Jenna: Hello and welcome to this Asset TV Alternative Investments Masterclass. Inflation remains severely high and the 60/40 portfolios at a brutal year with double digit losses across stocks and bonds, driving home the need for increased diversification. Joining us now to share more about different types of alternative investments, your benefits and important considerations for advisors, we have Troy Gayeski, Chief Market Strategist at FS Investments; Maurice Rabbenou, Senior Vice President at CAIS; Darby Nielson, Deputy Chief Investment Officer at Fidelity Investments; and Christian Clayton, Executive Vice President and strategist at PIMCO.

                                    Well everyone, thank you so much for being with us today. And Darby kicking us off here, how do you define alts and what sort of taxonomy would you use? And then likewise, how do you think about liquid versus illiquid alts?

Darby Nielson: So defining alts and liquidity of alts, I get to start with the basics I guess. And I'd say in basic terms, alternative investing is just an investment in anything that's not a public equity or bond or cash. And starting with some terminology, I'll talk about asset classes versus vehicles. And since you asked about liquidity, I like to think of alternatives in alternative investment categories. And I say that to distinguish between asset classes and vehicles, as I mentioned a moment ago. And we tend to think of them in five different categories. The first is hedge funds, hedge funds strategies, which are not necessarily an asset class. We don't think of them that way because a hedge fund strategy can invest in public equities or any sort of private asset classes. So hedge funds themselves are not necessarily an asset class, but certainly an alternative investment category.

                                    And they can include things like market neutral funds, macro funds, convertible arb funds. Hedge funds are definitely a big one that everybody's all heard about. The second one, I'd say as an asset class is private equity, which is acquiring equity stakes in private companies. This can be venture capital, buyout, private equity as many of us have heard about. The next category would be private credit. This could include things like direct lending, mezzanine debt, distress debt, and private credit is really lending to private companies in the same way you acquire equity in a private company and private in the case of private equity. The fourth category would be real assets as we think about these are things you can actually see and touch. It could be private real estate infrastructure, commodities. These are some of the things we think about as real assets. It could also include things like art.

                                    And then lastly, the fifth category would be digital assets. I know that could be an entirely separate session here, Jenna, but digital assets could be crypto assets, Bitcoin, Ether, as well as non fungible tokens, which are all digital. So if we've got those categories out of the way, then I'll talk for a moment about liquidity where as I said before, I think about liquidity in terms of asset classes and then vehicles where on the asset class spectrum. On one side, you have things like public equities and treasuries, very, very liquid. And then on the other side you have things like private equity and private credit I talked about a moment ago, not that liquid or your house for example. It's hard to sell your house quickly as an asset class. And then in the middle you have things like small cap equities and high yield bonds.

                                    So from an asset class perspective, that's one way to think about liquidity. And then there's the vehicles, which I mentioned before where on the liquid side you have things like mutual funds and ETFs. And on the illiquid side, you have things like limited partnerships. And then in the middle I'm sure we'll talk about newer structures or maybe not so new but interval funds, business development companies, structures more in the middle. So that's how to define them, different categories of alternatives, different ways to think about liquidity. And then just to wrap up on liquid alts versus illiquid alts, because I made the distinction, a liquid alt as an example would be something like a hedge fund strategy in a mutual fund structure. That's one way to think about a liquid alt. So covered a lot there Jenna, with the basics. I'll go back to you.

Jenna: Well, thank you for kicking us off there Darby and Christian, could you elaborate on the types of alternative solutions that are available to advisors and how do you determine which might be best for clients?

Christian Clayton: Yeah, I want to circle back to something Darby said up front. Darby kind of walked through the various asset classes that are available in the alt space and mention the middle space of interval funds, BDCs, non-trad REITs. I want to focus on middle space for a minute here because I think it's a very interesting space. If you go back over time, I think the majority of an alts allocation within wealth was to GPLP structures, traditional private funds. And the focus in a lot of the alt space and wealth over the last five years has been this idea of democratizing alts. And that's come in the form of non-traded REITs, BDCs interval funds, tender offer funds, where across those vehicle types you've seen roughly 150 billion raised over the last five years or so. And you've seen tremendous growth in each of these vehicles. And maybe I'll touch on them one by one and I'll start on the non-treated REIT side, right?

                                    The non-trad REIT is a very efficient way to own private real estate and you've seen tremendous growth in that space over the last two years. That's gone from about 100 billion in AUM to now just shy of 200 billion in AUM in the US over the last two years. You've seen the same thing on the BDC side as a way to get access to private middle market corporate loans, which has essentially doubled in AUM over the last two, three years as well. And then the third vehicle is interval funds and tender offer funds, which have grown from call it 40 billion to 85 or 90 billion in AUM over the last five years.

                                    And I think as you think about these solutions, the reason they've caught on is because ease of access, broad availability and accessibility, semi-liquid structures and really serving that need that investors have for diversification and/or income or return enhancement. And I think that general theme is something that's going to continue to build and take hold. And I think we're still in the early innings in terms of the need for these types of solutions and the size and the role they play in a portfolio.

Jenna:Maurice, I see you nodding your head. So I'll let you add to those comments if you'd like. And then we'd also love to hear your thoughts on what are some of the opportunities and the alternative investment market that are driving advisors to alts?

Maurice Rabbenou: Yeah Jen, I'm nodding because I think Christian hit on it at the end there. Bringing all of Darby's comments around what the alternative universe looks like into a practical implementation for advisors and their portfolios. And it's thinking about alternative strategies and solutions in the framework that the client ultimately is coming to an advisor to think about a solution for. And that's either I need income, I'm trying to achieve a growth target, or I just need broad diversification from other areas of my portfolio.

                                    And so between income, growth and diversification, we think that kind of helps advisors really bucket the alternative universe into an implementation within a portfolio. And I think it's important that advisors not get lost in the structure because I think we'll talk about structure and strategies a lot over the next hour but ultimately, having the outcome as the fundamental component for how do you use these is really going to be the takeaway from the conversation.

