Business Breakdowns
· Matt Reustle
[00:00:00] S0: Yeah, and maybe you can elaborate on some of the products that did become available to retail investors and how some of those played out. Maybe they can instruct what's going to happen in the future.
· Josh Clarkson
[00:00:00] S1: Call it in the pre-2020 era, pre-2015 era, there were private markets available for retail in a variety of structures. There were certainly non-traded REITs that have been around for a while, not necessarily brought to market by top-tier operators, not necessarily with the most shareholder-friendly structures. There have been various ETFs that tried to mimic alternative asset management returns. There had also been reinsurers set up by some big-name hedge funds where the investment portion would be handled by that big-name hedge fund, and you were supposed to be able to get that exposure. Bill Ackman certainly has a well-known closed-end fund listed in Amsterdam. But these had all been relatively niche products. Where you really saw real momentum get behind this in the private wealth channel was when BREIT and BCRED were rolled out by Blackstone about five or six years ago now. And then many other top-tier alternative asset management firms have brought out similar products that are non-traded BDCs, non-traded REITs, and interval funds are the three main categories. That's kind of what turned on the modern semi-liquid wealth channel private markets experience, if you will. And generally, it's proceeded pretty well. Investors have enjoyed really strong returns, really strong downside protection. And when there have been issues, such as BREIT in 2022, the managers have stepped in to structure transactions like what they did with UC Regents to ensure that investors were able to get access to the liquidity that they were promised, which generally speaking is about 5% of NAV a quarter, can vary a little bit by fund. Investor education is a really important part of this. The alts managers are doing a great job of being very clear about this. They're sometimes dependent on that intermediary being clear about it. But I do think it's very important that the investors in these products acknowledge that they are essentially illiquid compared to an ETF that you could sell your entire position in in a minute and should think about that appropriately in their liquidity needs and their financial portfolio.
· Matt Reustle
[00:00:00] S0: Do you have a quick summary on BREIT of how that played out? And you don't have to get into the nitty-gritty details, but how it worked through the system and as an example of what happens when you have, in theory, illiquid security dealing with some type of issue around it and how investors are treated or what their options are in that type of situation.
· Josh Clarkson
[00:00:00] S1: I'm not terribly close to that situation. I was not directly involved in it. I only know what I read. So I do want to caveat all of this. My recollection is that in 2022, when rates were going up—maybe it was early '23—BREIT received redemptions in excess of that 5% NAV that they generally distribute. My understanding is that the majority of those redemptions were from leveraged Asian private bank clients that were holding this on margin, which nobody really does with these instruments anymore. It's not done with interval funds. I have not read any story of a widow-orphan parent who suffered harm due to BREIT distributing assets as it always said it would. Some people referred to it as gating. I think that was a bit unfair because it just did what it said on the tin, and they then struck a deal with UC Regents. I'll admit I don't recall the specifics of it, but that essentially ensured they had plenty of liquidity to meet those investor redemption requests, and they've done so. Performance has been improving, net flows have been improving. So while certainly the media made a big storm of it, it really did exactly what it was supposed to do. Now, again, it's important investors realize that these are less liquid structures. I would counterpoise that to an incident that happened quite a few years before now. I think this was in the 2000-teens where a firm called Third Avenue had set up what was essentially a distressed debt fund in a mutual fund wrapper that would have daily liquidity. Even if these were liquid securities, they were generally pretty thinly traded because if you're in the middle of a bankruptcy for a midsize capital structure, those loans or bonds are not trading very frequently. They're certainly not trading in any size without moving the price. And when they got a lot of redemptions, they did have to gate the fund in a way that, if not had never been contemplated, certainly had not been as broadly advertised to potential investors as being possible. And that did lead to some really unfortunate outcomes for investors who did take quite a while to get their investments back. The products you see today largely solve for that type of risk by having limited liquidity, by maintaining liquidity sleeves in many cases so that they can be sure they always meet that liquidity.
· Josh Clarkson
It's very important that investors understand that you are trading liquidity for lower downside risk, potentially better returns, and that that is a trade-off you're making. And it needs to be viewed in the context of an entire portfolio that has plenty of liquidity for your near-term needs. But if you have some money that you can put aside and think about a little less liquidly, then it opens up an opportunity to have potentially much more attractive, consistent returns, limited volatility, and in many cases very strong income distributions. And those yield-oriented investments is where we've seen a lot of the initial interest in these alts for the private wealth channel. I predict—want to caveat that a lot here because I certainly don't have a crystal ball—you would see most of the initial interest in a defined contribution market in 401(k)s. I'll tell you right now that if I could invest in a private credit or private equity option in my daughter Emma's 529 plan, I'd do it in a heartbeat. It's tax-sheltered, it's long-term, it's really the perfect home for investment that produces very high ordinary income yields.
· Matt Reustle
[00:00:00] S0: The Third Avenue example feels like a design problem where you're offering daily liquidity connected to highly illiquid distressed bonds. Whereas investor education around the liquidity dynamics here with these funds, in theory, if the design is set up right and then the education is provided, you can have much cleaner process and outcomes. To your last point, having these in retirement accounts: there is a natural friction in retirement accounts to actually withdrawing it because of the penalties that you would face. Therefore, I can understand why there's almost a built-in barrier protection against liquidity pulls like that. And you mentioned some of the changes around marketing rules or potential changes around marketing rules. It does feel like we are seeing a bit of a push now on the marketing side, or things are changing a bit. So can you get into that and what the developments have been there and maybe what some of the impact could, in theory, be? Why are people out there marketing? What's the interest in marketing? Talk a little bit more about that.