E244: Structural Alpha vs. Storytelling w/Alan McKnight

Speaker 1 Alan, you're the CIO of Regents Banks, which manages roughly $70 billion in AUM. And if you count assets under advisement, $175 billion.

Speaker 1 You advise both pension funds on one end and smaller offices on the other end. Tell me how you deal with these two different asset classes and how do you advise them differently.

Speaker 2 Well, we take a very similar approach when it comes to advising them on total asset allocation and how they should be allocating capital.

Speaker 2 The biggest difference we see between the two parties would be around illiquidity and both their willingness to bear illiquidity and their ability to bear illiquidity.

Speaker 2 And every client is different, but when you think about those two groups, so often there's a desire to bear illiquidity, but then you have to unpack a bit to better understand how much do they really need from a liquidity perspective.

Speaker 2 And as they start to allocate across asset classes, particularly in the private realm, how much can they bear? How much liquidity will they need on a monthly, quarterly, annual basis?

Speaker 2 Because that's then really going to inform how they're able to allocate over the long term.

Speaker 2 And so we think they should take on very similar approaches in terms of the allocations, but you really have to understand both their willingness and their capacity to bear illiquidity.

Speaker 2 And the reason for that is that if they can bear more illiquidity, they can clip a much higher return.

Speaker 2 What we've seen over the past decade is in the private realm, you should be able to generate on an order of magnitude 200 to 500 basis points of additional return by allocating to privates and specifically private equity.

Speaker 2 But you also have to know that as we see today, you may be locked up for longer. You may not be able to access that capital as quickly as you had hoped at the outset.

Speaker 2 So that's going to be the biggest information component to the decision-making process.

Speaker 1 The way that I kind of look at this issue of assessing your liquidity needs is let's say you have 10 or 20 million dollars. First question you ask somebody is, how liquid do you want to be?

Speaker 1 And of course, everybody would say, I want to be totally liquid. And then if you reframe it as, let's say we give you total liquidity, you're going to be paying an extra three or 4%

Speaker 1 of charge on that liquidity. How much liquidity do you want now next quarter? And then people really start to think, well, maybe I don't need all 10 million.

Speaker 1 Maybe I'll only need 1 million over the next couple of years because I don't want to pay the 3% to 4% on the other 9 million. So it's really about how you think about your need for liquidity.

Speaker 1 And if you're aware of the trade-off of having liquidity versus illiquidity, that's when people really start to be really critical about what exactly they need.

Speaker 2 That's exactly right. And I think to that end, when you can start to model out what their true need is for liquidity, when you can map out to your great point, what does that look like next quarter?

Speaker 2 What does that look like for next year? What other additional investments do you have?

Speaker 2 And particularly in the smaller family office side, some of those may include private ownership of businesses and what that may look like as well.

Speaker 2 And then the other component to all this is around what Daniel Kahneman calls system one versus system two decision making and this idea that while you may be able to bear more ill liquidity, if your personality set is such or from a psychological perspective, you have this desire to jettison assets, you get very worried, you won't sell things, or even more of an emotional bent to that,

Speaker 2 that's not the place to have a higher allocation to privates. And again, that comes with time.
and with engagement and discussion with clients, but that's critical as well.

Speaker 1 It takes a certain level of self-awareness or experience to really understand your risk tolerance. A lot of people are completely unaware of how much risk they're willing to take.

Speaker 2 That's exactly right.

Speaker 1 When we last shouted, you mentioned that family offices with less than $100 million in funds have more access today to private investments, all sorts of very exotic types of investments than ever before.

Speaker 1 What are the confluence of factors that are providing this access to the sub $100 million

Speaker 1 investors?

Speaker 2 There are a litany of things that have really driven this shift in allocations and the ability for smaller entities, whether that be smaller family offices or smaller foundations and endowments.

Speaker 2 In both cases, they are now able to access a lot more. And one of the key components to it is technology and the ability to actually access investments.

Speaker 2 not just from a pure investment perspective, but from an administrative perspective, from a platform perspective, to better understand where their allocations reside, the ability to seamlessly allocate to those investments.

Speaker 2 It was just much harder and more rigorous years ago. And I think about when I first started in the business in 1994, to be able to do that.
The technologies didn't really allow for it.

Speaker 2 It was a very paper-based approach. And even the knowledge of many managers was not there.

Speaker 2 And so to be able to now, one, scale it from a technological perspective in terms of access to these managers and the ability to actually enter into these agreements.

Speaker 2 And then two, the knowledge and understanding of these asset classes. 20, 30 years ago, it was primarily an institutional world.

Speaker 2 And those managers and funds weren't really making a lot of effort within the smaller family and smaller private endowment and foundation markets. Now they are.

Speaker 2 And they're actually able to present and provide a lot more information alongside of what we've seen for many years in the public market.

Speaker 1 I had the CIO of iCapital, Lawrence Calcano, talk about this $150 trillion from retail going into the alternatives market, roughly the same size as all of institutional today.

Speaker 1 Now, I caution people, retail this people with over $5 million

Speaker 2 for what it's worth. That's right.

Speaker 1 Which is a very interesting, it was a very interesting definition of retail.

Speaker 1 But at the same time, today you have the top five firms, Apollo, Blackstones, accounting for 95% of this quote-unquote retail capital is only going to those five firms.

Speaker 1 What needs to happen for more managers to have access to this channel?

Speaker 2 I think it comes down to technology and scalability for some of the smaller and mid-sized managers.

Speaker 2 I think what we've seen for those large firms, one, they have an enormous sales slash marketing force to be able to get out and engage with clients.

Speaker 2 And to your point, the definition of client may vary, but they're able to get out and in front of that. Not dissimilar to what we saw over the past 50 years with public market firms.

Speaker 2 When you think about the fidelities of this world, the vanguards of this world, these really large public market investors, they used to be where the Blackstones and the Apollos and the KKRs were back in the 90s and 80s.

Speaker 2 And so it's really come a long way. And so I think they're now getting in front of those more.

Speaker 2 I think for a small or mid-sized manager, it's going to require more dedicated marketing and sales relationship management, as well as this concept of the actual fund and what those funds look like.

Speaker 2 Now, the more liquidity that you can actually provide to your underlying clients or prospective clients, the more information and transparency you can provide, the greater opportunity you'll have to be able to scale your fund and your firm over the long term.

