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 thrilled to be joined today by Patrick McGowan of Sanctuary Wealth. Welcome.
Patrick:
Thank you, Tony.
Tony:
So Pat, maybe just start with who is Sanctuary and what is your specific role? And then we'll kind of delve into a series of questions.
Patrick:
Thank you for having me, Tony. Sanctuary Wealth was founded in 2018 by wirehouse executives who spun out and created their own firm that they really wanted to build when they were inside the wirehouse. It's amazing how much it's grown since the beginning of the launch of Sanctuary Wealth. It's now grown from that day in 2018 to now, including 85 partner firms that have joined us and we're up to 30 billion dollars in assets under management.
And my role there is on the investment manager research and selection process. I oversee the alternative investment platform. I also am very involved in the traditional investment offerings that we can offer to our clients. And also work with our asset allocation group and work with our macro outlook and investment outlook.
We have a very large team that is supporting the platform that is Sanctuary Wealth.
Tony:
Well, again, thank you for joining us because you and I have a deep experience in the alternative space. And I think we've had the opportunity to partner together around alternative education, which I think is one of the big challenges for the industry.
So, maybe if you can, share with our audience how you're approaching education and what you perceive as some of the biggest challenges for advisors as they think about allocating capital.
Patrick:
Education in our approach is the number one thing we need to do for our advisors. There are a lot of ways to address the education.
There are very deep technical resources that you can go to. Things like offerings that CAIA has, but also organizations, the managers themselves are providing a lot of education that are great independent content. I know you do quite a bit of that yourself. And it's now I think to the point where we are including alternative investments in, particularly with the structures and types of funds that are coming out, in a lot of different types of portfolios, ubiquitously.
And so the education process is not so much product specific only, but it's about holistically in the portfolio as well. Some of the more recent with a lot of the perpetual offerings and talking about the historical returns of private markets. It's been about how can we add these to a portfolio for the long-term, not just for the length of one fund, but for in perpetuity. And how it augments returns, whether you're looking for income or growth or your, any of your objectives.
Tony:
Yeah, and let me kind of pick up on that structural discussion, because I think this is something that you and I've talked about quite a bit over the last couple of months. And we'd argue that there's this great inflection point as we look at the industry where I think the market is demanding advisors think about a more robust toolbox.
Product innovation has definitely helped bring alternatives to more of the mainstream. And we'll talk a little bit about registered funds in just a bit, but I think none of this works unless you have access to these world class managers and we're now finding more and more institutional quality managers bringing products to the market.
Let's talk a little bit about structure versus strategy because I do think that these new structures are great for individual investors and also great for those managers who are now thinking about bringing investments to the retail channel. I don't like the term retail channel, but that's the way that they think about it, we think of it as private wealth. But there's some education that needs to go into just understanding some of the structural tradeoffs between the traditional drawdown and some of these new structures and maybe talk a little bit about interval and tender offer funds specifically there.
Patrick:
If you look at the different types of private markets investments and you get into from larger investment strategies, like some areas of private credit, like direct lending, which are relatively large and they're starting to replace banks and that will continue to grow and has that trend has continued. All the way to niche year venture capital and things that maybe are not as large of an opportunity set inherently. When we look at the products you're talking about the drawdown and versus the perpetuals. On one hand, there's the discussion around their perpetuals are great, particularly for the strategies that are larger in size and scale and market cap. So when you look at direct lending or just non-bank lenders, looking at the large trend of non-banks replacing the place of where banks were, that is a massive opportunity where there's capital you can consistently put to work. And perpetual funds, in my view, when we look at managers, we confirm this, but in my view, managers could continue to be that and recycle and have velocity of capital to continue to invest in that.
Conversely, strategies, the opportunity set may be more episodic or maybe really to get the kinds of returns, say the dispersion in venture capital, as you know, is like very wide. So I'm going from one extreme from private credit to venture where the dispersion is very wide. Well, the top tier managers by nature of their strategy can't deploy capital all the time consistently without going outside of what they do best.
And so, they don't do great for perpetual vehicles. Now, having said that perpetual vehicles also have an interesting feature where you can continue to allocate them throughout cycles. And so it's great for a portfolio, whereas a drawdown fund has an opportunity to where you can allocate to it and you can capture in the investment period of that fund, let's say it's the next three years, there may be a really good catalyst, like a discount or a certain spread, an opportunity that the manager is seeing. And as an investor, we may see that as an opportunity where drawdown fund would make sense. It's a really interesting idea and I think that what we're seeing here is that for us specifically, the perpetual evergreen funds are newer and they have quickly taken off to become the predominant fund in the space.
