← Capital Allocators – Inside the Institutional Investment Industry
Capital Allocators – Inside the Institutional Investment Industry
Kristin Kallergis Rowland – Alts at J.P. Morgan’s Private Bank (Private Wealth 4, EP.447)
00:50:18
Kristin Kallergis Rowland is the Global Head of Alternative Investments for J.P. Morgan Wealth Management, where she oversees $180 billion of alternative investments within the $500 billion managed in J.P. Morgan’s $3 trillion private bank. The...
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- [00:00]
Kristin Kollergis Rowland
Foreign.
- [00:05]
Ted Seides
Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access Premium content@capitalallocators.com All opinions expressed by Ted and podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as.
- [00:43]
Kristin Kollergis Rowland
A basis for investment decisions. Clients of Capital Allocators or podcast guests.
- [00:47]
Ted Seides
May maintain positions in securities discussed on this podcast. Thirty years ago, institutional investors held most of their assets in stocks and bonds. David Swensen led a movement to an approach to portfolio management that broadened the asset mix to alternative investments, including hedge funds, private equity, venture capital, and real assets. These days, almost every institutional portfolio incorporates significant allocations to alternatives to produce better outcomes with similar risk or similar outcomes with lower risk. However, capital in the hands of individuals has not yet followed suit. Private wealth portfolios, particularly the so called mass affluent, typically hold only 2 to 5% of their assets and alternatives, compared to a range of 20 to 50% for institutions. But that's changing quickly. Innovations in structure have allowed individuals to access alternative strategies at lower minimums, with liquidity options not previously available. According to arctos Partners, the six largest private banking and wirehouse platforms committed $110 billion to funds last year, approximately twice the amount invested from the six largest institutional investors in North America. And those flows are just beginning. The potential investment dollars from private wealth to alternatives are staggering. Every 1% asset allocation shift would equate to approximately $500 billion of new investments. The impact of these capital flows will have ramifications for GPs and LPs for decades to come. How will the capital get deployed? What will it do to asset prices? What will it mean for returns and for fees? And who will win and who will lose? This mini series, Private wealth, explores the important questions raised by the accelerating convergence of institutional style investing with private wealth. We'll hear from three of the most influential asset owners, one each from the Private Banking Warehouse and RIA channels, and three of the most significant asset managers playing in this space. Just as this channel is in the early innings of changing the investment landscape, so too will this mini series be just the beginning of our exploration of what it means for you. My guest on the fourth episode of Private wealth is Kristin Kollergis Rowland, or KK, the global head of alternative investments for J.P. morgan Wealth Management, where she oversees $180 billion of alternative investments within the $500 billion managed in J.P. morgan's $3 trillion private bank. JPMorgan's investment approach resembles that of many institutions with centralized research, manager selection and portfolio construction that its financial advisors use in client portfolios. KK has spent her entire career in private wealth at JPMorgan, spanning investment functions and global geographies. Our conversation describes JP Morgan's centralized approach to alternative investing for its clients. We cover KK's journey through JP Morgan and the evolution of alternatives within the firm. We discussed the allocation strategies for private equity, private credit, real assets, venture capital investment and hedge funds, insights from JP Morgan's family office report, and the importance of portfolio construction tailored to diverse client needs. KK also shares her thoughts on the democratization of access to private markets, innovations in evergreen fund structures, and the challenges of scaling investment solutions across a global client base.
- [04:38]
Unknown
Before we get to the interview, we're excited to share a new opportunity to join the Capital Allocators team. We're hiring a Head of Content to lead everything we create and share with you, our listeners and followers. That includes our flagship podcasts, our newsletters and written content, our website and social channels, and our new video content. We're looking for someone who's excited to roll up their sleeves, get into the weeds and own our content processes from start to finish. Most importantly, we're looking for a fan of the show. Someone who's jazzed about long form interviews with leaders in the institutional investment industry. Someone who brings energy, pride and a sense of purpose to our mission of compounding knowledge and relationships among asset owners and investment managers. This person should be detail oriented, organized, experienced in project management, and ideally have a background in media or podcast production. The job posting is in the show notes and on our site@capitalallocators.com thanks so much for spreading the word about our Head of Content job opening.
- [05:43]
Ted Seides
Please enjoy my conversation with Kristen Colerjis.
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Kristin Kollergis Rowland
Rowland Kay Great to see you.
- [05:49]
Nice to see you.
- [05:50]
I would love you to take me through your path at JPMorgan that landed in this seat.
- [05:56]
It started in 08. Just graduated school. I started as a credit analyst in the Chicago office which is the old bank one where a lot of our credit was done out of. I I had always started on the wealth management side as part of the private bank, although there was lots of crossover business to do at the time and I was a credit analyst for a few Years I thought markets going down 3 to 5% a day was normal. It wasn't. But we were in a fortunate position to be JP Morgan at that time. After two years in Chicago, I moved to New York to work in the office of our head of investments and our CEO. And that was an incredible experience because we were hiring, building new products, especially in the world of alternatives in the sort of 2010, 2011 era, we changed the way in which we offered things to our clients. And then in 2013 my then boyfriend of many years, now husband, wanted to go to business school. And so I moved to London in 2013. Tons of change going on in the alternative industry there because of aifMD and the UK tech status changing and alternatives was at this sort of turning point about what was the future of it going to be within that region. I got a chance to run our European Middle east business, moved back in 17 to run our US platform and and then in Covid had a chance to take over a global business. So it's been a couple different cities in a couple different countries, but that's been 17 years at JP Morgan.
