MASTERCLASS: ETFs - December 2019
November 22, 2019
Remy Blaire: Welcome to Asset TV. Liquid alternative investments are funds that aim to provide investors with diversification as well as downside protection through alt investment strategies. The advantage is that they're liquid and require lower minimum investments. In a demanding investment environment, investors may look beyond the traditional and seek access in alternative investments.
Remy Blaire: I'm Remy Blaire, and joining us today to discuss liquid alternatives, Kimberly Flynn, Managing Director of Alternative Investments at XA Investments, Stan Sokolowski, Deputy Chief Investment Officer and Head of Portfolio Management at CIFC Asset Management and Richard P. Talley, SVP of Business Development at UMB Fund Services. This is Asset TV's Liquid Alternatives Masterclass. Well, thank you so much for joining me for today's masterclass.
Richard P. Talley: Thank you.
Remy Blaire: Well, first and foremost, I'd like to begin the discussion by talking about the investing landscape right now. We are in a decade old bull market; we just concluded a two-day fed meeting and there are no surprises in terms of the rate outlook. Now given that we have seen massive wealth generation or given this bull market, I want to start by talking about the current landscape. So, Kim, starting out with you, can you give me your take on the environment and what you're seeing in this cycle?
Kimberly Flynn: In some ways, the volatility in November, December should have created a moment of pause as advisors considered asset allocation for 2019. But part of what we've observed now as 2019, the bull market has continued. So, while alternatives have a permanent place in a client's portfolio, I think it's in an environment where you see tremendous equity market volatility followed by continued run inequities. So, it's a moment to pause and consider where your allocations are today if you're concerned or you're increasingly concerned about equity beta market risk.
Remy Blaire: And Rich, moving onto you. Indeed, we have seen equity markets recover as we head into the month of May, and we continue to see record highs for the major equity averages. But in terms of the landscape and the current cycle, what's your perspective?
Richard P. Talley: Well, from an administrative point of view, we're sort of on the back end of the two on my left and right of product creation. So, what we're seeing in the market is from... it's really being driven by the investor trying to get access to asset classes that were particularly geared towards the institutional investor. So that's what we're seeing from a product creation standpoint. We're seeing tender offer funds being created, and interval funds, which are a limited liquidity type product as opposed to the liquid all mutual funds that were in place 10 years ago.
Remy Blaire:And later on in this discussion, we'll be taking a closer look at product. But before that, we'll move on to you Stan. So, if you could tell me what you think of this current investing landscape and your observations.
Stan Sokolowski:I agree with Kim. Valuations are elevated, but we have trending growth, we have low inflation, we have high employment, and we have a supportive fed. For credit, it's goldilocks. And for investors, I'll paraphrase Kim again, it's really about how do you want to be positioned at this point? And in the world of investing, you can do anything at any time. Your choices are, do you want to be aggressive or do you want to be defensive? And at this juncture, at this point in the cycle and given valuations, we're arguing lean defensive.
Remy Blaire: And now that we've covered your individual perspectives, I want to move on to the macro economic landscape and how this affects your individual areas of expertise. So, Kim, starting out with you, can you tell me what you're seeing right now?
Kimberly Flynn: Well, I would agree. I think that advisors are increasingly becoming concerned, specifically about equity market risk. So, I don't know if they're necessarily getting defensive, but they're looking for ways to hedge that exposure. So, it might be using options, it might be using structured notes. And so, from a macro perspective, what we're seeing is an openness to alternatives, things that are not just traditional equity.
Kimberly Flynn: One way that our clients are thinking about alternatives is substituting the elevated levels of public equity exposure for either international equity exposure or private equity exposure. And so, there are many ways now to get investments that give you access to private credit, private equity, and so that's another way to address what is sort of an uncertain outlook.
Kimberly Flynn: People are hesitant to call an end of what we've seen a continued run in the equity market. And so, with that, some of these, either more defensive or exposures alternatives that give you returns that aren't correlated with equities, that's where we're seeing a lot more interest now and advisors are having interesting conversations with their clients around those.
Richard P. Talley: That's a good point.
Remy Blaire: And Rich, you work at UMB and you are a provider of funds services. So, what are some of the conversations that you're having?
Richard P. Talley: Well, I think over the past 18 months, we've seen a number of products from the tender offer fund side and the interval fund side, which essentially, continuously offered closed end funds. They're a little bit further out on the liquidity side of the equation as compared to let's say a liquid alt mutual fund and a little bit better liquidity in terms of then a non-traded read or a BDC.