Speaker 1 So it's about educating the market,

Speaker 1 doing the thought leadership, but also about product market fit.

Speaker 1 The same product that might be for institutional investors might not be for your regular family office or or your or your smaller ultra high net worth.

Speaker 2 That's exactly right. And I think that's the thing is it's not one size fit all.

Speaker 2 The manager side of the ledger, they need to be able to better understand what is really that fit and better understand where do they want to deliver that.

Speaker 2 And at the tip of the spear, what that relationship look like.

Speaker 2 And then from the LP side, better understand that just because you're inundated with information and they're all all these great managers, you need to build a diversified portfolio.

Speaker 2 So how can you do that in a way that is right for you, on your liquidity needs, as we talked about earlier, and on your overall asset allocation and what that may mean?

Speaker 1 One of these new products, it's not really new, it's been around for a decade, but now popular products are these semi-liquid interval funds.

Speaker 1 What are interval funds and what are the best practices today for managers that are building out these interval funds?

Speaker 2 Well, one, we are fans of the interval funds. We know that there are some challenges.

Speaker 2 There always are. When it comes to investing, there's no free lunch in investing.
There's no silver bullet. It's not as though that everything is going to solve every challenge.

Speaker 2 But at the core of it, the idea of an interval fund is one that allows a non-institutional investor to access private markets across the landscape of what that may mean at lower minimums with greater transparency and better, quite honestly, liquidity features typically over the long term.

Speaker 2 Now, with that, what that means is that doesn't mean that you're getting full public market, for the most part, type of liquidity, daily struck NAVs, and that you can quote unquote trade during the day.

Speaker 2 But you will have regular intervals that you can actually enter into additional asset growth or you may want to allocate more capital, or conversely, if you want to leave those funds.

Speaker 2 Now, the one big challenge that we always want to highlight to to our investors and when they're allocating interval funds is that if there are a number of other investors who are trying to get through the door at the same time as you, make sure you've really looked at the fine print around what your rights are as an investor and as an LP, because there may be some, there may be some restrictions along that.

Speaker 2 There may be gates associated with that.

Speaker 2 And we've seen that with some large funds that in the best interest of all investors, you may not be able to receive the liquidity that you might have hoped for or planned for at that time if a number of other parties are also trying to exit at the same time.

Speaker 2 And so I think that's the one thing about interval funds. So many great characteristics in terms of minimums, in terms of transparency, in terms of fees.

Speaker 2 But the flip side of that is you're going to bear a little bit more of a restrictive component for the most part

Speaker 2 within the liquidity feature.

Speaker 1 There seems to be the standard of 5% liquidity a quarter, so roughly 20% per quarter. And that's prorated.

Speaker 1 So if everybody goes for the gates, then if theoretically 100% redemptions are put into any one quarter, which is highly unlikely, each person will get roughly 5% of their investment back.

Speaker 2 That's exactly right. And I think that

Speaker 2 one of the way we've explained it is that while an integral fund gives you the concept that you'd be able to receive that liquidity consistently, sometimes it can be more binary in terms of if everyone is getting out, it may be more restrictive.

Speaker 2 When no one is wanting to, you actually should have no challenge with it. And so

Speaker 2 it's the muddy middle where you really need to understand what you may need. And again, getting back to our original points about liquidity and what that looks like.

Speaker 1 I want to go over the two use cases. One, there's two forms of liquidity needs, which I think get conflated.
One is some view on the market, equities are overvalued. Let's go into bonds.

Speaker 1 This is kind of a market sentiment liquidity. And then there's the individual.
Somebody wants to send their kids to college. Somebody wants to buy a new house.

Speaker 1 There's that kind of lifestyle liquidity. There's no real term, so perhaps we could define it, but some life happens liquidity.

Speaker 1 In the case that it has nothing to do with the market, and what percentage of times do you see clients able to totally liquidate? Or just talk to me about that. Like how practical is this liquidity?

Speaker 1 And if you have somebody that says,

Speaker 1 My kid wants to buy their first new home and I want to help them with that. I want to get them out in next year.
How likely are you able to get them out in a typical market environment?

Speaker 2 Well, I think that's the critical component there is the typical market environment. So unfortunately, it's rare that folks are asking for that in the normal market environment.

Speaker 2 But when they do, we would say

Speaker 2 you are able to access those funds and you will be able to actually receive the liquidity that you would hope for and that you should be able to garner via the docs. But let's back that up.

Speaker 2 prior to and try to set as many of those down prior to investing in a private vehicle around what are some of the key items that may be coming up at some point.

Speaker 2 It doesn't mean that something doesn't happen and you don't have a situation where, to your point,

Speaker 2 child is going to college, buying a house, or even when you think about the

Speaker 2 smaller foundation, where I still remember back in 2008, I was working with a small private foundation.

Speaker 2 And given the crisis that was going on and what had occurred with many beneficiary organizations that they were funding, they actually stepped up and needed more liquidity because they are actually raising their spending spending rate during the 2008, 2009 time period.

Speaker 2 Well, suddenly, a situation that we've never really contemplated because they had always had a 5% spending rate. No, we don't need that capital.
We can continue to let it grow. Well, now we do.

Speaker 2 And so those are the, that's a market dynamic. But the more you can, you can sort of plan for some of those market dynamics at the outset and keep that in

Speaker 2 sort of on the back end of something that could happen, the better off you'll be. So it is possible, but it's the work that needs needs to be done up front.

Speaker 1 Why does that happen so rarely in a typical market environment? Is that because people are so good at planning and only changes in the market environment create these liquidity needs?

Speaker 1 Or why is there such a disconnect there?

Speaker 2 I think the reality is that

Speaker 2 most people are comfortable with illiquidity in a normalized market environment.

Speaker 2 And they sort of, even though the NAV may be going up and down, they don't really challenge themselves on it until there's an environment where they start to question themselves.

Speaker 2 Getting back this idea of condomin and behavioral economics in finance, which is as humans, we make a lot of bad decisions.

Speaker 2 And the time we typically do that is when things are going on, we've been comfortable with that steady state for a long time,

Speaker 2 even if returns haven't been what we had hoped. It's not until we have to challenge our overall assumptions about market structure and what is happening that we start to see that.
And

Speaker 2 it's never perfect.