                                    And I think those three buckets really help solidify exactly what we're talking about. Now, the opportunity set for alternatives continues to be an appealing one for advisors and asset managers alike and that you look at what's available on the public market. That's just a shrinking marketplace and it has been, and I think a lot of people will probably recognize some broad market indices like the Wilshire 5000 or the FT Wilshire 5000, which was originally created to be as broad a market ETF as possible. Today there's not even 3,500 companies in that index, whereas if you look at the private market that that's a world that has over seven million private companies out there. And if you look at just the world of companies that have 50 plus or more employees, you're already talking nearly two million companies. So the pool with which these companies can play within certainly helps the opportunity set for investment managers.

                                    And then finally, you think about what is the opportunity set for each of these managers to really employ a toolkit of solutions. You can't get any more active as an investment manager than in a private equity or private credit manager where you get to come in, have conversations around setting up the management team, think about driving a value creation game plan and really executing on that growth strategy that you bought the company to employ rather than sitting back and just trying to choose whether Apple's management team is going to execute on their earnings projections as they sort of outline. And I think that driver's seat of the active management that the private equity companies and investment managers get to really sit within is the real advantage of choosing to go private rather than the alternative in the broadly public markets.

Jenna: Troy, your go-to catch phrase is the time for alts is now, what are the market forces that are creating the opportunity for alternatives and why do you believe that alternatives have so much potential in today's market?

Troy Gayeski:Yeah, so we started that time for alts campaign now kind of phrase back in October last year because it was so obvious at the time there would be much more challenging for 60/40 portfolios and 60/40 was effectively broken because you came into the year at very high PE multiples, record high multiples relative to any time in history rather than the dotcom bubble. You know how that turned out and fixed income was effectively return free risk. You had almost no return potential and a lot of risk of big pain from duration and that it has played out even worse than we thought last December. Although when the Fed announced quantitative tightening earlier this year, it was pretty much the dye was cast and the main driver of obviously the problems for 60/40 has been tighter monetary policy initially in the year QT has just started aggressively and that has major negative ramifications for most asset prices on a go forward basis.

                                    Then of course, the probability of a recession in the US has gone up dramatically, which last we checked recessions are not good for earnings nor are they good for equity prices. So in an environment where 60/40's toast, one of the beauties of alternatives, and again it's a broad asset class, there's different objectives but if you can focus on alternatives that have either gone above market income or total return and anything in the mid to low high single digits is why you should be shooting for with low risk income strategies would be senior secured commercial real estate debt. Total return strategies would be daily liquid 40 Act multi-strategy funds for instance. That's point one. So great opportunities there. Point two is low beta, low duration. In general, you don't need alternatives for beta duration. You can get that very liquid very cheaply and beta and duration are no longer your friend and both were your friend for about 40 years.

                                    So that's another key attribute for alternatives, a less downside potential. This is so important coming into the year when 60/40 was toast, it's even more important now that recession risk has gone up and the risk reward of being long equity real estate or real estate through equity exposures is now upside down and those will be income minus NAV deterioration for the next several years. So protecting to the downside, very, very critical where you can, don't fight the Fed, high five the Fed, focus on higher quality floating rate exposures where you can benefit to some extent by the Fed's aggressive tightening or focus on multi-strategy funds where income has gone up through an evolution of the change or the character of underlying investments to more income-oriented strategies. We don't know why people fight the Fed. The Fed always wins when they want tighter financial conditions. They get it.

                                    Alpha proposition, how the manager's adding value and strategies like senior lending, focus on LTV, spread to SOFR, geographic region and sector. In multi-strategy funds, there's a lot more moving parts in terms of being dynamic and opportunistic and differentiated exposures, marrying up individual trade opportunities that have attractive risk reward within some cases, some advisors that can add alpha on top of that. And then this is a point that was touched upon before, you can't underestimate how important the democratization of the asset class has been over the last five, seven, 12 years because if you look back to the 2002 bear market, at least you had a 6% 10 year treasure yield to hide out in and value did rather well the first 18 months of that bear market. You really couldn't access alternatives unless you were a family office like of multi-billion dollar size, a Saudi sovereign wealth fund, a CalPERS style pension, or a Yale endowment.

                                    The average investor could not access these strategies at that point. And that was the case in '08 as well in the globe financial crisis. And even in 2018, the last pre pandemic major dip, alternatives were not as user friendly or democratized. So when you look at strategies that are offered monthly subs or monthly reds subject to tender limits because of the asset liability matching 1099s accredited investor standard, in some cases tax advantages, very user friendly structures. And then data liquid 40 ACT funds are even more user friendly than that because you don't have to be even an accredited investor to invest.

                                    So these are some of the key reasons. The above market income or total return, the low beta, low duration, protecting to the downside, low downside risk where you can grab high quality floating rate exposures to keep doing so, a deep alpha proposition. And then of course, the icing on the cake or the cherry on top of the sundae is that almost every individual investor in America now can access these strategies. So that's why we've been so optimistic about alternatives in this environment and why we continue to espouse the phrase, the time for alts is now.

Jenna: Maurice, what would you say is driving this increased adoption of alts and why do you think now is a good time to discuss allocating to these investments within broader portfolios?

Maurice Rabbenou: Yeah, I have to agree with Troy on this. I mean, one, you look at your 60/40 statement at the midway point both down mid [teens 00:15:36] and how do you think about that everything driving in tandem? Certainly doesn't feel like the 60/40 is doing what it was designed to do. I think you start talking about where the accessibility of alts has really moved itself and become an opportunity for everyone to access. So certainly the barriers to entry have been lowered and the availability of structures that fit client portfolios has continued to increase. To Troy's point in the current environment, you look at opportunities that really jump off the page. I think there's areas where some of these managers have been waiting for an opportunity to take advantage of and you think the stress in the current market environment where rates have finally been pushed forward by the Fed with no shortage of continued increases on the horizon.

                                    So they're driving it forward where what does it ultimately mean for these companies that have debt on their balance sheets, that's all floating rate. It's an opportunity for them to have to reconsider what the cost of capital looks like for them. Well, at the same point on the demand side, you enter a recessionary environment, what does that ultimately look like for the income component of their balance sheet? So companies that didn't appropriately build up their capital stack, I think investors that were searching for yield might find that some of the companies, if not appropriately documented and appropriately underwritten may find themselves stressed. So just I think distress right now is an interesting opportunity for asset managers to take advantage of.