Richard P. Talley: Currently, we have about 12 or 13 in the pipeline, and really between sort of two types of products. Generally, in a tender offer fund, you might have a more difficult to value asset, maybe private equity, which we're seeing a lot of interest in in- terms of our servicing. And then on the front scale, on the interval fund side, we're seeing a lot of interests there because that's more of a weekly or a daily type product repurchasing on a periodic basis. So, it's really split between the two is where we're seeing the most interest in terms of these types of products recently.
Remy Blaire: And Stan, moving on to you, you're the head of portfolio management. So, what are some of the discussions you're having?
Stan Sokolowski: So with our clients, which range from large pools of capital and sovereign wealth and insurance and endowments and pension funds all the way to the retail investor, the conversations revolve around volatility risk, valuation risk, and even still, interest rate risk, which are probably as likely to go up as they are down these days. We've seen clients who don't want exposure to traditional equity products. They don't want that volatility, and on the other end of the spectrum, they don't want exposure to traditional fixed income, which really hasn't worked as it's supposed to in a number of years.
Stan Sokolowski: So we see investors moving to the middle, we call it new generation fixed income, shorter duration strategies, yielding strategies, this can be in both equities and credit, but a general demand to protect downside and generate income.
Remy Blaire: And now that we've covered that, I want to move on to the appeal of alternatives. And each and every one of you have highlighted what you think is the appeal of alternatives. But Kim, what do you think are some of the benefits in terms of redemption as well as performance?
Kimberly Flynn: Well, so alternatives are meant to provide returns that can diversify the portfolio. So, you're looking for either substitute returns or different sets of risks. So, what we see is that most advisors are still over allocated to US public equity. And so really, there's so many options. And I think that advisors need to think about making meaningful allocations to alternatives because advisors are time starved like everyone else, and so it's a big commitment of their time to start following real estate, private equity, private credit.
Kimberly Flynn: But we think it's worth that investment of time and it's worth the time that they'll need to take with their clients to educate them about some of these other options because it's not enough, I think, to express concerns about US equity valuations. I think what we're interested in seeing advisors do is start the conversation with their clients now because there's so many great choices that weren't available a few years ago.
Kimberly Flynn: I know Rich mentioned liquid alternatives, and the category of alternatives for individual investors has really grown because of a lot of product innovation. So, we're excited about the access points. And what was mentioned earlier too about new types of credit, there's a persistent desire or demand for income, and so we think alternatives that generate that type of income is a great way to add it to the portfolio and the client starts to see the benefit today. They're not waiting for some return down the road, they get that immediate benefit from that income contribution to the portfolio.
Remy Blaire: And gentlemen, do you have anything to add to Kim's comments regarding the appeal of alternatives?
Richard P. Talley: Well, from our point of view, you couldn't be more spot on in terms of education and training from the advisor to the investor. That's where we see one of the biggest hurdles in terms of areas for growth and also working with the platforms. But the appeal for investors to get access to sophisticated strategies such as alternative investments without some of the hurdles, the K1s, the accredited status, all those aspects, if you remove those, you're going to see a bit more upside in terms of the distribution capabilities from these type of alternative products.
Remy Blaire: And Stan, your perspective?
Stan Sokolowski: I'm going to echo the themes of Richard and Kim. Number one, accessibility. People have access today. These are strategies that were once maybe tactical allocations or only available to certain types of investors, and today more and more investors have access. And secondly these are probably going to be core holdings in portfolios going forward for many years to come. And then the other point about education, there has generally been a lack of awareness of how these products serve a portfolio, how they solve for a bunch of challenges that exist today, and that's also going to be a core theme moving out over the coming years.
Richard P. Talley: I can hear quite frequently with all my clients that these products are sold, they're not bought. So, there is a lot of upfront in terms of the training and education aspect from advisors or from managers going out and educating the advisor base on the product itself and why they should be in their clients' portfolios.
Remy Blaire: And there are viewers in the viewing audience who are watching or listening, and they might want to know about the right way to evaluate liquid alts. So, what do you have to say in terms of the evaluation process and from your individual viewpoints, what's the right way?
Kimberly Flynn: Well, I always start with the manager. In evaluating alternative strategies or alternative structures, at the heart of it, what's going to drive returns and performance is the manager's track record, their process. And what's happened in the registered fund space is what we've been talking about. Interval funds, tender offer funds, they have all the conveniences of mutual funds, but they're not mutual funds.
