Advisors interested in private markets need to get comfortable with the complex strategies that feature less disclosure and often involve locking up client money for years.sorbetto/iStockPhoto / Getty Images
Tony Davidow has been working with private market investments for decades. The senior alternatives investment strategist at the Franklin Templeton Institute got his start with a family office in New York before moving to Morgan Stanley, where he worked with large pension plans and endowments.
Franklin Templeton hired him to educate advisors on alternative investments, and the white papers and presentations he produced and delivered were the genesis of his recent book, Private Markets: Building Better Portfolios with Private Equity, Private Credit and Private Real Estate.
“I’ve definitely seen the evolution of private markets, which up until recently had really only been available to institutions and family offices,” he says. “Now what’s exciting is we’re bringing these strategies to the wealth [management] channel.”
Mr. Davidow sees retail adoption as a slow process. Advisors need to become comfortable with complex strategies that involve less disclosure and often lock up client money for years.
“If sold inappropriately and pushed as a product, and people have bad experiences because they didn’t understand the underlying investments were illiquid, that hurts all of us,” he says.
Mr. Davidow, who was in Toronto last week, spoke with Globe Advisor about private equity secondaries, commercial real estate debt, and why private investments aren’t for everyone.
You’ve worked with endowment funds and ultra-high-net-worth clients, but now the barrier is lower and private market funds are a lot more accessible. When you’re talking to advisors, what advice do you have for the types of clients who should be looking at these products?
The common pushback I get from advisors is that [these investments are] illiquid. Emotionally, that feels uncomfortable to investors. I can make the intellectual argument really easily: I just put a piece of paper in front of them that shows the superior risk-adjusted returns. The harder discussion is that emotional discussion, which is, you’re essentially giving up control of that asset for an extended period of time.
Illiquidity to me is just a feature. It’s not inherently good or bad. And we need to condition the advisor first and the investor second that there’s a reward for tying up capital, but it’s not for all your money. For most high-net-worth investors, that’s probably going to be 10 to 15 per cent.
If they’re comfortable and they treat that pool of capital differently – that’s their long-term capital, that’s their patient capital – they’re likely to be rewarded handsomely over the long run. But they shouldn’t think of it the same way they do of their traditional investments, where they want to head for the exits anytime there’s a bump in the road.
It’s been a great decade and a half for both private credit and private equity, but some investors suggest the good times have already occurred, and now this retail money is coming in and contributing to frothiness or chasing assets.
I think it’s way, way too early to be concerned about that. As much as there’s a lot of noise from the wealth management channel, it’s still a very, very small allocation given the overall pie. The way we look at it is that the public markets are shrinking. There are roughly half the number of publicly traded companies today as there were two decades ago, but the private market opportunity is growing.
We also know that many of those companies are going to stay private longer, and some will never go public. So, we’d argue that it’s a deeper and richer opportunity set, which in our view means we’ll continue to see that alpha generation over time. If it were a finite universe or a shrinking universe, I think it’d be tough to make that argument.
Where do you see the risks and opportunities in private investments today?
A lot of money has gone into private equity. One of the phenomena that affected the private equity ecosystem is a slowing of the exits – no initial public offerings, no mergers and acquisitions activity. So, many institutions found themselves overallocated to private equity. While that created a problem for private equity primary ownership, it created a great opportunity for the secondary market.
We think that continues for the next decade. For individual investors, we get diversification across vintage, we get diversification across general partners. We shorten the “J curve” – the time that you commit capital – because we’re buying seasoned assets, and we get our money back sooner, because those are more mature assets closer to distribution. For the wealth management channel, as we’re starting to introduce private markets, I would think of secondaries as my core private equity allocation.
[In] private credit, we think direct lending looks a little bit crowded, so we favour commercial real estate debt. There’s something of the magnitude of $3.2-trillion that will need to be financed in the next couple of years. We know that banks aren’t going to step in to lend capital, so private credit managers have the opportunity to step in to fulfill the needs, but they can be selective.
In 2021, you were a term taker. Because there was so much money chasing so few opportunities, the terms were being dictated to you. Now, if you’re a private credit manager, you’re a term maker, so you get the ability to negotiate the terms that you’re going to lend capital on, and you get the ability to negotiate covenants.
When we think about real estate, we think there are great opportunities not in the office sector because of the long-term secular headwinds, but areas like industrial, multi-family, [and] specialty retail. We think that now you can buy real estate below replacement costs in many situations, so that looks attractive to us.
And we like infrastructure. We think the opportunities are going to be in digital, connecting the world; decarbonization, thinking about how we deal with climate change; and deglobalization, the fact that supply chains need to be changed, whether it’s from COVID-19 or whether it’s from policies where we need to think about having things near-shored or re-shored. And lastly, changing demographics: where people live, how they live. So we think there’s a lot of opportunity in infrastructure, but maybe not in the way most people think about it.
This interview has been edited and condensed.