                                    Also, you think about the run up in private equity returns of the last three, five 10 years and then the recent pullback in the broader public markets, you're going to find yourself with the denominator effect that ultimately is going to create a challenge for a lot of investors on the institutional side who may need to rebalance some of their portfolios for their asset allocation into private equity. So we think the secondary's market is probably something that's going to have an opportunity for investment managers to take advantage of, just given on the LP needing to rebalance. But even on the GP secondary side, which has continued to be a growing portion of the secondary's market, the public market as an exit option continues to look less attractive. IPOs have certainly dried up. So more and more managers on the GP side are going to look to extend their fund rate, their funds with their prime assets. And so you're going to find GP-led secondaries or continuation funds as they're otherwise known as I think enter the marketplace more prevalently going forward.

Jenna: Do you think there's more room to run Christian? And would you agree with Troy here is now the time for alts and should advisors be considering alts right now?

Christian Clayton: Yes to both questions. Yes. I think there's more room to run and yes, I think the time is now. I think what's interesting, if you think back over the last decade, I think the reason people have allocated alts has changed and we've highlighted two benefits of an alternatives allocation, which is generally diversification and yield enhancement. I think for much of the last decade, that latter point of yield enhancement was key when we were living in a low yield world and that really pushed people further out the risk spectrum or pushed people into alternatives, which I view as very different from moving out on the risk spectrum as a way to enhance the yield of the overall portfolio. Then as you got into this year 2022, it's really been a different benefit. I think that's come to the forefront of an alt allocation, which is that diversification benefit, having something that's had a bit less mark to market volatility in a world where public equities and public fixed income are down [teens 00:19:27] to 20 plus percent over the course of the year. And so that's been a key benefit.

                                    I think as you think about where we go from here, 2023 and beyond, I think we're getting into a very interesting state of the world for a couple of reasons. Number one, some of that compensation for risk of illiquidity risk and complexity risk that you get in private markets is not as notable today as it's been in the past because you've had a sell off in public securities and a lot of private assets have been quite resilient this year. And so I think that creates an interesting kind of dichotomy between public and private investments. I think the other point is we're in a world where things have become very different. As the Feds hiked rates, it increases borrowing costs for companies and it's going to make it harder for companies to service their debt when they have floating rate financing.

                                    Commercial real estate is in a place of really significant uncertainty going forward. Long story short, our view is there is going to be very target rich opportunity in the private markets over the next 12, 18, 24 months where there's more compensation for risk for being a lender. Lenders are able to come in and negotiate and kind of arrange more bespoke types of financing solutions with partners and that's what makes us excited about the go forward prospects from here. We think that some of that compensation for being a lender is going to increase on a go forward basis and that generally speaking alternative solutions are a great way to capture that opportunity set.

Troy Gayeski: Yeah, Christian, I think you hit on a great point. When alternatives were first growing coming out of the dotcom bubble implosion, everybody used alternatives as the substitute for equities. It was equity like returns with less risk and then start in 13 given how low yields got, alternatives started to be used as the substitute for fixed income and that was kind of the main use case. And then really last October was the first time in a long time or perhaps ever in the history asset class that you could use them as a substitute for both. And now what we're seeing is folks that are very heavy in real estate equity investments starting to roll up the capital structure, lock in gains and favor senior secure debt as a way to protect to the downside as real estate rolls over. So the use cases have certainly evolved over the last 20 years. It's been really fascinating to watch this phenomenon.

Jenna: And of a chameleon asset class there, I guess you could say. Now, Darby, what are some reasons why alt should be included in a portfolio? I know Christian touched on diversification for example, would love to hear your thoughts as well. I mean why not just stick to traditional asset classes?

Darby Nielson: Yeah, I think this question gets to the benefits of alts, right, which Christian mentioned a moment ago. But Maurice and Troy, I think we've all been espousing some of the benefits and the last year or two, my team has been doing a lot of work, a lot of research on alts and how they could fit in a portfolio. And I know Maurice, I think you talked about income growth and diversification as the three buckets of the benefits of alts, but when we looked at it, we actually defined it as enhancing returns, managing risk and diversification. And I think we've all touched on those three things but that's the categories, buckets we put them in. And actually, I think some of those, Troy, you talked about before about the downside protection on the managing risk. So when we did our research looking at those three different categories, we found that Alts added a lot of value and even on top of traditional asset classes.

                                    I know you asked about that Jenna and I should say though that 60/40 for many, many years actually did pretty well. Traditional asset classes have done well. 60/40 offered a lot of benefits. I know it's been toast this year as Troy referred to it. The big question is going to be, is it going to be toast going forward even though it's gotten smoked this year? We'll see. But even if it's not, even if it does go back to being effective, I think Alts will still offer those three benefits I talked about a moment ago. So when we looked at enhancing returns as an example, on average, we found that things like private equity, direct lending, distressed debt, some of those categories I talked about before, we found that some of those categories actually offered a lot of enhanced returns. And I think those enhanced returns can come as either income or growth as Maurice and I think Troy were talking about a moment ago.

                                    So that's on enhancing returns. The other category we looked at was, or the other measure we looked at was managing risk as I talked about before, and Troy talked about this. In this case, we evaluated a lot of different alternative strategies as well as traditional asset classes to see how they did in big equity market declines. As Troy talked about before, when the market's down a lot, how do some of these alternatives fold up? And we actually found that some of the private equity categories, direct lending and private real estate actually held up pretty well. So managing risk, protecting that downside potentially is another benefit that we took a look at and we found that there. And then lastly, diversification as we talked about, we haven't talked too much about hedge fund strategies here, but we actually found some hedge fund strategies like macro market neutral, things like private real estate in our work looking at their correlations with other asset classes have offered some diversification.

                                    So those are the three benefits as we define them. And then the research we did and found how some of these different alternative asset classes and categories added value. A lot of us, we've talked about those before but those are some particular examples of how they might benefit a portfolio even above a traditional set of asset classes if and when 60/40 starts to work again.

Jenna: Yeah. With 60/40 being toast, as you said earlier, Troy, equities and bonds have been hit hard this year by what you call the galactic mean reversion. Could you explain that concept for us and some of the ways that advisors can navigate it?

Troy Gayeski: Yeah, so it's actually a pretty simple concept. And that if you look at market history, we periodically go through eras where you have outrageous levels of financial asset outperformance relative to the cash flowing potential of the real economy, measured by nominal GDP or real GDP or even corporate America. And after going through those extremely long or in some cases, shorter periods of outrageous outperformance, you have these lost decades or 1964 to 1982 periods or currently, what we're referring to as a galactic mean reversion where effectively gravity reasserts itself and you have a convergence between financial assets and now to lesser extent real estate back to the cash flowing potential of the real economy.