- [07:09]
So working your way up in private wealth, how do you think about putting a scope around what JP Morgan's private wealth business is?
- [07:18]
The earnings reports and stuff will come out with the almost $3 trillion that we have within that space. Alternatives as a piece of that is significant. It's not as significant as the portfolios that we manage on behalf of clients, which is almost a half a trillion dollars, but a lot of what we do in alternatives, which is about $178 billion, where we allocate to a lot of non JP Morgan, but also JPMorgan portfolios, is a piece of the portfolios. The client base themselves is what differentiates us. Anyone that has a few million dollars to several billion dollars, if you include our full wealth spectrum, it includes Chase, which is one of two households in America, all the way through to the institutional side private bank in particular. We'd been focused for the last many years on families that had anywhere from $5 million of net worth and above. And then those that participated in alternatives, partly by nature of it, because they had to be qualified, skewed higher. But we have incredible insight because we cover 1400-1900 billionaires in America. We cover a decent amount of those outside the US and so whether you're investing a couple hundred thousand or tens of millions of dollars, we have to have this suite of products to offer all client basis, which is fun.
- [08:25]
How do you organize that entire effort.
- [08:27]
All of it stems from how do we build great portfolios. And in the private markets, we think about allocating our portfolios. Half to 70% of it every year is in core private equity, 20 to 25% in growth equity and venture. Mostly growth equity, although we've been leading into venture the last couple years. 15 to 25% is in private debt offerings. We've been doing that since 07. And then real estate, real assets are broadly is another 15 to 25%. We always try to think of a few years ahead, but we start every year by saying do we have enough choice in these areas to build portfolios? We can do it for them, we could do it with them. A lot of clients actually do a combination. They'll get their core holdings and then they'll invest a la carte as well.
- [09:05]
If you take the asset allocation higher up than just alternatives, what does that look like on the platform?
- [09:10]
We run a family office report. We started it a couple years ago where we go to the top 200 families. About 25% of it was in pure equities, 46% of it was in alternatives and the remainder about just over 20% was in fixed income. Started the family office side because fascinating to know that within that 46% of alternatives, 15% was in direct real estate, 17% was in private equity funds, 6% was in hedge funds. If you look across our broad client base, a lot of clients were 60, 40, 60 equities, 40 fixed income across the board. It's probably now changing to maybe 45% equities, 15% in alternatives and the remainder still like fixed income and where you put private credit and which side it will depend. But generally speaking, that's how it's been.
- [09:56]
With such a wide range of clients. How do you organize your effort to create those portfolios and service the very many different clients that you have?
- [10:05]
It's all going to be based on client needs, which everyone's going to tell you anyone that serves the clients in these areas. Because a client that's a business owner is going to be very different than a financial institution type client. That's going to be very different than someone that's inherited wealth and trying to thinking about how to preserve it. But we do have goals based planning that we try to understand the needs of a client's portfolio. Do you want income? Do you want higher returns? Do you want a mix? I'm going through the process now as a client to figure out what are the goals in your portfolio. So I'm answering a Bunch of questions. They put it in a proprietary system to figure out what the output of that is and then how you actually want to make decisions and invest will come after. So then how we get organized is we have a whole group that's all about understanding the client. How do you actually make the decisions of building and preserving wealth over time? What are your goals? We have a whole separate group that then they speak to to say, what are the components of how we build those things? Do you want to do it yourself? Do you want us to do it for you? All that and then from the investment standpoint, we have an entire solutions group that we sit at the table formally every week to decide what our views are. I would argue with the credit folks for many years about the value of private credit versus public credit and the value of private equity versus public equity. There's a lot of different models in private banking or wirehouse models where you have a broker that's deciding at that unique level. We do a more unified approach to building what our views are and then letting clients figure out implementation themselves. And then we also do a daily morning meeting from 8 to 8:30 where we just break apart the markets, figure out where we want to focus on, ask questions like is now the time to invest in Mag7 or should you still be thinking about outside the US and stuff like that. But that's a little bit of how it comes together.
- [11:38]
So within the alternatives, how do you go about the manager research process?
- [11:43]
So we have just over 200 investment professionals. We have specialists that lead every sector and they're building market maps for where we want to invest. And we have an entire investment review committee process where we're understanding who these managers are out there, what needs they're filling in portfolio, but also the uniqueness of the trade off in the public side versus the private side. Most institutions fill a bucket. They say I want to invest X amount in private equity or private credit. Individuals don't. They just want to know what are the absolute returns. So we made a decision in 2013 to stop investing in some of the mega cap buyout funds because we felt like returns were coming down. So we do have a little bit of a macro view as to where future returns are going to be. We build our own long term capital market assumptions across every sub asset class, liquid and illiquid. And then we scan the market to say can we build a portfolio this year? I'm mostly focusing on the drawdown side right now the world of evergreen funds are changing all of this. But we have about 45 individuals that are specialists in their unique area of underwrite that are building market maps that we're reviewing on a weekly basis to figure out are there new themes or areas, are there people that can build consistency in a track record? And then we put them through what we call diligence. The managers might call it torture, but once we commit to doing something where we want to make sure that there's either a portfolio need or client demand, it's probably a 12 week process of serious underwrite. And then actually a big chunk of that process is what are the numbers not telling you? Or from a background check, people side, who do you want to be in business with for the long term? So it's a pretty rigorous process. But everyone tells you that if you speak to many of our managers who you've had on your podcast, they would say it's pretty intense just because we try to figure out how they're going to treat us in good times and bad. So we'll call their worst portfolio company and their best portfolio company and try to see the difference between the two.