Tony:
So I love the way you describe that because it's really a tradeoff. The traditional drawdown structure still is the preponderance of the assets in the industry, and it worked for certain structures and strategies better. I do want to kind of hit the nomenclature a little bit because I think you and I have joked in the past about we make things a little bit more complicated than perhaps they should be.
Perpetual, evergreen, some people call them semi liquid, I would refer to them maybe as registered funds, but generally we're talking about interval and tender offer funds. I think sometimes that nomenclature kind of tricks people up a little bit, but when I think about it, similar to the way that you described it, the advantage of the registered fund structures is they're available to more people. More investors can play.
Drawdowns are only available to qualified purchasers. So we're pretty dramatically limiting the field that can participate in it. Those registered funds typically have lower minimums. They have 1099 tax reporting, and then they do have this liquidity feature. I think you and I are in agreement about this. I still look at those vehicles as being long term investments, because if you want to capture that illiquidity premium, you need to hold them to the end. But they do have that safety valve. That liquidity provision, which I think is something advisors are definitely keenly aware of and they really like.
Patrick:
Correct. And to your point, I'll try to keep it high level, but we will use nomenclature and as you mentioned words that you and me use a lot, but the registered offerings existed in the past, but they were lifecycle funds. So they can fundraise pretty well, but the exits were unclear and sometimes they were relying on an IPO or things like that.
It was an uncertainty on the end. And I think a lot of. Investors in those funds viewed that they could get all the benefits of the registered offering being transparent with its filings and the accreditation standards and the minimums. But to your point, by having liquidity valve, you have this mechanism to where you can potentially get out on a quarterly, monthly, semiannual basis, depending upon a fund.
I will also say that when we look at the perpetual offerings and liquidity, it's really important from our perspective that, and I do this at our firm and our advisors understand it, but for anybody, that a manager may be really good at originating investments. They are able to find the right companies to buy or loan or do transactions on. But in the perpetual world where you're offering some liquidity, there's also a very important skillset that is separate from like drawdown funds, which is how do you manage that portfolio constantly? How are you optimizing the part of the fund that is the return driver for it? And how are you also optimizing that liquidity that you are making available to advisors? And what is that pool of assets? And what is your ability to manage that? So, we will meet with a manager. And this is a part of our whole process from top down is your ability to originate, your ability to invest and underwriting, but then also your ability to manage the portfolio. Maybe that's not your core competency, but this extra sleeve of liquidity – How are you managing it? What is your outlook? What is your model looking forward if you are met with a certain amount of redemptions or not a certain amount of redemptions? And what are you doing? There's a couple of different mechanisms you can use. That in itself is a really good determination to figure out which managers are really good in my view.
Tony:
And it's a perfect segue. One of the most challenging things I think for advisors is doing due diligence. You and your peers typically do due diligence at a headquarter level. And I think it's important that the advisor understands the work that you do in evaluating the strategy and the structure and comparing one fund versus the other.
But I think it's a little daunting for advisors because they don't have the same level of transparency that they would with a mutual fund and a separate account. Maybe if you can just talk a little bit about what are some of the nuances and what are the important things for advisors to know? I mean, they're not necessarily doing the same level of due diligence as you, but what are the important things for an advisor to think about when they're evaluating one fund versus the other?
Patrick:
I'm really impressed with the teams across the industry, particularly at Sanctuary, but I think that a lot of the advisors are equipped enough to ask these questions and they do pretty good due diligence, I think, in their mind of figuring out how these funds fit in the portfolio. I think some things that they would break it up into are determining first of all what their client goal is. So they're used to doing that on the traditional side. Is it income or growth? Or something, or a balance, something like that, or some version of those categories. And then looking at a fund and looking at the fund's underlying holdings and strategies, maybe not down to the “every single deal level”, but understand are these growth assets? Are they income assets?
And just making sure that the objective of the fund matches the objective of the client and what we're going for. And the prospectus will say, the objective of this fund is income or it's growth or it's capital appreciation, or some version of that. And then they should continue to go through and look at track record. But then also as important is making sure that if they looked at one fund, have they looked at another and compared the fees. Is it in line with other offerings that are out there?
So I think when they triangulate that it is an appropriate fund, it matches what their client is looking for and the client is suitable for it. Making sure that whether the fees are appropriate, are they in line or lower, that they're not too excessive. And it's really important that looking at those things helps put into context the performance of some funds.
So not to deviate from your question around advisors, what they should be looking for, but a lot of the times in our world, those differences, such as if one person's fee is higher or if they have an incentive fee and one manager does and one does not. Now that these funds are perpetual and evergreen, and sometimes even with tickers, you can see the differences. That creates a dispersion between managers. It is really important that an advisor looks at a fund and you see a dispersion, try to understand what could be causing that.
