E161: The Death of Modern Portfolio Theory? w/John Bowman

I've listened to interviews with Stan Drunken Miller.

I spoke to Cliff Asnes about this, about the difficulty of doing the right action in difficult times.

Liquidity is actually net a negative because it tempts you into wrong actions.

You sell at the exact wrong time when there's a drawdown just because of human evolutionary purposes.

What do you think about that?

We certainly have a fetish with liquidity.

The industry, I think we've been conditioned, and look,

not just the public and the clients, but the industry, to your point, has probably conditioned individuals to think about liquidity as table stakes, as a starting point, as a required level setting to have a further discussion.

And that is, I think, an unwinding dialogue that's currently going on in the visibles.

I think you're right.

There's some extent in which liquidity or illiquidity, I should say, protects us from the worst parts of ourselves.

Today, I'm excited to welcome John Bowman.

John, a seasoned expert in asset allocation and the CEO of Kaya, shares his insights on the evolution of asset management from the traditional bucketed approach to a total portfolio approach.

We'll explore the nuances of optimizing investment strategies around client goals rather than asset buckets, the blurring lines between asset classes themselves, and what the top pension funds, endowments, foundations, and family offices are doing today that differentiates them from their peers.

Without further ado, here's my conversation with John.

So, asset allocators are moving from a bucketed portfolio approach to a total portfolio approach.

Talk to me about the evolution.

Yeah, as you probably know, David, and as many listeners, I hope have realized, Kai's been doing a lot of work on TPA or total portfolio approach, as you've said.

I think there's some important context needed here because all of us have been kind of swimming in the water of modern portfolio theory for our entire careers.

Harry Markowitz, God rest his soul, passed away a couple of years ago, had invented modern portfolio theory.

And many of its offspring are apparatus that have been normalized, have been

kind of the, as I said, the water we swim in.

That's things like strategic asset allocation and efficient frontier and the idea of asset class taxonomy, benchmarking at the asset class level.

All of this came out of Markowitz's work.

And of course, all of us then were taught this through academia, through credentials like Kaya, through our apprenticeship as we grew up.

And an entire industry, the consultants grew up around supporting this approach to structuring portfolios, bucketing, as you say, David.

I think more recently, folks have stepped back, the more sophisticated asset owners, and just asked the question, not whether MPT and SAA have failed, but is there actually a more optimal way to build portfolios on behalf of clients?

The idea being that SAA, by definition, optimizes at the asset class level, individual buckets, to use your word, whereas TPA is meant to optimize around the total portfolio.

The idea that you start with the client's goal.

So it could be a spending rate for a university, could be an actuarial rate if you're a public pension, and it could be a goal if you are a high-net worth family.

And then building a series of strategies and assets that really support that particular approach rather than being constrained and handcuffed by these arbitrary structures along the way.

Just to play a devil's advocate, the bucketed approach, you might have a certain percentage for private equity, a certain percentage for venture capital, a certain percentage for private credit, but the purpose of it is to come out to a specific risk return between some target return with lower volatility.

How is that any different than using a total portfolio approach?

That's a great question.

And the guardrails that you're describing, the idea of diversification, the idea of ensuring that you're trying to constrain volatility, the idea of stuffing or mashing together different behaving correlations and risk premia, all of that, all those attributes that we subscribe to as part of kind of the worldview in which how to build portfolios is still very much the case.

If anything, it is escalated.

And so what do I mean by that?

So instead of using asset class percentages or ranges, as you described, which is what most asset allocators still use and what a board blesses that they have to operate within, the idea of risk management and return optimization is really centered around using different levers.

So, it could be what they call a reference portfolio.

So, this could be a ratio, for example, of equity-like exposure versus debt-like or fixed-income-like exposure.

So, instead of eight ranges representing different asset classes, you've simply got a ratio that you're trying to ensure that you're managing risk around.

That still ensures that you've got kind of these ballasts of growth optimization and stability optimization, but it gives the

CIO office, the individual and the total portfolio team, which is usually what they're...

they're organized around, much more flexibility in designing the portfolio and not being subject to kind of asset class teams just rolling a bunch of stuff up, mashing it together and pretending that it's diversified.

And the last thing I'll say, David, to your point, is I think the asset class model worked in the 90s and 2000s, the kind of industry we all grew up in, where

strategies really could be deemed existing in one lane.

They had an identity in any one of these asset classes.

And now we've got blurring assets, blurring asset classes, blurring strategies that don't really fit into one bucket or another.

And so there is false diversification in the SAA model that I think needs to be just recognized.

To put it another way, you have so much of your portfolio that could be invested into equities, which is higher risk than debt.

So in many ways, even the SP 500 or going long the stock market could be taking away some of that risk assets that you could put into, let's say, you have access to a top venture capital firm or top private equity firm.

Yeah.

All of what you've just described is still equity risk premium, right?

I think that's the other blend that we've seen, not just asset classes, but also public-private, liquid, illiquid.

Now, I should put a very important disclaimer on this.

Any allocator that's using a TPA approach, one of the first questions I get from those that are looking from the outside in is, what about

liquidity needs, right?

I've got pensioners that I need to write a check to.

I've got a university that I'm covering 30% of the operating plan of.

There is an overlay of liquidity needs that's critical here.

So, to your point, you can't, for your equity risk premium, you can't go all venture capital suddenly.

Not only would that blow up your risk budget and risk appetite, it would likely blow up your liquidity needs.

And so there are important constrainers and governors on this, but it just gives you a much wider palette and cafeteria of options that

typically we overly constrain ourselves.