- [13:33]
If you looked at some of those subsectors and maybe just grab private equity as an example, what does a market map of private equity look like?
- [13:41]
So after 2021, we recognized that our clients, those who were choosing a la carte, were overweight growth allocations. So we said, should we be investing behind value? When capital markets started closing up in 22, we said, should we be allocating to more of the mid market? They use a little bit less leverage, maybe two turns less on average, they have more exit opportunities, they can potentially buy cheaper depending on what their skill set is. So we'll do a market map that says, who are the 15 managers that are raising capital today that meet our minimum return threshold, that are willing or wanting to partner with us, want the diversification of private bank capital? And we look through it together and we literally go out and just meet all these managers. The last couple years we are investing in places like Asia, about 10% of our portfolios, even though on an a la carte basis there was less demand from clients. Same thing in growth and venture. Over the last two to three years, we were still making sure it was 20 to 25% of the portfolio, even though a lot of folks were digesting what they'd done in 2020 and 2021. So the market maps will say, how do we make sure that we're investing to build a portfolio over four to five years to make sure that every piece is complementary to the existing piece. But you also don't want to work with five managers in the same space that all come back to raise capital at the same time because then you can't have your capital matter to them.
- [14:58]
Now how do you think about the proof list or what's on the market map? If you're looking at what's happening this year compared to what's been invested in by the client supporters, most of what.
- [15:09]
We'Ve invested in, we're keeping in significant contact with these managers to watch every investment that they're making. Are things shifting? Are they doing what we underwrote them to do initially? Folks are questioning this concept of US exceptionalism right now. And, and so some stuff outside the US has helped us. So we'll just make sure that we're not overweight to any of our long term targets. Cause we always tell clients try to build over four to five years. If you only invested in 060708, you would not like me. You would actually hate me. Because those private equity managers are trying to exit most of their positions during the crisis. A lot of what we're doing is making sure that there's no sector overweight beyond really like a 25%. Tech is the one thing that's changing because we no longer really see it as a sector. It's a horizontal. And then we also do look at deal overlap. There's a lot of questions about that. And in places like private credit, we feel like we started in the upper end, upper mid market, even large cap, you could say. So our next manager was in the core middle market. You go from having an EBITDA average in your portfolio of 200 million to 75 million. And then the question is, do we go to lower middle market? Those are the debates that we have on an annual basis.
- [16:12]
How do you think about the size that a manager can deploy?
- [16:16]
Size definitely matters. That was a mistake of a lot of what happened pre the GFC and then post the great financial crisis. I would say though, there's some of these managers that everyone always say, how can you raise $15 billion or $20 billion and deploy that appropriately? If you look under the hood to figure out have you increased the size of your team? Has your deal size changed, have your return drivers changed, have the partners changed? There's a whole generational shift happening in the world of private investments right now that we're talking about. The size doesn't totally scare us. We try to think what's the expectation of you to persist from a return perspective. So if you look at the private equity industry. The data tells you that over the last decade, half the returns came from multiple expansion. That's not good or bad necessarily, but that's not going to persist. So where we've always focused in core private equity as an example, is managers that can drive three quarters of the return from proper operational improvement, driving earnings, driving revenue and thinking through if you do cut costs, is that good or bad and do you invest it back in the business? Size doesn't totally matter, but in our portfolios there were these shifts that we made. Like in 21 and 22, we started moving more into the core middle market. And in parts of our business, like our private equity group that's been Investing for over 40 years, they've stayed focused on the funds. Sub $2 billion. That was always the sweet spot of what they did. So we try to give our clients choice. We do think that middle market can outperform large cap and smaller funds can outperform bigger funds. But there's such dispersion. It's all about the manager selection process. It's even more exacerbated on the hedge fund side.
- [17:43]
How many different managers would you say in your, say just private equity will your clients invest in?
- [17:50]
We have offered over 200. There's about 85 to 90 active relationships that we have in the broad private blank offering. The concept of concentration in the industry is happening. There's a lot of acquisitions that happen to some of these managers. Even if we work with a great manager, could be a public manager that has many different arms of their organization, we really don't do everything that they do. We're not going to be a suite to offering the entire gp. We really want to focus on where are you the best and having our capital matter to them and then to our clients as well.
- [18:25]
What are some of the things you've seen that are the subtle differentiations between where you think a manager is great compared to another one that is good.
- [18:35]
People are what matter the most. I feel that way partly because that's what we think. At JPMorgan too, you can tell those subtle differences when you're meeting these teams over and over again. How they communicate with each other, how they talk about winning deals together, the consistency of how long a partner's been there. Do partner attribution analysis for all these fund managers. There's usually a story behind all of it. So I do think the people and the culture totally matters. There's one firm we work with that when a person at the top of the house gets Close to the age of 60, they choose to pass on their carrier to the next generation. And so it's led to them being a very big shop and continuing to have multi generational exceptional performance. The people thing is definitely part of it. Second is just how they articulate how they've driven performance in the past. You can quickly tell what they think their competitive moats are in those situations. And then if we invest with a private equity manager, we typically go to all the private credit managers and ask how they treat them. How do you treat your lender, which we obviously as a bank care about. Sourcing is certainly what differentiates, especially in some areas that are getting more and more crowded, like private credit. I think that'll be one of the bigger hurdles on a go forward basis. And then knowing those stress points in the market, like how you treated your partners across the board, those would probably be the three things. The consistency of how they've driven value and whether we think it can persist on a go forward basis.