Kimberly Flynn: So right there, you have to help your clients understand that you can get access now to some of the best institutional alternative managers. And I think it helps them to understand these managers, where they sit in the market, because these are the types of managers that people now have the ability to access, and they don't manage mutual funds, they don't manage ETFs, because what they do is active, it's alpha producing and oftentimes they're investing in less liquid or illiquid assets.
Kimberly Flynn: So all the more important focus on manager selection, you want to be working with the best alternative managers in the marketplace. From there, you can assess the strategy, some of the portfolio's parameters and specifics, but I think it does start with the manager.
Richard P. Talley: That's a good point.
Remy Blaire: And do you have anything to add in terms of some of the processes or considerations that come with selection?
Stan Sokolowski: From a credit perspective, what we tend to see first is lots of emotion and opinion substituting for facts and analysis. And there is a lot of fake news out there. And I do find that when we're talking with people and providing perspective versus what they think they know; it's been a two-way process. When we're working with our clients, it really revolves around three key questions, what's your risk tolerance, what's your target return and what's your liquidity need?
Stan Sokolowski: And then as the education continues and the perspective is provided, people begin to understand and eventually these products become a part of their portfolios.
Remy Blaire: That's very interesting. I've never heard the term fake news being applied to liquid alts, but there's a first time for everything.
Stan Sokolowski: Everywhere.
Remy Blaire: And so moving onto our next topic, I want to talk about the investing landscape for this type of asset. So, in terms of liquidity, Kim, can you tell me about the renewed interest that you saw at the end of last year? I know you highlighted this at the beginning of the conversation, but what did you see?
Kimberly Flynn: Well, innovations in the market have brought about the ability to structure or make available less liquid or illiquid assets that when brought to the marketplace in a registered fund format, the structure itself can provide investors liquidity even though the assets may be less liquid or illiquid. And so, you want to think about how the portfolio manager is able to manage liquidity so that they can provide shareholders liquidity.
Kimberly Flynn: All structures can be somewhat different in terms of the source of liquidity and how they provide liquidity. In the listed closed end fund marketplace as an example, a closed end fund is just that, it's closed. And so, 100% of a closed end fund’s asset can be invested in illiquid assets. And the liquidity is provided through the exchange listing. So, shareholders can buy and sell shares every day if they wanted to. What dictates the liquidity is secondary market trading of different funds, and every fund's a little bit different.
Kimberly Flynn: So it's interesting. I think liquidity is very much top of mind since 2008, and when you're trying to provide access to less liquid alternatives, there are tradeoffs that investors have to make in terms of how much liquidity they can have and when they can have it. And so, what's interesting is that your firm, my firm, there are a lot of new structures that are meant to give people access to the true institutional strategies but improving upon it by giving people interim liquidity.
Kimberly Flynn: So I think that there's a lot of focus on that aspect of these products. It's just one aspect, but obviously people desire the ability to have that liquidity. We also coach people though that for real estate or private equity, that should be part of a longer-term part of your portfolio. You shouldn't look to sell that first. So, there's also a bit of coaching around. You have some liquidity, or you may have limited liquidity and how you allocate to these types of alternative registered funds.
Richard P. Talley: Yeah. And it's really comes down to the manager and the strategy involved too. If you're running a more illiquid type strategy, whether it be real estate or PE, that might steer you down the road of more of a tender offered fund, which has the... The repurchase is really up to the board, at the board's discretion, where if you're running more of a liquid strategy, an interval fund might be more appropriate where essentially you have a periodic repurchase of... or redemptions that could be set on a monthly, quarterly, semiannual process. Just going back from a product creation point of view, we're seeing it sort of all over the place in terms of tender and interval at this point.
Remy Blaire: And Stan, moving on to you, we've gotten the perspective regarding liquid alternatives. So, what are you seeing in terms of the credit markets right now?
Stan Sokolowski: So the credit world is as diverse as the equity world. We have investment grade credit and non-investment grade credit. We have secured credit and unsecured credit, floating rate credit, fixed street credit, large companies and small companies. So, when it comes to investing in credit, I go back to those three questions. What's your target return? What's your risk tolerance? What are your liquidity needs? And on the vanilla, low fee, yield generating products, there's plenty of liquidity.
Stan Sokolowski: Certain portions of the credit market trade like water today. And for those who have less needs for liquidity, there are structured credit product offerings today that can yield mid-teens and almost looks like the new private equity. So, it's very diverse. Figure out where you want to be, figure out what your needs are and what solves for your challenges and you can find something in the credit market.
Remy Blaire: And going back to you, Kim, I want to take a closer look at interval funds. And Rich, I also want to bring you into the discussion. So, can you tell me why you think you're seeing this interest right now?
