Show V/O:
This is Alternative Allocations by Franklin Templeton, a monthly podcast where we share
practical, relatable advice and discuss new investment ideas with leaders in the field. Please subscribe on
Apple, Spotify or wherever you get your podcast to make sure you don’t miss an episode. Here is your host, Tony
Davidow.
Tony:
Welcome to the latest episode of the Alternative Allocations Podcast series. I’m absolutely
thrilled to be joined today by Jenny Johnson, President and CEO of Franklin Templeton. Welcome, Jenny.
Jenny:
Thank you. It's great to be here.
Tony:
And it's such an exciting time for Franklin Templeton. You have really transformed the firm and
certainly the way that people think about the firm with these acquisitions of great firms like Clarion, Benefit
Street Partners, Lexington, Alcentra, now all of a sudden we're an alternative powerhouse with, well, 260
billion in assets under management. Why has that been so important to you and the firm as we think about how
we're transforming this business?
Jenny:
Yeah, I mean, I have to credit it to back in like 2018, we were doing our strategic plan and we're
just watching the growth of allocation by really institutions to the private markets. And, you know, as you got
under the covers, it was clear that this was a real secular change in asset management. And so, you know, we
looked at it and said, all right, we need to be we need to be able to have a breadth of capabilities for our
clients. And so we essentially our first acquisition was in 2018 of Benefit Street Partners, which, you know, is
a private credit manager. And and then it was, you know, it has been a very focused effort to continue to build
out those capabilities.
Tony:
Yeah. And you kind of started where I really wanted to take the discussion. Historically,
Alternatives has been the domain of big institutions and family offices. All of these managers really started
out focused on that institutional segment. And now I think we're so excited about the opportunities in the
wealth management sector. But part of the challenges, as you know, we need to educate them. We need to provide
thought leadership. We really need to help them think through how to get exposure in the right way. Why has your
commitment to education of thought leadership been such an important part of this journey?
Jenny:
Well, so first of all, the reason I think it's really important that this capabilities are are
responsibly brought to the wealth channel is I think it's akin to, you know, the time where my father or my
grandfather got into the mutual fund business and mutual funds were created because only the wealthy had access
to the equity markets, the excess returns of the equity markets at a time where there was tremendous growth and
the average person didn't have access there. So somebody came up with the idea, let's consolidate client's money
and and charge a very low fee and give them diversification and liquidity. You know, we're at that same
inflection point because there's so many assets that are now being and great companies that are now being held
privately. And only the wealthy right now have access to that. And, you know, a pension fund has very
predictable cash flows because you know how many pensioners you're going to have to pay this year. And so it's
very predictable. So you can and it has been very easy for them to allocate a percentage of their portfolio into
these private markets, which, you know, can be up to ten plus years locked up capital. So, you know, the
challenge, though, is the average investor hopes that they don't have to tap into their savings. But what if
they need to tap into their savings? And and, you know, to much of their portfolio was allocated there and they
can't for whatever the emergency is to do it. So this is where it's really important that one you explain why
there's there's risk here, particularly from a liquidity standpoint. But there's also a real reward because
there are excess returns in these various markets. But, you know, they're also characteristics that can be
difficult. And so, you know, our experiences at Franklin Templeton, we want to be able to provide capability
across the full risk spectrum, Right. So it can be anywhere from, you know, a money market fund that's almost no
risk all the way up to a very, very risky, high octane equity or venture capital. But it's really important that
our clients understand the risk they're taking on. Right. And so that it is appropriate for their portfolio. And
that's why we realize as we're bringing this capability, it requires complicated education. Education, both of
our own Salesforce, education of financial advisors who bring this to their clients so they can figure out where
it's appropriate for clients. And then, of course, to the consumer.