- [19:47]
So you turn over to private credit. The structure of where assets are flowing. Private credit is totally different, much more concentrated. How have you thought about that and bringing that asset class to your clients?
- [19:58]
We started allocating in 07. There was certainly differentiation as this whole shift was happening out of the banks and into the private markets. A lot of people talk about how new this is. Asset classes. We don't think it's new, we just think it's shifted. Although I did see within the overall private credit industry you now have to differentiate between direct lending. So you think of the corporate private credit market. Someone said something like $3 trillion and a trillion and a half has been raised. But then you look at asset backed lending and it's like over a $20 trillion market that only half a trillion dollars been raised. So all these things are shifting. But if we started on the direct lending side and we started with large scaled managers, that's where we thought there was going to be a benefit to not just having beta, but also generating a little bit of al. And it makes sense. Most of those individual companies want to deal with one lender in a time of crisis. So we've skewed on the direct lending side towards larger scale managers. As that market continues to evolve and as the banks start to get back into some of these areas, we do think returns are going to come down probably by about 200 basis points on average. And then in the opportunistic credit side, we actually like those that can focus on microcycles to be smaller managers. So we Think that they can drive significant alpha, that they don't need a broad distress sell off for them to generate returns. The market and most allocations are overweight. Direct lending and don't have enough of the opportunistic credit. There's good reason for that. There were time periods where folks were overexposed to the more cyclical subsectors like energy and consumer and so they got out of that space. But the recent years there's been an over concentration in some sectors like software. We have yet to see how that plays out. We focused initially on the direct lenders. We'd always done some opportunistic micro cycle trades like coming out of the crisis, we did commercial mortgage backed securities, residential mortgage backed securities, non performing loans in Europe where we're focusing now on more asset backed lending or if I can be a lender in sports media entertainment. There's some of these subsectors that are really fascinating to us where we think you can still get a premium over just generic private credit.
- [21:57]
You mentioned starting to invest more in venture. How do you bring something that historically has pretty tight capacity constraints into a large scale platform?
- [22:07]
We did some analysis because we hired someone to lead our venture and growth initiative maybe seven years ago in 2012, 2013, when sort of the hybrid crossover market and growth equity market really started opening up. We only had a couple managers. He came in and maybe 17 or 18 and he said you're doing a lot of elite stage growth which has worked. But if you really wanted venture returns. And we know that the dispersion in private equity is 17% between top and bottom quartile in venture it's something like 27%. You probably shouldn't invest unless you're going to get access to some of the best. A lot of people assume that the best were like the best names, the longest term names. And he had this view that it was really funds that were between 50 and $250 million. But a lot of our clients, to your point, can't just allocate capital. The venture firms aren't going to be able to grow with you. So there's places like venture where we'll build portfolios. It's one of the places that we tell our clients to consider fund to funds. There are some that have gotten over the concept of fund of funds for core portfolios. But in venture it's certainly somewhere where it's one of those things that's hard to do yourself, pick and choose. Not to mention the choice isn't available and you don't Want to work with the firms that just need capital. And then the question is on a go forward basis, what does venture look like? Because a lot of these venture firms, you would look at the checks that they're putting in and the stage that they're in and you wouldn't really say they were traditional venture, you'd say they're multi stage. So we'll see how that evolves over the next two to three years.
- [23:29]
Then even if you're doing it on behalf of clients, you're still managing a large war chest compared to the potential opportunity set. So how have you gone about trying to get access to the funds you think are important to have in the venture side?
- [23:40]
In the private equity group, they were day one investors in probably in eight of the top ten since the beginning. So they've had super long term access. If you look at our client portfolios, even for the largest families, venture allocations was still less than 5%. It was 4.85%. So we do have a big client base, we do have a lot of capital at work, but the allocations are still small. There's other parts of the venture market that are opening up, like secondary venture. So a lot of our clients love that area because you can build diversified portfolios and there's only a few managers that do it really well. We think we're at this point in venture where everything's changing, where there's a ton of spin outs and there's just given the market environment over the last couple years in terms of valuation, reset the dollars available versus the dollars that are being raised. How we talked about Venture 20 years ago versus how we're gonna talk about it for the next, even five or 10 years will be drastically different. The banking system as a whole changed the way in which we serve venture. And when we acquired even like First Republic, it opened up our eyes a lot of those clients within that community. And I just finished a conference of our top 82 founders and top 50 venture growth managers. And we're building this ecosystem on this innovation economy that everyone, from Jamie down to everyone that covers these clients really believes in. So TBD and a lot of this stuff.
- [24:55]
How do you think about that integration of access to top founders, access to all these billionaires you manage capital for and bringing the relationship capital and the intellectual capital into the investment process.
