Rethinking Wealth: Unlocking the Power of Private Markets with Tony Davidow

Pierre Daillie: [00:00:00] Welcome to another episode of Insight is Capital, where we explore transformative ideas, shaping the investment world. I’m Pierre Daly, Managing Editor at AdvisorAnalyst.com. And in this episode, we are thrilled to be joined by Tony Davidow, Senior Alternatives Investment Strategist at Franklin Templeton Institute and award winning author of the soon to be released book, Private Markets: Building Better Portfolios with Private Equity.

Welcome to Private credit and private real estate. Prior to his current role, Tony held senior leadership roles with Morgan Stanley, Guggenheim, and Schwab, among other firms. He began his career working for a New York based family office and has worked directly with many institutions and ultra high net worth families over the years.

Today, we’re talking about the growing momentum toward allocating portfolio investments to alternative and private assets, a trend that’s redefining strategies for enhancing returns, achieving thoughtful and meaningful [00:01:00] diversification to protect portfolios from major market drawdowns. Tony shares insights on adopting a long-term institutional style mindset, akin to that of family offices and endowments, and how this approach can unlock opportunities for affluent retail investors. Join us as we unpack the lessons from institutional investing, explore the role of private equity, private credit, and real estate, and discuss how new vehicles are democratizing access to alternatives. Whether you’re an advisor, investor, or someone curious about the future of portfolio construction, this episode is packed with valuable perspectives.

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Announcement Disclainer: The views and opinions expressed in this broadcast are those of the individual guests and do not necessarily reflect the official policy or position of advisoranalyst. com or of our guests. This broadcast is meant to be for informational purposes only. Nothing discussed in this broadcast is intended to be considered as advice.

Pierre Daillie: Tony [00:02:00] welcome. It is an honor and a privilege to have you on the show. Thank you. Uh, very excited about our conversation today.

Tony Davidow: Thank you so much. I’m thrilled to be here. There’s a lot to unpack there.

Pierre Daillie: Absolutely. Um, it’s, it’s, uh, it is an unusual period. It’s an unusual period we’re in. I mean, the ground is shifting beneath our feet.

Stocks are at all time highs. Bond yields have been unexpectedly rising post two Fed rate cuts this year. Uh, so we seem to be at an inflection point. Uh, On the other end of 40 plus years of rising stock prices and falling interest rates and bond yields. So the timing of our conversation almost couldn’t be better.

Tony Davidow: Yeah, I agree with that. I think that the easy money was made, you know, during that extended bull market run and you and I were talking earlier about, you know, 2022 is one of those key inflection points where I think everyone was surprised when both stocks and bonds were down double digits. Um, and I think it served as a [00:03:00] little bit of a wake up call for advisors who got comfortable with that standard 60 40 portfolio.

And of course, as you and I were talking about, the, the message inherent in that, of course, is that with the 60, you would get all of your growth. With your 40, you would get some level of income, and then you’d get some ballast because stocks and bonds, in theory, didn’t move in lockstep with one another, except when 22 occurred, they were highly correlated.

And in fact, Pierre, you and I have been doing this for a long time. Over the last several years, what we’ve experienced is every time there’s a shock to the market, traditional investments tend to move in lockstep with one another. So to me, it really points to the need for a more robust and reliable toolbox, one that includes a broader set of strategies.

And that to me is, is the setup for a discussion around private equity, private credit, private real estate, because those are versatile and valuable tools. That historically advisors haven’t had access to it. Those are tools that obviously institutions and family offices have been using for decades [00:04:00] and decades.

Pierre Daillie: Tony, to begin, please tell us about the arc of your career. You’ve, you’ve been a well known voice and advocate for the inclusion of private market assets and portfolios for a long time. What is it initially that drew you into this asset class and how has your view on its importance evolved over the years?

Tony Davidow: And I think those two questions are somewhat related in the sense that I began my career, uh, working for a family office and again, working for a family office in the early stages of your career is, is kind of an oddity because that’s typically where you would want to end your career. But I think it gave me a great foundation to think about allocating capital.

In particular, I saw firsthand the value of using tools like private equity, private real estate to provide unique and differentiated outcomes for families. So I think that really formed the basis of the way That I think about allocating capital along my career, I had the opportunity to spend time when I was at Morgan Stanley.

I built and manage an institutional consulting business. So I worked with big institutions, [00:05:00] saw firsthand how they think about allocating capital, the value that they see of specific types of strategies. And then later at, at Morgan, spent time working with a lot of our ultra high net worth families and family offices.

And again, the, the higher end of the market clearly has embraced. Alternatives in a very meaningful way. Um, I’m sure we’ll get into it at some point during our discussion here, but I’m definitely a disciple of David Swenson, the former CIO of Yale. And again, those larger institutions have used alternatives in a very meaningful way.

And Yale famously used a 70 to 80 percent allocation to alternative to it. Chief, these outsized returns over the long run. So I think not only my practical experience, but just reading and seeing the things that are happening around me in the industry, I came to realize very early in my career that these tools are really important if you want to help clients achieve their goals, dreams and aspirations.

And it’s only recently. That I think the wealth [00:06:00] channel has had access to these incredible tools. So we’re kind of at this interesting inflection point as we’re trying to help advisors navigate, how do they use these tools appropriately? And are there lessons that we can learn from institutions to family offices who have a lot more experience in this space?

Pierre Daillie: It’s been a very long on ramp for advisors in the retail advisory space to get clients into that alternative investment channel. The accessibility of private market investments has recently widened to include a much broader investor base. What are some of the key product innovations and structural shifts that have made this possible?

Um, and what are some of the differences you’re noticing between adoption first by U. S. advisors and investors versus adoption by Canadian advisors and investors?

Tony Davidow: Yeah, yeah, I think, you know, not to, not to overstate this, but I do think that, um, We are at a different point in time. You know, you, you mentioned we’ve roughly been about a 5 percent allocation [00:07:00] across the wealth channel for a couple decades.

So it really hasn’t moved that much. But I would point out that at least in the private markets, this is a relatively new phenomena because the first generation of product were limited primarily to qualified purchasers, 5 million or more in investable assets. So again, not surprising that family offices and institutions use these tools.

