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. I'm thrilled to be joined today by Paul Jodice from Morgan Stanley. Paul, what a great opportunity to talk about all the great things that are happening on Morgan Stanley, the robustness of your platform, the quality the managers you’re bringing on board. Maybe if you can, just for our listeners, give us a little bit of your background and your role.
Paul:
Yeah, absolutely. And thank you so much for inviting me here today. I'm really glad we have this opportunity to do the podcast, heard a lot about you in these. And so just a pleasure to ask to join you and thank you for the great relationship we have between the two firms. When you look at, so part of Morgan Stanley Wealth Management, I've been there for coming on nine years now.
And before that, I've spent pretty much most of my entire career in the alternative asset space and got into it right out of college, didn't even know what venture capital and private equity was. And look where it is today, quite mainstream more than ever before. And just having that alternative asset background throughout most of my career, I've also had the opportunity to do that and work and live in not just the US, but also in Abu Dhabi and Singapore and really had an opportunity to broaden that compass, but also be ingrained in seeing how other people throughout the world look at alternative investments as well.
Now within Morgan Stanley Wealth Management, I co-head our global investment manager analysis group, which is our dedicated investment research outfit, if you will, that oversees the investment selection, the investment guidance across both our traditional products. So think about that in terms of our equities and fixed income, mutual funds, SMAs, ETFs.
And then we have the alternative research group, and I specifically head up and lead that group. And when you look at that group today, we have investment professionals broken out into four different verticals. We broke it out into hedge funds, private credit, private equity – which is both funds and we also do directs and co-investment research too as well – and then real assets, which is think about that in terms of real estate and infrastructure. And this entire group really supports the broader Morgan Stanley alternative investment platform.
So, we really bring a deep team of professionals on the research side of the equation and all it's to really make sure we bring robustness to that platform, which continues to grow quite significantly year in and year out.
Tony:
Very impressive. Very impressive. And of course, as a former Morgan Stanley person, once a Morgan person, always a Morgan person. It is incredible to see the growth, not only at Morgan, but across the industry over the last couple of years. And I think you've got a little bit of a head start because you've got a robust and deep platform. What are you hearing from advisors? Are there specific types of strategies you're looking for?
Paul:
I would say the growth of the platform today, I think it's actually grown quite significantly as I mentioned over the past couple of years, because look at it from the backdrop of what they've been experiencing, what we've all been experiencing. When you think about the recent volatility stemming from government policy, we've been in the mode of stickier inflation ahead, the specter of slowing growth, higher interest rate environment, the fact that the 60/40 portfolio isn't doing the job the way it once did. Advisors are saying, hey, how do I find that incremental alpha in my portfolio, the differentiated yield, some element of enhanced diversification to the traditional markets?
I need true maximum portfolio diversification in my portfolio, which our global investment committee has readily advised upon.
And I think what advisors have been doing, looking at it and saying, yes, I do need that. I'm going to need this to make sure I navigate these environments. And what maximum portfolio diversification really is and isn't, it's not about value versus growth, U.S. versus international. It's oh, by the way, if I'm going to dive into some of those attributes I need, hold on, isn't there 80% of companies that are $100 million and above private? A lot of concentration in the equity markets today. How do I find uncorrelated type returns?
So they've turned to alternative investments and really embraced them as part of being coming to the portfolio. And we've seen that if you look at our flows over the past several years, you've seen that adoption because they've recognized the importance of it. They've recognized that alternatives need to have a place in the portfolio based on what I just talked about.
Now, they've also, I think, become more knowledgeable as well. I think as alts have become more mainstream, if you will. People start becoming more knowledgeable and they get more comfortable putting them into the portfolio.
Now, when you look at, again, I think across the equation, again, they've continued to adopt around those four different segments to deliver on the attributes that they need within the portfolio to get that incremental alpha, lower volatility in portfolio, to achieve the objectives of why do I need alternatives? How do I want it to perform in the portfolio? The other thing as well as things have evolved, is products have become a little bit more user friendly to get into alts and to be able to utilize them. I think that's been important. That's where people have said, hey, I can now get into these strategies in a more simplified way, whereas traditionally I may have not.
