“History is always written wrong, and so always needs to be rewritten.” -George Santayana
George Santayana (his anglicized name) was a Spanish-born philosopher known for aphorisms like the above quote. According to Wikipedia, he was also an atheist, yet “he treasured the Spanish Catholic values, practices, and worldview.” His approach sounds conflicted yet pragmatic, which ties nicely into a broader discussion of alts, history, and humanity for this edition of alt.Blend.
Alternative History
Alternative investments may seem like a recent phenomenon to many investors, but the concept dates back over 150 years. Preqin (pronounced “pree-quinn” – a leading alts data/analytics platform) compiled a brief timeline of alternatives that includes some of the first alts:
- The development of the Transcontinental Railroad in 1852 (infrastructure)
- The creation of US Steel in 1901 (leveraged buyout, with JPM acquiring Carnegie Steel Co.)
- The emergence of the first venture capital fund and hedge fund in the late 1940s. More specifically, the first hedge fund was created in 1949 by Alfred Winslow Jones, when he coined both the phrase “hedged fund” and the structure to accompany it.
The above article also cites ERISA (Employee Retirement Income Security Act) as a catalyst to the evolution of alternatives. This legislation allowed pension funds – representing some of the largest pools of alts capital available – to branch out into this space, and this aspect is underappreciated in alts history. ERISA typically only comes up in conversation when discussing requirements of employer plans, like 401(k)s and 403(b)s – nothing to do with alts.
As we’ve touched on in other editions of alt.Blend, the alts industry has grown significantly in the decades since ERISA, resulting in many different segments, strategies, structures, and access points. And just from 2010 through 2019, industry assets increased from about $4.1 to $10.8 trillion. Alts are still a fraction of the size of global equity markets ($95 trillion, as of November 2020), global fixed-income markets ($119 trillion), or global currency markets ($2.4 quadrillion and trades more than half the value of the entire alts universe daily!), but they’re here to stay.
Dipping Our Toes in the Alts Pool
From the time I got involved in manager research in 2008/2009, I was enamored with the idea of uncovering better risk/reward opportunities for clients. That became an aspirational pursuit across all asset classes, and it led to a growing interest in alternatives because of the differentiation they could offer. By 2009/2010, my team and I included some of the early liquid alts strategies in client portfolios to help improve overall portfolio risk/return characteristics.
At that time, the liquid-alts menu was pretty limited, but there were some market-neutral, managed futures, long/short equity, and global macro funds from which to choose. Some were okay, but I don’t recall any of them being particularly compelling, and we continued to look for better solutions as we gained experience (sometimes via painful lessons). We even attempted to use a fund-of-funds structure (with quarterly liquidity) as a core alts solution; but, despite having “good” managers, the diverse underlying strategies seemed to cancel out one another, resulting in a flat performance for the fund month after month…so, it ended up being a short-lived affair.
Climbing the Platform
As the access and due-diligence capabilities of both our firm and alts industry improved, we were introduced to an ever-expanding menu of alts, including liquid, semi-liquid, and illiquid options. Several technology platforms emerged, which helped make sourcing, due diligence, access, and onboarding (i.e., paperwork and funding) a more cohesive and operationally tolerable experience.
One critical aspect of that evolution was that these platforms often created “feeder” funds with much lower investment minimums than investing directly into a given fund. As covered in the most recent alt.Blend (Nouveau Accredited), feeders can be especially appealing to 3(c)(1) fund managers since they only count as 1 of the fund’s 100 investment slots but can include many investors (vs. 1 direct investor counting as 1 slot). At the same time, for accredited investors with portfolios of $2-$5 million, feeders are a gamechanger. While a $1 million investment would be out of the question for them, a $100k commitment (~5% or less of a portfolio) is entirely feasible.
In essence, alts platforms functioned as a matchmaking service, helping investors/advisors find new ideas while allowing managers to access a broader universe of potential clients. As with any new technology, we have seen some of these platforms go by the wayside, but others have thrived and become major players in the alts world today. I have no doubt that their “ease of use” and overall value proposition have led to additional investment in the alts space.
Taking the Plunge
By 2016, we began a multi-year process of adding less-liquid limited partnerships and interval funds to client portfolios, with the aspiration to: a) help increase portfolio income that was becoming less available via traditional fixed income, and b) target similar or improved long-term growth while making the journey more palatable (i.e., reducing volatility). By understanding our clients’ cash flow and potential emergency cash needs, we could also be confident in their ability to sacrifice daily liquidity in 20, 30, or even 40+ percent of a given portfolio – especially when these investments had a strong cash flow component to them.
We could also ladder the liquidity structures to help make the true liquidity sacrifice more tolerable. For example, some funds allowed for quarterly liquidity, some had one or two-year lockups (perhaps with semi-annual or annual liquidity), and some were designed to last 5, 7, or even 10 years (but were designed to distribute capital along the way while ultimately returning the entire investment to limited partners over those timeframes). While the intention was to remain fully invested for the long term, there would be consistent distributions (monthly or quarterly from various funds), as well as a partial contingency plan via quarterly, semi-annual, or annual opportunities for liquidation (subject to gating, of course). Also, some funds involved drawdown structures, and we were staggering the investments themselves so that it would take years to ramp up to the full allocation.
Identification, Research, and Education
With that, fund-by-fund, client-by-client, and account-by-account, the initiative was put into action. After finding a strategy that seemed appealing, we conducted additional due diligence, including reviewing materials, conducting meetings with the managers (sometimes onsite at their offices), and speaking with other advisors/investors for added insight. In all cases, an institutional operational due-diligence process was conducted before any investment was made.
Once we believed that a given strategy had utility for our clients, we considered where it could be appropriately allocated, as – for a variety of reasons – certain investments make sense for some clients and not for others. Each client then had to be educated on the ideas we had in mind…and then there was the tedious process of undergoing compliance approval, completing sub docs (jargon for “subscription documents,” which is really just onboarding paperwork), and, finally, funding accounts (usually via wiring cash to the platform or fund in question).
And now an important public service announcement while we’re on the “historic” topic…
An Historically Bad Habit
At the time of writing, we are fast approaching July 4th, and we will celebrate the anniversary of the ratification of the Declaration of Independence on that day back in 1776. Was it a historic occasion? You bet. But was it an historic occasion? Not so much.
Time and time again, I hear people – primarily talking heads on national news programs – use the phrase “an historic occasion.” Mind you, these are not people speaking in a British accent, where a silent “h” effectively means “historic” begins with a vowel sound (i.e., “historic” becomes “istoric”). No, they are firmly pronouncing the “h,” which is a consonant. Therefore, it’s “a historic occasion.” With the holiday coming up, we may be in for more “an historic” incidents (“On an historic occasion back in 1776…”) than usual, so be warned.
It’s probably not even the newscasters’ fault – it’s more likely the writers who feed the teleprompters, and they really should know better, considering this concept is taught in like first grade. Let’s please stop the madness, recognize our past mistakes, and move on. Perhaps we can even leverage meme culture, and a cohort on Reddit or Twitter can somehow shame people into never saying “an historic” again? That would be a historic day. Thanks for your consideration.
Next Time
In part two of this post, I’ll revisit my experience with the CAIA (chartered alternative investment analyst) – an essential part of my alternatives education. We’ll also recap the alts investments that were ultimately implemented for our clients, highlighting the good, the bad, and the ugly of the journey along the way.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
