Optimizing portfolios around risk and illiquidity tolerance

Transcript

Jake Miller Hi, I'm Jake Miller, co-founder at Opto Investments.

Michael Durso Michael Durso, co-founder and CEO of Shorehaven Wealth Partners.

All of our clients start with a risk analysis and we've talked a lot with them around, okay, well, here's your thought process on risk. What does that really mean? Historically, you might have said I was conservative, a moderate, aggressive, very different between the two of us. And so we really try to quantify that with technology. And this is just another iteration in that. Right? We're looking at our current portfolios for clients. We're looking at that risk tolerance and saying if we're able to add five or 10% of a private exposure, you know, diversified, and you qualify for that, well, the benefits there from a risk reduction standpoint to get you in line with how you feel from a risk tolerance standpoint are beneficial.

Jake Miller You and I've spent hours together in Opto’s tools where you can really start to visualize some of that of what does the downside look like on a five, ten, 15 year basis? How do I make sure that that is getting lifted while also increasing the top end?

Michael Durso Of course. Jake Miller And there's real logical reasons for that diversification to exist. We aren't just, you know, hoping it's there. One big difference between public and private markets is you can have a dynamic and publics that we've all seen many times where something goes down, and the people who are levered along and then have to sell, and then other people get scared, and they sell, and price movements, and in the downward direction particular can really get ahead of where fundamental value is Because these are vehicles where people are committing to the long term success of these vehicles and the underlying companies, you aren’t subject to as much of that, you know, sort of pure animal spirits piece of the market. And so that can be highly diversifying in down markets to have something that is continuing to perform. It's still a quality company. It's EBITA positive. Those cash flows can go to support, even taking advantage of some of the dislocations on the public side.

Michael Durso Yeah, absolutely. And I think that that is the core benefit from our clients is that we've always talked about long-term investing. We don't want clients who are chasing that hot dot who are looking to call us and say, Well, now I want to get out for two months or three months. We are long-term investors because we understand the benefits of being in it for the long run. And I think one of the things that people don't talk about enough with private markets is how beneficial that lock up is sometimes and the ability that you're putting that money to work early. And we're talking about five, ten-year vehicles where that money's going to be put to work overtime, and that money being locked up is beneficial to you and so with the way that we've always thought about investing, this is just another added benefit to we understand that a portion of your portfolio should always be liquid and we have enough of that on the ETF side, right? We have plenty of liquidity where God forbid, something comes up, and you need that money tomorrow or next week; we can handle that. But for the portion of the portfolio that is, you know, 10% of your overall investable net worth, we feel very comfortable with the fact that that lock-up is beneficial to you in the long run.

Jake Miller Yeah, we we think about this very similarly, of, you know, how do I understand what is my illiquidity budget and you know, just stuff that you do excellently and planning where I can look at what my spending income, current liquid assets are. And in most cases, for most people, they're in a really healthy position, of course, where we want to help them think about it is, you know, illiquidity sounds scary, but how do we quantify that number and say, you're not going to touch us anyway? How do we maximize the benefit of that? And so, yeah, some of these semi liquid structures that are out there aren't really taking full advantage of, you know, most families are long term investors. They're planning for their future, for their children. They can take those long-term bets that are creative and capture that fully with with true about private market exposure versus these sort of hybrid vehicles that have a place but probably aren't the best capture some of that long-term value creation.

Michael Durso Definitely and you see it in interval funds. You see it with the open structures where quarterly you can take money out. And yes, there's a benefit to that for those clients who need that. But when you have the type of client that isn't taking advantage of that anyway, well, let's think about it a little bit differently and make it beneficial to have that that lockup period.

And that's something that we've really been cognizant of when talking to clients around. You have to understand that this is a long term portion of your portfolio. Luckily, we have relationships with our clients where we know whether they're touching that money or not, and we have other portions where it's kicking off enough income or there's enough liquidity that if they ever do need it, we have the ability to access it.

Jake Miller Which is a good point on privates as well. There's a misconception in terms of how these distributions and liquidity will work. Of course, the capital is locked up, but unlike a public equity where the dividend yield is quite low, I think it's 1.7% for the S&P right now. Once you enter the harvest period, you're getting a return of capital and additional returns sent back to you in cash. It's not locked up in a vehicle. They figure I need to figure out how to sell. And so while the first couple of years you're locked up, you start seeing realizations pretty quickly and can use those to fund lifestyle or to roll back into private markets and build out almost much like a muni ladder, a self-sustaining program that captures the best of private markets through time.

Michael Durso That's a great point. And I think it really, again, just ties into what we've always done for clients, right? We have the ability to project income pretty powerfully through using SMA muni bonds. We know what those coupons are and we know what your income is going to look like over the next one, three, five, ten years. And so the hope with this is that as we get through that j curve and we start to reach those distribution years, well, let's figure out what we're going to do with that capital. How much of it do you think should be returned back to the client for potentially, who knows, Maybe they have a vacation house they want to buy or maybe their child's hitting college age, or if this is money, you're going to reinvest back into the portfolio anyway. Well, great. Well, maybe we start a fund 2.0 and maybe that is just venture capital or just private credit or whatever the market is deeming to be the best value at that point in time. And so I think that's a great point, that although there is lock-up of capital, there's flexibility in what that looks like over that 3 to 5 year time frame.