Tony:
It's great having this conversation because I think we're all seeing the same sort of thing, which is we believe there are three primary drivers of advisor adoption. One is the market environment. As you point out, the 60/40 portfolio failed us most notably in 2022 when both the 60 and the 40 were down double digits.
We think product evolution has helped democratize alternative investments, whether you like that term or not, it's helped make them more scalable across advisor practices. Then at the end of the day, none of this works unless you have access to world-class managers. It's so exciting to see those world-class managers raising their hand and saying, I'm going to bring a product to the wealth channel, where historically there had been some hesitancy in doing that.
We think those three drivers continue to be a big part of the story. I did want to pick up on something where I think you were taking the discussion, which is really a lot of the reason that we have the podcast and all the work that we do here, which is helping advisors have those better informed discussions. Because ultimately, if they have a good experience, they're going to be more comfortable to increase their allocations over time.
What are you guys doing to help educate the advisors and providing access to all this information that you have at your fingertips, but get it to the advisors who ultimately then can share it with the individual investors?
Paul:
Advisor education is critical to adoption of alternatives in the portfolio. You need to understand, when you think about alternatives in portfolios, mid-single digits. And so, if you're mid-single digits and then you get that whole other component of your portfolio, I got to spend a lot more probably time and effort on that mid-single digit allocation to get comfortable in putting it in my portfolio, so the education becomes really critical.
Because if you think about it, okay, first and foremost, how should I allocate within alternatives? Because not all alternatives are created equal. So I need guidance in terms of how do I start looking across those different areas?
That's usually your first approach there. How do I be able to find ways to keep going back to the characteristics of incremental alpha, differentiated yield, uncorrelated type returns? So how do I get that right blend first off?
Then you have to think about, okay, just because I got it right there, now the work begins. Tony, this is where the work begins. It's, oh my gosh, now I got to get the sub-strategy allocations right. Because if I don't get the sub-strategy allocations right, I'll not be building my portfolios correctly. Think about how we build public equity portfolios, how we think about the core, how we build a diversified portfolio across small, mid, large, et cetera. The same holds true in terms of building a private equity portfolio, getting those allocations across bio, growth and venture correct, same within credit, across direct lending, across asset-based finance, specialty lending, opportunistic type strategies, et cetera. I can go on to the other types of strategies.
So there's a lot that has to go into doing it correctly. And so, we at our firm, we do a lot of work around providing the asset allocation advice and guidance. We do spend time working across our global investment office and our global investment manager analysis team to help come up with a portfolio implementation guide, examples of how to do private market implementation across those sub-strategies. So, we try to make sure we provide that hand-holding as best as we can, but, oh, by the way, now you got to fill in the products into those different buckets now. So, do you see how sometimes education needs to truly be there to help spoon feed the advisors ease of use, making it easier and simpler for them to focus on their practice as well?
So, we also work closely with a lot of our partners, so our alternative investment partners for the research and education and experience to help provide the insights. How does private credit, what's the role it plays within a portfolio? How should I think of it behaves? How should I think private equity should behave? As simple as that.
So, we do a lot of work, not just ourselves in putting out and educating our clients and our advisors, but we also leverage the alternative investment community. I mean, why wouldn't we? We have great relationships with them. So, we just did a call yesterday with our entire advisor base with a big private credit manager just to talk about the state of private credit. Just to talk about it. What are we seeing for PIKs [payments-in-kind]? What are we seeing for non-accruals? What do we think is going to happen with performance when interest rates potentially adjust?
Tony:
Yeah. I think the reality is an interesting time and we're all in this together. It's really the purpose of my role at Franklin Templeton is to help the advisors regardless of where they are.
And as you described the why private equity, why private credit, we'll view that as more foundational, but a lot of the research and the work that we've done is building better portfolios. And I think for the advisors who are using, but are looking at more scalable ways to incorporate or those who maybe are power users, but they're looking about different sorts of systematic ways of incorporating these strategies to provide different outcomes over time. That has been the genesis of my book. It's the reason I wrote the book. And it's really a lot of the discussions that I have in my travels across the country. The most sophisticated advisors are all looking, how do I refine my practice to make it repeatable?
How do I use these more robust and reliable tools to have better outcomes for my clients? So it's a really exciting time, but I think to your point, there's this coalescing where all of the industry is aligning to help have better informed decisions because we all know we win and lose together.