                                    So if you think about the last five, 10, 15, 20, 30, even 40 years, there's been three major drivers of the meteoric gains in most financial assets because remember, coming out of the global financial crisis, we bought into the 94P ratio. In the '70s, we were at a seven prior to QE3, we couldn't get up quantitative easing three, we couldn't get above 14. And then we peaked here at 21.2 coming into this year. But the three major drivers are all going the other way and going the other way hard. The first would be lower interest rates, which started in the Volcker era of course. After he was crushed inflation and he was able to cut and success of Feds cut for a long period of time.

                                    And so lower rates don't only lead to lower borrowing costs, which allow the economy to lever up, but they also led to higher and higher PE multiples or valuations for all asset classes. Not just stocks, not just real estate, but pretty much every chart says the same thing upward to the right. Within many cases, hockey stick like moves. Last we checked interest rates are going the other way and going the other way fast. The second, which is really a more recent phenomenon in the last 13 years, is just rampant levels of money supply growth.

                                    Most of the post GFC period, the Fed struggled to get inflation to 2%, let alone above it. Their favorite tool to do that was quantitative easing, which ballooned money supply dramatically. And then of course, the mother of all money supply binges or increases was coming out of the pandemic where it grew by 42% over a very short period of time. And the golden rule for risk taking is whenever money supply grows faster than normal GDP, it's risk on. You can take risk comfortably. And whenever money supply grows slower than normal GDP much harder for assets to go up and money supplies actually not only stagnated but contracted now, which is almost unprecedented in history. So that's the second factor going the other way.

                                    And then lastly, if you think of globalization, which really started with Ross Perot's giant sucking sound back when NAFTA was signed and jobs going down to Mexico, but then went on steroids when China entered WTO in the early 2000s, which was the greatest labor supply shock in the history of mankind, what globalization did is it not only acted as a tremendous inflation suppressor and made the Fed's job very hard to get inflation back up to two, but it also helped boost corporate profit margins on the S&P from 5.5% to 12 to 14. And we are now deglobalizing particularly with regards to China at light speed.

                                    And so bottom line is we've been to periods like this before. They're nothing unusual. We're not calling for a lost decade, but it's very easy to imagine a three to five years that are a choppy, sloppy, mess of markets where it's very hard to make money in both equities and fixed income. And Darby, I think you brought up a great point before about this concept of, hey, like 60/40 has gotten obliterated this year and certainly no one thinks it's going to be nearly as bad the next five years as it's been the first 10 and a half months of this year. But the important point there is if you're a permeable in fixed income or in equities, and there's still a few of you out there, I think, I hope not, but I'm pretty sure there are, just remember what you're playing for here coming out of this, right?

                                    You're not playing for '13 or '09 or 2019 to '21 or the late '90s type of bull market. What you're playing for is in October of '02 to October of '07 bull market where there is no QE. The Fed cuts rates in a mirror image of the 15, 18 hiking cycle. You don't experience multiple expansion and returns are reasonable, call it mid to low high single digits, but it's just driven by earnings growth, the old fashioned way. So we certainly don't think 60/40 is going to be as broken the next five years has been this year, but it's not like you're ever going to enjoy meteoric returns like you did in that '19 to '21 period or '09 to '13 or even the late nineties. So that's what we mean when we were talking about galactic mean reversion.

Darby Nielson: More of, I was going to say, the combination of the two Sorry Christian, go ahead.

Christian Clayton: Go ahead, please, please.

Darby Nielson: I was going to say, as we talk about 60/40 and how it's done so poorly this year, the galactic mean reversion I think has to do with the returns because the returns this year, the reverting to the mean, but there's also the diversification benefits that we haven't gotten this year. And if you look at the correlation between equities and bonds over 50 years, it's been pretty low the last couple decades, but there was a period where it was not that low before that when inflation was high.

Troy Gayeski: That's right.

Darby Nielson: Going into a higher inflation environment, it may not just be the lower returns, you may not also get the diversification benefits. And I think that's also been a factor in the underperformance of 60/40. Jen, I was just going to make that point. Christian, go ahead.

Christian Clayton: Yeah, I wanted to chime in on the point about it being potentially harder to make money on a go forward basis. Everything that you had cited was market related, which completely agree with what you said. I also think there's an element that's investor related, which is just investor psychology. And I think there's a benefit in an alternatives allocation there where unfortunately, many investors have a tendency to buy high and sell low. And Morningstar publishes a study where they look at realized investor returns versus fund returns, which essentially just looks at when people are buying and selling mutual funds and what impact that might have on their return. And the key point is generally when you look at a lot of risk assets, that realized return is something around 30%, a 30% gap between fund returns and investor returns, where unfortunately investors are timing things poorly.

                                    And I think one of the benefits of these structures is that you're not able to pull your money out on a daily basis. Typically, there's quarterly, sometimes monthly types of gates or redemption features, which allows, one, investors to not make a poor timing decision. But then I think the second point is it gives the managers an advantage to stay invested and take advantage of volatility that we're seeing in the markets. And I think that's going to be a key trend over the next 12 months. Volatility has picked up and we think will persist. And so having a manager that can be a bit more opportunistic and look to capitalize on that volatility, we think will be key. And then the other kind of just general point as you think about an alts allocation is still, as we look at portfolios, we think the average investor is far more liquid than they should be.

                                    If you look at the average allocation to alts in an advisor directed portfolio five years ago is about 5%. Today, it's about 7.5%. So it's grown by 50%, which is great progress but still a much smaller allocation than what you'd see from an endowment foundation, someone that may have very similar return or income profiles but are implementing a different allocation to get there. And so our view is, you'll see that trend continue in terms of five to seven, half to 10 and upward from there because of the benefits we've been discussing.

Troy Gayeski: Christian, are you suggesting that investors buy high and sell low?

Christian Clayton: I'm saying unfortunately that happens.

Troy Gayeski: Really?

Jenna: Maurice, you look like you had something to add as well.