Tony:
Yeah, and thank you, because I think that is so important, right? We want to we want to do it
responsibly. I really appreciate that positioning. You talked a little bit about pension plans. And again, we
know big institutions have allocated you know, we have all seen the Yale Endowment with 70, 80% allocation to
alternatives and pension plans. I think based on Preqin data, it's roughly 30% allocation across the board. The
wealth channel has historically been around 5%. I think that data is pretty stubborn, but I think we would argue
at least there's this confluence of events, right? We have a market environment that is demanding a different
playbook, right? More tools at your disposal. We have product innovation which have made these institutional
capabilities more readily available to a broader group of clients – registered funds, the interval tender offer
funds in particular. But I've argued none of it works unless we have access to world class managers, which
again, I think is a really important part here, because these are very specialized markets. As we think about
the wealth management channel and the opportunities, in addition maybe to the commitment that we've made in
education, how are we going to get there and what do we think that looks like over the you know, if it's 5%
today, is it going to be 10%? Is it going to be 20%? And how do you think we get there?
Jenny:
Well, first, let me readdress the point about world class managers. The dispersion in returns in
this category is huge. You know, if you pick an underperforming, you know, global equity manager, you might be
out a couple hundred basis points up till I think this number was through 2022 that the over 20 year window the
top quartile private equity firms outperformed the bottom quartile by 20% a year. The top quartile real estate
firms outperformed the bottom quartile by 10% a year and the top quartile private credit firms outperformed the
bottom quartile by 5% a year. It's so massive, the choice of manager, so important that, you know, part of this
process is not only creating the right vehicles, but also selecting the right managers. It's really, really
important. And it also worries me a little bit as some of this is coming into the wealth channel, because folks
in the wealth channel have been so trained to think it's all fees, fees, fees, and the only ones in this
industry that are ever going to be on sale are the bottom quartile performing managers. And often you're better
off being in the public markets than with a bottom performing manager. So that's kind of the first. You know,
it's a message I feel is really important to get out there because as you know, I think like 41k plans are a
great place for this, but that's where the fiduciary is. First thing they look to is, well, let's just look at
fees. But then from there, you know, I think the good news is the kind of product innovation with things like
interval funds are making it more liquid, right? So there's an element of liquidity in there which is going to
make it more accessible to more, more people in the retail channel. But it is still really important that
they're selective. And so, you know, for some people it might be 30% of their savings that they could put in
like a pension fund. And some people maybe they just don't feel like they could have any locked-up capital. And
that's why I'm such a believer in the financial advisor who knows that end client and really understands the
spending patterns of the end client to figure out what's appropriate.
Tony:
One of the one of the white papers that I wrote that actually has been republished in multiple
magazines has really focused on this creation of an illiquidity bucket. I call it The cost of being too liquid.
And, you know, there's a couple of messages embedded in there. One of those is something you picked up on, which
is institutions have been doing this for a long time, but they have the wherewithal to have an illiquidity
bucket. They can put that money aside. They hold it. They expect to hold it for 10 to 12 years or whatever the
duration is. And even though these structures have more liquid features and I'm I'm certainly trying to
emphasize to the advisor community that we should think of them as long term. If you want to get that
illiquidity premium, you have to hold it all the way. Although they have liquidity features, if you think you're
in it today and out of it tomorrow, you're not going to have the same experience. So I think it's really
important we try to condition people to think this is your long term investment and oh, by the way, that also
helps condition investors to think long term. As you and I know, everyone says they're a long-term investor
until you get market volatility.
Jenny:
Yeah, the worst time to pull it out.
Tony:
Exactly. I do want to pick up on your point. You've mentioned a couple of times, you know, the the
pension plans and their allocations. And, you know, we certainly cite a lot of institutional data in the stuff
that we write. It's great to see institutions have been allocating quite a bit to this, but there's been this
issue of we believe that it's right and appropriate, but in the DC market we haven't really seen the follow
through. And I think part of it is just maybe a lack of understanding from the regulators or a lack of clarity
on how to get those into those funds. But you mentioned 401k plans, I would argue target date funds, 401k plans.
It would be great if all retirees could access alternative investments. And I know as a firm, we've looked at
that and I know there's been discussions with the regulators. Any sense of where we are there and where we might
be going?
Jenny:
Well, it's interesting. We modeled out just to really try to understand how important was this
important enough to really go through the complexity of trying to do product creation and and think through it.