I've listened to

interviews with Stan Drunken Miller.

I spoke to Cliff Asnes about this, about the difficulty of doing the right action in difficult times, holding onto your portfolio, which really has brought me to this belief that past a certain amount, so let's say you're a university that has to pay off 5% a year, liquidity is actually net a negative because it tempts you into wrong actions.

You sell at the exact wrong time when there's a drawdown just because of human evolutionary purposes.

I know that view is very haradoxical.

What do you think about that?

And is liquidity net a negative?

We certainly have a fetish with liquidity.

The industry, I think we've been conditioned.

And look,

not just the public and the clients, but the industry, to your point, has probably conditioned individuals to think about liquidity as a as table sticks, as a starting point, as a required

level setting to have a further discussion.

And that is a...

I think an unwinding dialogue that's currently going on in the business because I think you're right.

There's some extent in which liquidity or illiquidity, I should say, protects us from the worst parts of ourselves.

If we don't have the ability to trade in and out of things,

it actually could solve for and maintain some discipline in ensuring that our focus and our anchor is still long-term and looking through cycles.

The worst mistakes are typically made, as you've just alluded to, in the heat of the moment when things look really ugly and you panic, or when hubris takes over at the peak and you think that this is never going going to end.

And illiquidity does lock up your ability to be flexible.

And I heard one individual say that, you know, if the stock market only marked every six months, most individuals would probably have much better performance because they wouldn't have the ability to trade every day, every moment, even every week.

I think he was trying to make an extreme point, but the point is, I think you're right.

I think sometimes we over-index against flexibility when in reality, that actually could work against against us.

There have been numerous behavioral studies that show that invest,

especially retail investors that check their portfolio daily, underperform those that check it quarterly and yearly.

There's really no limit to the more rare you check your portfolio, the higher your returns.

Absolutely.

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Asset management used to rely on the 60-40 portfolio, but today that's also evolved.

Tell me about that, and what's the gold standard today?

You're a little bit younger than me, but some of your listeners might remember in my freezer growing up in the 80s was this box of ice cream called Neapolitan.

I don't know if you remember this, but it was basically you open it up and there were three very distinct columns of ice cream.

You had chocolate, vanilla, and strawberry.

And by the way, my mother used to get really mad because I used to do this surgical sting operation to pull out just the chocolate bits.

But the reality was, I think to your question, most of the history of asset management has built portfolios similar to the Neapolitan approach.

You've got 60, 40, and maybe a little bit of high-octane juice that we might call alternatives over in the corner, right?

And these things don't mix.

They are distinct.

We think of them as three separate categories.

And I think, as I've already alluded to through the TPA question, things are starting to blur.

It's really hard to have single-lane thought processes anymore about asset classes, about individual strategies, about managers.

And so, in reality, this approach to even bucketing at the groups of asset class approach is starting to be flawed.

So in many ways, asset owners are looking at this and going, so first of all, I've got to deal with these multiple avenues by which to seek risk premia and different types of cash flows and different portions of the global economy, right?

Because any portfolio wants to touch all the pieces and parts and opportunities of the global economy.

But I'd also say that you're starting to see asset owners, at least the more sophisticated ones, move away from kind of this, this, let's just fill up the buckets to your earlier question, to the metaphor I often use is kind of this sophisticated cockpit now.

So imagine you're flying, you know, a very sophisticated spaceship and there are all these knobs and joysticks and dials and indicators that suddenly are that the asset owner has access to.

And this sophisticated instrumentation can take the forms of several things.

So instead of just choosing the best manager for the best bucket, what they're doing are things like co-investing and direct investing and continuation funds and secondaries.

And the most interesting, I think, is sometimes they're deciding just to stay in the family, as you might say, and creating joint ventures with other asset owners

to build GPs, to invest in GPs, to structure different access to risk premia that they don't feel either they're overpaying for or they don't feel like there's a GP that really nails it.

And so

they're using a much wider tool set to build a portfolio.

And I think this is fundamentally changing.

First of all, the job of the CIO at the asset owner.

It's a much more complicated job with the need for a much broader skill set.

The Canadian model kind of got this flywheel going.

And I think today we've even gone beyond and gone more advanced than that.

But I think the kind of traditional endowment model that, you know, Yale popularized, where, again, you've got an SAA and you're going out to this beauty contest and choosing the best managers to fill up these buckets is giving way to a much more complicated approach, but a much more beneficial approach to achieving investment.

The only thing worse than a 60-40 portfolio is really being paralyzed and doing nothing.

That's one of the strengths of the 60-40 portfolio.

It's very intuitive.

If you look at assets that a family office might want to invest in, there's literally an infinite amount of assets.

You have Miami real estate, Venezuelan oil, Norwegian electric cars.

There's an infinite amount of assets.

So, how does a family office go about building out a program?

And talk to me about the evolution and how you would start year one, year five, year 10, and talk to me about that.

So, family offices are unique.

You know, the old adage, if you've seen one family office, you've seen one family office, right?

So, it's hard to generalize, first of all.

But I think just to use maybe your example right there, first of all, I would say is that to circle back to the TPA or the more flexible approach, if a Venezuelan oil opportunity came up and your SAA or your asset class range that you had built with, in this case, the family or the groups of advisors the family had appointed to kind of govern you had already been at your max on infrastructure or energy or real assets, whatever the specific category is in which this would fit, you're stuck not being able to take advantage of Venezuelan oil.