Maurice Rabbenou: I think Christian, you hit on it, which is the current under allocation of advisors and clients today is that it's something that we've all kind of realized and have seen. We're calling the great reallocation, which is you talk about the wealth community today, which sits around $40 trillion with the allocations to alts that you kind of outlined. And that's just in the advisor directed. But holistically, we're still in the low single digit allocation to alts. More and more we think even if you increase to where a moderate client as recommended by most CIOs at the institutions that we're talking about, you move to a 50, 30, 20 moderate allocation of equities, bonds, alts. The amount that we are expecting to see move into the alternative space is north of $5 trillion as we just think about some of those rough numbers. And so we're going to continue to think about all of the ingredients that we kind of outlined here.

                                    CAIS just recently did a survey with Mercer around advisor sentiments and where they're looking at alternatives and nearly nine out of 10 advisors indicated that they plan on increasing their alts allocation in the coming two years. And when you break that down, more than half of them expect to be north of 15% allocated to alts. So there's a real trend in wave moving into all the topics and benefits of the alternative universe that we just kind of described. So I think from our standpoint, that great reallocation is real and it's coming in meaningful ways, whether it's becoming because of the structural advantages that kind of Troy and Darby touched on, or just the overall strategy advantages that these asset classes offer.

Jenna: So to quickly name a few, Troy, what types of strategies would you consider during the galactic mean reversion?

Troy Gayeski: Yeah, so I think the important thing to think about for alts or your entire portfolio is that this is a time where you want to focus on the northwest quadrant of the efficient frontier, right? Lower risk except maturely accept mid to low high single digit returns. It's not a time to be a hero. This certainly isn't a green light go environment like '19 to '21. This is a time to focus most of your investments on the northwest quadrant efficient frontier. And so some of our favorites right now are again, senior secured commercial real estate, private loans where you have 70 LTV or below. You have consistent low high single digit returns that are benefiting to some extent from Fed rate hikes because the majority of assets are floating rate. You have tremendous economic and downside protection because you really need to eat through that 30% equity cushion or greater to ever realize a loss.

                                    And historically, both default rates and more important loss severities or how much you lose in a downturn are exceptionally low in senior lending. Now what you give up for this, of course, is you're never going to make 15 or 18%, you're just not. But that's yesterday's trade, right? That's why you own real estate equity for, which was awesome for years and is now upside down. So we've seen a lot of advisors start to rotate up the capital structure and lock in some of their equity gains. Another example would be multi-strategy, low beta, low duration approaches where you can have differentiated exposures in terms of go after things like interest only cash flows that benefit from home price declines and throw off very good carry or take advantage of some of the outrageous levels of volatility in markets. For instance, European interest rate volatility is off the charts. So you can sell super expensive European rate vol and buy back very expensive US rate vol and lock in positive carry.

                                    So again, those are two northwest quadrant strategies that are both very democratized and accessible. If you're going to move out on the risk spectrum, and at the end of the day, every asset in a portfolio is not going to be locked in a northwest quadrant, you're going to have some room for risk. We would just suggest that people demand in an attractive level of income, whether it's through an attractive dividend in a listed BDC or a dynamic closed end fund strategy, or if you look at the CLO market right now, which of many interval funds are targeting for higher returns. You have roughly double the income per equivalent credit rating there as you do in the high yield bond market. So those are higher risk allocations where you're going to have more volatility and certainly more downside.

                                    But the beauty is in an environment like this, cash flow is king, right? Cash flows don't lie. You don't need prices to go up to make an attractive return. You could tolerate some degree of mark to market to the downside given where yields are and you could withstand some degree of default risk given where yields are. And let's say, like I'm completely wrong and we just started one of the greatest bull markets in the history of mankind, given the starting level for price, whether it's a discount to NAV that's traded in public securities or whether it's where CLO prices are starting today, you have much more upside capture. So for higher risk strategies, more volatile. We like those that have abundant cash flows, but for your alternatives in general, you still want to be focused on northwest quadrant strategies like senior secured commercial real estate lending or 40 act multi-strategy solutions.

Darby Nielson: Hey, Troy, I almost couldn't resist asking you. You always want to be in the northwest quadrant of the efficient-

Troy Gayeski: Yeah, so-

Darby Nielson: I think you did a good job explaining why you might want to go out further on the risk spectrum to get the higher return.

Troy Gayeski: Yeah, well look, I've always been a northwest quadrant guy, right?

Darby Nielson: That's what I mean.

Troy Gayeski: Yeah, that's what most alternatives are there for. That being said-

Darby Nielson: I think you did a nice job explaining it. As long as you stay out of the southern half, right?

Troy Gayeski: Yeah, but I guess the point I was making is that if you look at a total client allocation, we're talking about 5% alts, 10% alts 20% alts, 30% alts, very few clients are going to turn into Yale. They're not going to have 60, 80% in alternatives for a variety of reasons. So there are also alternative strategies that are further out in the risk spectrum because if you own MLPs and you own no cash flowing tech, why not look at strategies that are either alternatives or very close to alternatives, alternative strategies packaged as listed vehicles that offer abundant income. But you have to understand that you're going to have to tolerate more volatility.

Jenna: Yeah, that's a great point. And building off of that, I mean Christian, why haven't some investors decided to go all in? And then I'd also love to hear your thoughts on interval funds. I know you mentioned those earlier.

Christian Clayton: Yeah, look, I think why investors haven't gone all in is there's a bit of nuance in that question. I think more folks are increasing their allocation and part of it has been better solutions coming to market over the last five or 10 years that are providing kind of unique solutions and solutions that can be more broadly accessible. I mean, I think if you look historically where a lot of the alt space was dominated by products that required QP eligibility, it meant that the average advisor couldn't allocate across their book. And now as a lot of solutions are coming to market that are available to credit investors or some even broader than that to the retail public, it makes it a lot easier for advisors to use alts in their books because they can use it across their client accounts.

                                    I think the other thing that's been a big trend is just education focus on this space. PIMCO has really leaned into the interval fund structure pretty hard. If you go back just five or six years ago, there were almost no interval funds launched on the wirehouse platforms, on the IBD platforms. There were a handful, but not like it is today where essentially every large wealth platform has interval funds available. And so I think the combination of broadening the solutions, broadening access of those solutions and a focus on education has driven this increased usage and will continue to drive usage all in. Maybe to the point about what you've seen in alts allocation of some of the university endowment funds probably isn't practical in the wealth space given just different return and liquidity needs. But I think you'll see more folks increase their alts allocation to 10% to 15% relative to kind of five to seven where it may be today.

