Business Breakdowns
· 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.
· Josh Clarkson
[00:00:00] S1: I do think it's worth exploring that a little further as it is related to some of the things that we're going to talk about here in terms of how winners will establish themselves in this market and the importance of brand and profile and media engagement and those types of tools in winning in the wealth and retail market. So specifically, that change was regarding Rule 506(b) and 506(c), as they're called, which are two oft-used exemptions to the registration requirement for funds that firms avail themselves of to avoid registration. And in exchange, they will only solicit investments and only allow investments from accredited investors. Now, 506(b) has historically been the one that was most often used, but that bars general solicitation. So that's kind of the famous reason why you often hear a fund can't disclose its returns or its specific investments, or otherwise has to be rather tight-lipped. 506(c) allows general solicitation. So that means you can announce the launch of a fund, not just its closing. You can talk about the fund while it's in market in deep levels of detail. And now, historically, 506(c) was viewed as having additional burdens in terms of verifying investors' accredited status. But this no-action letter that was issued in March of this year greatly leveled the playing field between (b) and (c) in terms of what's needed to verify someone is accredited and what a manager can rely on in making that determination safely within the bounds of the law. So that, in turn, makes it much easier for managers who so choose to use 506(c) and, in turn, be able to communicate that they've launched this new private credit fund, the new asset-based fund, a new private equity fund, a new structured credit fund, a new real estate or infrastructure fund, whatever it may be. So it lets them talk about that. It creates opportunities to engage with the media and other external stakeholders, and it allows them to talk about that as it's in market with a lot of specificity. Now, that fund itself may be one that's pursuing investors in the wealth channel, for example, a new evergreen fund or the like. Or also, that fund itself could be more institutionally focused, but the strategy is very similar to what they're raising money for on the wealth side.
· Josh Clarkson
And it gives them a way to talk about that strategy out there in the world they otherwise wouldn't be able to. And we will talk about this more later about what will separate winners from losers in this market and the importance of establishing and building a brand and a positive profile and being viewed as an expert in your space, someone that somebody's going to entrust their capital with. And one of the lowest-cost, easiest ways to do that is media engagement. There's all this great owned content you can develop and the like. But just engaging with the media, putting news out when you have good things happen, being an expert voice on relevant trends, that's a relatively light lift compared to some of these other things, but can pay huge dividends in terms of positive name recognition across a really broad audience. And if you're now able to talk about your fund when it launches, that's a really low lift way to get some really positive narrative points out there in the market. And so I do think that more managers will avail themselves of 506(c), and you'll see more people out there talking about funds that they are launching or while they're in market, because not only will it benefit the fundraising campaign for that specific fund, but it can do an absolute ton in terms of elevating the firm overall, which is really going to be the name of the game to ensure that you're in a position to win this market.
· Matt Reustle
[00:00:00] S0: I want to dive a little bit deeper into that point about the vehicles that, in theory, would be best fits or most naturally suited to benefit from a potential wave of demand. You have a pretty good perspective on the broader private landscape. How would you isolate between, whether it's the different asset classes, the different strategies, whatever it might be, what fits, and the puts and takes to the relative strategies?