But for most advisors across the wealth channel, it was pretty limited. They weren’t really broadly available. So as we look at the world, we think there are three key pillars that have really Started to change the adoption. One is the market environment on it. And specifically, I noticed, you know, 2022 when stock and bonds were down so much.

I think it served as a little bit of a wake up call for advisers. The second, which you mentioned, is product innovation. So at least here in the States, and I think the same product structures are available in Canada, we’ve started to see the introduction of new evergreen type structures, which are typically available at lower minimums.

Um, [00:08:00] they’re evergreen, meaning they’re on the shelf all the time, rather than waiting for a subscription period. Uh, they tend to have more flexible features that has made it much more broadly available. But I think at the end of the day, none of this would really make sense unless you had access to world class managers and institutional managers who have experience, you know, decades of decades managing private market capital.

I think that’s. Absolutely critical to being successful here. We don’t want to water down the offering and offer things that really don’t provide the same sort of experience. Otherwise that’s a miss for the individual investor. So we think this confluence of events, the market environment demanding a more robust and reliable toolbox, the product innovation that has made these more available to a broader group of investors and the access to those world class managers really makes this a very exciting time to be talking about it.

Pierre Daillie: So we’ve, I mean, we’ve talked about how advisors are gradually increasing allocations to alternatives, um, but [00:09:00] there’s still a lot of hesitation, right?

Tony Davidow: Yeah, and maybe I should also kind of back up a little bit. So I use the term evergreen. And again, you know, there’s, there’s this language problem, which maybe makes things a little bit more confusing than it should.

So the first generation of fund are often referred to as drawdown funds, which describes how capital is drawn down and put to work over an extended period of time. Okay. In, in the U. S. at least the way that we often describe them are evergreen or perpetual funds, which are on the shelf and available all the time.

Those are technically structured as interval funds, tender offer funds, private BDCs, or non traded REITs. So, again, the language I think is, is one of the You know, the the hurdles that we all need to overcome and you mentioned earlier about advisor adoption and lessons learned. I would say that when we talk to advisors, there’s really three primary things that they struggle with.

Right? One is they need to be comfortable and understanding the merits. Of each of the underlying [00:10:00] strategies, and that’s something I think is is relatively easy to do, because there’s a lot of information available. Certainly, we and other firms have developed training materials. Organizations like the Kaya Association have have certainly helped.

You know, in that journey in providing not only online training, but research and all of that. So helping the advisor understand the merits of the strategy, I think is important. The other is the structural trade offs, because you’re right that a lot of advisors are comfortable with mutual funds and ETFs and SMAs, which are daily, liquid, easy to understand.

The structure sometimes can be confusing, so we want to make sure they understand the structural trade offs and understanding the underlying investments are still illiquid in nature. And then the third thing, and this is, I think, one of the impediments that has slowed the growth, but I think it’s important to do it the right way, is the advisor needs to know all of this.

But then they need to turn around and have a discussion with a client. And I think sometimes that transmission and [00:11:00] having the discussion with clients is, is daunting, right? Because the language is different. And clients, you know, as we all know, that when clients don’t understand something, and it sounds unfamiliar.

It sounds risky and there’s this notion that if it’s unfamiliar or if it’s uncomfortable, it must carry more risk with it. So I think we’re working through that process and my hope and expectation is that we gradually get advisors comfortable. They gradually get their clients comfortable. I think the mistake would be to.

Try to give them some sort of slick sales pitch and they sell a fund and the client gets it and then all of a sudden they realize afterwards, oh, by the way, I didn’t realize it was an illiquid investment or I didn’t really realize how complex and confusing this was. So I think it’s really important to do it the right way.

And it’s good to see, at least here in the States, and I suspect they’re in Canada as well, as I speak to my colleagues, that we’re trying to lead with education, we’re trying to do it the right way, [00:12:00] we’re trying to make sure the advisor understands it, and we’re trying to make sure they have better informed discussions with their clients.

That leads to a better outcome and better expectations all around.

Pierre Daillie: The other idea that’s interesting is the way that, that, you know, private equity and private credit have been, you know, consistently. You know, at times it, you know, like when, when we had the big, big drawdown in March of 2020, um, it was almost, uh, you know, it almost sounded like mockery at times when commentators would say that, you know, private equity assets or private market assets are not marked to market.

So their valuations, you know, don’t change from one day to the next, like publicly traded assets. Right. So, so, you know, Oh, guess what? You know, I have private assets in my portfolio, but they didn’t, you know, they, they’re not getting marked down like the stock market. Right. And, and, and so, you know, that, [00:13:00] that seemed to be like a long bone of contention in that period that somehow private market assets were laundering volatility, right?

I think that’s Cliff Asness who came up with that term, right? So there’s, there’s, there’s, there’s all these, there’s these longstanding conflicts that, that occur across the. Uh, industry where, you know, there seems to be this battle between publicly traded assets and privately traded assets.

Tony Davidow: Pierre, if I could just, there’s, there’s a lot.

There’s a lot there. And I, I would just kind of point out that I think this is part of the problem that we’re having, right? Yeah. We have language alternative investment broadly, and, and at least the way that we describe the world. We think alternative investments include private markets. And hedge fund strategies, but some people throw crypto and NFT and all sorts of things that don’t fit neatly into another box alternative becomes this big moniker of everything that’s different.

And then lastly, your common and private markets. I agree with you [00:14:00] 100%. I think there’s a lot of misinformation out there, and there’s a lot of pointing the finger because whatever becomes popular, people are trying to point. Holes in it are our goal with all that we do here. And again, my role at the Franklin Templeton Institute is solely focused on helping advisors have better informed discussions with clients and better understanding how these tools work.

So what we try to do is we try to take that very in complex, um, sort of jargon that we all fall into and help describe how these tools work for individual clients. And I think the more that we can simplify it and we can think about that next level discussion that the advisor needs to have with their end client, the better we’re going to be in managing expectation.