Whereas in a TPA approach, you've got much more flexibility to kind of optimize capital and shift capital towards an area without these arbitrary limits.

So I just want to kind of put a cap on connecting the dots with some of those last couple statements.

I think when you're starting, what I hear often in a family office is

family offices, by their nature, inherently, tend to have more flexibility, more delegated creativity.

It doesn't mean that

the family office and the individual is not going to be deeply involved, but typically they're not as bound to a governance structure, maybe even an SAA generally.

They don't have to go through governance approvals that typically paralyzes it, you to use your word.

And so you've got much more freedom and nimble nature of degrees of freedom.

What you often see, though, is that a typical

wealthy family maybe is likely not an investment professional.

They likely were an entrepreneur, they likely had a liquidity event, and so as a result, you've got to build out institutional capability.

That means joint dependency and joint mutual respect that you have some delegation to choose kind of the under their terms of goals and risk and return capabilities and expectations.

You need to have some degrees of freedom to operate within that.

Developing these manager relationships is not easy.

Getting access to the best forms of particularly private capital, any liquid opportunities, is challenging.

It takes quite a while to break through

from a new LP perspective and to these very tightly and crowded and popular GP opportunities.

And so it really is a relationship building, networking-building exercise, and then certainly a

work in managing up to ensure that mutual expectations are set between the ultimate owner, the family, the individual, and the CIO office.

And we're seeing this

significantly accelerate the velocity of what was kind of inside baseball family offices that were run by the family or extensions of the family moving into a really institutionalized, professionalized, outsourced CIO effectively.

And that takes a lot of work,

but that is probably one of of the biggest themes that we're seeing: the rise, the maturity, the coming of age of the family office today.

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A couple of views on this.

One is there's certain things you shouldn't do.

You shouldn't give your money to a large bank and just kind of outsource that for many different reasons.

There's a principal agent problem.

You shouldn't try to build a program that's fully mature within a couple of years for a couple of different reasons.

And what you should do is you should focus on, just like a great business, where do you have the competitive advantage?

Where do you have the right to win?

So if you look at the top institutional investors, they're not trying to be a eight or even nine out of 10 in a bunch of assets.

They try to be a 9.5, 10 out of 10 on a couple assets, get the average in other assets.

The way that they fundamentally do this is they go direct or maybe even build out

a direct investing program and a fund program in a couple areas.

And then they might even use a fund to fund in other areas.

Where a lot of family offices get wrong is they actually go in the exact opposite.

They start direct investing because they don't have to pay fees,

losing millions and millions of dollars.

in mistakes.

And then at some point, they go to a fund, also usually adversely selected.

It's very difficult in a lot of asset classes to to get into the top funds without having decade-long relationship with a fund or in the ecosystem and then maybe if they concede in in year 10 they'll go to a fund of fund i think they should go the exact opposite direction which is start with a top fund of fund learn what good looks like one of the main things that you have to be able to be good investor in any space is to know what does excellence look like learn that so that at least you know when you're getting access to a good manager and then if the fund of fund is a good partner they'll start introducing you to the funds over time you start investing into funds once you've mastered fund investing then and only then and sometimes this could be year 10 you start actually investing directly into companies and directly into investments which is the most sophisticated thing you could do i couldn't agree more with that i mean i think to your point on principal agent uh which of course exists in any asset owner asset manager relationship but i think is uh particularly important and perhaps even more highlighted in a family office relationship.

Because first of all, you have to step back, and this is kind of identity, as I mentioned, and managing up and ensuring alignment.

Is this perpetual multi-generational capital?

Is this individual or family attempting to create a sustainable lifeline of wealth for grandchildren, great-grandchildren?

Or in many cases, and this is the other extreme, do we want to give this all away?

And we're maximizing for charitable giving, right?

There's a whole lot in between that.

But first of all, understanding where on that spectrum or continuum does the purpose lie.

And then, as a result, that changes

the purpose of the corpus of the funds significantly.

It obviously changes things like your asset allocation, the types of lockup and time horizon that you'd be willing to pursue.

And then I think what you're also getting at, David, which is really wise, is this idea of today's on-ramps.

Again, in the old days, you either

were in your 60-40 kind of public solution, or you had drawdown,

you know, double-digit year types of tie-ups or lock-ups on your capital.

There are a whole lot other options to get your feet wet, to use maybe a different way to say what you've said, as far as funded funds, co-investing alongside of folks, secondaries that allow you to create proxies for these illiquid asset classes and risk premia without overcommitting.

to your point.

Because again, that idea of learning and navigating and understanding this ecosystem is something that both the family member and the cio or whatever equivalent role that person is needs to get comfortable with before you dive in deep because if you go too quickly as i think you're getting at you're you're almost inevitably going to make some mistakes uh in both choosing your managers and asset allocation there's a concept from a previous guest alex fermosi that i love which is paying down your ignorance debt if tomorrow i was to go deep into private credit i would ask myself, how many years before I become an excellent in that space?

And how do I most quickly pay down my ignorance debt?

One way is to lose a lot of money, which is the default how family offices do it.

The other one is to invest into fund of funds, learn from their experience.

You'd not only learn from mistakes, you could also learn from successes.

Like I mentioned earlier, what does excellence look like?

See what excellence looks like, make the pattern recognition, and pay down your ignorance debt significantly faster than if you were just kind of blindly making mistakes.

I think that's really well said.

And I would just say this, not that aspiring or current CIOs of family offices need any advice, but this is the conversation you need to have with the family before you accept the job.