- [25:09]
The fact that we're one of the biggest spenders of technology as a firm helps us understand the product. We spend over $800 million on cyber every year to keep our clients safe. That gives Us really good intel into a tech manager or cyber manager that's telling us that they have a great product. Having just been at this event, the founders themselves who said one of the best places to test your product is JP Morgan because you have such specialists in these areas in that ecosystem we actually use a lot of the banks knowledge to understand the products and then we figure out the luck versus skill. What did they bring to the table, how do they add value to those companies and how do they build portfolios over time? Because we do also allow our clients to invest direct to cap tables for a lot of these investments. I think the total number it's trillions of dollars that we spend in technology overall. There's some sectors like health care in the VC market where given our healthcare practice we can really understand which businesses are going to scale longer term versus be a feature versus an actual product.
- [26:06]
How do you organize the information from that frontline conversation with the founder to the manager research person who's having a conversation with a healthcare vc?
- [26:16]
A lot of people say we have X number of meetings a year, just our investment professionals. We've tracked for the last several years over 3,000 meetings a year. There's a lot of people that do that. But most of the time at JP Morgan we joke that it's bringing the JP Morgan bus. It's people like myself that work with clients. It's the portfolio manager, it's the due diligence person that we're all building and learning together. That sounds very inefficient but in practice it works just the way in which we run discipline around trying to give quick nos and spend time on the longer yeses. We can pretty quickly distill down who are like our top 15 to 25 targets in a certain area or the companies based on some of the cross line of business partnerships and so forth.
- [26:55]
How do investment decisions get made?
- [26:57]
Our diligence team will bring a fundament to investment review committee every week and we'll have two to four managers that are presented on a regular basis. It starts with our investment review community process which we have a entire presentation about whether it's people philosophy process and how do you generate consistent alpha over the long term. All the things that you'd expect. We have our own in house operational diligence team. That's a big part of it. You can have a great investment but if you're not operationally set up to do it, it's gonna be hard for us to invest. We kept all of our structuring in house Whether we set up a vehicle or whether you could be direct to the fund, the actual investment decisions, it's rare that you get to investment committee and something's a no because you've already worked on all these processes before. Then it's matching the can you deliver your historical returns on a go forward basis with demand? There are great ideas out there, but if clients aren't allocating to a certain space, I don't want to waste either side's time. Let's say if we invest $30 billion a year, 10 to 20% of that is managed by us, where we can build a portfolio that our clients trust in us and then the rest is based on where there's client demand that's going to shift over the years ahead. More and more clients don't want to have to choose between manager A and manager B, similar to how we build their overall portfolios. They just want to say, do you think this can meet my long term needs? And if so, I trust in you to build something for me.
- [28:14]
When you aggregate all the investment activity you're doing, there's a lot of market power you're bringing to bear. As a big investor in the space, how do you think about the right level of extraction? So you could think about that as a fee discount for your client. You could think about it as a partnership with a manager where you're part.
- [28:31]
Of a gp, it'll depend on every subsector. Private credit's a good example of where when you invested 10 years ago, you would make sure that you weren't paying on committed capital, you'd pay on invested capital, but as the returns come down, so should the fees. We're always focused on the net return and then we're making sure that whatever the economics that a fund manager is driving is truly either for their business or for future investments. We rarely take GP economics. We do from time to time, but we're mostly focused on how do you generate the best net returns. If we're going to bring in institutional size capital, we want to make sure that we get most favored nations. And that discount, we'll work hard to get those for our clients because we think it's appropriate. Though you always want to balance not pushing a manager too hard on that because you want to make sure that if they have a new generation of partners that are coming up, you know, in venture and growth, you don't get a lot of that carried interest for several years. So paying a higher management fee is more appropriate. But then making sure that there are step ups in economics is important. It'll depend on each sub asset class. Lower returns. We obviously are going to continue to drive returns economics lower for the higher return oriented places. It's just understanding what the waterfall is going to be. I would also say when there's opportunistic trades in the market. So there was one of our greatest partners in the technology space that in March of 2020 wanted to make a call on more liquid markets. We created a structure with them that was a 0 and 20 structure. So 0% management fee, 20% incentive fee that got struck at the end of the fund life. The reason we did that was because we felt like it was more of a beta play. But there's still a lot of clients that in March of 2020 didn't invest in tech stocks. We could raise a billion dollars in the matter of days get that investor in the market. It was supposed to be a two year term. A year later that manager said the opportunity sets mostly played out and so they distribute in kind the top 10 stocks. But I bring that up because most people just look across the industry and say am I somewhat in line? But then if you really want to be a great partner to us and you see those opportunistic type trades, it's making sure that clients love alignment as most people do. But especially in opportunistic trades is aligning the economics to whatever the opportunity set is.
- [30:37]
How do you think of layering in taxes?
- [30:40]
I'll start by saying we don't give tax advice. It's interesting because there's two sides of the tax equation. One is the fact that just over 40% of the capital that we allocate to fund managers comes from non US clients. So there are certain structures that in private credit are much more beneficial to non US investors. Like a business development company, whether it's traded or non traded, public or private. The fact that you're not paying the same effectively connected income as a non US investor changes the entire return stream. There were funds that on average in the direct lending space would take off 200 basis points of return if you were a non US investor. BDC has helped some of that. So there are structural differences. And then anything real assets oriented, real estate infrastructure, they were part of that effectively connected income world. So a lot of that you can solve for in structure today. A lot of it, not all of it. For US taxpayers. There's this whole shift that's taking place around asset location, not just asset allocation. And so it started in the long only side. And even on the ETF side with some of these like smart tax aware strategies or tax loss harvesting, that's moving into alternatives. We've tried that in places like doing insurance dedicated funds. And there's differences between whether you want an annuity, a non annuity. I still think there's a lot of work that needs to be done around that space. Both educating clients but also making sure that you have the right investments behind it. Someone did tell me once, just because you put ketchup on a meal and it tastes great, if it didn't taste great without the ketchup, it's not a great meal. Right? It's a bad analogy cause I don't love ketchup. But the point is, is with taxes, we are trying to think about how do we build tax aware alternative sleeves in places like hedge funds and private credit and then just take what you can on the tax side for private equity and the equity oriented solutions. There's going to be a massive shift over the next couple years. We JP Morgan have made some strategic investments on the technology side, firms like 55ip and others that can help us understand this. But I do think that we have a long way to go.
