Turning Quantity Into Quality
Ask a CIO #22
At this point, there’s something comforting about seeing that familiar, flimsy Spirit Halloween banner pop up in my neighborhood empty storefront. Who among us hasn’t ducked into one for a last-minute costume or decoration? Surely we can all appreciate the mish mash collection of polyester outfits held together with well-placed Velcro? There’s something for everyone, because truly, anything can be a costume!
Spirit Halloween has gifted us SNL skits and memes and inflatable T-Rex costumes we didn’t know we needed in our lives. It’s almost (heavy emphasis on almost) a shame to see them disappear overnight, like magic.
But the thing I most appreciate about Spirit Halloween, is the incredible business behind these haunted house garage sales. The company reportedly leases 1,500 storefronts and hires 50,000 seasonal workers from August to November. The company’s operational efficiency and scale is remarkable.1 There’s admittedly not much of a connection to this week’s question, but it is Halloween after all.
This week, I’m taking on a slightly different kind of question. It’s one that we’ve received in various iterations since we started Ivy Invest.
Why doesn’t Ivy Invest offer a marketplace of alternative investment choices?
When we set out to build Ivy Invest, we were very clear on our decision to provide a single product – an all-in-one portfolio that would be constructed and overseen by our team.
Piecing together a multi-asset class portfolio, particularly a portfolio that includes both traditional public market and alternative private market investments, is not an exercise that the majority of individual investors, including many financial advisors, have previously undertaken. On the alternative asset side, the learning curve is steep, the markets are opaque, and participants often don’t share very much information publicly. Asking people to make their own selections from a menu of unfamiliar, less liquid, more complex investments seemed to us an unreasonable burden to place on potential Ivy Invest investors.
Last week, we discussed how having a lot of deal flow improves the likelihood of a venture capital firm finding the best investments. I firmly believe this concept extends to other asset classes, and importantly, is also relevant to this week’s question.
Let’s take for example, specialty finance and asset-based lending, which are private credit strategies that lately appear to be attracting more investor interest.2 When institutional LPs evaluate managers running these strategies, one of the first things they try to understand is the manager’s loan origination capabilities. They want to understand their ability to consistently generate a high volume of potential loans (the lender equivalent to a lot of deal flow). When lenders have strong origination pipelines, they can have greater visibility into the borrower base, the market dynamics, and of course, can be more selective about the loans they fund.3
Now let’s apply that same lens to evaluating managers. Pick any strategy – let’s go with long/short equity hedge funds as an example.4 If an investor has only seen 2 managers, the investor is likely using superficial metrics to distinguish them from each other. Maybe each fund has a different sector or geographic focus, and that’s the best way to tell them apart. But that really doesn’t really tell you anything about the manager’s skill in their strategy.
Now let’s say the investor goes on to see 20 long/short equity managers. The investor is now seeing likely multiple managers in each category. Maybe the investor has now seen 5 long/short equity managers focused on the technology sector, and another 5 long/short managers focused on emerging market equities. Maybe 5 of the managers are market neutral, and another 5 are long-biased. Now, the investor has a better framework for comparing long/short technology funds against each other. The investor might also start to have an opinion on long-biased versus market neutral, and a perspective on how leverage is used in each.
Now let’s say the investor has seen 200 long/short equity managers. This investor likely has a perspective on which sectors, if any, require specialist expertise. This investor likely has a perspective on what constitutes compelling long alpha and short alpha in various market conditions. This investor likely has a strong perspective on whether a manager has a distinct process or whether it looks the same as 100 other funds.
Take it one step further. Layer in other hedge fund strategies (credit, macro, event-driven, etc), layer in private equity, layer in real assets, layer in private credit. Investors that have seen a critical mass of managers in each of these strategies might decide against long/short equities altogether or they may confirm their interest in the strategy.5
Every additional manager provides an additional data point. Every additional data point helps better calibrate what baseline average looks like, so that above or below average increasingly looks clearer. In other words, it takes seeing enough quantity to reach a confidence level around quality.
It is both my belief and my experience that alternative investments, as part of a broader portfolio, can provide the opportunity to generate the kinds of returns that make all this complexity worthwhile. But only if you know what you’re doing. The notion of providing a marketplace, even a curated marketplace, to potential investors with limited to no background made no sense to us.
Thanks for joining, and Happy Halloween! As always, reach out to askacio@ivyinvest.co.
Until next week,
Wendy
It also reportedly generates over $1.8 billion in revenue (How Spirit Halloween stores real estate work – cnbc.com). The company was previously private equity owned, but it now appears to be privately owned by the management team. To be clear, this is not a recommendation to buy, sell, or hold any security related to this company.
These strategies include things like litigation finance, royalties, equipment leasing, aircraft leasing, etc.
In the case of many specialty lenders, managers that have built robust platforms dedicated to originating and servicing loans in their specific markets have a decided advantage. Building out these platforms can take a lot of time and capital, but there’s generally a terrific flywheel once built.
Long/short equity is a strategy where fund managers invest long in a set of stocks they think are undervalued and sell short a set of other stocks they think are overvalued. The short positions also frequently serve to hedge (hence, hedge funds) the portfolio and provide some protection in market downturns.
Just a hypothetical, I’m not trying to pick on any strategy.