Kimberly Flynn: It's just as what Stan said, that credit is, I think, one of the growing categories in the interval fund market. It's well over 30 to 40% of the market as a whole for interval funds. But we're seeing new filings every day. We're almost seeing more new filings in that space. The asset growth is going to be coming as these funds get on platforms and the funds launch.
Kimberly Flynn: So we're seeing a lot of diversity in terms of the variety of alternative strategies. Clearly a lot of interest along the spectrum of credit that was discussed. There's a growing number of infrastructure or private equity or real asset type funds that are also coming because you think... Think about those holdings, many of them are less liquid and don't fit into a mutual fund, so this would be a good place to access that type of alternative.
Kimberly Flynn: We've also seen insurance linked and fund to funds. And I think we're going to continue to see an expansion in the numbers and the types of funds. As more and more alternative managers are looking to participate, many of them don't have access to high net worth or mass affluent investors. So, as they look to diversify their business, the pension funds and the endowments aren't growing nearly at the pace. Think about the RAA market growth. And so, everybody is really observing what's happening with respect to growth in the individual investor marketplace, and that's why we're seeing so much interest driving the product development of these types of funds.
Richard Talley: That's a great point. The market for interval and tender offer is about $54 billion. Wow. That sounds great. $14 trillion equity market, it doesn't compare. But what we are seeing is, in 2018, about 40% growth in the interval fund market. It's about $27 billion now. So, for us, we're the glass is half full as far as what we see, as far as product being started. The key is removing some of those hurdles from a distribution point of view.
Richard Talley: Some of these products still are checking application, if you can believe it. So, automating these type of products, making them more like, from a processing point of view, like a mutual fund through Fundserv, being able to automate subscriptions and redemptions, that's really going to take these types of funds to really the next level.
Remy Blaire: And speaking of trend, I want to move on to a conversation about the outlook for liquid alts going forward. Now Kim, starting out with you, if you could tell me a little bit about allocating part of an investor's expense budget to alpha producing alternatives, what's your take?
Kimberly Flynn: Well, absolutely. I think that the big push in trend to passive ETFs has brought this question of fees and expense top of mind, and rightfully so. So, the advisor now who's using a lot more ETFs in their client's book, they have an opportunity in terms of their expense budget because now so much of the ETFs are 10, 15 basis points. And so, in that sense, they have a budget for alpha or higher returning type investments.
Kimberly Flynn: And so while most of these alternative products that we've talked about tend to be actively managed and at a higher price point, I think that in the context of an overall portfolio, when you're doing expense budgeting across and you're reserving 20% of your portfolio for alpha producing alternatives, it makes fees which could range anywhere from one and a quarter to 2%.
Kimberly Flynn: Some of these funds also have performance fees, some of them have income incentive fees. And that's okay too because the benefit is that there's a nice alignment between the manager and the investor, but it does make the fee higher. And so that goes back to that conversation around the expense budget, that I think in the context of an overall portfolio where you have some of those nice economies with the ETFs, you can budget in higher priced alternatives, because ultimately when you're doing that, you're budgeting in higher returns and higher potential income when you're making that allocation decision.
Richard P. Talley: When you think about it, when we talk about incentive fees and those type of expenses, most of the accredited market is familiar with those concepts. Of the 54 billion, about 34 billion is accredited investors. So, we need to push down and broaden that base in terms of investors coming in. And that comes back to education, and we can talk about that distribution discussion.
Remy Blaire: And Stan moving onto you, could you give us an overview of what you're seeing in terms of the senior secured corporate loan market? And in terms of performance, what are you seeing in this asset class right now?
Stan Sokolowski: There's really two key things we look at when we answer that question. Number one is fundamentals, and credit is performing today. Earnings continue to expand and most importantly, cashflow is up. Secondly, there always are and always will be idiosyncratic challenges from very specific issuers, but we're not seeing any indications of a cyclical turn related to the economy or any other negative trends.
Stan Sokolowski: Finally, what I'd say as it relates specifically to senior secured credit, it's the cheapest house on the credit block today. If you’re bullish credit or loans, you're talking about yields. If you're bearish credit and loans, you're talking about spreads. The real way to evaluate value today is what are you getting for your excess spread, which is how much you are getting paid to take the risk you are receiving? And today that number is elevated.
Stan Sokolowski: So that's the fundamental side. On the technical side, demand for new generation fixed income products is driving a lot of new sophisticated pension funds, large insurance companies, endowments, family offices. Investors that look at the asset class loans and say, "Wait a minute, isn't this a bank product?" Fake news. 95% of the investors in this trillion and a quarter market are non-bank investors. So, we're seeing them move from those traditional fixed income products where today, globally, $10 trillion is yielding negative into these shorter duration yielding products and solutions.