Speaker 2 But again, if you can create a liquidity bucket at the outset, but both for individuals on the retail side of the house, but also on the institutional side, because they're not immune to this either.

Speaker 2 I mean, the institutions are made up of individuals. And so they will feel some of the same pressures regardless of what they may consider at the outset.

Speaker 1 If I was to go to the extreme opposite end of the spectrum, and if I was to use interval funds as really semi-liquid, and if I wasn't trying to outsmart the market, you know, sly at the bottom of the market, which I think is extremely difficult, could they be used more proactively as a way to generate an illiquidity premium with otherwise liquid assets?

Speaker 1 I know that's an extremely risky strategy, but let's just go down this thought experiment.

Speaker 1 Let's say that an institution wanted to take that illiquidity risk, the risk that their funds would not be liquid. How would that work?

Speaker 1 And does that make any sense versus kind of a stock and bond liquid portfolio?

Speaker 2 I think it can. I think one of the ways you could do that is almost consider it more of

Speaker 2 having a larger weight to the interval side, which would be more on the private market side, but then having almost what I would describe as extreme liquidity on the public market side and balancing those two.

Speaker 2 So this idea that, you know, some, when they talk about public markets, they say, yes, they're fully liquid, but the reality is if there is a market dislocation and you have a sell-off there, you're loath to want to sell into that.

Speaker 2 So that could be your standard public market investment to emerging markets. That could be at international developed.
That could be small cap, micro cap, you name it. And so I think that's the

Speaker 2 element that you have to consider as you go into it. And on the interval side of fun things, you can use it and leverage it, but understand that

Speaker 2 you may need to sell some of your public market exposure that doesn't feel great at the time.

Speaker 2 You may not want to wear that at the time, but you're going to need to do that if you need to then fund some other investments over on the private side that are compelling at the time.

Speaker 2 And not be able to, if you can't access those, if there are some restrictions in that and some gates in that that are not going to be, you're not going to be able to get over.

Speaker 1 One interesting way that I've seen interval funds work or these semi-liquid structures is the CIO of North Dakota Land Trust, Frank McHale.

Speaker 1 And before they go in and pick out their managers, they try to get exposure to the beta out of the asset class.

Speaker 1 So in this case, they would go into lower middle market private equity through an interval fund.

Speaker 1 And as they bring on the alpha, the managers that could outperform that benchmark, they start liquidating the interval funds and start allocating to those managers.

Speaker 1 What do you think about the strategy?

Speaker 2 I think it's a great idea. And I think if you can access that in a way where, again, you've almost have a step function of how you allocate and you feel comfortable with that.

Speaker 2 I think one of the interesting components to that, I was thinking about this over the weekend. I don't know if you've ever heard of, there's a famous pianist named Archer Rubenstein.

Speaker 2 He's well known

Speaker 2 in the early 1900s, and he was judging a piano competition in 1932 in Warsaw, the Chopin competition.

Speaker 2 And famously, when all the judges came together at the end of the competition, he had only scored all of the competitors either 0 or 20.

Speaker 2 And people were flabbergasted. They said, You can't do that.
There has to be something in between. And his response was, no, you can either play the piano or you can't.

Speaker 2 And so I think it gets to this idea of alpha, an active manager alpha, and that there are that many alpha generators out there.

Speaker 2 I think that's one of the challenges that we all face in the business, which is it's not as though just because you can raise a fund or because you can be an allocator, you're going to be able to discern what is alpha and who's going to be able to generate that alpha.

Speaker 2 So I think that works to your good question around reallocating to, but you really need to understand, am I moving myself on the frontier?

Speaker 2 Am I improving myself upon the frontier by reallocating that out with the illiquidity that I'm now starting to bear?

Speaker 1 I love that you've mentioned the behavioral economics and all these things. And I think one of the issues that a lot of people have is they don't start.

Speaker 1 The only thing worse than actually selling at the bottom, which I think is like the biggest behavioral finance repeatable mistake, is actually not even investing.

Speaker 1 So if you think you put in $1,000 in 2000 in 2001 at the trough of the market, then it goes up to 2008, and then you sell at the exact, you literally hit it at the exact same day, you're still up 3, 4 X.

Speaker 1 It's much better than having that $1,000 and either spending it or having it in treasuries.

Speaker 1 And I think one of the great things about the strategy, and you could use them in public markets, you buy the S ⁇ P 500 500, and then you try to, yes, you do your research, you do deep fundamental research.

Speaker 1 Maybe you find only two stocks that you think you have an advantage over the S ⁇ P 500, but it solves that kind of analysis paralysis issue, which I think is extremely underrated.

Speaker 2 You're exactly right. We talk about it a lot.
And the way we've thought about it is this idea that you have to get both sides of the trade right. It's not just selling.

Speaker 2 So the idea of market timing, I'm going to sell and I'm going to eat cash. But to your point, what's going to prompt you to get back in?

Speaker 2 Because as long as the market starts moving higher, there are going to be a litany of reasons why you should stay in cash. It's going to feel good, that human behavioral aspect.

Speaker 2 Oh, it's going to feel good. Oh, it's going to turn back down again.
I'm going to catch it again when it goes down.

Speaker 2 What we've seen from all the data is that we don't do that. Investors don't then reallocate it

Speaker 2 when things start to get bad. And so they basically watch it all the way up and they miss the majority of the return.

Speaker 2 And it may feel better, but it's incredibly punitive to your returns.

Speaker 2 You know, and We're big fans of the Stoic philosophers here and this idea of FFT is talking about we can't control the external events around us, but we can control our reactions to them.

Speaker 2 That's sort of the seminal point for us around

Speaker 2 things are going to go on. You're going to get the noise.
It's the ability to withstand that noise

Speaker 2 and

Speaker 2 keep getting back to the data and the hard rigor of that that is going to allow you to generate the types of returns you need, whether you're an individual or an institution.

Speaker 2 If you're a private foundation, you're spending 5% a year and you've got inflation and you've got costs.

Speaker 2 Just to stay even, you're going to need to generate an excess of 8%.

Speaker 2 So

Speaker 2 you have to take that type of mindset in our view.

Speaker 1 To take it down to the neurobiological level, so if you think of human beings as biological beings, is you have all these things that are happening in your mind. The amygdala is triggered.