- [32:34]
How do you structure say hedge funds in particular, which many of the strategies are tax inefficient, into something that might make more sense?
- [32:43]
There are ways in which you can build portfolios of insurance dedicated funds that will help solve some of this. We started doing that. So that's part of the answer. Part of the answer is also clients are putting these in their retirement accounts. There's limits as to how you do that, but I always go back to what's your funding source and what's it solving in your portfolio? If you asked us 10 years ago, the funding source for most hedge funds was equity and that's completely shifted. Even in our portfolios, the funding source is fixed income. So if I can try to earn equity like returns with fixed income volatility, even when you consider taxes, I still think that you can get a premium over just traditional fixed income. Even though stock bond correlations have come down most recently, we've just come out of a period where they certainly didn't provide the same diversification. And so we try to focus less on taxes. There's enough evidence that gives us confidence to continue to invest in uncorrelated hedge fund strategies. Be aware of the taxes, but not be overly concerned if it truly adds portfolio diversification.
- [33:38]
Integral funds have started expanding in use, particularly in the private wealth area. What's your take?
- [33:45]
We hadn't done Much up until recently, we are creating our own. As the industry evolved in private credit, which is the main source of the interval funds, we preferred tender offer funds versus interval. We preferred the concept that in some of the worst market drawdowns that a fund manager could or a board could say it's not the right time to sell. The industry has now evolved and it's mature enough to think that there are appropriate interval funds out there. And as a portfolio manager, if you're managing a portfolio of underlying funds, you love interval funds because you know that you're going to find some way to get that capital back. Our view on it is certainly shifting over the last couple years, but I still think there's some places like in the non treated REITs and other places where I'm glad that they had more of the tender offer feature to them. A lot of people built interval funds to access the retail investor and it came with a lot of fees and a lot of stuff in them. We were buyer beware for a long time and there's more choice available and so there's more competition from a manager perspective to make sure that the economics are appropriate.
- [34:47]
How have you thought about the application of all of these alternatives into the Chase side? So private wealth, but the lower end, not the large family offices.
- [34:56]
A lot of these families that we serve in Chase want to do the goals based analysis. Want to figure this out myself, Anton Pill, who oversees our entire global alternative investment solutions across asset and wealth management. We fundamentally believe that the access shouldn't be limited to those that are the wealthiest. And so we want to expand that access elsewhere. Especially if you consider the fact that the universe of investing, if you look over the last 20 years, people talk about the number of public listed companies has been in a significant decline or outside the US access to these markets. It's mainly the private markets. And so if we see this as a fundamental issue that if you want to get access to the real economy, you need access to private markets. And so we're going to look to roll this out in the coming quarters. But we want to do it with the right structure, the right economics and the right alignment. Our client base and our advisors that are giving us feedback in terms of how we build these portfolios are very excited about what's to come.
- [35:50]
This movement of capital into alternatives. Why is it happening now? Compared to the noise about democratization or alts or the hedge fund structures 10, 15 years ago, it's probably twofold.
- [36:01]
For many, many years I had to convince great general partners to want Private bank capital, individuals capital. And a lot of people just saw it as way easier to go to some institution, work really hard with a CIO and get a $100 million check. And they didn't want to deal with all the administration of the tiny little tickets. We've been investing since the 80s and 90s. In the early 2000s, we really started going to some of the best GPS in the world to partner with them. And they just did it as an experiment. They just wanted to try it out. They'd give you 50 million or 200 million dollars. And then all of a sudden 0809 happened. And there were certain asset classes like private debt and real estate that were ahead of others in terms of accepting individuals capital and appreciating that it was very diversified capital. The re up rate for individuals is pretty high, but especially for a firm. I might not have the client re up with you if you're a gp, but I likely have new clients that also want to invest. The diversification aspect of it is a significant one. And then all of a sudden you run into a 2022 period where if you're an institution and you're tied to a mandate and you can't have more than 17% in private equity, it doesn't matter how good that GP is, you're not going to your board to get approval for the next fund. Especially at a time where distributions paid in from existing funds are at the lowest level they've been in since the great financial crisis. The reason why, most recently it's interesting, is because one, people are reminded of the diversification benefits of individuals capital. Two, their shops are set up to be able to work that client relationship. There's a structuring aspect where there's platforms that will do this for the GP so that they don't have to handle all the administrative stuff. So I think it's like all coming together, technology, et cetera, at the exact same time with these new structures that are coming that are allowing people to invest and then allowing GPS to have other people take care of the admin for them.
- [37:48]
Of the different structures you mentioned, interval funds, what are the things that you think will get the most traction in that space?