Stan Sokolowski: And then finally, what I would say overall is there has been a big shift from public markets to "private markets". There have been superior results and quite frankly, it's been a faster, more efficient way for issuers to access capital as well.
Remy Blaire: And because you highlighted fundamentals, I want to bring the conversation back to market trends and discussing fundamentals. When people are talking to clients, they need to make sure that they're communicating properly. This is from the advisor side. So, can you tell me about some of the client conversations that are happening right now regarding alternative investment opportunities?
Kimberly Flynn: Well, absolutely. So, we observe the same things in terms of the fundamental strength of the credit market. And so, our firm has credit focused registered funds, and we got a lot of questions from advisors, mostly about the technical nature of some of the pricing changes that they observed in the loans and in the structure of credit. And so, when you see a technical sell off, that's a very different signal for advisors than when you see a fundamental sell off. We haven't seen that...
Kimberly Flynn: The concern if you saw a fundamental weakness would be that you would be more concerned about credit. So, we remain very constructive on credit and income broadly, and in particular the categories that we were just discussing, some of the private credit opportunities. And so, I think that the conversation's really while there's uncertainty now with the rate environment that we're in, advisors aren't clamoring, necessarily, for floating rate product.
Kimberly Flynn: But if you recall, we're still not out of what feels like a historically low environment for rates. And as I mentioned, there's a perennial need for income. And so that's why some of these alternatives that we've discussed, the yields really vary. But you're talking about 6% yields on the low end, upwards of the teens in terms of current yields for this wide spectrum of credit alternatives. And so, I think for clients that are thinking about, Well, how do I meet those income needs? I'm not going to be able to meet it with my equity allocations.
Kimberly Flynn: And so I like this term that you're using, the new fixed income? Is that how you-
Stan Sokolowski: New generation fixed income.
Kimberly Flynn: New generation of fixed income. Because I think that encompasses a lot of the trend that we're seeing, and I think that advisors are open to having that type of conversation, looking for income in other places besides just traditional fixed income.
Remy Blaire: And Kim, this is a purely subjective question, but these calls, are they ones that an advisor likes having with their clients or how do they go?
Kimberly Flynn: Oh, absolutely. So, I think that when you're talking with clients about alternatives, it gives you an opportunity to have a conversation that you control, and it's... Clients like to hear new ideas. Some of them like to hear venture capital or private equity ideas because they're business owners and they can relate to those types of-
Richard P. Talley: They tend to be early adopters from an investment strategy wise, so if you can find that one group who's managing a couple billion, that they're always open, they want to be a first mover, they want access to the PM, they want to have the personal connection and that's where some of those opportunities can lie.
Kimberly Flynn: Yeah, so you're not being reactive or defensive when you're having these types of client conversations. And so, are you really going to call up your client to talk about the ETF portfolio? Probably not, but you are going to call up your client to talk about a new real estate opportunity or a new credit opportunity or maybe something that gives them access to private equity. I think those are really the constructive dialogs that these advisors want to have.
Kimberly Flynn: I think it's also why they're doing more in the way of estate and tax planning. This fits nicely into the mix of, as an advisor, I am providing value added services, I'm not just answering your question about which way the S&P 500 went today. Right? You're able to give your clients more in this way.
Richard P. Talley: Sure.
Stan Sokolowski: My personal experience reconciles because what I'm seeing from my conversation with wholesalers and RIAs is if you're one of them and all you have in your solution toolkit is traditional equity or traditional fixed income, you're going to struggle with your clients, and that's been a big theme that I've experienced personally in recent weeks even.
Remy Blaire: And Rich, you have a unique perspective. So, can you tell me a little bit about what you're seeing in terms of product experience? What do you think is the key to launching as well as administrating these products?
Richard P. Talley: Well, I'm sure both my colleagues here can attest, you can't just walk into a wirehouse and say, "I'm launching a product, and here, take it." You have to have some type of track record. You incubated an SMA or an LP and have somewhat of a track record before you even walk into some of these wirehouses, platforms, intermediaries. So that's key.
Richard P. Talley: I jotted a couple of notes down. I was in a seminar about a year ago, and I carried it with me in terms of some ideas of success for a manager who is starting up a new fund, a closed end fund, an interval fund or a tender fund, you have to gain access to the platform for distribution, track record is key, effectively train and educate the advisors that you're going out and pitching to. That's critical in terms of them understanding your product, and it's how they fit into their clients' portfolios. Crucial.