I mean, how many very recent examples have we seen?

of very wealthy individuals that have just cycled through CIO after CIO after solution after solution because it's clear they never aligned around these key principles that you're articulating.

So more than any other asset owner, you have to get on the same page because there's all kinds of behavioral, psychological, and personal elements that are somewhat neutralized when you're talking about an organizational asset owner, right?

But the individual is the asset owner.

And so that comes with all kinds of thorny issues you've got to sort through.

If you take a step back and you look at it from the lens of behavioral conditioning and behavioral psychology, a single family office is typically set up by somebody that is extraordinary successful, 0.001%.

And most of the time, they become extraordinary successful by relying on their instincts, by going against the grain, by zigging when everybody else was zagging.

So these tend to be very

confident, self-sufficient people that just happen to be going into a new industry.

So it could be a very,

it could be a recipe for a difficult situation for CIO to navigate.

Absolutely.

And that's exactly my point.

These folks should be relied on.

They have tremendous intellectual horsepower to add to the process.

But you've got to make sure you've got it maybe talking formally, separation of duties, delegation of authority, expectations mapped out, even verbally.

You know, this is typically informal, seat of the pants type work at most family offices.

And I'm just suggesting you will be much more successful and frankly happier if you have these conversations earlier.

And you have an interesting vantage point.

You're the CEO of CAIA Association.

So what is CAIA and what do you do on a day-to-day as the CEO?

So Kaya is the global professional body for the alternatives industry.

And so we've been that for almost a quarter of a century.

We started in the early 2000s, David.

And really the way I like to tell the story very briefly is that in the late 90s, when these unconstrained equity strategies were being birthed out of the investment banks,

allocators didn't know what to do with them.

To your point, they were almost all 60-40 back then, all public, debt, and equity.

And suddenly you had these very idiosyncratic, publicly traded strategies, trading strategies that

they didn't know how to fit.

into a diversified portfolio or what they complemented or what type of correlation they had.

Is this appropriate for a long-term portfolio?

And so there was this figurative pilgrimage up to Western Massachusetts at the University of Massachusetts, the business school had the very first kind of center, meaning it was an endowed kind of department that was studying what we now call hedge funds.

We didn't even have a name for this stuff back then.

But, and they built some indices and some products around how to track them, how to build kind of a universe of what was out there.

And again, how to properly use them from a research perspective in a diversified portfolio.

And out of that came this revelation that while we kind of had the traditional stuff locked up as far as in MBAs and maybe with the CFA, there was no body of knowledge or credential or certification for all this other stuff.

Now, the other stuff was just hedge funds back then,

but out of that came this idea for a educational program, formal educational program that is now called Kayak.

Now, fast forward

10, 12 years, GFC happens and private capital moves from the backwaters and the high finance cowboy world to mainstream asset classes and asset owners.

And so now our body of knowledge at Cayat is everything outside of public equity, debt, and cash, kind of a traditional portfolio construction.

So it would be all flavors and forms and stratifications of private capital, plus still hedge funds.

and everything in between.

And that's what we teach is kind of what are these asset classes, how to structure them into

a portfolio for purposes of long-term achievement and of investment outcomes.

To your question on

what do we do day to day,

education is clearly a big part of what we're trying to build.

I mean, that is our bread and butter, our capstone course is this high-stakes examination that we have 14,000, as you mentioned, charter holders that have matriculated through this program around the world.

I would say more importantly, though, our mission actually is to create the most energized community of investment professionals, whether they have gone through the program or not.

What we're trying to do is to help all investment professionals see around the corner what formative strategies are coming next.

It was hedge funds 25 years ago, but what's coming next?

How do you navigate modern capital allocation techniques?

That's why we were uniquely qualified to publish this TPA report that we talked about a little bit earlier.

So what's coming?

What's on the horizon?

What's next?

Next is here is kind of our mantra.

And so we see ourselves as kind of

the telescope to help professionals navigate what's coming down the road and

ensure that they're aligned around professionalism and ethics and their clients' needs in order to get there.

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As somebody who has multiple Ivy League degrees, I'm very skeptical of the relevance of kind of the modern education system in the day-to-day of the institutional world.

How do you make sure that your materials are relevant?

How do you make sure that you're preparing people for 2025, not for a decade ago?

Yeah.

So our entire

outline, body of knowledge, whatever you want to call it, is really built from the outside in.

This is no, just to break any myths or debunk any misunderstandings.

This is not an ivory tower of a bunch of academics deciding what the industry needs to learn.

It is, in fact, sourced, prioritized, sparked through conversations with high-level CIOs at big asset owners.

That's probably the disproportional source

of how that outline or body of knowledge kind of evolves to your question.

But we do roundtables and discussions and formal surveys with big asset management, senior leaders, with consultants, with all service providers to try to get a sense for how are all the actors within this system operating?

What are their challenges?

What are they fearful for?

What talent and skills do they need in the next generation of professionals?

And I just want to hit one more thing too, David.

Like when I go to talk to the big GPs of private organizations,

there's no doubt that there's this sense of kind of apprenticeship.

We teach our way and our approach on the job.

And I'm the first to say we have never positioned ourselves nor pretend to replace what that apprenticeship model does.

This is not about building the muscles of technical skills so that when you go sit down at your desk at Blackstone, you are more job ready to do what they want you to do in that case.

This is about helping someone understand

the metaphor I like to use is it's getting your industry GPS.

How do you navigate through this very complex and even increasingly complex industry?

How do you understand how LPs, your ultimate clients, build portfolios?