Speaker 1 You have all these stress hormones when things go down. And it mostly leads to analysis by paralysis.
So people do nothing,

Speaker 1 which is, you know, probably in A-

Speaker 1 response to the market going down. Sometimes it leads to panic.
You can't deal with the panic. That's the worst thing that you could do.

Speaker 1 The former CIO of Northern Trust, Thomas Swaney, and he thought it was very important for his bond portfolio.

Speaker 1 to be truly hedged against the stock portfolio so that when stocks go down, the bonds actually go up in that once a once a decade event

Speaker 1 and if you double click on this neurobiologically as you're receiving pain mentally you're also receiving positive and dopamine and positive emotions which allows you to have a neurology neurobiological balance to take kind of more rational action because i think that's the issue is people get out of their rational mind into their kind of like reptilian part of their brain to their very stress stress and and irrational part of their brain that's exactly right and i'll humorous anecdote.

Speaker 2 When I was first in the business, I worked with a trader, Georgie, and his comment to me when I was very young in my career was when the market was going down, he said, Alan, you know what I do?

Speaker 2 And he sat on the desk there. And this is the old school days of, you know, the phone's out, the turret.

Speaker 2 And he said, you know what I do every time when the market's going down and I just want to call and sell a bunch of positions? I said, no, Georgie, what do you do?

Speaker 2 And he said, I put my finger in the drawer and flam it a couple of times until that feeling goes away. I can't help but think of that.

Speaker 2 When you have days like earlier this year in April, you have Literation Day, and you have there's always something.

Speaker 2 And to your point, maybe sometimes you need just a physical action to try to limit yourself from making bad decisions.

Speaker 2 Get back to the playbook as an investor, particularly as an institutional investor, keep coming back to the playbook as a high-performing investment team. What are the things you need to do?

Speaker 2 How do you communicate? How do you ensure that you're thinking through those things? Are you fully hedged? Can you look at the numbers again? Is it actually doing what you think it's going to do?

Speaker 2 And I think that's going to be the

Speaker 2 to drive your success long term.

Speaker 1 One of the

Speaker 1 either entertaining, if I was to be a little bit diabolical or sad aspects was that

Speaker 1 people re-engineer how they act during the last crisis and they basically either pretend that they didn't panic sell or that they took the right action. And that happens again.

Speaker 1 We saw this in the Trump tariff earlier this year. So many people were telling me, well, yes, if we didn't have the discipline, this would be a great strategy.

Speaker 1 This is a great theoretical strategy for this other person. And then I saw with my own eyes these people making the same decisions and selling at that 20% dip.

Speaker 1 I think there was like a one-month recovery from the Trump tariff kind of trough.

Speaker 1 So you just see this over and over.

Speaker 2 And over and over, people

Speaker 1 delude themselves into thinking that the last time they took the right action.

Speaker 2 And I actually was,

Speaker 1 I was very impacted when I listened to Stan Drunken Miller, arguably one of the greatest traders of all time. He was George Soros' first trader.

Speaker 1 And when he said that nothing seems as cheap as after this went up 40%, once I realized that Stan Drunkenmiller was subject to that same human bias, I kind of gave myself the grace to think, you know, instead of trying to become

Speaker 1 a better trader than Stan Drunkenmiller.

Speaker 2 Yeah, good luck with that. Yeah.

Speaker 1 Perhaps better to have self-awareness and know these human biases and to structure around them ahead of time instead of trying to do this like heroic action that nobody seems to be able to do.

Speaker 2 Without a doubt. To double click on that, I think one, I've never met a back test that I didn't like.

Speaker 2 Whenever someone shot something in front of me, how it would have solved every past issue, every past complaint would have been solved with this wonderful backtest.

Speaker 2 I'm highly skeptical. And it's the other element of,

Speaker 2 you know, it was great when we were living on the savanna and being chased by a predator. Yes, you should just run as quickly as you can.

Speaker 2 That's not the same when you have your terminal up and you're seeing a cascade of red. But to your point, it happens to everyone.

Speaker 2 And the best of us are able to, are able to, on the margin, not allow ourselves to be sucked into it. But it's still very easy to do.

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Speaker 2 I think the other element to that and this whole discussion about privates is critical because

Speaker 2 when you are locked up, in many cases, you can't do anything about it. And that's a huge benefit that people don't talk about quite as much.

Speaker 2 But the fact that you can't do anything about it limits that human desire to jettison an asset, to do something about it, because it's immaterial.

Speaker 2 So I think that, you know, people don't talk about that as much, but I do think that's a real benefit to private market investing that has helped generate some of that illiquidity premium is that you just, it's not possible, which will be interesting now.

Speaker 2 Once we start to get more data on interval funds and more of these hybrid types of vehicles, I think it's going to take us a little time to sort of see what, what really did that generate?

Speaker 2 Like, do we see similar returns to your point earlier about North Dakota?

Speaker 2 Is that a beta? Is it close to a beta of private market? You know, again, I just think it'll be interesting, but we won't really know until we get a couple more years of,

Speaker 2 I would say, robust data sets around.

Speaker 2 I

Speaker 1 would have termed it called the virtue of illiquidity, which is for most investors, illiquidity is

Speaker 1 a virtuous, and the more volatile asset class, the more virtuous it is.

Speaker 2 The best case of this is crypto.

Speaker 1 I literally know, you could actually A-B test this because I know LPs that were in crypto funds and also in crypto assets. So directly in coins.

Speaker 1 And they tell me, they told me all their returns came from their locked up funds because they couldn't sell. That one thing was much more valuable than whether there was even Alpha in the manager.

Speaker 1 It's whether or not they were locked up.

Speaker 2 That's a great case, test case. I think that's one that would be great to look at over time.

Speaker 2 If you look, you know, a few years when you have, say, a decade's worth of data around that, if you could go through and profile investors and survey them to see what was the actual experienced level of data around that.

Speaker 2 I think you're right, though. We certainly have seen it in every other asset class.
So I don't,

Speaker 2 you know, I would be surprised if you didn't see it there and on the private side over time.

Speaker 1 I wanted to create a fund going back to 2014, a liquid Bitcoin fund, where you would put in money and the main feature it would be is that you, it wouldn't sell for 10 years.

Speaker 1 And it's a strategy that you couldn't actually do yourself. So why can't you go and buy the ETF for these behavioral reasons?