Jenna: Darby, how do you think that investors should be thinking about allocating to alts and any key considerations that should go into evaluating different types of strategies?

Darby Nielson: Sure. I mean I think the key considerations are all the benefits we've been talking about here, whether it's enhancing returns through income or growth as Maurice described it, or managing risk as Troy and I have been talking about, hopefully some protection on the downside. And then the diversification as we've all been talking about. Those are the key considerations. And then when you think about how they might affect your portfolio, if you include them in your portfolio. Three things to consider, actually the first two are the two axes on your efficient frontier performance and risk. We're on a roll here. And on the performance side, obviously you want to consider that. And then risk again, could be managing downside risk or just volatility, but then liquidity, right? Liquidity, we keep talking about it. Christian has mentioned it, I think, a couple times is an important consideration as you think about including it in your portfolio. So performance, risk and liquidity.

                                    And then you have to pick the assets themselves. It's one thing to decide to allocate to alts, then what kind of alts, but then I don't know if we've gotten into it yet, but there's a lot of dispersion even within a certain category. Even if you just look at all distressed debt managers, there's a lot of dispersion around the average return there. And that's why due diligence manager research is a critical component to including alts in a portfolio. And when you think about that, my team actually has a framework to look at that. Number one is performance as we've been talking about here, but also a risk adjusted performance, getting you in that northwest corner of the frontier. The second thing to think about is strategy consistency. Does the manager do what they say they're going to do? Do they stay within the taxonomy that we put them in at Fidelity, as we talked about before, where sometimes it's okay to have performance that's not great as long as you do what you're supposed to be doing and the strategy consistency.

                                    The other thing is to consider the people. I think someone might have mentioned that before, the actual managers of the strategy, are they experienced? Do they have high integrity? Do they have the right incentives and are they committed to the strategies themselves? The people is an important consideration. And then the process itself, the risk management component. Do they have good risk controls in place? Is the process understandable? I think that's another thing that investors should consider. We consider that as we look at a strategy because if it's very opaque, you might want to be a little careful with it. So like I said, performance, strategy, consistency, people, process. A couple other things we, of course, consider is fees and liquidity. I talked about that before. Fees are obviously an important component.

                                    Liquidity, I talked about is one of the key considerations. And then the last thing, a little different from other traditional strategies is just partnership and governance. What are the compliance procedures in place? What does auditing look like? How about valuation methodology? All these things that one might not think about so much in the traditional asset class categories, but those are six things we look at in our framework for evaluating alternatives to evaluate how will they fit in from a performance risk and liquidity perspective.

Maurice Rabbenou: Darby, I got to say, I think you brought to light important considerations that advisors have to be thinking about as they're starting to understand this space. Manager dispersion in particular is drastically different than what it looks like on the public equity side where it might be a 200 basis point dispersion from your top tier versus your lowest performer. Whereas on the private equity side, that could be up north of 2,500 basis points and even more 30 to 3,500 plus in venture. And so manager selection is critical in making sure that you get all of the benefits and have the right outcome, even beyond timing, the way Christian thought about it from the behavioral investor management, just pure selection of the manager. And then diligence is critical, making sure you're in the right managers, both on the investment diligence side, ensuring that they have the right people and track record but also on the operational due diligence side.

                                    I think in this space in particular, many of the headline news risk comes from the operational side of the equation, more so than it does from the investment side. Underperformance is underperformance, but fraud or anything along those lines is really where you're going to run a risk and need the team to do it. And I think this is where advisors, they may have the education, they may understand the why of alts, but they fall down on just the capability of doing the diligence required to build out a robust portfolio of alts. And I think that's precisely why here at CAIS, we partnered with Mercer to provide advisors with that both investment and operational due diligence. And those teams are north of 30 on just operational due diligence, background checks, vendor checks, forensic audit. And then on the investment side, obviously a robust team. And I think this is where advisors really need a lot of support in trying to put into practice the alternative portfolio.

Darby Nielson: Yeah, that's exactly right, Maurice. All those risks you talked about, it comes from the people. That's why I mentioned the experience and the integrity, the partnership and governance with compliance and auditing and then the operational due diligence. It's all well said.

Maurice Rabbenou: Yeah, absolutely.

Jenna: Yeah, those are all great points. And let's talk a little bit more about performance and that dispersion, Darby. How have alts performed and how does the volatility of alts stacked up against other asset classes?

Darby Nielson: Yeah, I mean we've talked about the benefits and the enhancement of performance that an investor can get from alts. But we should also talk about the volatility as you asked about a moment ago. And then we also talked about 60/40 already. But we've looked at alts a lot of different strategies as I mentioned. And on the enhancing returns, performance category, as I said, we found a lot of private equity categories, direct lending, the stressed debt have actually added value over time. We've talked about it a little bit, but it's worth noting the drivers of the performance in some of these alternative categories where I don't remember who mentioned it, but there's a bit of an illiquidity premium, right? Christian, I think might have mentioned that before. In our research though, we did control for that exposure if you use public market equivalents to control for those exposures.

                                    We still found that some of those alternative asset categories have done pretty well. Some of those in particular that I mentioned that I've had decent performance at least over the period we studied on average. But again, it really gets down to doing that manager due diligence because of dispersion. From a volatility perspective, again, it depends on which category you look at, but how they stack up. Some of them are a little on the higher side of volatility like venture capital, but it only ranks around where emerging market equities would be. And then somewhere in the middle, you have other categories like distressed debt, but it's only in the category volatility of maybe large cap equities or high yield bonds. And then some other categories in the hedge fund space can be on the lower side. So again, it depends on which alternative strategies categories you look at, how they stack up.

                                    But I guess it's worth noting that they can run across the spectrum, meaning alternatives are not all at the top of the volatility list if you look at the stack ranking. And then finally, just to get to your question about performance, I wanted to make a note on recent performance. We've talked about it already, 60/40, the underperformance, 20% of public equities and bonds going into this year, as Troy talked about, there was a lot of excitement about alternatives because rates were so low, multiples were so high. There was a lot of excitement about alts. And guess what, they've actually done what they were supposed to do this year. If you look at a lot of those categories I talked about, I think direct lending is slightly positive, even though a lot of these other categories are down 20%.

