“As we grow older, the horizon begins to fade away.” – Jack Johnson, The Horizon Has Been Defeated
When we’re born, our world seems clearly defined and quite limited. We exist in a crib, a nursery, or another space not of our choosing, entirely at the mercy of our caretakers (usually our parents). As we grow, possibilities expand commensurately with our ability to move around. At first, that may mean just getting to different rooms of our home, but it quickly evolves to accessing additional spaces (previously child-proofed closets, higher shelves) and eventually exploring the outdoors on our own.
After planes, trains, and automobiles take us to far-off places, experience shows that the horizon is a fleeting visual construct of our world (because the Earth is round 😊). On a smaller scale, constant movement occurs at the molecular level within ourselves or the solid objects we interact with – but it’s beyond human perception. Larger things we generally regard as static – like trees – operate on a much slower timeline than our attention span prefers. As it turns out, groups of trees migrate over time (10-20 kilometers per decade!) by spreading their seeds in a given direction.
That all is to say that perception is NOT reality, contrary to the oft-uttered phrase. Instead, “more than meets the eye” is the more accurate descriptor of human interaction (not just Transformers). Things aren’t always what they seem. Perspective, experience, and context are vital for making sense of the world around us. Today, let’s build on that notion and this final “horizon” quote of Jack Johnson’s to continue developing our understanding of Alts while wrapping up this four-part series. Here we go!
When you meet a fun guy, go deeper.
The mushrooms we encounter are just the tip of the iceberg of a vast underground world. I focused on above-ground items in the intro paragraphs, which ignores a vitally important realm of life. Fungi below the Earth’s surface may answer the “why” of which plants, animals, and (yes) mushrooms exist in a given region – conducting the orchestra of life around us. As this article points out, fungi are “a totally separate kingdom to plants and animals, and it’s possibly the biggest kingdom about which we know very, very little…”…and we’re already “finding innovative applications in fashion, health, technology, and art.” It’s an utterly fascinating topic that deserves its own Alt Blend, but – for now –keep in mind that we are only scratching the surface of what fungi has to offer, and there will be exciting alternative investment opportunities that come alongside our continued understanding.
The PE-tree dish
Whether you view it as a feature or a bug, private equity can be a lot like trees: PE investments appear to do very little on a daily basis, even though there is an incredible amount of action taking place within them. Even with all of that underlying activity, on the surface, investors (LPs) typically only receive a quarterly statement with a modest valuation change and some capital being called or distributed, so even an Alts enthusiast like myself must admit that it can be dull over short-term periods. More evidence of action can be found in quarterly letters (sometimes with photos) from the manager, but it’s akin to watching the leaves of trees return each spring and blow away in the fall – largely cosmetic adjustments to the overall backdrop. Then, after a couple of years (or ten), we may find that patience has paid off: the value of our investment has grown meaningfully as long as the manager has more or less achieved their objectives. For those monitoring investments (often advisors), meetings/calls with PE managers can be helpful reminders that progress is being made. It’s very human to want instant gratification, and private investing can starkly oppose that desire. Ultimately, however, if a given fund is successful, real value will be created, and the LPs will see their investment grow.
As private equity tends to be inherently long-term, I also find that regular income distributions help a LOT. It’s much easier to have a long-term, even perpetual, investment if it provides steady cash flow along the way. Much more challenging to endure, however, is (for example) a 15-year venture capital fund where the investment is locked up and no cashflows are received until the fund’s final years. Whether public or private, maintaining appropriate expectations regarding our investments is vital, but there are also continued efforts to make private investing more palatable.
License to ill-iquid
From my perspective, illiquidity is a feature – not a bug – of PE structures. It keeps LPs committed to the long-term vision private investing often requires and prevents them from making rash decisions that investors very often make when they can do so (e.g., “panic selling”). At the same time, I don’t believe that traditional drawdown structures are always necessary to execute private investment strategies. In addition, capital calls and distributions can make investment returns confusing or even misleading. Receiving a 40% return on an investment may be fun to tell your friends about, but if it’s only on a small fraction of the money you’ve committed to a fund (because the manager has only called and invested a small amount of capital), then it isn’t moving the needle of your wealth. The uncalled capital could also be sitting idle in the interim, detracting from overall returns (which was especially painful in the decade+ of zero interest rates we collectively endured leading up to 2022).
Anecdotally, I am continuing to see private investment managers warm to the notion that there are opportunities for managing illiquid investments in more palatable ways for investors. It’s encouraging to see managers I voiced this opinion to several years ago now offering interval-fund solutions alongside their flagship strategies. Some are even replacing drawdown structures altogether. It’s important to point out that interval structures have some limitations vs. drawdown funds (they have to maintain a greater degree of liquid holdings and often cannot use as much leverage as they otherwise might); however, those differences will vary on a strategy-by-strategy basis. Suppose an interval fund takes 100% of a client’s capital up front rather than calling it over 3-5 years. In that case, a lower return on the invested capital may be perfectly acceptable as it could be more profitable for the investor (i.e., lower return on more money sooner vs. higher return on less money later). These structures also may come with reduced investor qualifications, easier purchase/redemption processes, simplified reporting and tax-filing requirements (no cap calls or K-1s), and lower fund expenses – thus providing an opportunity to save time and money.
Looking out to the horizon, I expect this ongoing democratization of Alts to continue, and I find it to be an exciting trend across the private investment landscape.
Crypto
I’ll keep this short, but some crypto and blockchain technologies continue developing into more pragmatic solutions. The original premise of why crypto (specifically Bitcoin) could have been valuable was a straightforward supply and demand argument: the Bitcoin protocol inherently limits supply, so more demand should naturally increase the price (this premise hasn’t changed, as far as I know).
Looking beyond Bitcoin, however, there are blockchain solutions that can be more fundamentally valued. The Ethereum platform is a technology upon which many companies/software solutions are being formed. Simply put, traffic on the platform generates fees and regular cashflows to which standard fundamental analysis (like discounted cash flow models) can be applied – new tech, old approach. Add to that more and more use cases (like tokenization that we’ve discussed in the past), and some specific parts of blockchain/crypto will look more and more like real businesses. And, on the “democratization” front, these solutions stand to allow anyone to own pieces of otherwise illiquid assets (I can buy one token that represents a small fraction of a large commercial property) as well as crush transaction costs (imagine instantly buying property via tokens validated by the blockchain, instead of a 60-day closing process with multiple unnecessary parties involved).
I may be right; I may be crazy.
Even if I’m wrong about all of this, I’m certain that as we defeat the current horizon and existing limitations fade, the world will have many exciting things in store for the human experience and our investing future.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