Speaker 2 Yeah, because you will be tempted.

Speaker 1 But if somebody else has the keys,

Speaker 1 and people, I started talking about this probably over a decade ago. It triggers a lot of people.
They really hate it. And some people think it's funny or interesting.

Speaker 1 On that vein of alpha, you said it's so rare. It's so hard to generate alpha.
I completely agree with you. One of the things that I really look for is structural alpha.

Speaker 1 Where is there alpha actually embedded in the structures? Best example that I have of that is secondaries. You have somebody that today needs liquidity.

Speaker 1 The endowments, for example, are being hit from different sides from anywhere from the endowment tax to foreign students no longer able to attend and pay premium tuitions.

Speaker 1 Somebody is willing to sell their position for, let's say, a 10, 20% discount. There's somebody that's able to buy it and get that 10 to 20% discount upfront.
I call that structural alpha.

Speaker 1 How much do you look for structural alpha? And what are your thoughts in general about this type of mouth?

Speaker 2 We definitely think it's prevalent.

Speaker 2 And I think you used one of the best examples on the secondary front, which is you have a very clear understanding and transparency around what those assets are worth because they've had a chance to mature over time.

Speaker 2 And you have a real good feel for

Speaker 2 what's the NAV of this?

Speaker 2 What could I actually liquidate for and then to be able to get some sort of discount on that is incredibly valuable i think you can see that more on the real estate side as well because the you can get better mark to markets for that even though it's not perfect i do think on the particularly on the commercial real estate side and with certain funds you actually can can get a a true and strike a nav on that to say, okay, what do I think the mark to market would be on a building, on an area?

Speaker 2 It's a little harder to do when you start getting more nuanced on the on the business front.

Speaker 2 Like if you're getting into what do I think this company is worth, as an outside investor, you're looking in and trying to get that transparency into a fund.

Speaker 2 I think secondaries are incredibly valuable there.

Speaker 2 And I think they're only going to get better liquidity features over time because the more investors allocate to and have higher weights to privates, the more you will find times where

Speaker 2 they've gotten over their skis on what that allocation would be. And it's about it's not even getting over their skis.
It can be just the dynamics of the public market.

Speaker 2 So the math math of it, that you have a real drawdown in public market investments and suddenly your privates are a much higher weight to your total portfolio. It wasn't an intended plan.

Speaker 2 We saw this back in 08, 09. We've seen it again in Liberation Day where people said, oh, no,

Speaker 2 I didn't plan to have a 50% allocation, but

Speaker 2 public markets have gone quite a bit, down quite a bit. And I can't keep bearing.
this overweight, if you will, on the private side. And so I think that's going to drive secondaries as well.

Speaker 2 But But I do think there is that structural, that structural alpha and the willingness and ability to be decisive when that comes about.

Speaker 2 And some of that gets, again, to having a higher liquidity feature. If you have some liquidity, you have the ability to go out and purchase those

Speaker 2 interests at the discounts that you want.

Speaker 2 It really doesn't help you if you acknowledge the fact that that's a great deal and you can get, you can generate better alpha from it, but you don't have have any liquidity to go buy it because you've got to go sell a bunch of your illiquids to try to then enter into it.

Speaker 2 So I think that's what we may see is having a higher base of true liquid portfolios, that they're indifferent in terms of timing around when they would actually access those, in terms of having to sell if they needed to.

Speaker 1 What is the answer to that? You could predict every 10 to 20 years, there's this black swan event, the global financial crisis, COVID.

Speaker 1 How do the smartest institutional investors position themselves to not only not take wrong action, which is hard to sell, but to be opportunistic during those times?

Speaker 1 How do you actually execute or prepare to execute on that stretch?

Speaker 2 Our view is that it comes down to this almost barbell approach where you have hyper-liquid. and hyper-private.
And so you would have the ability to access the public market when you needed to.

Speaker 2 And even on your private side, you're indifferent almost to when and if you realize or monetize some of those assets. I think that's what we see even today.

Speaker 2 We're not seeing as many of the funds be actually able to realize some of the profits that they have or realize some of the investments that they have.

Speaker 2 And a number of investors are frustrated because they're saying, well, I thought you were going to start to

Speaker 2 distribute. So if you have this barbell approach, I think you can mitigate some of that because because you just have, you have less that's in the middle.

Speaker 2 Now, that goes counter to some of the conversation we had earlier about interval funds. But obviously, because you'd say, look, if you barbell it, you don't have the interval funds.

Speaker 2 You either have distinctly deep private and full liquid daily when I need it. I can take it and move it if I need to.

Speaker 1 The mark of a highly sophisticated person is to be able to hold two very different

Speaker 1 beliefs in their head. On that, why would you want to go directly in a manager? Let's just take away the alpha, but you could go directly in a manager.

Speaker 1 You could go into interval funds of like managers. Just talk to me about the trade-offs between those strategies.

Speaker 2 I think you could direct into a manager because you have higher conviction.

Speaker 2 You feel that those, hopefully, you will get some better terms along those lines in terms of what you could actually realize there.

Speaker 2 That will depend on how big you are and how much money you've allocated historically. So you do need that backstory a bit around whether you'll be able to.

Speaker 2 But theoretically, you should be able to get overall better terms, including liquidity,

Speaker 2 if you're going direct to the manager and even on some of those types of co-investments, co-directs that people are doing.

Speaker 2 And that's, we haven't talked about it yet, but those are the other aspects of this. If you're a long-term investor with directs in your, I mean, direct.

Speaker 2 to the fund investment, there are going to be time periods where you will also hopefully then be able to realize some co-investments, some other opportunities opportunistic along the way.

Speaker 2 And because you're not going to get those if you're new to the game,

Speaker 2 those just aren't going to be delivered to you regularly.

Speaker 1 Another form of structural alpha, your investment is bringing down your fees through the co-investments.

Speaker 1 But of course, you have to be able to not only get those opportunities, you have to be able to differentiate which ones are good, which ones are not.

Speaker 2 That's right.

Speaker 1 You have the unenviable position of figuring out what to do with $175 billion. It's not an easy job given that it's

Speaker 1 roughly a sixth of a trillion dollars. How do you go about generating alpha and good returns on such a vast amount of capital?

Speaker 2 More than anything else, it comes down to process. And I know you probably hear that a lot.