How do you understand how your organization fits within the broader sense of actors and value chains?

This is important stuff.

And I think the individual, I think our industry tends to be way too specialist

and track way too early and doesn't give you kind of

a generalist approach, almost

a liberal arts view of professional development.

Let me put it that way, multidisciplinary approach to professional development.

And all this convergence and TPA stuff we've been talking about is just further validation, I think, that you need much more rounded professionals, whether you're valuing a real estate asset, you got to be great at that.

You're going to learn that on the job at your GP.

But how that fits into a total portfolio, how to think about your professional development around this entire ecosystem, that's not something that that GP would would find interesting or important to teach you.

And I think that's where third-party education is critical.

One of the benefits of your vantage point is you're getting data from thousands of institutions and thousands of allocators.

What are the cutting-edge allocators?

What do their portfolios look like today, 2025?

We talked a bit about at the high-level TPA and how they're constructed, but just maybe just I'll break down some numbers for you because

Kaya takes a lot of primary data and great organizations, friends like PreQuin and Morningstar and others, do this as well.

We take a lot of that primary data, massage it a bit, and create what I think is the best representation of your question, which is what is the current AUM and how does it allocate across the institutional world?

So, on our numbers, total investable assets

globally, is about $120 trillion

U.S.

That's both high net worth and what we typically call institutional asset owners.

$25 trillion,

which is 21% or so, is in what we would broadly call or historically call alternatives.

So hedge funds all the way through all forms of private capital.

By the way, that 21%

is up from kind of mid-teens since the COVID time.

So it's just exploded.

And if you go back to kind of GFC, as I talked about earlier, when private capital was really on the outside looking in, had yet to mature as a significant industry, it was probably high single digits.

So this has really come up age, very quickly, become a quarter of the typical institution's portfolio and very short,

from a broader history perspective, very short order.

So 25 trillion in alts.

Over 40% of that is now in private equity.

And that's stratified from buyout, growth, and VC.

So I'm bunching all of private equity together into that 40 to 45% 45% or 12 or so trillion.

Five of it is still in hedge funds.

So that's where we started.

Hedge funds has been kind of $4 to $5 trillion for almost 10 years.

And there's been a wild roller coaster on that that you're probably familiar with.

We could talk through, but that's largely remained stable, still the second largest representation in that pie chart, if you want to think about it that way.

Real estate is on its heels, though.

about four and a half trillion of that, significant increase.

A lot of the Canadians and other asset owners, as I talked about earlier, are now buying direct real estate.

So when I talk about some of the massaging, real estate is underreported if you just look at funds, you know, drawdown funds, but significant real estate occurs through direct investing of these big asset owners.

So that's almost as big as hedge funds now.

And then you get a long tail of private credit, which is now $2 trillion, which is shocking, infrastructure, natural resources.

That's kind of the long-form flow.

Now, the only other thing I'd say is we all remember from our statistics classes, danger of the mean or the average, right?

I mentioned that 21% is the average.

If you look at a typical endowment where sovereign, it could be up at 40, 50, 60%

alternatives.

Whereas the high net worth investor, which is about half of that total $120 trillion, is 2% to 3%.

So you get this kind of mushy,

very flawed signal that the average is 21%, when in reality,

it exists in more of a barbell approach, depending on the type of asset owners you're talking about.

Reminds me of the saying, the future is already here.

It's just not evenly distributed.

Yeah, there you go.

I've had people on this podcast like Lawrence Calcano, founder and CEO of iCapital, and kind of the democratization of alternatives is a big trend.

How do we get that alternatives number higher in the high net worth, ultra high net worth?

And what are the main frictions to that today?

Yeah.

So I alluded to this earlier, but just to punctuate it a bit, again, the average institution is 40, 50%

alternatives.

the average wealthy family i'm talking high net worth and ultra high net worth even

over 10 million over 100 million you're talking two to three percent on average just to do some quick math for folks to get a sense for the tsunami or tectonic shift you're talking about in dollar terms before i get to your question uh if you simply just take two to three percent and modestly extrapolate.

So let's just say this thing doubles or gets to 10%

over the next 10 years, right?

If it's already 70 trillion, meaning the high net worth AUM is already 70 trillion, just do that math.

You're talking several trillion dollars of money moving from kind of traditional, let's call it ETFs or mutual funds to alternatives.

And so to your point, with Lawrence, and we work very closely with iCapital, this democratization thing is happening at very fast paces.

The demand is voracious.

I think most investors generally, particularly high net worth investors, realize they've been kind of late to the game, missed the game over the last two, three decades as private capital in particular has come of age.

And it's not that they're all just trying to juice the portfolio.

This is not a return pursuit.

This is about a diversification pursuit.

This is about access to the global economy.

As you know, David, 90% of U.S.

companies are private.

Something like 82%

of companies that have over 100 million of revenues are private.

So this is, I like to challenge folks that talk about return chasing with private capital, you know, the e-liquidity premium debate that we often have.

Is it two?

Is it three?

Is it five?

The much more important argument for private capital is just a pursuit of beta.

If you want beta to the global economy, the U.S.

economy, you simply have to have a significant chunk of your portfolio in the private markets, or you're going to miss a lot of the activity, a lot of the enterprising innovation, right?

Particularly in the new economy.

So I'll just set that aside for a moment.

On ramps, what's missing?

You finally have much to Lawrence and iCapital's credit, which is

really the category killer in many ways.

There are certainly some others.