Right, right. And, and, and I think that’s something as an industry, we all need to do a better job on because, you know, rather than pointing fingers at one another, I think at the end of the day, we want advisors to understand these tools and then they can determine how and [00:15:00] where to use them, uh, to solve a client needs.

Pierre Daillie: One of the things that, that I came to understand, and I think it might dovetail into your explanation of the term evergreen was that, you know, I mean, first of all, the goal of introducing alternatives to a portfolio to, you know, to that of advisors, introducing, uh, allocations to alternative assets to their clients portfolios is to introduce alternative return streams that are.

Structurally uncorrelated to their stock and bond allocations. And, you know, the, the, the, the point there is that, you know, there’s always been a long discussion about correlations and the stock bond, the stock bond correlation. And how, you know, bonds are supposed to act as the ballast to equities when there’s equity drawdowns and the, the trade off generally works, but there’s times like 2022 where it didn’t, and all correlations went to [00:16:00] one.

And the same thing happened in spring of 2020, where all correlations went to one and everything was being sold off and have. So, so the key is, you know, how do you introduce alternative investment allocations to your portfolios that are not going to Along with your equity and bond assets. So if you don’t have structurally uncorrelated assets that don’t, that, that will behave differently or provide a different return stream during those key drawdown moments and provide you with liquidity and provide you with, with, uh, you know, alternative streams that, that offset your losses during those periods.

Structurally uncorrelated. Something that is structured, something that is always uncorrelated to your stock and bond allocations. Does that, does that also fit in with the definition of Evergreen?

Tony Davidow: Evergreen is just a structure, right? So Evergreen is like a mutual fund structure, but, uh, but I did want to pick up on something you said, which I think is, is a critical importance.

And that [00:17:00] is, I always believe we should define and advance the role that each one of these investments play in a portfolio. So I’ll give you kind of the high level and then, you know. You and I can certainly delve into any of this in greater detail. The reason you typically are adding private equity to your portfolio is you want to capture that illiquidity premium, right?

Over the long run, private equity has historically delivered 300 to 500 basis points excess return relative to the public markets. And therefore, I want to increase the return in my portfolio. I add private credit because I want to increase the income and get those, uh, higher returns that I’ve seen over time.

Um, if I, if I think about, you know, that whole defensive sort of discussion that you’re talking about, which is, uh, low to negative correlation, and I mentioned low to negative because most, most investments are positively correlated. There’s actually very few other than managed futures. There’s very few that are actually consistently negatively correlated.

But private real estate, for example, has a negative correlation to both stocks and [00:18:00] bonds publicly traded REITs. which a lot of people feel like are the same thing. Publicly traded rates have a 0. 69 correlation to the S& P 500. So again, we need to be careful as we define what are the roles that each one of the investments play, but we typically start by defining the role that the investment plays, and then we have a better sense of how we can measure the success over time.

So I’m not necessarily adding private equity because I’m looking for diversification. Although clearly there is some diversification advantage relative to the equity markets is it’s an equity beta play. It just happened to have a higher return profile attached to it and better risk adjusted returns.

Uh, private real estate, I’m probably thinking about I can get growth and income, but I do have the defensive protection because they have negative correlation to the stock and bond market. And that’s a great value when I know I’m going to have shocks along the way. And you mentioned hedge funds, I view hedge funds as.

Can be both offensive or defensive, depending how you use those, uh, but understand [00:19:00] the differences across the hedge funds. But I think one of the mistakes that sometimes advisors fall into is we paint all of these with the same brush and they add a tool and they’re expecting, well, you know, you know, How come I’m, I’m not getting the diversification advantage?

Well, is that the role that I really assign for this particular type of investment? And the other thing that I think about, which I think kind of leads us down that discussion of portfolio construction is as I start to put the pieces of the puzzle together, Ultimately, what I’m trying to do is I’m trying to increase the likelihood of a client achieving their long term goals over the long run.

Sometimes it’s maximizing return, sometimes it’s minimizing risk, sometimes it’s a combination of the two of those. Sometimes it’s increasing the income. So to me, I tend to look at things from a goals based investing format to say, what is it we’re trying to solve for each pool of money? I think we all fall into the trap of, did my investment outperform the market?

And I know with advisors, they struggle with that, especially in a rising [00:20:00] bull market like we have from 2009 to 2020, the market went straight up and everyone’s getting defensive about positioning their portfolio relative to the S& P 500. But I think the more instructive discussion is to have is, have I helped increase the likelihood of achieving your goals over the long run?

Now that’s challenging for alternative investment. It’s challenging in general because of this behavioral sort of bias that clients have, which is, I want to do as well as my friend’s portfolio where you and I were talking earlier about they may fall in love with a hot stock. And how come you didn’t own that hot stock in my portfolio or this hot fund?

How come I didn’t have that in my portfolio? We’re what we should really focus on is the overall portfolio. Is the overall portfolio lined appropriately and is it fulfilling my expectations over the long run?

Pierre Daillie: So you, you just coming back to one, one issue that you brought up earlier, which is that, you know, advisors, uh, had [00:21:00] have had to learn about the alternative strategies about private markets, private equity, private credit, and private real estate.

But as you said, when they go and have that conversation with their client, they’re running up against. The educational gap that exists between them and their clients and the client, if it’s unfamiliar or misunderstood, then it often falls on deaf ears or it’s too difficult to implement or it gets implemented and then, you know, one or two years in the client is wondering, why do I own this?

I thought one of the interesting factoids about private equity was the fact that the private equity market consisting of companies with over a hundred million dollars in revenue is roughly eight times larger than the public equity market of the same size companies.

Tony Davidow: Almost 90 percent of it. So 87 percent of the companies with a hundred million or more revenue is, is a Private market, [00:22:00] right?

And that’s just in the US alone, by the way, we see the same phenomena across the globe. The other sort of corollary to that is the public market, which, you know, 20 years ago was 8000 companies is now roughly 4000 companies. So the public markets are shrinking. The private markets are growing. So Pierre, one of the things, you know, I often Often get it.

Maybe this is where you want to lead the discussion is, you know, so yes, historically, private equity has delivered this illiquidity premium. Do we think it will persist? And, you know, I’ll have advisors say, gee, with everyone paying so much attention, do we think that alpha goes away? And my quick answer is no.