Paul:
Oh, I completely agree with you and we're all in this together. And I think why go it alone and bring to bear because it's important for people to be educated and informed. I think Tony, just a little bit to what you're talking about in terms of even on around portfolios, I think that's a trend we're starting to see too as well is the maturation of the alternative industry is continuing to present itself. Just like we've seen in the equities, mutual fund, model portfolios, et cetera.
I think the next wave here is, are we going to start to see even more increased model solutions within alternatives themselves? And that's going to spoon feed advisors. Here you go. You don't have to think about it. I just did everything you told me. I just told you a couple of minutes ago about, oh, we got to start with asset allocation across the alts markets. Now I got to go into substrategies. Okay. If I can deliver you all that and then the products, because a lot of people see a lot of products out there and they spend so much time looking at the products and they just give up, paralyzed by all these products.
If we can deliver that, that saves them a lot of time and they can, again, focus on the practice and they can focus on servicing their clients better. And I just think that's just probably a natural evolution of an industry that continues to mature.
Tony:
We agree with that. And again, it doesn't replace, I suspect that there will be some power users who continue to view that as the value proposition. But I think for a lot of those advisors who maybe feel it's too daunting, if they could say, here's what I'm trying to solve for my client and we could develop for them model portfolios, it would be a really elegant solution.
Paul:
It's adoption, right? If there's still that mid-single digit adoption. So how do you increase adoption?
Tony:
Yeah.
Paul:
Again, I think it's early on, but I would infer that if you put more model portfolios and ease of use into advisor's hands, I got to believe that's going to increase the adoption rate. And the adoption rate of having alternatives in portfolios, there's benefits to it. And people are missing out on the benefits or have missed out on those benefits we just talked about earlier in our discussion around the 60/40 portfolio not doing its job the way it once did and needing to find that maximum portfolio diversification. So, it's definitely an evolution that can help solve for that.
Tony:
We agree a hundred percent. We think the advisor wins, the client wins. It's really good for the overall industry. And I think it's that healthy evolution that we need to have tools that regardless of where an advisor is on their journey.
Paul:
Yeah, I agree with you. And you talk about tools and you can even talk about the evolution of the structure of products nowadays as well. And we talk about that. But I mean, I think that also feeds into a little bit of a maybe tied in with a little bit of a comment you made earlier about some of the managers in the alternative space really saying, hey, the wealth space is quite interesting as a future LP base of mine. Now, I think we've always, at Morgan Stanley, we've always had high quality access. I'd just say that with alternative managers looking at wealth now more so than ever before, our bench is even getting even better.
And so it's just a win-win situation for clients today, even more so than in the past. And so we're just seeing that bench. I mean, Tony, like you see this as well is when you look at what's going on out there in the markets, there's this thing called DPI, distributions paid in.
It's not looking so good. You look back to I think even like the 2019 buyout years, institutions are facing a little bit of a challenge. They're not getting the dollars back to be able to increase their commitments back into fund managers. Maybe if I have usually a commit 75 to that fund, maybe I'm doing 50 this year. Or if I used to do it across five funds, I'm doing it across three funds.
And I think alternative investment managers are saying to themselves, well, hold on. How do I start to solve for the future LP base of mine? Where do I see the future stickiness at capital, long-term type capital, and they're looking to the wealth space. And they're also looking at those adoption numbers and saying, well, hey, if those adoption numbers start to go up incrementally across a denominator, wow, that's interesting for me. And by the way, I got to start delivering product that also helps solve for that too.
Tony:
And that's where I wanted to take the discussion next. You have a pretty unique seat in the sense that I suspect you see every manager and every product in the world. And we certainly have a view that drawdown and evergreen funds certainly have a place in client portfolios. Some strategies fit better in one versus the other. But I'm curious, based on what you're seeing, is there a preference of one versus the other? Are you seeing more demand for evergreen because they're more scalable?
What are you seeing as everyone approaches you when you're looking at what ultimately your advisors are looking for?
Paul:
I mean, evergreen is the word of the day. It's most conversations I feel like I have is around evergreen.
Tony:
By the way, it's better than semi-liquid, right? Not our favorite terminology.