Richard P. Talley: Some other steps, clarify your brand, set strategic goals, meaning you're starting up this new fund, are you just gathering assets? Are you looking at margins? Are you looking at revenue? You've got to set those key goals on the outset. Focus on buyers and platforms, critical. Invest in marketing and PR. A lot of people, a lot of managers who are bringing up a new product think they have to go right to the hiring a wholesale route. It's really website PR marketing, putting out content for the advisors to consume and to know your product better.
Richard P. Talley: Sales analytics is another thing. Identifying who is buying it and where they're buying it. Is it a group down in Atlanta who is consuming up a lot of the alternative type products that you're selling? You need to have that type of intelligence. UMB has a lot of... From our distribution toolkit, we have a number of answers for those questions in terms of from the manager side of the equation.
Remy Blaire: And when you're responding to challenges intelligence is key. So, before I move away from you, can you tell me about some of the challenges that asset managers are currently facing and give us a little bit of insight?
Richard P. Talley: Well, I think my colleagues can tell that from an asset management side, I think when you're talking about these types of products, strategies are sound. They're proven. Time tested, back tested, proven. It's really the distribution angle that's not... it's got some work to do in terms of, maturity is concerned. Platforms, like I said, they tended... still do and take these products on in a very similar old-fashioned way, you check an application.
Richard P. Talley: But what we're seeing that's really reassuring for us and we're a part of this is there's a couple of avenues out there, a couple of solutions. One of that is being the Depository trust clearing corporation. They have an alternative investment platform. It's called AIP. That's where they work with the administrators, the custodians and the platforms to streamline and have a straight through process.
Richard P. Talley: Some other areas of iCapital and art investor closing that gap between the manager and the investor in the RAA. They're stepping in from a Fintech point of view and really throwing technology around that equation. So that's what we're seeing in terms of closing that gap and being able to readily invest in these types of products in an easy fashion to do.
Kimberly Flynn: I think the key challenge that we see for asset managers entering is how do I raise the first 50 to 100 million. So, a lot of the other successes that come or the milestones that you would hit, the platform ads and getting traction come once you've raised that initial amount of money, and so it's sort of the classic getting going problem. But when you're dealing with less liquid assets, you want to be investing in a diversified way.
Kimberly Flynn: So that's one of the particular challenges with these types of funds, that maybe mutual funds, they have a similar problem in terms of trying to scale themselves, but that's one of the things, that it's really key to have a strategy around, how do I raise the first 50 to 100 million in capital?
Richard P. Talley: And these expense ratios and these expenses overall are much more expensive than a typical LP, so your breaking even point as an advisor is probably at the 150 range in terms of before you're capturing your management fee.
Stan Sokolowski: Lots of expense pressure. These strategies require sophisticated operations, risk management, business management, support, technology. They're expensive, and if you're too small, you're going to struggle to compete and actually gain product access. If you're too large, it's going to be a lot of large manager beta. So, there is a sweet spot.
Remy Blaire: Looking ahead in this current environment, what are some of the risks that are top of mind right now? We know there is predictable risk when it comes to monetary policy, and then there is uncertainty, whether it's black swan or a geopolitical event. What are some risks that are on your radar right now?
Stan Sokolowski: From a credit perspective? Yup. Black swan. If I look at a two-and-a-half-decade track record for senior secured loans, for example, positive in each of those two and a half decades with the exception of one year, 2008. So obviously, the black swan is out there. I think a lot of the advice we provide to our clients around recessions is don't fear them. There've been three recessions in the past 30 years, and we're just exiting the 50th period of a growth slowdown that's occurred in that same 30 years. So, we don't fear the recession. You're always trying to look around corners for where you can add value or avoid challenges and capture opportunities, but credit seems to be an asset class that can perform in slightly recessionary and low growth environment.
Kimberly Flynn: I think that the two risks that advisors faced in terms of these types of opportunities, one is the hesitation risk. And I think there's a lot of missed opportunities, partly because of the comfort level with equity, meaning that equity is a great source of return, but it comes with a lot of inherent risk. Whereas there's some hesitation around adoption of alternatives because it's a different risk, it might actually be less risk than US equity. And so, I think hesitation risk as a concern.
Kimberly Flynn: And then another risk that we see too is this sort of short-term thinking. And the short term thinking that both investors and advisors sometimes have leads to turnover in the portfolio or coming out of an opportunity too soon. And so, there's this pervasive amount of short termism in the market. And so those are the two concerns that we see because many of these alternative strategies, real estate alone or private equity, they're meant to work over multiple cycles, so that short term thinking really could be at odds with your client's best interest. So those are the concerns that I have.