But iCapital has really taken some of those earlier fund-to-fund approaches we talked about a few moments ago and institutionalized them and made them much more accessible to the average individual.

And so they've built this basically this software connecting tool that ensures that low minimums,

folks that don't want to do a lot of administrative work, have access to these other forms of risk premium.

So the aggregators, as I call iCapital and others, are certainly a big opportunity.

Probably the even bigger innovation are the private capital firms themselves, the GPs themselves,

also disintermediating their product development set and saying, look, instead of these traditional drawdown funds that have high minimums, long lockup capabilities, and the J-curve that we all know of, meaning it takes five, eight years before you're even getting positive breakthrough on your DPI, your return on cash, they're creating semi-liquid structures, semi-liquid products that allow the individual

with lower income levels, just from a regulatory standpoint, to participate.

But back to our liquidity question of earlier, and we can debate the merit of these semi-liquid structures, but it gives you liquidity in certain intervals or episodes, right?

It gives you a little bit more ability to have flexibility around your time horizon,

to pull a little bit of capital back, to invest in even things like ETFs.

State Street and Apollo just announced a private credit ETF, daily liquidity,

which we would have never thought.

So the point is, is that you've got this plethora on this new smorgasbord of opportunities that have moved to the individual, their liquidity, their psychology, their behavioral tendencies, and offered access to real estate, private equity, private debt now in a way that is much easier for advisors to execute on.

So I think those are probably the two biggest changes on the on-ramps.

We haven't seen regulation move.

That would probably be the third leg of the stool.

But I think that, and I'm specifically talking about the accredited investor rule

and opening that up even further, 401k access, some of these opportunities we've debated.

I expect that that's only a matter of time as well.

We just saw the latest change regulatory from SEC 506C, which basically makes 506C as difficult as a 506B

from a fund manager.

What that practically means is that a fund manager doesn't now have to confirm somebody's accreditation.

They could self-accredit, accreditize, which makes it so that venture funds, private equity funds can now advertise on podcasts or other media their funds and they're within kind of the same regulatory scheme of what they would have privately without advertisements.

Yeah.

Yeah.

And I would look

as the chartered alternative investment association, you know, educational not-for-profit, it would be, I'd be remiss in not saying that the disclaimer and the worry on all of this is that the product proliferation and the pursuit

of AUM and profit outpace education and understanding and fiduciary duty, right?

And maybe this is an obvious statement, but we've got to make sure that these advisors, meaning the intermediaries and the ultimate client, know what they're buying.

They know

the mismatch between underlying assets in some of these funds and maybe their psychology, their rooted psychology and access to liquidity.

We've already seen some headlines in the last couple of years about perhaps a misunderstanding in how often and how much liquidity they might have access to, kind of run on the bank type of behavior.

And so I think we've got to understand that at the very ethos of these private capital products is the idea that they are private and long-term.

And locking that up is almost

table stakes to ensuring that this operational improvement and the ultimate return pattern can actually manifest itself.

And if we apply at the individual client level public market thinking to the pursuit of these products, we're going to be in big, big trouble.

And so this, the educational machinery, obviously Kaya is part of this, but also the GPs are part of this, and they understand this.

It's got to really ensure that we're educating well and

with full transparency and that these clients really know what they're getting into.

I just looked up how many financial advisors are there in the United States?

There's between 240 and 350,000.

In many ways, they are the gatekeepers to the private capital.

And it's upon them and also upon the industry to help educate these financial advisors so that they can offer fiduciary education, fiduciary action for their end clients, and also make sure that their clients have a prepared mind where there is fluctuations, there is a liquidity.

I want to double click on the interval funds that you were talking about.

One of the firms that

were a Trailblazer in the Space Pantheon started about a decade ago, but now you could get it Blackstone, Stephstone.

And typically, a lot of these

interval funds will have a typically these funds will have a 5% liquidity maximum per year.

So if everybody tries to liquidate in any one quarter, it'll be pro rata.

So typically you have to wait at least five years to get liquidity, potentially even more.

And that's something people need to be prepared for.

That being said, there was a lot of controversy around, you know, Blackstone and everybody going for the gate and then only

giving 5% liquidity.

That fund ended up recovering.

And if there was this run on the bank, it becomes a situation where Blackstone would have had to sell a lot of properties in a fire sale, and it would become the self-fulfilling prophecies.

There's a view out there that these liquidity constraints are very positive.

I subscribe to that view.

It goes back to our beginning of the conversation on liquidity, whether it's a good or bad thing.

I think overall, it's actually a bad thing.

Unless you have unplanned events as an individual investor, you shouldn't have more liquidity than I think you could handle.

That last point is important.

Look,

I'm realistic and empathetic.

There are extraordinary situations in people's lives that require immediate liquidity needs, and we should not dismiss that.

I was with

a founder of a VC fund that all your listeners would know maybe two years ago, and he said something interesting, a little bit biased, kind of talking his own book, but he said he was talking to his, you know, 23-year-old that was in this individual's first job, establishing his 401k.

And there were no alternative or private capital options in the 401k.

And this founder basically said, you know, why would a 23-year-old need any liquidity?

Now,

that's a very extreme view.

But again, you're 50 years, let's hope, or 40 years away from retirement, 50 years or more, we hope, away from death and the need of all that liquidity.

Do we really need to be 80, 90% liquid at that age?

Certainly what I tell my children is that this stuff, you know, set it and forget it.

This is long-term.

Don't be thinking about access to this at all in your calculus of

your operating budget and even your chunky savings plans.

This is decades off.

So I think that's the right way to think about it.