                                    So that's long term performance, different categories to think about that have enhanced returns, how they stack up from a volatility perspective. And then very recently, I think it's worth noting only through June 30th because there's a lag in reporting some of this data, but June 30th, but through the middle of the year, I mean, as we know, equities and bonds had been toasted, but alternatives have actually held up pretty well. And like I said, did what we were hoping going into the year.

Troy Gayeski: Amen Darby. Amen. It's great to see alternatives do what we had hoped they would in such a challenging environment for 60/40, right?

Darby Nielson: Yeah, I mean, just circling back to what you were saying, I think maybe in October, I think you were saying, you started really talking about the benefits of alts. And then I remember going into December, January, it was where rates were and where multiples in the equity markets pour itself out, so far.

Troy Gayeski: There's no greater joy than delivering positive performance investors in an environment where so many other assets are struggling. I know that's what puts the biggest smile on my face.

Jenna: Yeah, one of the few asset classes that did what it was supposed to. Now, Christian, how might the significant performance dispersion between public and private assets that we've seen in 2022 impact how advisors use alts going forward? And then we also talked a bit here about the possibility of a recession on the horizon. So how are alts expected to perform in the midst of a recession and following, why might an investor choose alts in the current environment?

Christian Clayton: Yeah. The performance dispersion this year between public securities and private securities is pretty unique. And anecdotally, I think it's starting to lead to some changes in terms of how folks are allocating. We've touched on some of the specific points in terms of how investors might be allocating different asset classes, but I think there's two things going on. The first is this denominator effect, which Maurice I think already touched on, which is if you have your private allocation flat or up five, 10% this year and your public security's down 10, 15, 20% this year, suddenly your asset allocation has gotten out of whack. And so I think you're going to see some folks rebalance as we get into the start of the next year just to achieve what they want from the overall kind of diversification standpoint. But then the second theme that's starting to catch hold, which I've been hearing in advisor conversations, is folks that are looking to rebalance away from things that have been a bit more stable into areas that they think have potentially cheaper valuations or more upside from here.

                                    And I think you're going to see folks start to reallocate to areas where prices have already started to come down somewhat, spreads are a bit wider, compensation for risk is a bit higher. And I think that theme is going to continue to play out over 2023. So the way that we're thinking about it is it's a great time to approach private markets with a fresh balance sheet with dry powder where you can take advantage of some of this stress that's flowing through to markets as markets slow down and as flow activity slows down significantly. So that's kind of the first part of your question. The second part of your question was about how alts might perform through a recession. And I think there's a couple things here. I think the first point is, from my perspective at least, one of the key benefits of an alternative strategy or structure is it allows managers to stay invested over a longer horizon.

                                    And I think the key point there is if you're managing a mutual fund and you get into a more challenging environment, you're kind of playing defense, right? You're facing potentially daily outflows thinking through liquidity, which bonds to sell to meet those redemptions. In a structure that doesn't provide daily liquidity, you can kind of flip that on its head and be in a much more offensive type of posture and look for that volatility as a path to generate returns, source investments, and attractive entry point.

                                    And so I think that as you think about a recession and kind of the alt space, generally those types of environments create the most attractive entry points on a go forward basis because it allows managers to get into deals at much cheaper valuations. And maybe circling back to 2021, it was almost the polar opposite of that environment. You had record inflows into alts. You had a lot of capital being raised in strategies that had somewhat narrow mandates. And so deals were closing at tighter and tighter valuations. And I think you're going to see that reverse completely as we get into 2023.

Maurice Rabbenou: Christian, I think you're touching on a broader point is how the definition of alts continues to expand. Where I know we've seen traditional strategies move into alternative structures so that way they can capture some of that illiquidity premium. And I think that that's really what we're all trying to drive at is alts can mean a lot of different things. The bottom line is how do you find solutions and returns beyond just the public equities or public markets? I think to your earlier comments, the dry powder comment, I don't think we've touched on the patient capital of deployment that a lot of these managers also offer clients. And that goes to the vintage year diversification within the private equity space and allocating even in the midst of a or the throes of a recession, allows that manager to take the two, three, four years to find the best opportunity to put those dollars to work, really allows them to find the best relative value opportunity rather than just being forced to put all dollars to work the moment you give it to them.

Jenna: And Maurice, sticking with you here, how are advisors access accessing ... Start that from the top. Sticking with you here, Maurice, how are advisors accessing these various strategies? And as we wrap up this panel discussion, where have you seen innovation in products and what kinds of innovation and trends do you think that we can expect to see moving forward?

Maurice Rabbenou:       00:57:39           Yeah, I think the access point we touched for a while on structure, and certainly BDCs, interval funds, non-trad REITs have been proliferated across the industry and making sure advisors can access across their entire book of business, the solutions within the alternative space. I think the way we're approaching it for advisors, access also means the entirety of pre-trade, trade and post trade experience of bringing what is a complex and really historically an institutional focused product to the retail world. And so we think about pre-trade, including one access to these managers, whether that be at lower minimums or just secured capacity. We talked about education in this space, we talked about the diligence, and then you think about trade, that's the actual transaction, that's the automation and subs, digitization of that process. And then post trade on the reporting. So access, I think has to include the entire ecosystem there.

                                    As you think about innovation going forward, for us, we're spending a lot of time understanding where's the puck going. You hear the SEC unanimously approve the idea of expanding the definition of accredited investor. That's likely going to spur more thought around how's the retail market access alternatives and maybe their 401k and defined contribution plans, what's happening on that space, on the technology front, blockchain certainly a topic that's happening and pressing the ball forward. I think for us here at CAIS, it's conversations with our asset management partners, industry professionals across in our innovation lab that we're constantly talking about some of this on the forefront, but it all comes back to how does it fit for the advisor and the pre-trade, trade and post-trade experience, ensuring that they can not only simply access the strategies, but make sure it integrates into everything that they're doing in their book of business.

Jenna: Yeah. Darby, what are you most excited about, or what should investors have to look forward to in the old landscape and have a feeling that you'll also touch on digital assets and quant investing, which Troy, I know you have thoughts on as well with digital assets. So why don't you kick us off Darby, and then Troy, would love to hear your thoughts as well.