And part of it is, I think the size of the opportunity set one is growing pretty substantially over time. It’s interesting to know, too, that not only is the private ecosystem growing, Those companies are staying private longer and many of those will never go public. Right. So, you know, when I worked at Morgan Stanley and I had the opportunity to work with a lot of our banking clients, [00:23:00] we work with a lot of those young entrepreneurs and they needed to go public because they needed the capital to.

Fuel their growth and continue kind of their evolution and all of that. That’s not the case today. Today, there’s an abundance of capital. So I think a lot of those companies will remain private. And a lot of those companies can do a lot more when they’re in the private sector, and they’re not answering to shareholders on a quarterly basis.

So I think one of the things that often gets missed is, you know, private equity. Again, they get painted with this negative brush, but private equity. Um, really provides a lot of value, not just the capital that they provide these young companies, but often it’s the human capital. It’s, you know, bringing in a new CFO or helping make introductions.

And as you’re a private enterprise, you have the flexibility to say, Oh, I want to enter a new vertical, or I want to, I want to buy a business and you can do that without the scrutiny of the public markets and shareholders looking over your shoulder. So there’s a lot of [00:24:00] freedom that comes with being a private company.

And I argue that. Private equity is, is really there to help unlock the value of those companies. And that’s why we think that growth continues. And that’s why we think the opportunity set will continue to get larger and larger. It’s interesting. We spent a lot of time looking at the opportunities within the border share in the U S but as you and I were talking about earlier, we have colleagues in Canada and Europe and Asia who are begging for this and the markets there are certainly robust, but I think they’re going to be much more, um, um, Uh, of a robust and growing market over time as more capital goes into those markets, as more capital helps fuel the opportunities and the growth abroad.

So we’re really excited about the private markets. We think it’s just a different way of looking at getting exposure to the markets. You could do it through the public. You could do it through the private. We don’t think it’s a one or the other. It’s just what is the right percentage. And a lot of that right percentage may come down to the topic that we haven’t talked about yet, but I know you’ve had on your list.

And [00:25:00] that is Illiquidity. These are illiquid investments. And that is perhaps the biggest challenge for advisors and investors to get comfortable with.

Pierre Daillie: I think investors, you know, because of companies like Google and Amazon, uh, a lot of investors are, I mean, I can, you know, there’s a laundry list obviously of companies like that, but just to pick some big names, um, these companies were private before they went public and investors often say, you know, Oh, if only I could have, you know, been an early investor, a seed cap, a seed capital investor, you know, in, in Google.

Or Apple or, or any of these companies that are, that are today’s giants. Um, And, you know, that is, that is what’s out there. That is, that is the pool of opportunity potentially that’s out there in that, that 87 percent of us companies alone that are, um, that have annual revenues exceeding a hundred million dollars.[00:26:00]

Um, that’s, that’s, if you stop and think about it, that’s kind of mind blowing.

Tony Davidow: Yeah. And I think it’s important. I mean, I did want to note though, that. Not all of those companies will be Apple, Amazon, and Google, but some will. And the ability to get some of those, we all know about the outsized returns when they go public, but how do you identify them?

And, you know, it kind of pointed to another That’s where diversification comes in, right? And the expertise to source those companies, be early investors and guide them along the way, it kind of points to another thing that I hear a lot, which is, you know, gee, I look at my portfolio now, you mentioned NVIDIA, I see NVIDIA and IBM and Microsoft, all names that I’m comfortable with.

And when I’m investing in private equity, I don’t know those names. And what I try to do is I try to give them kind of those stories. And you mentioned Google, when I was at Morgan Stanley, I had the opportunity to work with, uh, many of the Google executives. And if you [00:27:00] can tell the story and personalize it a little bit.

Ideally, what we want to do with private equity is we want to identify the next Google, Apple, Amazon, Tesla, and talk about all these great companies that were once private and they went on a journey. And in my, I wrote a book that you mentioned in the beginning, it’s coming out in February. And one of the things I had the opportunity to do with the book, because you have a lot more runway to tell a story, is I wanted to tell the story of some of those companies when they were really struggling.

Young companies and there were ideas and then all of a sudden you start to get capital and you’re investing, but you realize you need a little adult supervision. So you’re looking for a partner to bring in somebody who becomes your CFO or CEO to help manage the company for the next stage of growth and all of that.

We sometimes lose sight of the fact that that is a journey that they go on. Ultimately, we catch them. As that company has matured quite a bit, and it it goes to the public market, but there’s a lot of work that goes on getting them prepared to go public, and then there’s a lot of [00:28:00] work. Obviously, once they’re a public company, they’re in a position to make acquisitions and do other things.

So I tried to provide a little bit of the arc of that journey for investors and for advisors just as they think about it, because there’s It’s relatable when you look at your portfolio and their names that are comfortable to you. It’s a little daunting when you don’t know the names or you don’t necessarily see all the underlying investment.

So I think again, as an industry, we need to get everyone comfortable with how these Companies work, how value is created, how value is unlocked over time. And then ultimately, I think, you know, my belief has always been that as more advisors and investors get exposure to this and that positive experiences, they get more comfortable, allocate more capital over time.

We don’t, we don’t think from zero to 10 percent or zero to 20 percent and one fell swoop. You have to. Go through a process gradually, get comfortable with it, understand how they work, understand that they are truly [00:29:00] long term investments. But then as you get comfortable, I think you get comfortable increasing that allocation and maybe venturing out in different areas as you get your exposure.

Pierre Daillie: It’s interesting, like, you know, if you look at, you know, every advisor’s business, I mean, the, the, the largest proportion of wealthy investors, they’re in the entrepreneurial class. So, I mean, the subject of private equity should be very near and dear to those investors who have either, you know, who have built, you know, multi generational companies.

If anything, if you have clients who are entrepreneurial. Who have businesses, family owned businesses, and they’ve had financial success from that, they’re probably the most likely to understand the private equity conversation. Very quickly, and they’re, and they’re also likely to understand the illiquidity conversation more rapidly as well.