Paul:
Evergreen is probably highly encouraged for a lot of folks nowadays. I think sometimes even if you say the word semi-liquid, people hear the word liquid. But again, this is the maturation of the industry.
Now we're having different products, product innovation, development. We've been drawdown funds, and now we have the evergreen offerings. And we've just seen that natural evolution in the real estate space, then went to the private credit space. Now it's in the private equity space more so than ever before. We're starting to see it in the infrastructure space. Traditionally wealth clients didn't want those 15-year lockup funds.
Oh, and by the way, we're starting to see even more product development within the evergreen space amongst sub-strategies. We're starting to see more and more on the asset-backed side of the world. I suspect we're going to start to see that across all the different sub-strategies. And so that's a good thing. That's a good thing to be able to allow people to develop portfolios in a very thoughtful way. Again, it goes back to what I talked about, about building your portfolios correctly to achieve the right outcomes and the right risk-return profiles, et cetera.
So, we get these questions all the time. I think each has its benefits, and each has its considerations at the end of the day. On the evergreen side of the equation, I think a lot of advisors like it because I don't have to deal with cap calls, 1099, ease of access, you can get immediate diversification. It all goes in on day one, and that's my NAV. I don't have to think about doing my pacing plans. Takes a lot of thought process out.
Tony:
We always use that as well, and that's why, again, we react the same way you do to that term semi-liquid. I think investors should always think of them as being long-term in nature if you want to capture that illiquidity premium. But we think of that as a safety valve should your circumstances change, there is a mechanism for liquidity, as opposed to the drawdown. Just think of that as locked up forever.
Paul:
Yeah, absolutely. And that's how we think about it too, as well. This isn't something you get in and trade in and out of. We have to have a little bit longer-term mindset. And from a couple of different points of view is evergreens are providing people the ability to adopt alts in their portfolios at lower minimums, flexibility, nimbleness. I don't have to be tied up too much in one specific fund. I can start to build a portfolio of evergreen offerings now. I can put them in and then I can maybe augment it with some other drawdown funds to help me express a view on a certain strategy that I can't traditionally get yet in an evergreen offering. Like a traditional VC, early stage, or you have some of the small cap buyout.
So it provides for flexibility, ease of use. I think drawdowns, again, to your point, we talked about earlier was, there are some folks who just only want their drawdowns. And the question becomes is the drawdowns, there are a lot of strategies out there that probably don't suit themselves well yet for an evergreen offering.
Yet. I say yet because I feel like in this world, innovation always seems to take over. But again, I think all of these now are providing tools in the toolkit, and that's a good thing. It's a tool in the toolkit. It's not the be all end all.
Tony:
It's a great thing because to your point, I think advisors have more tools at their disposal than ever before. And advisors can choose how to use them. It's interesting. We've had multiple guests on here. People are focused more on the institutional market or the multifamily office who have talked about the notion of combining drawdown and evergreen. And I think that's the way that we think about it.
There are trade-offs with each. That evergreen structure is probably more scalable for advisors, but it also gives you that more immediate exposure. So, from an asset allocation perspective, I get the more immediate exposure.
With drawdown, I know I've got to build out a plan, a pacing plan that may be three or four years to get fully allocated. So, our view is the same. It's just one is better than the other, depending on what we're trying to solve for clients. But it's great to have a robust menu of a combination of the two.
If I could, I wanted to maybe switch a little bit of gears because you mentioned something that we certainly speak a lot about here, and that is the market environment. You talked about DPI and the fact that we've had very few exits over the last couple of years, which in our view has actually benefited the secondary market.
So, as we look at the opportunities, our highest conviction ideas have been for the last two years, secondaries at the top of our list. We like real estate because we think valuations are down, and we think that a lot of real estate, other than offices, look attractive and are often available below replacement costs. And then we like real estate debt. We think that's an interesting play on some of the disruption going on.
But I'm just curious, sitting in your seat, again, you have managers calling on you, and you're also probably thinking about what are the needs you want to fill for? Are there areas, you mentioned infrastructure as well, are there areas that you're trying to fill either based on demand or based on where you think the best opportunities are?