Speaker 2 One of the nuances to that for us is this idea of process accountability over outcome accountability.

Speaker 2 And people talk a lot about process, but when things,

Speaker 2 when you start to review how you've done your point on generating alpha, it's altogether more about if I generated a higher return, I generated alpha, then I must have been successful.

Speaker 2 What we want to do is back up on that and say, was the process that we, how we arrived at making that investment decision, we do a lot of work around this in terms of

Speaker 2 We have a landscape of other investments we could have made. Was it the right decision? And did we do the right work up front to actually make that allocation and that investment versus really

Speaker 2 confusing skill and luck? And I think that's one of the key elements to investing more broadly.

Speaker 2 It is always too easy to be able to say, gosh, I was so smart because this investment went really well and

Speaker 2 leave it at that and say, great investment.

Speaker 2 I think to be successful over time, you have to unpack and double click on.

Speaker 2 Did I make the right, did I do the right work in making that investment? Was my thinking right in that, in the process?

Speaker 2 Because I may have had the best process and it just hasn't been realized yet, but it looks terrible from an outcome accountability perspective.

Speaker 2 And investors saying, gosh, why are you still holding this? It's not working. But if you still believe in the process and what you did, that's great.

Speaker 2 Versus assuming that all positive outcomes are because of skill versus some of the luck. And that's where we really want to do.

Speaker 2 a deep dive on if we got everything wrong and it just happened to work out well we shouldn't congratulate ourselves. We shouldn't pat ourselves on the back around

Speaker 2 on having made that investment. And I think that's what, over time, that coupled with patience and the willing to play the long game, more than anything else, is

Speaker 2 what helps us. And then the final follow would just be: you know, we've really bought into this idea of like the high-performing investment team.

Speaker 2 And I don't know if you've ever spoken with Jim Ware, other folks that focus around how you structure an investment team, how do you

Speaker 2 reinforce curiosity, accountability, candor, awareness, appreciation, the things within the team? Because at the end of the day, our assets go up and down the elevator every day.

Speaker 2 Our people are the decision makers, the thought process leaders. So you've really got to find ways to ensure that works.
It works well every single day.

Speaker 2 Sanchez, it's the team.

Speaker 1 that is working at the factory creating the process that is the alpha. So the process, the finished finished product is the process.

Speaker 1 And it's the team members that work every day with their hammer building out the process.

Speaker 2 Exactly right.

Speaker 2 And then the willingness, I guess the final point to that would be as you do that, a willingness to be wrong.

Speaker 2 And

Speaker 2 failure,

Speaker 2 it's not failure, it's learning.

Speaker 2 So we're going to make bad decisions. We're going to make poor investments.

Speaker 2 What you want to ensure is that any of the bad investments don't cause you to to undermine your overall portfolio and your strategy don't allow any of them to be that

Speaker 2 the one

Speaker 2 real mistake and so i think and that gets into sizing of your portfolios and what that may look like as well but

Speaker 2 everyone is going to make poor decisions i think it was roger feddere did at dartmouth commencement a couple of years ago and he was talking about how many of his how many of matches he won, which I believe he over his career won over 80% of his matches, but he only won around 50 to 55%

Speaker 2 of his actual points.

Speaker 2 So, backing up to investing is on a day-to-day basis, you know, it's a coin flip as to whether you win it.

Speaker 2 But what you want to win is that 80% of your matches, you want to win the big decisions, the big investments, the one that are really going to drive alpha over the long term.

Speaker 2 That's going to be the critical success feature.

Speaker 1 One of the issues, and I think about this often, is,

Speaker 1 for lack of a better word, the misalignment of incentives. Just brought brought up a latest report.
The average CIO, so the most senior person at a public pension fund is 6.3 years average tenure.

Speaker 1 For endowment universities, there's different studies, but anywhere from 5.8 to 10 years. So you have this mismatch between what are you building?

Speaker 1 These are literally 10-year funds, and the CIOs are churning twice during one fund cycle, and you should be investing for a minimum two fund cycles. Sometimes you're in these vintages

Speaker 1 three or four times, which is obviously, you know, the roughly 20, 20-year time periods from start to finish.

Speaker 1 Talk to me about that misalignment. How do you better align allocators with their investment decisions?

Speaker 2 It's a great question and one that we debate quite a bit. I don't think there's a good answer, quite honestly.

Speaker 2 Because I liken it to, and the closest probably proxy is with athletics and with coaches of sports.

Speaker 2 you inherit a team of players and if you win this in this case the nfl if you win the Super Bowl that year and you just got brought in, was that because of your skill?

Speaker 2 Or was it because the coach before you had already set up a framework and a team? And yes, you may bring some other people in. I think the more you can do and

Speaker 2 weight

Speaker 2 the compensation on the back end, where you start to realize that over five, 10, 15 years.

Speaker 2 And I think by doing that, you also

Speaker 2 start to limit the types of individuals who want to work in an organization like that, which is a good thing.

Speaker 2 Because I think people, if they truly buy into how they're going to run the organization and deliver alpha over time,

Speaker 2 they should be more than happy to say, you know what?

Speaker 2 It may be 15 years.

Speaker 2 And even if there's a balloon at the end where I get paid out more, or you hold it over time until such time that I'm able to be compensated for that, I have to reach certain marks.

Speaker 2 I think that makes sense.

Speaker 2 I mean, for the same idea that over time in a public company, if you can use more restricted stock and back end it as much as possible, the better off you'll be as a shareholder and stakeholder.

Speaker 2 I don't, I haven't seen any really great ways to do that because the other aspect is it's a dynamic market and there's always competition for talent. And so

Speaker 2 for the same reason that a team can go and pay for someone and pay an egregious amount of money just because they want them, it's hard to then put some of those restricted covenants on.

Speaker 2 But I do think if you could do that in a very transparent manner, you would attract the right type of talent.

Speaker 1 Yeah, I asked this question, which is when you look at the top investors, is it a function of the investor or the institution in terms of them taking risks and all these things?

Speaker 1 And the way that was answered was that the most talented investors go to the most talented asset allocators.

Speaker 1 So they basically re-aggregate themselves into more efficient where their style of investing is appreciated and is aligned with the long-term kind of style of the institution.

Speaker 2 I completely agree. I think that the best investors at the LP level, on the actual solution or product level, fund level, want to have like-minded conversations with their investors.