- [37:55]
If you look at fundraising across the industry, on the drawdown side, it's been a decline the last three years. If you look at my business, it's been up last year surpassed even 2021. More clients coming into wealth. These access points, opening up the evergreen space, interval funds. There's been debate about what's the future of a lot of these drawdown spaces for managers that are in the, what I call no man's land. And this is what I mean by that. Your returns are somewhere between 11 to 14% net returns is what you've delivered and you are looking to lock up your capital for 10 to 15 years. And no one ever ends on time if you're in that zone. For individuals and taxpayers, there's not a lot of bid for those type of portfolios unless it's super diversifying or very niche oriented. Because many people would rather accept 8 to 10% returns, go into these private market evergreen portfolios and compound that money and not have to make new investment decisions every two to three years to recommit to a fund manager and not know when you're going to call capital or distribute capital. And if they trust in you, they want you to do it for them. So I do think these evergreen portfolios are solving, I'm not going to say problems, but a lot of the annoyance of allocating to traditional drawdown funds. And that's why I think the momentum is just going to continue from here.
- [39:08]
When you talk to a client about the choice of an evergreen fund or a drawdown vehicle, what's your expectation of the return dilution because of the liquidity provided by the evergreen fund?
- [39:20]
Most of these fund managers in the private market evergreen space, there's still less than 500 of them that exist today hold anywhere between 15 to 25% in liquid securities and they do charge higher fees in certain areas like credit. It's actually pretty minimal. Most of our senior secured direct lending, we've moved almost entirely to evergreen portfolios in private equity. I would still say our first thought is start with a drawdown fund for most of the managers that we're looking at and then think about the evergreen portfolio. But return dilution is anywhere from 2 to 500 basis points. The question is, is it really dilutive to you? Were you investing the uninvested cash? Because a lot of these firms make assumptions that your uninvested cash, you're still earning 6, 7%. A lot of people just don't. They leave it in cash because they just never want to be in a situation where they can't fund a capital call. So when we advise our clients about it, we first ask them 10 questions that are really about how do you invest your uninvested cash? How do you think about making decisions over the long term? How do you think about vintage year diversification? There's still a significant portion of our Clients that only ever invested in one fund and then they were like, we'll wait for it to see returns. And the J curve is a real thing that takes three to four years more. Of the income oriented things, we've moved towards the evergreen. We prefer the evergreen. So in places like direct lending, core plus real estate and even value add a little bit and an infrastructure investment, the core core plus space, we prefer a lot of the evergreen strategies. And then in the more directional private equity, definitely growth venture, we prefer drawdown funds.
- [40:52]
As more money comes in, as people start to look at these different evergreen fund structures, have you seen any change in the fees from the drawdown structures.
- [41:00]
On the equity side? Not yet. Credit side, we definitely have. Even over the last three years we've probably seen about 25 basis points lower on the management fee side and on the carry, maybe down 2.5% to 5%. On the private equity side, there's a lot less people that have enough levers to put into an evergreen portfolio and continue to invest and take in monthly or quarterly flows into the portfolio. There's a premium being paid on the private equity side. Like most of these fund managers, you're paying, if not 2 and 20, slightly more than that because they're still helping you from a convenience perspective of dealing with your uninvested cash and getting access to co invest in other areas in the market.
- [41:39]
As you're talking to all your clients, what are some of the biggest trends you're seeing in how they're shifting capital?
- [41:45]
The era of doing a lot of co invest in the growth and venture space has gone away and we didn't do that much of it. There were a lot of other platforms that had done a lot of it. Most of those things are starting to come to fruition. So direct investing, even our largest families, is less than 5% of their portfolios. Which surprises me because it takes up a lot of conversation because you get excited about those things. So they're moving more towards portfolios. Most recently, folks are, especially given all of the innovation taking place within artificial intelligence. Reinvesting again in venture and growth is certainly a top theme in private equity. What surprised me is that people are moving back towards the core diversified holdings. The managers that are multi sector are great operators by background and can drive returns. There's been a shift within that private equity line of our choice into the core diversified holdings in private credit. People are starting to think about other sources of income, not just direct lending, having corporate exposure there and then hedge funds. We went from a period in 2014, where we made a strategic asset allocation shift downwards in hedge funds as we thought that rates were going to stay lower for longer. So our strategic asset allocation is 10%. We had negative flows for a period of almost seven years. And then in 2019, 2020, we saw flows come back into that market and we've seen significant flows accelerate since then. So the shift towards building portfolio resiliency in areas like uncorrelated hedge funds, in places like real assets, those are some big shifts. And then the last thing I'll say, which is probably the first thing I should have mentioned, is the move into infrastructure investments has been pretty phenomenal. Part of that is because one of the biggest questions on people's minds over the last couple years is the future of inflation. And a lot of these infrastructure portfolios, you have 20 to 30 year contracts, you're in super monopolistic underlying subsectors of the economy. I know that I'll pay whatever my water bill says and whatever my electricity says, right. And a lot of the income is CPI adjusted. So for all those reasons, infrastructure has been a place that our clients have certainly leaned into the institutional world. Got there almost a decade ago. Most of those institutional portfolios can be high single digits, even low double digits. They've replaced traditional liquid fixed income with that. Clients over the last four or five years have started to, it's starting to really accelerate.
- [44:02]
At the onset you mentioned changing around how you went about your investing and I'd love to hear the different iterations of that and where you've landed today on the platform.
