8:54One, I want to address performance because you're entirely right. If you look at short-term performance over the last three years, a global 60-40 portfolio has outperformed U.S. endowments. The average U.S. endowment return underperformed the global 60-40 by 6.8 % or 340 basis points per annum, the top quartile endowment returns underperformed by 250 basis points annually. Now, that's over three years, and we all know investors tend to be short term. If you look at the five-year number, the average endowment has returned 8.3 % and has outperformed a global 60-40 by 170 basis points, and the top quartile has outperformed by 250 basis points.

9:48over 10 years, the numbers are even more consistent with those figures. So over the past 10 years, the top quartile has outperformed the global 60-40 by 160 basis points. And even, ready for this, the bottom quartile, okay, has outperformed a 60-40 portfolio by 30 basis points annually. Okay. Let's translate that though. So let's say you have a billion dollar portfolio. if you have top quartile performance versus a global 60-40 over the 10-year period, that's a$288 million difference. So we're talking big numbers here. And this is the nice thing about being an endowment, is that you don't have an LP that's going to withdraw.

10:34You have one captive LP. And so in theory, this is why they have the capacity to make these long-term, relatively illiquid, alpha-generating investments, strictly because there's just none of that sort of like short-term demand for withdrawals. Absolutely. And I think that's the advantage of the endowment model, is that you're able to think really long-term about asset allocation and basically to take advantage of forced selling and dislocations in the market. And that's really what separates the top quartile from really the median and the bottom quartile. But when you were at Brown, for instance, did you ever feel some sort of short-term pressure?

11:22Maybe not just because you had to report returns, I think on a yearly basis, but maybe because the university needed a bunch of money suddenly for some big project, I don't know, a new building or something. I get the point that endowments are investing on a very long time horizon. But on the other hand, I feel like there must be moments where you do have to come up with the money. You know, you're pointing out something that a lot of people don't think about, which is that there is a fundamental conflict between the administration and then the management of the endowment. Obviously, the administration would like to spend the money to work on projects, and there are a lot of important projects out there.

12:13But as a steward of the endowment, you actually have to work with your investment committee to show them exactly what we were just talking about, which is small differences in compounding over long periods of time add up to huge, huge numbers. So what I did and with my team, we would constantly show them over 10, 20, and 30 years what taking a higher distribution would cost the endowment. And that really allowed us to sort of do our job long-term and think long-term. But the answer to your question is, yes, it's the performance derby every year. It's like college sports, and everyone's waiting for those numbers to come out.

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14:09Easy Cater, your business tool for food. To learn more, visit easycater.com slash podcast. You know, so much in finance and these questions, whether we're talking about the university's board having a manager or having an endowment manager, whether we're talking about the endowment manager allocating to multi-strategy hedge funds, when we're talking about the hedge funds compensating the PMs, it's like principal agent problems all the way down. And even though you have that captive LP and you don't have to worry about withdrawals, you still have to worry about career risk, right? Because an endowment manager can get fired.

14:51A hundred percent. And so it's like it's really at every chain, it's like this constant puzzle of trying to get each link in the chain aligned and for some sort of, you know, everyone's optimal, optimal performance. But it's interesting, in my new seat, I get to meet all of the CIOs across the country. And I will tell you, the talent pool is extremely, extremely deep. And so many of them, when I go in and talk to them, I'm actually learning just as much as I hope I'm educating. It's really amazing the level of sophistication of these endowments. I've been super impressed. And I didn't get that at Brown because you don't have that much interaction because you're competing with people.

15:39Yeah. Right. I didn't think David Swenson was going to call me up and give me his best best man. That just is not going to happen. Since you brought up Swenson, talk to us, you know, let's just go back in time in history and talk to us about the rise of all investing at university endowments. Is it really just as simple as endowments have long-term investing horizons and so illiquid assets that need to be held onto for a long time are a really good match? Is that the story? That's at the heart of it, which is if you have long-term money, you should be able to use the illiquidity premium and you should be able to earn more.