Speaker 2 They, particularly if

Speaker 2 they've had and deliver strong enough returns over time, that kind of alpha, they're looking for other investors along that line.

Speaker 2 I think that's why some of them now have actually appreciated going into large family offices who may not have as many restrictive elements to how they can do it and are just putting it away and look at it as a multi-generational type of investment.

Speaker 2 That can be compelling. So even if they're starting new funds, they may look to that marketplace because they feel that they can bind like-minded investors to allocate with in them with them.

Speaker 1 As basic as it sounds, I think it does come down to two factors. One is how do you align

Speaker 1 the individual? How do you solve for the principal agent problem? The best way is to make the principal the agent, meaning that you

Speaker 1 give them upside and

Speaker 1 you tie their compensation to their investment decisions. And two is, and perhaps this is like a psychological,

Speaker 1 purely psychological aspect, but... Part of their investing or working at that institution should be actually putting real dollars at work into those investments.

Speaker 1 It could be as little as $1,000 or $10,000, but it's amazing how much much that improves investors' abilities.

Speaker 1 Once you have real money at stake, it just crystallizes your thinking and makes people so much more focused on making the right investments.

Speaker 2 I completely agree on that. And I think one of the things that we've seen over time, and it may help solve for it, is with some of these firms and funds getting so large, having some of that may

Speaker 2 may challenge the convention that you necessarily need to be larger as a business and you just need to grow assets because that's going to grow the pie of your business and your PL, but it may not be the right thing for your investors.

Speaker 2 And I think if you have it more aligned in that way, it may cause folks to, and investors maybe hold off on growing the firm as much as they have to ensure that they're still going to be able to deliver the types of returns within the funds that they manage.

Speaker 1 How do you go about getting up to speed on a completely new industry or something that maybe before like crypto was that institutional and now should be looked on by institutional investors.

Speaker 2 How do you get about educating yourself on use space?

Speaker 2 Well, I can tell you how I used to do it, which seems incredibly archaic now of I literally had binders full of research.

Speaker 2 And I used to get teased early in my career because I have what people call my stacks, which were just stacks of research all around my desk with everything I could find and sort of taking the approach more of this holistic, it's not just reading the most recent quarterly letter or investment.

Speaker 2 It was really more about trying to find holistically interesting thoughts and ideas and leaders across a host of disciplines, not any one thing.

Speaker 2 And certainly not just an investing, really looking across everything. Now,

Speaker 2 I think that artificial intelligence provides a lens into so many industries and so much data so quickly that it has really become almost the greatest research assistant of all time.

Speaker 2 And that as long as you learn how to query and you're asking the right questions and you're able to then follow up with even better questions after that, the time I used to spend searching for calling companies, firms, funds, going to the library to go track something down is now readily available.

Speaker 2 And I think

Speaker 2 the flip side to that is

Speaker 2 to the point earlier about analysis paralysis is almost information paralysis.

Speaker 2 You have to find a way to cut through the noise and try to cut through just the availability of data and information to make it more manageable. But

Speaker 2 at the top of the cone, I want to get as much as I can. I think my biggest challenge now is how do I narrow it more to

Speaker 2 make it more useful?

Speaker 2 And we're continuing to work on that.

Speaker 2 We have a number of dashboards that the team has created around data sets and through AI to pull. and aggregate a lot of information and data.

Speaker 2 But in terms of learning more at the tip of the spear, it's still just a lot of reading and talking to individuals that I trust and know.

Speaker 2 And it gets to your point earlier about like-minded investors wanting to find other like-minded investors.

Speaker 2 I think it's talking with people like yourself, talking to other members of the community more broadly to say, what are you thinking about? What are you reading? What are you looking at?

Speaker 2 And then spending the time and doing the work.

Speaker 1 Let's say you've done your AI research and it's starting to become, I kind of think about it as this really fuzzy picture in an industry.

Speaker 2 And you start to see, you start to

Speaker 1 put some things in focus. It's kind of like feeling an elephant.
You're feeling like different parts of the elephant. That's right.

Speaker 2 Is it the trunk? Is it the tail? And you're slowly starting.

Speaker 1 Okay, this has a trunk. Oh.
But you still don't quite know that it's five times the size of you.

Speaker 1 So there's still

Speaker 1 a lot of ignorance debt to be paid. Term coined by Alex Dermeszi.

Speaker 2 So at which point do you look to meet with the actual managers?

Speaker 1 And are you trying to do it early to improve your querying? Are you trying to come in kind of with somewhat of a baked idea? And talk to me about how you interact with the GPs versus AI today in 2025.

Speaker 2 I probably interact with the GPs earlier than historically because you can get, I think you can get up to speed with just a very thin layer of knowledge earlier on.

Speaker 2 you're able to i'm able to aggregate that and get to that point and my team i think is able to get to that point quicker But then I think the work after that is much more, if not, I mean, not more so, but certainly as detailed as prior years because

Speaker 2 you still have that thin layer of knowledge that you're having to work through. And you start to talk to managers and you start to talk to investors and LPs and to GPs.

Speaker 2 And you start to have to think through, okay,

Speaker 2 I need to learn more and I need to talk to as many as possible. I think historically, say 10 years ago, 15 years ago, you probably did more work on the top of the cone and you brought it down.

Speaker 2 And then you started to arrive at who those managers are, particularly in more niche or specialty strategies.

Speaker 2 There are probably fewer that actually did it. And so you started to get a very narrow list of who you even wanted to talk to.
I think now it's more learn more at the top, talk to a lot more managers.

Speaker 2 You may have to weed through and talk to more of those GPs over time and then start to coalesce as a team around who is it we want to

Speaker 2 sort of soft circle as who we would want to work with?

Speaker 2 What's the main difference?

Speaker 1 Maybe you could highlight some of the key differences.

Speaker 2 Research and information is far more accessible now than it used to be. Instead of having to go out and ask for someone to send you docs, wait for them, or

Speaker 2 getting waiting until something gets filed, the data sets, all that sort of thing. Now you can, even in the private asset classes, the data is much more robust on

Speaker 2 various strategies than it used to be. So I think it's AI, but it's also just technology more broadly has really changed the face of it.

Speaker 2 And then because of the sheer number of managers and funds, you're just, you're going to have to wade through more and get through more.