Darby Nielson: Yeah, sure. Like I said at the start, digital assets, we consider a category of alternatives. Again, that could probably be an entirely different session, but I have-

Jenna: Yes, we actually have a digital assets masterclass, so you're spot on there,

Darby Nielson: I was guessing you did, Jenna, you probably hosted it. But I'm excited about a lot of things, excited and fascinated in a lot of things here. I mean, first of all, I'm excited about Fidelity continuing to expand its capabilities and alternative product offerings. We've launched new products recently, but also just excited about continuing to see alts become more accessible in the marketplace for advisors. We talked a little bit about the allocations to alts by institutions, traditional institutions, endowments and foundations versus advisors. And there's ways to go, especially in the advisor community, but making it more accessible, having more structures out there, more alternatives that are accessible for advisors. I'm excited about seeing that. As you said, I'm also very interested to see how the digital assets landscape plays out. I know there's been quite a bit of volatility recently, but that's something, as I said, we consider an alternative. It'll be interesting to see how it shakes out.

                                    And then, Jenna, you queued me up there. You're right. I am a quant by background and I'm fascinated to see in the coming years how advancements in data and technology may affect alternative investing. And I say that because as a quant, I spent my career watching quant and index investing really change, completely change the landscape of equity investing, public equity investing. And so how that might affect alternatives is something that will be fascinating to see. And I'll leave you with that, something to think about, right? Using a quant model in a private equity structure to pick the investments using data technology in a private equity fund to pick the investments with a quant model. It's something to think about, something to see over time. So a lot to be excited about at Fidelity, in the industry, more accessibility and just seeing how things like crypto digital assets and how quant might affect the landscape. It's pretty exciting.

Troy Gayeski: Yeah. Jen, I'd just add, I mean when we think about this environment, it's such a golden opportunity for all to serve that clear need in a client portfolio, generate consistent returns, reduce risk, provide diversification, all great things in user friendly wrappers. And we spend quite a bit of time talking about what a relatively cloudy environment it still is with occasional lightning bolts going off in the 60/40 portfolio. But there's two very bright silver linings to this cloudy environment. The first is that the probability of a global financial crisis is extremely low. You can't say it's zero, but it's extremely low just given the strength of the banking system in terms of excess liquidity and tier one capital. The much better underwriting that took place in loans of all stripes, but particularly in commercial or residential real estate and also just the regulatory reform that took place.

                                    So GFC probability, extremely low. And then of course, the second bright silver lining is that the alternatives have been democratized and average investors can access these strategies when they're very timely. And two other things there, I mean, in order to actually access them, and this has actually been one of my biggest frustrations this past year, advisors and clients have to fight inertia and actually go through the steps to minimize beta or duration, embrace alternatives. And we know that does add some logistical burden as Maurice was alluding to. Everyone's racing to make that as user friendly as possible, but you have to fight inertia.

                                    And then second point is, even though we expect a repeat, a GFC is an exceptional probability. The probability of declines in residential and commercial real estate are exceptionally high, which is why we've been focusing on rolling up the capital structure, focusing on senior debt instead of the equity part of the capital structure. And then our multi-strategy fund actually investing in securities that benefit from slower refinance activity, which typically in a declining housing market, very few folks kick in a couple extra 10 or 20, 30,000 or even a $100,000 in their home to save a few hundred bucks a month on their mortgage payments. So there are certainly ways to adapt to the changing trajectory in the real estate market that can benefit investors. And knock on wood, the risk of a repeat of the GFC is still exceptionally low.

Jenna: Glad you mentioned that. Yeah, go ahead.

Christian Clayton: I want to jump in with maybe one view that's a little bit contrary into some of the other points we've discussed so far. And we've talked a lot about the 60/40 portfolio and clearly this year, the 60/40 portfolio has been extremely challenging, particularly relative to private credit, private equity, private real estate. I think the flip side of that coin is now there's much more compensation in bonds than there was 12 months ago, right? Absolutely. I mean, if you buy an agency mortgage today, you're getting more yield than you got in high yield credit at the end of 2021.

                                    So I think taking a step back, it's clearly been a pretty unique year here in 2022, but I think the way that we look at it, there's still an important role for bonds for a 60/40 portfolio and view Alts as part of that kind of diversifying higher return, higher yield seeking part of that portfolio. But I think our view would be a little bit different in terms of 60/40. In some ways, that portfolio we think has better prospects on a go forward basis than it has a number of years, given the starting place for yields has been reset as we've gotten into 2022.

Troy Gayeski: Yeah, it's certainly true that fixed income isn't returned free risk anymore, right? You're not guaranteed to lose money and guaranteed to make nothing. And Christian's a great point, you make an agency RMBS because that's something we're legging into in our tactical asset allocation strategy and I usually use this as a point to make when people are convinced that QT is priced in the markets. It's like, well if you think that, then look at the agency RMBS market, you have the second widest spreads in the history of mankind, only wider during the global financial crisis when you had garbage credit quality, the agencies were insolvent, the Russians were selling, they were trying to convince the Chinese to sell. And spreads have gotten that wide. Why? Because the Fed stopped buying and then has allowed a tiny amount of their portfolio to run off. So this has created pockets of opportunity, which Darby is one of the reasons I was mentioning before. In certain parts of your portfolio, you can tolerate risk and if you're going to tolerate risk, you might as well get paid a very handsome level of income to do so.

Darby Nielson: Totally agree. I totally got the northeast of the efficient frontier argument and Christian, I'm glad you raised that because you're right. Equities and bonds look very different than they did a year ago, and there's a lot of opportunity and fixed income as you said, Troy. And I was thinking, actually Christian, I can't tell you how many conferences I've been to in the last six months where somebody says, raise your hand if you think 60/40 is dead. And I never raised my hand. So I'm with you.

Jenna: Well, good to end on a good contrarian call there. Thanks for bringing that up, Christian. No, everyone, thank you so much again for joining us and thank you to everyone watching this Alternative Investments Masterclass. Once again, I was joined by Darby Nielson, Deputy Chief Investment Officer at Fidelity Investments; Maurice Rabbenou, Senior Vice President at CAIS; Troy Gayeski, Chief Market Strategist at FS Investments; and Christian Clayton, executive Vice President and strategist at PIMCO. And I'm your host, Jenna Dagenhart with Asset TV.