Michael Durso and Jake Miller explore private markets' role during market downturns
Jake Miller: Hi, I'm Jake Miller, co-founder at Opto Investments.
Michael Durso: Michael Durso, co-founder and CEO of Shorehaven Wealth Partners.
Jake Miller: I think a lot of investors have looked at the last two years where the common knowledge of stocks and bonds being diversifying hasn't actually worked out. How did that picture and the headwinds around rising interest rates, inflation, geopolitical risks lead to a little bit more thought on where could private markets fit in and actually reduce risk counter to maybe prevailing opinion that they might be riskier?
Michael Durso: Yeah, it's something that's interesting because I think that, as you mentioned, I think when you first bring up private markets, people kind of put their antennas up like, this is going to be too risky for me. I don't want this. But what we found historically is just adding that additional diversifier on the private side has really protected portfolios.
And you look at 2022, and, you know, equity markets were down upwards of 20%. Bond markets had the worst year in history. And even having those tiny portions on the, you know, liquid alts, let's call it in the portfolios, was really beneficial for downside protection. And when we think about putting portfolios together, we're never sitting down and saying, you know, we're going to hit a home run, and everyone else is going to hit singles; that's not really our style, but we definitely want to participate in the markets as thoughtful as possible but really protect you on the downside.
And the goal there is that if you are a long-term investor and you can protect on the downside, the compounding effect going forward is just so powerful. And so the ability to utilize private markets from a diversification standpoint, when we see a lot of risks out there in those traditional 60-40 portfolios, is really something that interested us.
And where you see rates currently, you see what's going on in the fixed income markets, you see what's going on with inflation, on the equity markets. From a geopolitical standpoint, I think the ability to invest in private markets kind of removes a little bit of that noise because of the day-to-day whipsaw that you just see in the public markets and the speed at which information is now processed today. You think back ten, 15 years ago, we didn't have Twitter, we didn't have high-frequency trading, we didn't have people logging into their fidelity counts on a daily basis. Things are just processed so quickly now that I think that the whipsaw in markets is going to be here to stay. And one of the ways to get around that is to build these long-term portfolios with powerful diversifiers in things that just don't trade daily.
Jake Miller: Yeah, and there are today both secular and more tactical reasons that we find the private market opportunities particularly interesting. And so, on your point about where equity markets are going, one framework I like to come back to, I call it the equity pyramid. And so if I think the top of the pyramid is like ACWI, a world index. What's that going to be driven by? It's basically growth. If people spend more, sales are up, margins usually do better in that scenario, equities do well.
I can go one level deeper; U.S. versus Europe, what's going to drive that? A little bit of competitive advantage relative economies. In the U.S., I could go by industry, automobiles versus health care. What's going to drive that? That's consumer behavior. It's starting to get more diversified; it's less like pure growth.
When we get all the way down to the level of private companies. It's much more about the competition and the quality of management teams to gain market share to outcompete the folks around them. And when you pick good managers, you increase your probability of doing that. And lo and behold, whether or not one company is doing better than another ends up having very little to do with overall macroeconomic conditions.
And in some ways, that can even be helpful. What happens in a recession, people might look for, Hey, can I reduce cost? There's a new entrant on the scene from this venture capitalist. They think they can reduce this cost by 50%. They actually gain market share in those periods. So you start to add more ways to win to a portfolio in addition to a diversified investor base.