Kimberly Flynn: In addition to what you were saying, just in terms... I think the advisors are on the pulse of the market, and I feel like they have a good sense of that. But some of these other hesitation risk or short-term thinking risk are ones that have a big impact in the end on return.
Stan Sokolowski: I'll quote Peter Lynch, "More money has been lost preparing for or anticipating corrections than in corrections themselves." And a lot of these products lift that burden off of the investor. They're designed to work through a cycle and really keep folks invested when it's really hard to be invested, quite frankly.
Remy Blaire: And when it comes to approach and adoption, are you seeing any generational differences when it comes to the current environment and in particular this type of asset? If you look at millennials, they may not have experienced the financial crisis in the same way that gen x or baby boomers have. So, have you noticed any generational differences?
Stan Sokolowski: Wow. Granularly, we've not experienced it. But where we do see it is... like I said, at the large pools of capital, they're thinking differently. And in order to survive, they need new ideas and new solutions because the traditional ones really aren't providing what they need today. So, where I see generational shift is in thinking. And a lot of these trends have just begun to establish themselves in the past few years and they're going to continue for decades to come.
Kimberly Flynn: I would agree there. I think the millennials will drive change quickly because in a good way, they demand more, and they're demanding access, they're demanding lower fees, and so I think they are subtly bringing about change. We know now that the money is typically still held in the hands of the older generations, but I think you're right, it is a shift in thinking that permeates the whole business.
Richard P. Talley: Yeah. I would agree. You see how firms such as SoFi are catering to the millennials in terms of they just want their business now. They may not be generating a lot of fee in revenue from them, but they know down the line that they're going to be either the recipients of inheritance or basically just next the group up in terms of income generating.
Remy Blaire: And that brings me to my next topic, which is education of the industry. Based on what you're seeing on a daily basis, what do you think working and what's not? What do you think needs to happen in terms of education?
Kimberly Flynn: Well, I think that what we believe to be working and what we see working is video, ways for advisors on their own time to be able to digest insights. So that works. And then another way to reach advisors is through thought leadership or white papers. So, I think that there's a thirst for that information. And whereas 10 years ago, you would have had to go to lunch or cocktails, a lot of the advisors don't have time for that. And so, you need to convey information in a way that is thoughtful about their time, and that's why video is a good way to do it, that's why white papers are great. So, we see a lot more firms taking advantage of those types of ways to get in front of new advisors.
Remy Blaire: And what about yourself?
Richard P. Talley: So our clients are approaching it in a very similar way. So, you are a manager, you're starting out, you've got a track record. How do you disseminate that information under a budget that you've got from a marketing and PR standpoint effectively? There's no better way than from a content perspective of hosting a link on your site, in terms of basically PM commentary. You could have thought leadership; you could have a weekly digest of what's going on in the market. Advisors thirst for that stuff and they love it. And they love when they get access to the managers themselves for their clients. So those aspects are just multiple components of the overall strategy that you can put in place.
Remy Blaire: And Stan, you've brought up the term fake news before. So, are there any pet peeves you have in terms of education? What are some of the incorrect or some of the misinformation that really bugs you?
Stan Sokolowski: Wow. You touched a nerve. I tend to quote Mark Twain when this question comes up. "If you do not read the newspapers, you're uninformed. If you read the newspapers, you're misinformed." And we're certainly seeing a lot of that panic and emotion around credit in the media today.
Kimberly Flynn: What should you read?
Stan Sokolowski: Well, let's talk about that. Since the depths of the crisis, '09, year today, today, what's the best performing risk adjusted asset class? US leverage loans. The next six are also credit categories. Then there's 60-40 equity, traditional fixed income and then S&P incomes. So, it's subjects like that. It's covenant light and how that's being presented in the market. It's leverage and how that's being presented. And look, there's some validity to some of the trends that are occurring, but when you step back and do the analysis and provide perspective, there's a level of comfort that is coming.
Stan Sokolowski: So we definitely see a lot of that emotion and opinion out there, and that creates high levels of anxiety, that creates a lot of skepticism. By the way, these are all adjectives I love to see because as a risk taker, when I see that, I take comfort because that means the problem doesn't exist where I'm operating. And then finally, what I would also comment from a risk-taking perspective, we see elevated levels of cash out there. And given where we think we are economically, these technicals tend to provide a lot of support to what we're doing. And I'll be clear too, I'm a credit guy. I am not bullish, but I'm not bearish either.