And so our Solutions team modeled out adding real estate and private credit to kind of a managed account
solution. So like a target date solution, but, you know, managed account solution. And just by going anywhere
from 10 to 30% of the portfolio in real estate or private credit, it raised, and they were using the average
return, right, so if you pick better manager, your returns even going to be hard on that. They were showing net
of fees 1 to 3% a year in a kicker, a return. That’s huge over somebody's lifetime for retirement. So we looked
at that and said okay that didn't even include private equity or other types of alternatives. This is worth
really getting in there and, you know, working with 401k providers and educating them on this. The reason I
personally like the 401k is what gets difficult. So mutual funds today can have up to 15% of their assets in
illiquid holdings. The challenge for the manager is if the market drops and the you're illiquids become more
than 15% market drops, people do a bunch of redemptions. You now have breached that number and you can't sort of
rebalance it. And so you know what ends up happening is if they're willing to allocate on a mutual fund to
alternatives, they have to keep it low enough that they'll never breach the 15% threshold, so you don't get the
full value of it. But in a 401k plan, you always have cash flows coming into that account every every time their
paychecks. And so it always keeps even in market volatile times you see the big the flows going in to people who
you know managers who have big 401k businesses because the the employees not even thinking about it, just it
gets taken out of their paycheck. So that's good news because it provides that illiquidity. Number two, people
don't tend to pull their money out of the 401k plan and three, there's actually a mechanism for kind of hardship
lending. You know, I have a problem, I can borrow against it. And so it's the perfect sort of ecosystem to be
able to deliver this, certainly as we're, you know, first kind of getting into it, introducing it to the
channel. Again, this is where fees are really important because that's probably the channel because you have
fiduciary sitting over every plan who you know, the easiest thing is to say, well, I picked the low cost
product. You know what? You know that I was focused on fees and that's the easy thing to do. But in this
particular case, that is going to end up, I think, with bad outcomes.
Tony:
Yeah, it's fascinating. I hope you're right, because I really feel like everyone should be exposed
to these investments in a smart and an intelligent sort of way. And that seems to me to be the one big
opportunity we're missing out on. If I could, I'd love to talk a little bit about the investment outlook. You
spent a lot of time traveling all over the world. It's great to see you, you know, all over the world talking
about alternatives, your passion, my passion. As we look at the environment today, you know, clearly not all
opportunities are created equally, but private credit certainly looks really interesting here. We recently had
Rich Byrne, President of Benefits Street Partners, on as a guest and he was talking how private credit looks
very attractive in today’s market environment. Secondaries look like they're well positioned as we're seeing a
lot of reallocation of capital. And even within real estate, you know, there are sectors of real estate that
look really attractive here. I think offices get the headline, but industrials, multifamily look attractive.
What are you seeing and are there opportunities out there that maybe, you know, we're not paying enough
attention to?
Jenny:
Well, I think you hit the big ones and, you know, you take private credit. This is really a
secular change because of, you know, the I think the the response of regulators to the global financial crisis
where they raised capital requirements for banks. And so banks’ capital is very expensive to them. They only
want to use it for their best clients. And so they're not lending like they used to lend. You know, when we look
at Silicon Valley Bank, Silicon Valley Bank’s blow up wasn't because of bad credit, it was because of duration
and interest rate portfolio of U.S. Treasuries. So if you look at that, you know, the last sort of people still
lending on the banking side were the regional banks and post SVB, they're not really even lending anymore. So
that's what's created this industry of private credit. And you know, when you look at private credit managers,
the interesting thing is it's just as important. Their underwriting is equally important to their sourcing of
deals, the relationships they have with sponsors, the relationship they have with, you know, direct, small and
midsize businesses – kind of like the old banking feature, right? And so they're serving that market. And the
reality is it's just getting bigger and pushed more and more out of the traditional banking system into this
private credit market. You know, and and it's honestly, it's it's a different risk profile. When a bank lends
every taxpayer, you know, and the government is sort of backing those loans through the FDIC insurance, whereas
when it's done through a private credit and raised in a fund, there isn't that same risk of capital. Right. It's
borne by the investors. And so, you know, I look at that in part because there's just less providers, because
you don't have the the banks in the in the business as much, you know, are Benefit Street Partners and Alcentra
would tell you they're seeing the best deals they've seen since the you know, post global financial crisis. And
let me just on the Lexington Partners and secondaries. I love secondaries. Again, it's kind of the time that
we're living in, which is you've had $6 trillion deployed in in the private equity arena. You've had about 150,
160 billion raised in secondaries. And if you're an LP, you may not you're not getting as many realizations,
right? So you're not getting funding from those private equity investments, and yet they are doing capital
calls. So you risk breaching the amount that your investment mandate allows you to allocate to private equity
and if you don't meet the capital calls, you're going to be left out of the next capital calls with that best
manager. So if you're with that top quartile manager, as we talked about earlier, you're going to want to make
your capital calls because you don't want to be left out. And so they end up going to a Lexington Partners and
say, you know, can you come in here and take, and this is a real transaction they had, take a billion dollars
off of my, you know, outside of my, you know, portfolio and do it in 30 days. And Lexington can choose the
vintages and the managers and buy it at a discount. And you know, the discounts today are 20% on, you know,
private equity and private credit and real estate's around $0.78 on the dollar. And venture is only late-stage
venture and it's at a 50% discount. So like you just look at those and that's a supply and demand issue. That's
not a pricing. Right. The valuations have already been valued at what what the market feels is appropriate.