- [44:11]
In 2011, we did this whole shift towards building portfolios for our clients. We looked at some of the data, realized that when you made a portfolio decision versus a la carte, you helped clients building diversification. Then we learned a lot of lessons around investing in more cyclical sectors and longer term structures. We invested in Brazilian private equity and even though we did great on a local currency, we did not do great on a dollar basis. And all things considered, we made a few mistakes. But they continue to inform us about how we actually want to build portfolios. And then we would have maybe a dozen ideas a year. Now we have close to three dozen ideas a year. And we've hired a lot of people who have come from great organizations that come from portfolio building and they've realized that in private markets, for example, the optimal number of funds in a portfolio should actually be between it's like 22 and 27 funds where as we started shifting there and offering more choice, our clients Were like, aren't you diluting returns? And it was actually very additive to returns. We've added sector specialization. We started nine years ago in real estate, eight years ago in infrastructure, six, seven years ago in venture growth. A lot of those shifts were really just like the lens in which we looked at the world, how we packaged it for a client. Most families just want your best thinking. If you told me that your target return over the long haul was 9 or 10%, which is going to be US large cap equities and long term capital market assumptions, you don't need to venture in your portfolio to achieve that. So we've just kind of shifted into recognizing that we can build great portfolios. We have great choice. It does come with diversification underneath and having multiple skill sets. As the world's opening up, it's not just allocating to primary funds, it's allocating these evergreen portfolios, it's allocating to secondary portfolios. Some of these markets are opening up in a way that we wouldn't have imagined 15 years ago.
- [45:57]
What initiatives do you have on the come that you're excited about?
- [46:00]
We've spent a lot of time lately on themes outside the US So whether it's places like Japan or developed Europe, sports media entertainment is an ecosystem that we as a bank have a lot of intelligence in, both from our clients and our overall capabilities in that space. As those markets open up to private market investors at the end of last year was things like the NFL opening up. There's a lot of things changing in baseball, hockey, et cetera. And it's a place that our clients understand and are really interested in. We have favored more of the lending side to the equation. We'll probably make some investments on the equity side. And if you believe that volatility is here to stay. The concept of thinking through portfolio resiliency, when we came out with our outlook for the year and the things that we were most focused on, it was the number one most clicked thing out there. Our clients are really trying to think of understanding the concentration in public markets, especially in things like the S and P, understanding the role that equities and bonds play with each other and figuring out where there's places where you can access some of these megatrends.
- [47:04]
What are you most concerned about?
- [47:05]
Clients understanding what they own. It's a big one, especially on the drawdown side, meaning we've done a good job so far. But as more and more people come into a space and investing, just understanding what that is, making sure that you're buying Things that actually are working towards meeting your long term goals. Number two is when you think about all these markets opening up, there's still a lot of these that haven't been tested yet. And there are some places that are priced to perfection. There are parts of the credit markets that are. I won't say all, but having to explain the differences is really important.
- [47:33]
Okay. Kay. I want to make sure I get a chance to ask a couple closing questions.
- [47:36]
Oh, okay.
- [47:37]
What's your favorite hobby or activity outside of work and family?
- [47:40]
Probably yoga. I was gonna say paddle tennis. Cause I'm like a Chicago gal and we love playing padel tennis, but my husband is a serious paddle tennis player and I'm like, not. So he'd be like, are you serious? That's what you picked? But if I had even more time, I'd probably keep playing paddle tennis.
- [47:53]
What was your first paid job and what'd you learn from it?
- [47:56]
I was an intern at Morgan Stanley in our Lake Forest, Illinois office, which is where I'm from. And at the end of the summer, they offered me my bonus in cash or Apple stock. And I picked cash. It was the dumbest thing I could have done. So that was lesson number one. But I will say lesson number two a year later. I worked at UBS for a neighbor of mine. And every morning I was like the coffee girl. If you were good at it, they'd keep asking you to do it the next day, every day. There were seven orders for coffee, and one of the gentlemen wanted a half decaf, half regular, with five ice cubes, seven shakes of vanilla, and two tablespoons half and half. I did it every day because I was like, they're paying me to go get coffee. This is the best. And then at the end of the summer, they matched my bonus with my entire salary for the summer. And they said, this is because you never complained once about getting the coffee. It was one of those lessons of sometimes people are just testing you in ways that you don't know. But Those were my two first intern stories before I landed at JPMorgan.
- [48:48]
How's your life turned out differently from how you expected it to.
- [48:51]
I would have never imagined getting to work internationally. I would have never imagined being in the same firm for 17 years. I've been with my husband for over 20 years, since we were itty bitty. And then I have an amazing daughter and family that I'm really excited about on the way.
- [49:05]
If the next five years are a chapter in your life, what's that chapter about?
- [49:09]
Professional. It's just the access to alternatives because I truly think this is a fundamental problem if we don't figure out how to give access to private markets and private companies to individuals when they think about their long term needs and portfolios. So that's a cheesy and probably cliche thing to say, but it's truly where we're focused and personally just raising really good people. My daughter is a total sweetheart, but there's a lot of influences out there in the world for our children. Whether it's Jonathan Haidt or others that I like read about this anxious generation and what's to come, it does concern me. And so I just want to make sure that she's got a good life and the soon to be boy has a new life too.
- [49:43]
Kk, thanks so much for sharing all this.
- [49:45]
Thanks for including me. Nice to see you.
- [49:47]
You too.
- [49:48]
Ted Seides
Thanks for listening to the show. To learn more, hop on our website@capitalallocators.com where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content including podcast, transcripts, my investment portfolio, and a lot more. Have a good one and see you next time.