And if you're in deaccumulation stage at folks like my age, 50 plus, moving towards retirement, again, that's a different liquidity profile.

And you plan around that.

But once you've decided with my liquidity budget, I don't need access to this.

then let it go.

And I think, again, we're working against long conditioned psychology that I want access to everything all the time.

And that should be normal.

And that's a real danger, I think, in building portfolio allocations.

Just said another way, how do you actually, as a 23-year-old investing in 401k, how do you actually get liquidity?

Let's say in five years you wanted liquidity.

There's no way to get it.

You could take out $10,000 for your first home, I believe.

You could borrow for 60 days.

These are all like one-off, one-off transactions.

But even if you wanted liquidity, you couldn't get it.

So why in the world would you be 80%, 90% liquid if there's there's no way to actually exercise that liquidity, even for hardships?

We put these arbitrary penalty gates on, which I think are a

quite wise

inhibitor of pulling out.

But

yeah, I think you're absolutely right.

I think this, and this is probably the biggest missed opportunity so far, is the 401k structure maybe, given its retirement, long time horizon.

identity, as I just articulated, it may be the best vehicle to start introducing and sprinkling in private capital.

Maybe even more so than these direct interval funds and registered funds that we're seeing pop up almost daily now.

And yet we haven't had the ability to do so.

So I'm really hopeful that we'll get an opportunity.

I have to plug one of my portfolio companies,

formerly Alto IRA, that allows you to actually take your Roth IRA and or your IRA and invest into alternatives.

Similarly to iCapital, they have created all the guardrails to do it at a very cost-efficient manner.

So shout out to Alto.

When you look at the future of alternative industry, let's say these frictions get out of the way.

What does the alternatives industry look like in 2030?

Perhaps the most ironic thing I'm going to say on this discussion with you is that Kaya has oddly been in the business of making the word alternative or the category alternatives obsolete.

Now, it's in our name.

So I'm going to have a branding problem I'm going to have to deal with, but that's my issue.

But

alternatives, at least most of the categories that fit that vernacular are largely mainstream now.

I mean, is private equity and hedge funds really that alternative

and unknown and off in the distance to my point on Neapolitan and blending of portfolios a bit more.

So I think, first of all, there's going to be an understanding that the standard of building a portfolio includes all of these different spectrums of opportunity, that it is not just about 60, 40 and then plus a little bit of this other stuff, right?

It's eight to 10 options instead of two that we historically and that our parents built portfolios on.

So that's first is mindset, culture, language, logos, the way that we talk about it.

The other thing is that this is going to be a lot bigger for all those reasons.

I think in most institutions, I mentioned 40, 50, 60, there's not huge upside.

GPs see this.

There's not a huge upside in massively moving to the liquidity budget a bit earlier because these asset owners, these corpuses have liabilities typically, in moving the Yale endowment from 60 to 80 percent private capital.

That's not going to happen for obvious reasons.

But when you're starting at 2% to 3% for half of the world's AUM, again, back to

the high net worth, that number is going to explode.

And as I mentioned, just a couple more percent, just doubling that or going to 10%, still a fraction of even the bottom range of an institution is many trillions of dollars flowing into alternatives.

So I'd expect from a number perspective that that 25 trillion I mentioned earlier, jumping above, well above 30 trillion, being 25% or more of your typical portfolio.

And I think most of that will be wealth management buying private capital in different forms, as we talked about.

So I think that will be, if we were to wake up from our cryo chamber in eight years, what we'd see.

I think if you look at people's portfolio, if they're in the market cap weighted S ⁇ P 500, at some point they had 70 or 80 percent of their money in the magnificent seven.

So another way they were not diversified.

They might have thought it sounds great marketing SP 500, but if 70, 80 percent of your money is in a handful of stocks, you're not really diversified.

Similar to you, I believe that if you don't have some of your money in alternatives, you are short alternatives.

You are actively deciding not only to go short private equity, venture capital, private credit, and some mix of that.

Obviously, some of these are risky assets with long-term horizons, but you're also choosing not to diversify.

We started the conversation with Harry Moskowitz, who won the Nobel Prize for his theory on Efficient Frontier, which basically showed this graph of returns and risk, which basically you could have higher returns with lower risk.

or the same returns with lower risk.

So it's not a question of why should you invest in alternatives.

It's a question of why are you not investing?

Why are you shorting alternatives?

We have the CIO of Bitwise.

He said a similar thing on Bitcoin.

Bitcoin is 2% of the

global market cap.

If you don't have Bitcoin in your portfolio, you're saying I'm short Bitcoin, essentially.

You're making a directional bet against Bitcoin.

I think that's a way to get people to

get off their butt and basically make decisions.

Because as in many things in life, not making a decision is a decision in itself.

Maybe just to

raise that even further, you're short the future, right?

And I'm not meaning to be dramatic, hyperbolic with that.

But as I said, and as you said, SP 500 is largely big tech.

And that doesn't mean they're not innovating and they're not still going to dominate for a long time, but also old tech, right?

Where is all the new economy existing?

Will they're staying private longer, sometimes forever?

Most debt and credit is existing for a whole lot of reasons that we didn't talk about, but obviously regulation and the bank's sensitivity and capitalization ratios.

Most credit is being extended in the developed West through private channels.

And so if you want to fund the new economy, you don't even need to take a view on which asset classes are going to be

the best performing.

It has to exist in private capital.

So you have to start with kind of that general existential question, right?

The majority of the economy exists in the private capital markets.