Tony:
I think it's so important for advisors just to understand, and by the way, sometimes you get what you pay for, so the lowest cost isn't always the best, but definitely it's important to spend the time to really understand all fees and the impact it has on the portfolio.
Pat, I just want to maybe close it out and talk a little bit about the outlook, and I'm curious. We've seen a lot of growth in products coming to the market over the last couple of years. You're kind of in a unique position where managers are calling on you every day saying, you know, I've got a new product, I've got a new product.
Where are you seeing the biggest demand from the advisors and what sort of product innovation are you seeing that maybe the future looks a little bit different than the past?
Patrick:
I view it in two areas. I think that on one hand, I truly believe that there is a place for core allocations to alternatives to go into the asset classes and strategies that are pulling away from the public markets.
I do think that there is a lot of interest and there will be continued interest in managers in areas like direct lending and private credit and real estate lending. There are these huge opportunities, multi trillion-dollar opportunities for private lenders to get involved there. Same on the equity side. I think there's fewer companies going public and therefore there is going to be a huge opportunity set there. Those strategies historically have still outperformed the public market equivalents.
Where I'm also really excited about are when you look at the landscape of all the private market strategies and you see dispersions of returns, let's say in venture capital or in private equity where the dispersion is the widest. Of course, you would look at them and as we do, we look at the top quartile managers. We look at what are they doing? What is the geography are they in? What is their strategy? Who's on that team? What is the size of the funds? What is the size of the deals they're doing? And what we find is there are some strategies that may not scale quite as well as for an evergreen perpetual vehicle. Instead of getting you a little bit of a return premium over public markets, it could potentially be something that is even more interesting.
It may not work quite well as far as I can see on the perpetual land, but things like some parts of the venture capital space, smaller buyout managers typically have outperformed larger ones. Things like GP stakes is also a really interesting opportunity because you're getting a pro rata portion of the management fee and carry of the under of the GP itself, not just the fund itself. Those strategies I think if somebody can, eventually they will, find a way to scale them, I think those would be really interesting opportunities for us to get more exposure on the on the registered fund side as well. But certainly it's really amazing to go back to what we're really excited about is for almost for all of our teams to be aware that the largest areas of the market, such as private credit and whether it's in real estate or direct lending and same on private equity, whether it's GP led LP led secondaries, or just massive opportunities, that are going to give you a really interesting, hopefully positive risk return profile.
So we're really excited about that. They're great products, great fees, great investing across all the institutional accounts. And we're really excited about those funds.
Tony:
I'm going to add one more question. You mentioned it twice, the dispersion of return, and you and I know the data well, the dispersion of return between the top and the bottom quartile traditional equity fund is a couple hundred basis points.
The dispersion of return between the top and the bottom private equity fund could be 2000, 3000 basis points, depending on the time period. Are there attributes that are common with the successful managers, those who typically deliver top quartile returns, versus what we see across the industry?
Patrick:
I think so. The answer to that question does change a little bit depending upon what you're looking at exactly. So for example, in venture capital, the top quartile managers tend to stay top quartile managers because the best managers are approached usually win if there is a bakeoff on who can invest in a company, particularly if it’s a really interesting venture capital software company. Because those companies want to be matched with the best private venture capital firms and it creates a persistence of returns. And so a lot of times the managers that haven't done that well are not shown or not given the opportunity to invest in the best deal.
So it creates an ongoing persistence, but it's also very difficult to get into the top manager funds because they're oversubscribed. What we've found in private equity is that a manager who has a top quartile return, there's only a 30 percent chance that that manager remains in the top quartile of the next vintage.
It has less to do with the track record necessarily, but it's to understand what's really important in private equity is where are they investing. A lot of times the best private equity managers have focused, let's say, on small buyout. And let's say they had a few people on that team that were the key investors for that bond. And over time, what you've seen is, I'm just coming up with a hypothetical example, but you see it. Is that the fund will then not just do small buyout deals but start to creep up into mid-market mega buyout, large buyout, and that's when you see the returns potentially transform and potentially just have a different outcome.
Same thing with geography. So for us, there are some statistics that show, I'll describe it this way, managers that have a track record for doing something very well, as long as they keep doing that, well, they have a much higher outcome that they'll continue to do well. The managers that we see start to change their strategy is where you start to see some turnover mostly.
Tony:
Great insights as always. Pat, thank you so much for joining us. I think we covered a lot of ground here today. I'm hopeful that advisors got some really nice nuggets about structure versus strategy, conducting due diligence. And there are some attributes that seem to be persistent over time, which I think is something that you can't replace the experience that you have and the experience that a manager brings to these very specialized markets.
So thanks so much, Pat. Great having you on this episode, and we look forward to having you back in the future.
Patrick:
Thank you, Tony. I appreciate it.
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