Remy Blaire: Interesting. So, before we wrap up, this discussion on liquid alts, I want to address some of the criticism out there regarding the segment. And you mentioned fees as well as concerns about illiquid assets being put into liquid packaging. So how do we address some of the criticism that's out there in the general marketplace when it comes to this asset class?
Kimberly Flynn: Well, I think some of the criticism is true, in the sense that many of the liquid alternative mutual funds were billed as a good way to access alternatives, but they could only access a very small subset of the market, things that were highly liquid, like future strategies and some hedge fund strategies like long/short equity. So, the criticism, I think, is sourced from unhappiness because of poor performance, which is a legitimate concern.
Kimberly Flynn: I think the new category of liquid alternatives; you're accessing alternatives using different structures. And so, structure is important here because you have to have the fit between the underlying strategy and the actual structure. And so, some of the concerns about alternatives, most of the ones that I hear are just lack of familiarity with either the structure or the strategy.
Kimberly Flynn: And so I think that those concerns can be addressed with time, with adoption, with some education. And we talked about fees because I think that the higher price point, it will be worth it if you get higher returns or higher income. And so that's the goal and that explains why you see higher fees relative to ETFs, for sure. But I think the value is there if you were to compare these types of alternatives to traditional mutual funds because you're getting categorically different types of assets. And there's really no other place that individual investors can access these types of investments, unless you meet the minimums for a limited partnership.
Richard P. Talley: Well, yeah, and then you're at a whole new ballgame. I recently read a study of advisors. 66% shows that they invest in no alternatives at all and the rest have about 10% allocation across their clients. So, you can look at it two ways. You're like, "Well, did we even penetrated this at all, or there's a lot of upside here in terms of where we can go." The feedback we hear from our clients is A, fees, oversold, underperformed. That's the baseline.
Richard P. Talley: And then lack of liquidity within the product, meaning, "What do you mean, I have to wait a quarter to get my shares back?" They're not used to that in terms of general mutual fund lingo. So that's where education and training really come into play in terms of, here's how this is positioned in your portfolio and why. On scale, you should perform greater than the market and be less correlated. That's where you want to be. So those are some of the things that we're hearing from our clients.
Remy Blaire: But regarding the limitations on redemption, do you think that prevents people from resorting to panic selling?
Stan Sokolowski: From a credit perspective, I'll give you a couple of case studies. December of last year, one of the worst months for credit in a decade, down 2%. Those products of concern that the media had expressed reluctance about for liquidity, the plumbing performed very well. First quarter of 2016, the plumbing worked, or be at lower prices. And I think in the credit world, what we did experience was high levels of trading liquidity and transactions, bids and offers were meeting. Or be it at times there were lower prices.
Stan Sokolowski: But Howard Marks wrote about this in the spring of 2015, is liquidity being able to sell or is liquidity being able to sell at a price you want to achieve at a point in time you want to achieve it? So, I would argue from my experience in the past couple of years, liquidity exists, prices move around, opportunities are created.
Kimberly Flynn: We generally think that the one way to outperform is the way that endowments have shown us that they're able to outperform, and they outperform, in large, part due to liquidity premiums. Some people refer to as illiquidity premiums. But you're getting paid for that trade off. And so that's what we want clients to think about, which is it is a tradeoff and you may not want to sell that credit investment that you had in portfolio in December. It might've been an opportunity to add more.
Kimberly Flynn: So that conversation around liquidity is really important. You can't avoid that conversation because of the fact that the tenders can be pro rated. And I think that when you have selling, you'll have people who are disappointed because they can't exit. And so that as an advisor is what you want to avoid. You don't want your clients to be disappointed. And so, we like to talk about liquidity limits and the reason for the difference in liquidity upfront so that there's no misunderstanding.
Richard P. Talley: Yeah. You're exactly right. Liquidity premium right there that you mentioned, so well done.
Remy Blaire: Well, thank you so much for joining me for today's masterclass. I think we were able to dissect a lot of information and disseminate it to the viewing audience. So, thank you so much for your insight today.
Richard P. Talley: Thank you.
Kimberly Flynn: Thank you.
Remy Blaire: And thank you for watching. Joining me in the studio today was Kimberly Flynn, Managing Director of Alternative Investments at XA Investments, Stan Sokolowski, Deputy Chief Investment Officer and Head of Portfolio Management at CIFC Asset Management and Richard P. Talley, SVP of Business Development at UMB Fund Services. From our studio in New York City, I'm Remy Blaire for Asset TV.