16:20And I think that's what David and many of the CIOs realized. And they had the long-term capital to do that. And it's worked. And what's also amazing is the percentage of alternatives that these firms own. that the endowments invest in. So the average high-performing endowment has 55 % of their assets in alternatives. The top quartile and the Ivy Leagues all have over 65 % in alternatives, and they've worked. And I think people are trying to call the demise of alternatives, and especially even the endowment model. And I don't think we have the evidence yet that it's broken. One thing I always wanted to ask someone who actually works at an endowment, and in fact, you led the endowment, but do you just have like hedge funds and private equity just knocking at your door and constantly pitching new things to you?

17:22How do you make that initial connection between a potential, not client, manager? Manager. Between a potential manager. That's a great question. So I think that you have a choice when you're an allocator and an investor, which is you can lead or you can be led. And so the answer is we always had people coming and trying to pitch us. But what I always encouraged my team to do was to research deeply markets or big, deep alpha ponds. So let me give you a specific example, biotechnology. So what I would say to the team is, wow, biotech stocks, 25 % of them are trading under cash right now. let's go do some research on that segment and then they would go out and market map biotechnology giving us all the different types of players in their approach and that's how you get context how you end up being a mediocre investor is just getting the flavor of the day and usually the flavor of the day is traveling around the country and as contrarians what we like to do is to pick things that were sort of off consensus, not loved.

18:46One of my favorite expressions I used to say to my team was, what would make you really uncomfortable to recommend in front of an investment committee? If it makes you really uncomfortable, go research it. One of the things you mentioned is that, you know, one of the nice things about endowments is they can be the ones who buy when everyone is selling. And typically, there's true. So let's you know, this Yale headline that we got, and you said it's a big deal. We're in this sort of confluence of events where universities are, they're, you know, they're anxious about their money that's coming from the federal government.

19:27They're anxious about foreign students continuing to come to the U.S. There's obviously the market decline itself. So are we in a moment where there is some like inability or some constraints on the endowment to be, I don't know if buyers of last resort, but the opportunistic investors of the moment? Like, is this actually a moment where that's under a threat? And the endowment tax, as you mentioned. Well, I think it's endowment tax. I think it's a lot of the NIH funding at these schools combined with a perfect storm of markets receding. And so these models are being challenged, right? So I think the people who are playing offense and are being proactive, and I would probably put Yale in that category, are going out and testing the market and saying, you know, where is my liquidity?

20:19I just take a step back on private equity because that's what they've gone out and are trying to sell. If you look at the asset class, I think it is a fantastic asset class. And I want to just talk about this. I don't work in private equity at Blackstone, so I have my endowment hat on. But I want you to think about the value proposition. The value proposition is that I'm investing in the largest universe of companies out there, which are private companies with experts who I'm lending money to in terms of a management fee because that management fee comes back to me, the investor. And then we calculate an 8 % preferred return before the manager makes any money.

21:12And if you think about it, 8 % to 10 % is about what the stock market has done over the last 50 years. So the value proposition is I, the manager, until I add value over that public market, will not earn any incentive fees and I will pay you back. That structure in itself protects investors. And even in the fourth quartile, and I'm quoting Cambridge and Associates data now, even in the fourth quartile of buyout managers and the Cambridge database changes every month, but call it over 1 ,200 managers, even the fourth quartile is positive over a rolling 10-year basis. It's a good asset class, but what I always hear is the doubters.

21:59And they want to say there's too much dry powder and capital is not being returned. Nope. Or it's hard to deploy capital. Or it's hard to deploy. And the reality is it has been hard to get capital back for the last three years. Public markets are closed. Mergers are not accelerating like we thought they were. So the longer this goes on, the more this endowment model, Joe, to your point, is going to be challenged. It is definitely challenging, but I think the smart endowments are already taking action to grab for that liquidity. And think about it. Ten years ago, there was no deep secondary market.

22:42The thought that you could sell, okay,$6 billion of private equity assets, it's pretty amazing. It's definitely different to how it used to be. But just on the PE point, you described your sort of research process earlier, and you gave an example in the case of biotech. But if you're researching those ideas, your team is trying to find alpha itself. What's the benefit of investing in a third party like private equity or like a hedge fund versus just investing directly? Yeah, it would be almost impossible to recreate the type of competitive advantage that the managers that we invested in Brown had.