Speaker 2 Why not save the marketing materials and the data and really just try to dig down in terms of what's really there?

Speaker 2 What is their outfit? What are they really delivering on? And that's harder to do as well when if they don't have long-term track records.

Speaker 2 Well, every time you have new funds and managers that come to market, I'm trying to better understand, is this something that we would be interested in when they don't necessarily have the level of history and track record that we may have utilized in the past.

Speaker 1 There's kind of this game theory of AI where the managers have more AI and are able to produce more information. And essentially, you have more AI to wheat through that.
But maybe

Speaker 1 all things being equal, you basically have a similar amount of time they're spending.

Speaker 2 That's right. It's almost the

Speaker 2 at the at the top level, you still, it's modern warfare of just, there's just, it's just a lot being, being pushed from both sides and received, pushed, received.

Speaker 2 But then at the end of it, it comes to hand to hand.

Speaker 2 Just, it's still, there's going to be an element of the relationship side of getting on the phone and talking to folks and meeting with people to get a sense of under the hood, what's really going on and how does it work?

Speaker 2 And why should we invest with someone? And at the core of that is trust, particularly when you're making direct investments and it could be a 10, 15, or even longer time period of ownership of that

Speaker 2 asset.

Speaker 1 I underestimated trust, which sounds ridiculous. But when I was at NLP myself and I was looking to invest into a crypto fund, there's some funds that

Speaker 2 on paper look like they were doing better.

Speaker 1 And there are some fan manager fund managers that I knew personally for many years.

Speaker 1 And I found myself actually willing to give up potential results with trust. Is that something that you've ever done? Or is that something that's common in asset management? And if so, why?

Speaker 2 The key for us is trust, but verify.

Speaker 2 And

Speaker 2 it's, you want to build on the trust. You want to build that rapport and relationship with the managers and understand what they're doing.

Speaker 2 But then it comes down to verification on it, because you could have someone that you have built a relationship with, but if the data is not accurate,

Speaker 2 yeah, it really,

Speaker 2 it really wasn't worth it, obviously. And I think there have been a few times in my career where

Speaker 2 you lean into the idea that you think you understand something and maybe you've done the work, but it would have been better to have tempered your expectations even.

Speaker 2 And it's easy to your point earlier about Stanley Druck and Miller and the idea of how as humans, we sometimes want to overextrapolate

Speaker 2 what is going to occur. And you just become

Speaker 2 immune to some of the data that is there and is telling you one thing, but you may want to say, well, but I trust them. I've had good investments with them in the past.

Speaker 2 It doesn't mean necessarily this one is going to be that case. And that's why we always want to reinforce underwriting every investment.
And you have to re-underwrite investments.

Speaker 2 And just because one fund with people you trust or one GP, that doesn't mean that they bring out a new fund and a new strategy and it may be a new asset class, but necessarily it's the right one.

Speaker 2 Every one of those needs to be re-under it.

Speaker 1 The entire concept of re-underwriting implies that people just assume that you should continue investing. So it's this implicit non-underwriting default.
Right.

Speaker 2 And even, you know, we, it's, it gets back to the

Speaker 2 phrase I used earlier around process accountability of re-underwriting that what you're already in of saying, okay, does this make sense? Would we we still do that today?

Speaker 2 If we had free capital, would we allocate the strategy? Would we allocate to this asset class? Does it still make sense to us today based on what we know?

Speaker 1 Going back to when you graduated from business school in 2002, what is one piece of advice that you could go back and give Alan, younger Alan, at that point that would either help you accelerate your career or avoid costly mistakes?

Speaker 2 One thing else, it would be take on those projects and those those roles that seem the least interesting, but are probably the most informative and valuable and likely the most challenging when you, when you take them on.

Speaker 2 I remember I took on a project when I was working at Morgan Stanley, and it was to really learn more about the trading side of things.

Speaker 2 I was running a fund at the time, running up a strategy with a Copium. I think it would have been, it would have behooved me to have to have jumped at that chance.

Speaker 2 I don't think I saw it as much as being such a great opportunity.

Speaker 2 And I look back over the course of my career, I think those opportunities of stepping into the Vanguard of saying, I would love to go do that.

Speaker 2 I would love to learn about the other parts of the business, of learning how administratively, how do we handle all these, getting to the private side, of learning more about the actual logistics of all of this, sitting down and working through some of those features of it, of all aspects of the investment process from alpha to Omega, would have really benefited me.

Speaker 2 I think I've been very fortunate and blessed over my career, but I think if I had done more of that and really stepped up more on some of those opportunities, I probably could have learned more and been more valuable to the teams that I worked on over time.

Speaker 1 If everybody in the industry wants to do the very sexy two, three tasks, there's not much alpha there. And there's a lot of alpha in the things that people just are hard or people don't want to do.

Speaker 2 That's exactly right. And I tell that to college students all the time when they call and ask for advice.
They set up meetings. I do events around

Speaker 2 every aspect of it is important. Every aspect of the investment process.
Everybody wants to do what's really interesting and sexy at the time and gets a lot of hype.

Speaker 2 But the things behind the scenes are the ones which will allow you to learn more and you can pick up the other stuff.

Speaker 2 It will come.

Speaker 1 What would you like our listeners to know about you, Regions Bank, or anything else you'd like to highlight?

Speaker 2 I would highlight that we continue to believe at the core of all that we do is this idea that you have to think global, but act act local.

Speaker 2 And the concept that you have to do the work around thinking at a global scale across asset classes, diversification, and even being able to push yourself to invest in things that you may not have had the comfort in historically and learning about that and doing the hard work, as we talked about at the outset, on what does liquidity look like?

Speaker 2 What does my risk profile look like? taking a real temperature around

Speaker 2 my psychological makeup, my families, my institutions, my teams, to better understand what that dynamic is so that you make better decisions over time.

Speaker 2 And at the core of it, it's going to be that process accountability, but you can only do that if you've done the work up front around what are the things as an organization, as a team, make us successful and a willingness to have that curiosity and candor when things are not working.

Speaker 1 Well, Alan, there's so much more to unpack. Looking forward to having you on again in the future.
I look forward to continuing this conversation.

Speaker 2 It was an absolute pleasure. Thanks so much for spending the time with me today.

Speaker 1 Thank you, Alan. That's it for today's episode of How to Invest.
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