Tony Davidow: That’s exactly right. I go back [00:30:00] to my time, you know, dealing with a lot of, you know, Morgan Stanley investment banking clients, uh, they were comfortable with it because they saw the freedom that they have as a CEO of a private company to do things. So it wasn’t a stretch to think that a lot of those.

Investors when they had capital that they were making, you know, 20, 30, 40 percent allocations to private markets because they understood it. The flip side of that is, um, and there’s, there’s a fair amount of studies here in the States. And I think the data that I’ve looked at is similar in Canada and other parts of the world.

But the reality is high net worth investors are ultra high net worth investors who have made a lot of their money, as you point out, through private enterprises. Mm hmm. Their expectation is that’s what they want, right? They want to have access to that. And if they’re having a conversation with an advisor and advisor says either they don’t believe in it or they don’t have access to it, they will likely find another advisor who will, right?

Right. So to me, it’s It’s table stakes that at the very minimum, [00:31:00] you have to have the knowledge, you have to be conversationally proficient about it, and you have to have access to private markets. Because if you want to deal with high net worth and ultra high net worth investors who are comfortable with private markets, as you suggest, they’re going to demand it.

They’re going to demand somebody who can get them into the best ideas out there.

Pierre Daillie: So if you’re an advisor and you’re not talking to your, your, your affluent clients, about, about private markets. Um, you run the risk of losing them. The best case scenario obviously is, is introducing it to them. It was being able to bring it forward.

Exactly. Interesting. Um, yeah. So, so, um, speaking of illiquidity, uh, in this context, um, illiquidity is a feature, it’s not a bug and, and, you know, but, but most, Advisors today still view, because of their experience with public markets, they still view illiquidity as a problem as opposed to a feature.

Tony Davidow: [00:32:00] Yeah, it’s, it’s clearly the, the biggest issue that I hear from advisors and I know they hear the same thing from their investors.

So, um, I write a lot. Um, and part of the reason I write a lot is I get a lot of the same questions over and over again. So I’ve heard that question for years and years and years. So I’ve written probably the most, um, the most used white paper that I’ve written over the last couple of years, a paper called “The cost of being too liquid.”

And I take that whole challenge head on and I say, well, first of all, we need to paint the picture for the advisor. And then ultimately for the investor of why it is that you would invest in illiquid investments in the first place. Well, you capture this illiquidity premium. Okay, that’s easy to understand.

That’s an intellectual discussion goes relatively well. Oftentimes. It’s the emotional discussion, which is the more challenging which is again advisors and investors have been conditioned to think I need to have a hundred percent liquidity I need to have access to my funds all the time And I turn that around a little bit with advisors and I say, well, what if we thought [00:33:00] about this the way that institutions think about it, the way that the Yale endowment does, which is, what if I determine in advance, what is the appropriate illiquidity bucket? Put a portion of capital aside, maybe it’s 10, maybe it’s 15%, determine with your client, when you go through the discovery process, how much capital are you comfortable putting aside for 10 years?

Determine that, put that money aside, allocate it differently. And then the next time there’s a market shock and the investor is like, I’m, I’m, I’m scared. I want to head for the exits. Think of your traditional investments. Your traditional investment. You can either get out of the market, you move it to cash.

You can do all sorts of more defensive things, but what we’re teaching investors with that Illiquidity bucket is to truly be a long term investor, which I argue is good for the advisor and it’s also good for the investor because we all know we all know we are wired to react to stimuli, emotional stimuli, as opposed to making the sound and logical decisions.

So if we can develop that [00:34:00] illiquidity bucket. And carve that money out, put it aside, truly treat that as long term capital, or as institutions think about it as patient capital. If we had that patient capital, that would be a good thing for investors and a good thing for advisors. So that paper, and I know at the end we were going to provide access to it.

Some of our research, um, that paper has been used, um, pretty broadly across. And I know that, uh, that paper I think was published in two publications in Australia. So it doesn’t just work in America. It’s a discussion that I think kind of persists across the globe.

Pierre Daillie: Yeah. It’s, you know, it’s a universal idea.

Tony, in the U S the, the conversations have, have shifted from why alternatives to how do I allocate to alternatives?

Tony Davidow: They generally have. I’m not suggesting everyone’s at the same stage. I mean, I think one of the things that we certainly recognize, I think it’s the same sort of phenomena, you know, across the globe is not everyone’s at the state, same stage in their journey.

There’s [00:35:00] certainly advisors who are very advanced and their power users. I’ve been able to use alternatives in a big way. There are some advisors who are still getting their feet wet and starting on their journey. So it’s tough to generalize, but I think that, you know, the more I travel around the country and I speak to advisors, I’m no longer getting the question, why?

I’m getting the question, how? Which I think is a healthy sort of thing. So a lot of the research that our advisors cover and our. I’ve been focusing on and a lot of the things that I deliver when I’m in market meeting with advisors is really focusing on portfolio construction and really illustrating the impact of adding alternatives or diversified basket of alternatives, which is even better if the client has to wear with all.

to show the impact that it has in helping clients achieve their long term goals, dreams, and aspirations. So I I’ve, I’ve written a series of white papers called building better portfolios, which I use case studies, and those have been very well received because it illustrates for the advisor the how it, it [00:36:00] helps them imagine as they go back to their book of business, I have 10 clients like this, and this is the way that I can think about adding alternatives.

And there, there’s a little bit of a. A message in there too, which I think is important is as you and I were talking about earlier, not all alternatives are created equally. So the beauty of having these products now available at lower minimums is I can actually have exposure to private equity and private real estate and maybe a macro hedge fund strategy all within the same pool of capital where in the early days, you know, leading up to the global financial crisis.

I mean, we typically have fun to find the options that were available, which were kind of dull instruments. Now we have sharp instruments that allow us to get precise sort of exposures over time. So I think product evolution has really come a long way and bringing the minimums down allows for better diversification across the types of tools that we can use with clients, which again, hopefully help us achieve their client goals over the long run.