23:27And I think that trying to do it direct. At an endowment, you have a smaller team, you have less resources, you have one investment committee. at Blackstone, you're constantly iterating. You have multiple investment committees, you have multiple oversight, you have a risk committee, and you have just so much more data, so much more information. That's why it's such a competitive advantage. The concept of scale is so powerful. So when I transitioned from Brown to Blackstone, I was overwhelmed at the power of the scale, the data, the manager access. If I could have run the Brown endowment portfolio on the Blackstone platform, I would have really made money.

24:16Well, you did make real money. I mean, while you were at Brown, even without the Blackstone platform. Let's talk about hedge funds, real big picture. How would you describe the reasons for the rise of the multi-strategy model? Why has that model even more than the single managed, how would you characterize it? Why that particular flavor of hedge fund has become so popular? Sure. I think that when I think about the multi-strat world, I think about a tiering of talent. And it's clear to me that Millennium, Citadel, and the top players have really distinguish themselves. And they've done that by providing a very, very consistent return with a high sharp that is completely uncorrelated to stocks and bonds, which is nirvana for a manager because what people realized, and Joe, the wake-up call was in 2022 when stocks and bonds were both down high teens and the Millenniums and Citadels of the world earned their standard returns, which are, call it 12 % plus.

25:28That is what you want in your portfolio as a true diversifier and something that provides a ballast. So they have unlimited demand. So the results have spoke for themselves. Results have spoke for themselves. And, you know, these are not easy things to recreate. If you look at Millennium, it has more employees than Blackstone. Wow. That's crazy. OK, then give us some give us some color on the past couple of weeks. I can't believe it's only been 20 days since Liberation Day on April 2nd. But what's your impression of what it was like at the multi strats over the past month or so? Yeah, it's interesting.

26:10Obviously, it's in the headlines that they're down, but they're really not down that much. If being down 1 % is a crime in this environment, I'll take that asset class all day long. But what has happened is it's been the fastest growing asset class among hedge funds. Goldman Sachs quotes that that multi-strat universe has been growing 16 % year over year, and their data is pretty good. It matches ours pretty closely. But what's happened is that there have been a lot of new entrants. And the new entrants are the area that I worry about because in order to get the type of diversification that you need, you need amazing technology.

26:55you need a lot of teams. Okay, let me be specific. There's over 300 teams at Millennium Trading. That is a very hard thing to recreate. Risk management systems and a culture of performance and excellence. They're really hard to recreate. So I think if there's a problem, it's going to be in these new emerging managers. It's not going to be with the top tier. Can you talk a little bit more about the due diligence process on a multistrat because, okay, you have the top line returns and there's a line. And as you said, it's been a really good line and it's extraordinary, even outside of the very elites.

27:36It's been just extremely impressive. And then you can point to, okay, even in 2022 when stocks and bonds were both down, they produced good returns. So again, further impressive. Is there a further level where when you're probing a multistrat manager, that you can look to discover whether the pods themselves are truly uncorrelated and can be expected to deliver uncorrelated returns in the future. Yes. And that's our job. And I mean, when you think about the quality of earnings of a company, let's say the average S &P company that reports, the analysts all focus on quality of earnings. We focus on quality of return.

28:18How diversified is that return? What subsectors is it coming from? How many managers have been on the platform for X period of time? How many of them account for, you know, what's the breakdown of who's making the profit? How diversified is that across strategies, et cetera? So that's what we spend a lot of time doing.

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30:22Brokerage services for U.S.-listed registered securities, options and bonds, and a self-directed account are offered by Public Investing, Inc. Member FINRA and SIPC. Crypto trading provided by Backed Crypto Solutions, LLC. Complete disclosures available at public.com. slash disclosure. When you're doing the due diligence, can you talk to pod managers? How deep into the system is an outside investor able to get? If you have a good long-term relationship and you're a large allocator of capital, we get a lot of information to make a very, very good decision. I think if you're just trying to do it on your own, you have no shot.