They're just getting it because there's not enough secondary managers out there to make those acquisitions.
Tony:
Yeah, I agree with you. I think it's a really exciting time. And you know, again, for seasoned
managers and people who are long term oriented, this is a great environment for the private markets. I think
that people can be much more selective in how they allocate capital. The price that they pay for private credit,
the covenants that you get built in. So really exciting time for us. I'm glad we're having this series and we
can share with everyone as we're thinking about the world. I have to ask you, you actually have such a unique
vantage point of looking at the world. If you can put on your crystal ball and think about where are we going to
be, you know, five years from now, ten years from now, from the growth of alternative broadly, but maybe what
the landscape looks like? I mean, we've certainly gone through a transformation. I'd say in the last decade, the
rate of change has been incredible. And you can only imagine that rate is only going to accelerate going
forward.
Jenny:
Yeah, I mean, I think a lot of a lot of the private markets were fueled by the fact that we were
in a zero interest rate environment for a decade or more. And, you know, but and there was a lot of people
skeptical about whether it would remain once rates raised. But I think there's other factors. I already
mentioned on the private credit side. It's just banks’ capital so expensive now that they're choosing not to
lend like they used to. And I think in the private equity space, the reality is, you know, people have a choice.
CEOs, if they have a choice to remain private, they're preferring to remain private versus going public. You
know, if you're a public company, you end up having pressure on quarterly earnings in a time of great
technological innovation and change. You need to be investing in things that may not pay off for 5 to 10 years.
I think Franklin Templeton is fortunate in that we still have kind of founders that own a nice chunk of the
company. So even though we're public, we still have the ability to think a little bit more generationally and
longer term. But I think that CEOs are recognizing that that's a hard environment to be in. And so you see it in
the numbers. In 2000, you know, just the average company went public after three years. By about 2019, it was I
think it was 9 to 10 years. And by 22 it's 14 to 15 years. So all that early growth years are being captured in
the private markets. And I don't see that changing because of this dynamic around public company and the
scrutinies around public companies. So, you know, I think that it's here to stay. When you ask me what does the
future look like, I think one it you're going have all those categories that still exist. I think energy
transition you know much more controversial in the U.S., but you see tremendous demand still outside the U.S.
and in Asia. And so there's going to be opportunities to invest there. And then honestly, with technology,
you're going to see much more personalization that's brought to the individual and they're going to be able to
tilt their portfolios – some private, some public and with some amount of impact component to it. And they're
going to be really customized portfolios. And I think that Blockchain plays a big part in all of this and how to
figure out a better way to deliver alternatives.
Tony:
Jenny Johnson, thank you so much. This has been quite a journey, talking about where we've been,
where we're going, and to me a very, very exciting future. Thank you for being my guest. This has been terrific
and I hope everyone continues to follow the Alternative Allocations podcast series. Thank you again, Jenny.
Jenny:
Thank you.
Tonny:
And good luck investing, everyone.
Jenny:
Thank you.
Show V/O:
Thanks for listening to Alternative Allocations by Franklin Templeton. For more
information, please go to alternativeallocationspodcast.com and don’t forget to subscribe wherever you get your
podcasts.