So we’re, [00:37:00] we’re really at a really interesting point in time with products. being more broadly available is a lot of great products coming to the market from institutional quality managers. There’s a lot of emphasis on education, helping advisors do things the right way. Um, the one thing we haven’t really touched on, but I know you and I were talking about earlier I’d argue it also enhances the advisor’s value proposition, having these tools, because the tools that they had in the past were good, but maybe not appropriate given today’s market environment.

So why wouldn’t you avail yourself of providing your client with the biggest and best, uh, tools? Or the tools that the biggest and best institutional allocators have used for decades and decades. So it really is kind of an exciting time and use the term democratization. It’s really the democratization of alternative investments that I think allow us to get to that next level.

Pierre Daillie: Beyond just increasing the percentage allocated to alternatives, how should advisors think about [00:38:00] strategically incorporating private market assets into a portfolio? Like, where do you fund it from and how do you go about choosing the right managers or multi managers? How do you, how do you go about doing that?

Tony Davidow: Yeah, and that’s a lot of the work that we’re doing with this whole Building Better Portfolios series. I think, you know, where do you fund it from? That’s one of the most challenging ones, right? So we begin by, in a very simplistic sort of way, think about what is the role that we establish for each one of these investments?

So I made the comment earlier that private equity is in our portfolio largely because of growth. There are four primary goals that all investments play. Growth, income, defense, or inflation hedging. Growth. Clearly, that is where I’m thinking about allocating to private equity. If I’m looking for more income in my portfolio, maybe I’m thinking about private credit or private real estate.

If I’m thinking about defense, I’m probably thinking about something like macro. Global macro is more of a defensive strategy. If I’m thinking about inflation hedging, I’m [00:39:00] thinking about real estate or infrastructure. So if I establish that in the beginning, it also makes it easier for me to think about sourcing capital.

All things being equal that I haven’t changed my long term strategic allocation. I’m going to source my private equity from my growth bucket. I’m going to take it from another growth asset like my traditional equity allocation. I’m going to lessen my S& P 500 exposure, and I’m going to think about using that to source my private equity.

If I’m thinking about private credit, I’m going to take that from one of my income allocations. Right. So that. at least conceptually lays out how and where you would source your capital. I think the due diligence question and evaluating funds and strategies, that, that is a challenge. Um, and we would say there’s a couple of ways that you should go about that.

One is somebody has to do due diligence. So I know a lot of the firms are doing due diligence at the headquarter level, leveraged due diligence that’s done at the headquarter level, leveraged due diligence that may be done by third party providers. At least here in the States, there’s a lot of third [00:40:00] party providers that do due diligence.

Do diligence and then ultimately, at the end of the day, for the advisor, they need to get comfortable that they understand the story and, you know, carry you and I’ve been doing this for a long time. I tend to fall back on kind of the four P’s, but the four P’s really focus on the investment process, right?

The people, the performance, the philosophy. But, but we really need to focus on as well when we’re dealing with the private markets is the ODD, the operational due diligence, right? So we need to also, somebody needs to do operational due diligence to understand the pricing, you know, how do they price securities that they have independent checks and balances in place and all of that.

So hopefully that’s being done by somebody and I would definitely leverage research that’s done. To evaluate, to winnow that menu of options down to what are the right and appropriate ones for each one of their clients. And I think ultimately for every advisor, the advisor needs to get comfortable with the story.

Did they understand the story? Can they repeat the story? Do they [00:41:00] understand what’s the manager’s, what’s the edge that they have in the marketplace? If all of the managers sound exactly the same, what’s the one thing that they do that’s different than the other person? At the end of the day, especially in the private markets, nothing will replace the experience and the depth of resources that you apply to this marketplace.

You can’t have somebody who is a traditional manager wake up one day and said, I want to, I want to manage private equity because that’s where all the flow is. And I’m going to. I’m going to evaluate companies in the same way. It just doesn’t work that way. So you definitely need deep, dedicated and very experienced resources in this market.

Pierre Daillie: Well, yeah, I mean, it sounds like because of that, there’s definitely a potential for greater dispersion of returns within private markets and especially in areas like private credit. How can, how can advisors and investors identify and access experienced managers who are, you know, Best position to navigate this market environment.

Tony Davidow: Yeah. And there certainly is a [00:42:00] substantially larger dispersion of return when we’re looking at the private markets, the difference between the top and the bottom global equity manager might be a couple hundred basis points. The difference between the top and the bottom private equity manager might be 2, 000, 2, 500 basis points.

So definitely a big dispersion. The one thing we do see though, is we do see that the top and the bottom Tend to be the top and the bottom tend to be the bottom. Now, that’s not the case with traditional investments. We typically see the rotation. The top becomes the bottom and vice versa, but it’s somewhat intuitive in the sense that the best managers are often getting the best deals.

So definitely identify those managers with deep and dedicated resources. People who have been doing it for a long time. People who have consistently delivered returns, right? They’ve got, uh, top quartile funds. They’re more likely to continue to be the best place to allocate capital in the future.

Pierre Daillie: Where do you begin?

I mean, where do you begin to [00:43:00] start to identify Those resources that will help to narrow, narrow down that list.

Tony Davidow: Yeah, I think, I think it’s, it’s probably the same in Canada that we have here. A lot of the firms are waking up to the fact that they need to have a menu of options. Uh, so I suspect many of the headquarter firms in Canada are building out their platform today.

That’s the first central step, right? Because. If somebody is worthy enough of getting on the platform, it means that they hit the basic criteria. They’ve got the experience, they’ve got a track record and all of that. Uh, leverage, uh, the asset managers who definitely can tell you about their funds, but they can also tell you about the competitive landscape.

Who are the likely competitors? How do they compare? This fund is comparable, but we deliver it with much less risk or we’re taking different sector bets. I always encourage people to leverage some of the external resources. Our friends with the CHI Association have a big footprint in [00:44:00] Canada, and they’re looking to expand that over time.

They provide independent research. Certainly, you can leverage the Franklin Templeton Institute, although Franklin Templeton has great products. Um, I never talk about that. All of our research is independent. It’s all looking at the asset class performance, helping to advise advisors as they think about allocating capital.