And then from there, I think you're right.

Is that just being wise about how to pursue it, building these on-ramps, ensuring that you're well educated, ensuring that you're sophisticated, ensuring that you don't jump in that deep water, as you articulated well, David, a bit too early.

But I think absolutely this is not, we're in the early innings of all of this, particularly on the high net worth investor.

And diversification is a good thing.

And I think for most of us that are, let's just say, 40 years or below, and I I don't mean this as a judgment, it's just fact, most of our careers have operated in a risk-on beta environment, public equity markets tearing up

the scorecard.

And that's not normal.

It's felt normal for a long time, but that's not normal.

If we go back to a more normal, alpha-oriented...

more disciplined approach to separation between asset classes and geographies and styles, then I think you're going to need a much more diversified portfolio with different access to risk premia and cash flow mechanisms.

And I think those investors will be rewarded in the coming years.

You're really an advocate for having a general understanding of different asset classes regardless, regardless of which asset class you're in.

Why does it matter if I'm a GP in private equity, why does it matter that I understand private credit?

And what's the rationale behind that?

We touched a little bit on this earlier, David.

One is simply that we're in a world now that has blurred a lot and being a multidisciplinary professional is much more important than it used to be.

So I think this industry has suffered from maybe the doctor mentality, right?

You go through your pre-med,

they all go to medical school, but then they specialize very quickly if you want to be a dermatologist, right?

You would never go to a dermatologist to your question and say, you know, can you help me?

I think I sprained my ankle, right?

Go to orthopedic for that.

Or if you think you have cancer, you're going to a very different type of doctor.

And I think that is a flawed approach.

It's been the way that we've thought about investments historically, but it's been a flawed approach because, again,

the world has changed.

Systems thinking, the ability to understand and put together and see connections across asset classes, across geographies, now the introduction of geopolitics, structurally higher interest rates and inflation,

parallel trading and

supply world that

are now coming into fruition.

All of these things play a massive role in how to think about an individual valuing a specific asset.

And so even if you're stuck deep as a junior level associate valuing a piece of real estate property, just to kind of illustrate your question,

you need to understand the LP that's walking in the door to consider your strategy, even if you're not the head of IR, even if you're not the head portfolio manager.

that they're thinking about the total portfolio and its inclusion, as we talked about at length, in delivering on an investment outcome.

I think the days where you're parading through a bunch of real estate GPs and it's a beauty contest, who's got the best return capability to fit a certain bucket because I've got a certain need, those are largely over.

And if GPs, I say this all the time to GPs, if you're still approaching the LP that way, you're not speaking their language because they're thinking about a whole lot of other different dynamics.

So again, I go back to it, doesn't change the fact that you need to learn, again, this illustration, real estate valuation in an apprenticeship model, bumping shoulders, you know, rubbing elbows with all of the senior folks to learn your craft.

But understanding the ecosystem, the GPS illustration, I think is critical for the future investment professional.

It's not mutually exclusive.

You want to be the best real estate GP, and also you want to have a strategic view on the industry.

If you want to be in a leadership position, either on the LP or GP side, you have to understand

the ecosystem.

I talk to venture capital funds all the time.

You're You're not only competing against other venture capital funds, you're competing against private equity, you're competing against SP 500.

Whether you know it or not, you have to understand the risks and rewards of each asset classes and the pros and cons of investing so that you could sell against your competition.

How do you sell against your competition if you don't know who your competition is?

We didn't talk about it much, but the MA, even within the GP world, where the traditional folks, you know, the T-Row prices, pick your poster child of 90s, 60, 40 asset management, right?

Maybe it's T-Row Price, maybe it's Franklin Templeton, BlackRock.

These folks are aggressively moving into private capital.

So even if you're sitting in your seat to use our poor associate in real estate, you're suddenly surrounded by six or seven other asset classes just within your organization before you even get to the LP discussion I tried to articulate earlier.

So understanding how

that market, that huge stable of thoroughbreds that the organization is now committing to and how it is expressed to the public, you need to be way more than head down in valuing your Class A office building in Detroit.

I think that would be a very narrow way to think about both your own professional development and your success within your particular firm.

How should people stay in touch with you?

How could they learn more about Kaya?

Very active.

We try to be fun and human on social media.

So I would check out our Kaya handles.

And I'm pretty active on LinkedIn and on

alternative memes.

Sometimes, particularly on X, I'm a little bit more playful on X than I am on LinkedIn but

to my point on energized community earlier our mission is about having a bit of fun along the way like let's not take ourselves too seriously David I think sometimes we suffer from that as an industry if I'm honest so certainly our handles through LinkedIn and through X kaya.org is where you can find out about these educational programs I've alluded to many times.

I didn't mention the,

we obviously have our high-stakes Kaya credential.

We talked a bit about the wealth management challenge, opportunity end challenge.

We launched an entire online platform to help the wealth management value chain kind of get up to speed on this.

Think of Netflix library of opportunity at the asset class and portfolio construction level.

We do not want to let them hunt and gather by themselves.

They need a lot of help.

They need some hand-holding along the way to get up to speed, get their acumen up on the alternative side to ensure they're good fiduciaries.

So that is all available on the website.

Tons of content, whether you're a member or part of the community or not, thought leadership, podcasts, blogs, newsletters.

You can access the large majority of what we offer, whether you're a paying member or not.

Well, John, thank you for the work that you're doing and looking forward to sitting down in person soon.

Dave, it's a pleasure.

Thanks so much.

Thanks for listening to my conversation with John.

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