Paul:
Infrastructure is one of those, and we're seeing the great dynamics that are occurring with the need for power against the backdrop of AI. But it also acts as an inflation hedge too as well, cash flows, and I think that's important. So there's got some double benefits to it. Secondaries have been an area of focus because secondaries are becoming even more so a liquidity provider in an otherwise illiquid market.
We talked about the fact that institutions, other investors are saying, how do I redeploy capital into perhaps some good vintage years ahead? I want to maybe use some, go to the secondary market, trim some of my older holdings to redeploy some of that capital back in, or maybe just want to restructure the portfolio a little bit as a portfolio management tool. And GPs with the LPs going around saying, hey, I need liquidity. Oh, by the way, you want me to commit to your next fund? I need you to send some money back to me. And so they've been tapping into, again, innovative structures, the continuation vehicles to help saying, hey, I kind of want to hold on to a couple of these assets a little bit longer because I really like them. I don't want to give them to somebody else where they're going to reap the benefits. So they've been leveraging the continuation vehicles to help drive liquidity back. And so from those dynamics that are occurring there, the secondary market continues to be that liquidity provider.
I don't see that ending just yet, but we also, from that secondary side of the equation, we still think the buyout space with people who have that operational mindset is important too as well. And we do like the, obviously the opportunistic type credit out there. Think about that capital solutions. We have a lot of good companies out there, just not great balance sheets, just not good cap structures in place. Still have stickier inflation, higher interest rate environment, need to restructure those companies.
So those are just a couple of the things that we've been talking about with advisors and clients as well.
Tony:
I'll just pick up on that secondary comment. We're also of the same view that when all of a sudden exits pick up and you get that normal flow, we don't think the opportunity goes away in secondaries. We think they're here to stay.
We know that institutions are actually using secondary programs as a constant tool of refreshing their portfolios. But for an individual investor, a lot of your advisors, a lot of their clients, isn't it great to get that built-in diversification across vintage GP? So I think the relative attractiveness of secondaries is that's definitely here to stay.
Paul:
It's good to get that into a portfolio, kickstart a portfolio, get the diversification going, getting the IRR enhancement over ongoing cashflow. That's important. So, to your point, it's not secondary in nature anymore. It's almost become almost a primary stop. And it's definitely having a little bit of a resurgence as well into the limelight. And I think people are starting to understand it more and more and understanding the roles and benefits it plays. And advisors and our clients like it for just that diversification and the overall experience.
Tony:
Paul, I could spend the whole morning talking to you. This is great. There's 100% alignment on the views and the opportunities. I wanted to leave you with one last question, and that's maybe going back to the beginning. You and I were talking about the fact that 5% to 6% allocation across the industry, and we recognize there's some people sitting on the sidelines and there's some power users. What will it take?
And maybe it's not one thing, maybe it's multiple things, but what will it take to see the industry allocation go from that 5% to 10% to the 10% to 15% recognizing that some are always going to be higher than that, some will be 30, 40, and some will continue to sit on the sidelines?
Paul:
Look, I think it becomes what we talked about is a blend of the education, how it plays a role in the portfolio, how it works, allowing advisors to become more comfortable with putting it into portfolios and talking about it with their clients. I think product innovation, product innovation with the evergreens have definitely allowed for more ready adoption because the benefits we talked about are the characteristics we talked about. But then I think if you can start to deliver model portfolio solutions, that becomes another way for people could just say, you've just taken out all this thought process for me. Thank you. Here we go. Plug and play.
Look at all these pre-built portfolios, ETFs, mutual funds out there. Any asset management website, investment advisor website, there's pre-built portfolios. So a natural evolution of the industry says probably you're going to have a pre-built portfolio for alts, and that's a click of the button.
Tony:
We agree. Education is key. Positive experience is really important. The more comfortable you get, the more likely you're going to increase your allocation. I like the idea of model portfolios because I think that appeals to a segment of the advisor community. It's just a natural evolution of this very exciting industry that you and I love talking about and love living in.
So Paul, thank you so much for your time today. This has been fantastic. For all of our listeners, if you liked the episode, please rate us. Let us know what you like. Feel free to reach out if there are ideas and topics you would like for us to consider. This has been a great discussion, Paul. We'll have to have you back in the not-so-distant future.
Paul:
Thanks Tony. Really appreciate it. Thanks for inviting me.
Tony:
Thank you.
Show V/O:
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