So we have a slew of white papers or resources at advisors disposal. Uh, and I know a lot of our competitors do the same thing. So for an advisor, who’s starting on this journey, ask a lot of questions. Leverage a lot of the research that’s being done on the space for you. Uh, if you’re thinking about allocating to a fund, ask them tough questions, you know, ask them tough questions and ask them who’s their competitor in the marketplace.

Pierre Daillie: That’s great. I think, I think, you know, that’s probably, it seems like initially it’s the hardest thing to do, but, but if you’re, if you’re on a platform already, um, then look at the platform, right? Look [00:45:00] at what’s available through your platform because more than likely it’s already been vetted. And, uh, you know, it’s been approved for, for distribution on that platform.

Tony Davidow: Yeah, and I would tell you, uh, they should, you know, advisors, donors, really, they should definitely take comfort because I know that the level of due diligence of all of the headquarter firms to get the, Products on boarded, the types of questions they ask, the diligence that they’re doing and looking at, uh, the team, the resources, similar funds that have been managed, that that is a big threshold to get over.

So the fact that somebody is on your platform, that means they’ve gone through those hurdles. That’s a great starting point. And then a lot of those firms have dedicated resources that can help you to, uh, among the three real estate funds that are on your platform. This is how we rank them. This is the risk return trade off on this one versus that one.

So, so definitely leverage the resources.

Pierre Daillie: Looking ahead, Tony, what, what are some of the key trends that you see shaping [00:46:00] the private markets landscape over the next 10 years?

Tony Davidow: Yeah, it’s exciting. I think, you know, we are still in the early innings, you know, not to use a baseball analogy, but, you know, maybe we’re in the third or the fourth inning.

There’s a lot that will continue to come. Um, You know, you made the comment earlier, you know, we’re not expecting people to go from 5 percent to 20 percent in one fell swoop. But as an industry, we think, you know, a 20 percent allocation probably serves advisors and investors better. So I suspect you’ll start to see more and more high quality products coming to the market.

A lot of these institutional caliber managers were hesitant to enter the wealth channel. Uh, with the expectation that that money may be hot money. Um, but I think their product kind of solves for the needs of the individual investors, but also solves for the needs of those institutional managers who want some protection so they can invest in the long run and not have to meet daily redemptions.

So I think you’re going to start to see more and more managers bring products to the marketplace. I think as the size of the market grows, you’re. Probably going to see more diversification [00:47:00] of products and more granular sort of strategies, not just a private equity fund, but maybe we’re going to get, you know, more granular type exposures that are out there.

Um, it wouldn’t surprise me if we start to see more public and private. Uh, structures where there’s a fund together that maybe helps make those allocation decisions, which sometimes can be challenging for advisors. Could there be some sort of a completion portfolio where an advisor buys into it and somebody else is making those decisions for you?

I think those, those are all exciting things to look out for, but I think the basic building blocks are there today for advisors to start on that journey and the hope and expectation is everyone’s on their journey. They may go faster, they may go slower, but ultimately it’s a good thing for the advisor, it’s a good thing for the industry, and it’s a good thing for the individual investor.

Pierre Daillie: Are there any ideas, is there, is there any areas in particular that hold, um, great promise in, in your opinion?

Tony Davidow: Yeah, so we [00:48:00] actually put out a private market outlook twice a year. I’m actually working on one now that will come out in January, which we’d be happy to share with your readers. So if we identify the big ideas that we’re focused on now, probably our highest conviction idea is secondaries.

We love the secondary market. And and the secondary market has certainly benefited because of all the flow that has been going into private equity. But what have we experienced over the last couple of years? Kind of a slowdown of exit. So institutions need liquidity. Secondary managers can provide that liquidity.

Um, so secondaries for us look really attractive. for the foreseeable future that has grown from kind of a niche industry, maybe 10 years ago, to now what we refer to as a vital cog in the overall private equity ecosystem. We love that space. That’s, that’s probably our highest conviction idea. Uh, real estate, even though real estate has been getting a lot of bad press because of the concerns about the office sector, [00:49:00] we actually like real estate because we think valuations have come down quite a bit over the last couple of years.

And again, if you can be more selective in allocating capital, avoid real estate. Because I think that’s going to be a trouble spot for a while. But if you can look at areas like industrials, multifamily, and life sciences, we think that looks attractive. And, and perhaps a different sort of play that, um, You know, you can think about with real estate and some of the disruption going on is real estate debt.

Look at the lending side of the equation. Uh, so again, we think there’s likely will continue to be some stress on the real estate market. We think those lenders who can negotiate favorable terms and covenants will actually be able to take advantage of some of that disruption. So different sort of ways of playing the real estate perspective there.

Pierre Daillie: Fantastic. Um, uh, you mentioned, you mentioned secondaries. Can you, can you give, uh, an example of.

Tony Davidow: Yeah. So I, I’d like to give kind of a, a [00:50:00] high level example, you know, maybe just to think about it. So imagine your ABC pension fund, whatever a large pension fund would be in Canada. And you go back over the last couple of years, what happened in 21 is the S and P 500 is up.

17 percent private equities up 49 percent oversize returns and a lot of money going into that market. So imagine your ABC Canadian pension plan and you wake up and you realize, Oh, I’m outside of my limits, right? I have a 15 percent target allocation of private equity in my fund, but now I’m sitting at something like 17, 18%.

So what do you do? You can either sell off pieces individually, where you could say, I need to sell about a billion dollars of assets. And I go to somebody who’s an established player in the secondary market and say, I have a billion dollars of assets. Some of those assets are seasoned. Would you be willing to take those off my hand?

And there’s a, there’s a handful of secondary managers who are really established in this market. And the secondary manager says, I will [00:51:00] look at that. I will. Take that off your hand, but I’m not going to take it on a hundred cents on the dollar. I’m going to take it at a discount. And what they essentially do is they take the asset from the original investor in it, which provides built in diversification.

And what we have found in America, at least, you know, the secondary market has really exploded. And now that’s a very large viable market because what do they do? They’re providing liquidity to the institutions who need the liquidity. They’re also now offering to individual investors. So if I’m an investor investing in that fund, what do I get?

