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Bill Kelly discusses misconceptions and how to help investors think about allocating to private markets
Key Takeaways
- It is important to manage investor expectations and caution against unrealistic beliefs that alternative investments can be a “quick fix”.
- Diversification can help reduce risk and volatility, but any benefits should not be measured over short periods, as market timing is basically impossible for even the most sophisticated investors.
- Matching the duration of investments to your financial goals and needs is crucial. For those with long time horizons, private markets can help capture complexity and illiquidity premiums.
Transcript
I'm Bill Kelly, the CEO of the CAIA association. We're a global credentialing body focused on better outcomes for the end investor. We have about 14,000 members in over 100 different countries.
Every investor has expectations and those expectations have got to be grounded in reality. One of my fears is that if you don't like the 6040, you're worried about inflation sustaining it 3, 4 or 5%. Let me go dial up some private equity or some alternatives, and that's going to get me out of this hole.
As I talk to investors around the world, these are the misconceptions I think that sits at the top of the list. There is no free lunch diversification and used to be one. I think if you do it right, it still can be, but you can't just magically bring forward returns that meet your expectations by diversifying into alternative groups. I think the very best value proposition for alternatives is to lighten your drawdown risk, have better risk-adjusted returns over time, and dampen down your volatility, which is something most investors want.
But if you don't get it in a quarter or a year, oftentimes we've seen investors flipping out of this asset class and to another or you told me this is going to do X and it did Y instead measuring X and Y in quarters or even one or two years is a fool's errand. And oftentimes, that leads the investor to think about market timing, which again, you can talk to the smartest investors in the world, the Howard Mark’s, the Warren Buffett's. Nobody can market time their way to better outcomes. And we've seen these returns time and time again, Dalbar surveys and others where even in the garden variety S&P 500 world investors leaving 300 basis points plus on the table vis-à-vis just buying the beta and staying fully invested. I think one of the value propositions around alternatives is maybe protect the investors behavioral instincts, which is to tack in and out.
And if I think about private equity, selling it for what the value proposition is, a long-term investment managed by hopefully a very smart and interactive GP full stop. And that's what's going to keep the investor fully engaged and fully invested. But if we're going to take a very sophisticated investment like this and put it into a 40-act fund or an interval fund, the outcome may or may not be the same because you're introducing the concept of regular liquidity into the mix.
So if I dial this all back up, I think the very best advice you can give to the investor is let's start with the liability side of your balance sheet. Let's try to wall off rings of liquidity. And if this is 6 to 9 month cash flow, you have no business putting this anywhere other than in your money market fund.
But if you've got those outer rings that are going to be in your estate for your kids and you're 55, 60 years old, liquidity is not a page-one risk. And the simple concept, and this gets back to David Swensen the hallmarks of the endowment model match the duration of your liabilities to the duration of your investments. And if some of these liabilities about saving for retirement when you're still quite young or investing in the next generation of family capital accumulation, you can go very, very long in the investment side and capture not only, as I said, a complexity and illiquidity premium, but really get yourself involved in the early stages of capital formation.
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