Well, I get a shortened J curve because a lot of those positions are more mature. And if we understand how the J curve works, there’s kind of a drawdown period. So if I’m getting an asset that’s already been seasoned a little bit, the J curve gets shortened. I get my distribution return coming back to me sooner and I get to The built in diversification, I get diversification across GP, across geography, across stages.

So I’m getting some VC, some growth, some buy out of my fund. So [00:52:00] I got all the built in benefits. So for an individual investor, it’s almost the perfect investment because isn’t that what you want? You want diversified private equity exposure. I’m actually get that in a single solution.

Pierre Daillie: That’s very interesting.

I mean, you’re, you’re, you’re solving the rebalancing problem for, for a, uh, long lived asset, like a pension fund and, and, and providing that opportunity to, to, uh, new investors. Right. I mean, it, it,

Tony Davidow: it, it really is. I, I think a perfect investment. If you’re thinking about, you know, the way that you want to get diversified exposure, right?

You’re, you’re getting a lot of the advantages, um, that you would get if you were an institution and kind of staging them out across vintages. You’re actually getting that, uh, through a single vehicle. The, the one thing I would point out, ’cause you know, sometimes I hear well, that, that’s great for individual investors.

Well, the reality is. Institutions also use the secondary market, right? Because what they’re doing is they get that built in [00:53:00] advantage. Either that’s the way that they leg into a transaction, or they have primers and secondaries kind of sitting side by side with one another. So that, that to us represents kind of a growing and viable part of the marketplace.

Pierre Daillie: It’s interesting because it’s analogous to when, uh, fund managers have to sell, you know, assets that they love because they’re out of balance, right? They’re over, they’re overweight. And, and then investors look at that and they say, you know, why did you sell that? Why did you, why did you cut, you know, your, your position in Nvidia, for example, or, you know, or any, any largely, uh, appreciated asset when, when it’s still, you know, You know, going strong and, and then, and then as well, you know, willfully, you know, we had to cut our position there because it, it, it’s gotten too large for our fund.

Right. But it’s the same, it’s the same problem. And it’s being solved. I mean, in the public markets, it gets solved very, very quickly, obviously, very easily, but, but in, in, in private [00:54:00] markets, there has to be a mechanism for it. So that’s, thanks for explaining that, but it’s

Tony Davidow: even exacerbated a little bit more because not only do you need to lessen your exposure to get within bounds, institutions often are there.

Committed to future funds, so if your distributions right, the money you get back, if I’m not getting distributions and exits have slowed, which has happened over the last couple of years, I’m committed to XYZ fund and you know, all of these funds in the future, you have to constantly do it. So a lot of institutions have a regularly Discipline secondary program in place.

So they’re reaching those next funds, right? I want to make sure I, cause that next fund may have the next Nvidia in it. I don’t know what the next Nvidia is, but we don’t want to miss out on that opportunity because I’m over my threshold today. So it kind of feeds itself. You really need liquidity in the marketplace.

So that’s why we think secondaries represent a really valuable tool for individual investors, but they also provide a lot of advantages to [00:55:00] that institution who has to constantly. Uh, turn over their portfolios.

Pierre Daillie: Interesting and amazing. I, you know, I still, you know, I hate to, I feel like I’m dwelling on it, but I, but when, when you stop and you think that, that 87 percent of, of the, you know, private that, sorry, that 87 percent of companies in the U.

S. grossing over a hundred million in revenue, uh, are private. Uh, and you think about how vast that is. And, and, and then you also look at the shrinking public equity market. Um, it just seems to me it’s, it’s, it’s like the old, um, you know, the old argument that, that, you know, if you, if you’re only investing in your, if you’re only investing in your home country, you’re missing out on, on all the opportunity globally.

Um, you know, there’s, there’s, there’s so much that investors and advisors alike need to. You know, then you need to learn, need to educate themselves on, in terms of, of [00:56:00] what actually constitutes opportunity in today’s markets and, you know, have a wider awareness of these, these opportunities that exist.

It’s, it’s vast. And you can see where, where even the argument that, you know, like if you, you know, consider, you know, the maverick, uh, David Swenson at Yale endowment. Um, you know, being sort of the, the early adopter of this idea of, of increasing illiquidity in a portfolio by investing in, you know, private, in private markets, um, that no matter how popular that idea gets, the, the, the swimming pool is so large.

For for those opportunities that that there’s very little chance of saturation,

Tony Davidow: and that’s one of the key parts of it, right? I mean, if it was a finite pool, you might get concerned, but that pool continues to grow, right? Is more money remains in that private market [00:57:00] ecosystem. Those companies can stay private longer.

I think that pool of capital continues to grow. And, and, and again, this is just in the U. S. alone. We cite that number, 19, 000 companies with 100 million or more in revenue. But the reality is there are ample opportunities in Canada and Europe and Asia. And we’re going to see the growth of private capital around the globe.

That’s a good thing. That’s where all the opportunities are going to come from. Those exciting young ideas and companies that are going to be ground changing. They’re going to do a lot of that when they’re private. And then they may or may not go to the public markets thereafter.

Pierre Daillie: So, Tony, where can advisors and investors find you?

Well, the easy thing

Tony Davidow: It seems like I’m everywhere. The easy thing is I think we’ll provide links at the end to our content, which is available on the Alts by FT Knowledge Hub. Uh, no products, just information. And that’s available in white paper format, [00:58:00] blogs, or I also have a podcast. The other way to find me is on LinkedIn.

I’m, I’m, I’m prolific in posting. I, uh, post a podcast on a blog series, but I also share research that we’re working on here. My sole focus is to help advisors make better decisions. better informed decisions. So I hope that the information that we’ve talked about today or information that we share help advisors really understand this really new, exciting opportunity in front of them.

Pierre Daillie: Excellent. Tony. Um, wow. I mean, it’s been, it’s been quite a discussion. It’s been a pleasure to talk to you. Um, thank you so much for your incredibly valuable time and

Tony Davidow: your insight. Well, thank you, Pierre. This has been a fantastic for me as well. And hopefully I’ll come up and visit you in Canada in the not too distant future.

Love to see you. Great. Thank [00:59:00] you.