Ivy Invest was built to simplify access to more investment options for more people, leveling the playing field for everyday investors.
As we built Ivy, we realized that the investment information gap is as wide as the investment access gap. So we decided to launch this newsletter – it’s our attempt to fill in the missing pieces. We settled on an advice column format because we want to know what you’re curious to know. We figure if our readers are asking about it, then it’s worth writing about. And if nobody is asking about it, then it probably isn’t. The world doesn’t need another newsletter writer opining into the void.
Let’s get to it!
Updating a traditional portfolio
A traditional 60/40 portfolio includes 60% stocks and 40% bonds. How should I think about the 60/40 portfolio concept once I add alternative assets, like private equity or real estate? For example, is real estate part of the 40?
Big picture, the 60/40 portfolio was designed to be a balanced portfolio, benefiting from both growth (generated by stocks) and income (generated by bonds). Just as importantly, the 60/40 portfolio was designed to be diversified, with stocks and bonds representing different, non-correlated risk profiles.
Extrapolating from that, one heuristic to map alternative assets is to determine whether the investment type provides the portfolio with growth or income. Using this approach, asset classes including private equity and venture capital, which seek to capture high returns and growth, are part of the 60%. Asset classes including private credit and real estate, which seek to generate consistent income, are part of the 40%.
Of course, not every investment falls neatly into growth or income. A second approach, and my preferred one, is to take a risk-based view. In this approach, all investments, and in particular, all investment risks, are evaluated relative to equities and equity risk.1
Using this lens, private equity and venture capital, which are unsurprisingly correlated to public equities, stay in the 60% equity bucket. But publicly traded REITs (real estate investment trusts), also stay in the equity bucket! While publicly traded REITs are real estate on a look-through basis, they often behave like equities and are in fact quite correlated to public equity markets. On the other hand, hard asset real estate and private REITs have a generally low correlation to equities, and so those investments would go in the 40% non-equity bucket. As another example, long-biased hedge funds (which tend to have high equity correlation) would go in the 60% equity-oriented bucket, but macro hedge funds (which tend to have low equity correlation) would go in the 40% non-equity bucket.
As a general rule of thumb, I recommend evaluating investments from a risk-based approach. You always have more control over the risks you take versus the returns you’ll generate.
Don’t try to time the market
With the stock market at an all-time high, what advice do you have for investing in the market?
It’s tempting to try to make market calls, and certainly, some of the usual shorthand measures of stock market value would indicate that the market is running hot. As you noted, the stock market is at an all-time high. The Shiller PE ratio – the ratio of the S&P 500 over 10-year inflation adjusted earnings – is over 34 (vs. a long-run average of 17.5). Warren Buffet’s preferred indicator – the ratio of the total stock market capitalization to U.S. GDP – is almost 190% (Buffett considers 100% to be fair value). And meme stocks are flaring up again.
On the other hand, inflation seems to be moderating, the U.S. economy continues to chug along, and corporate earnings reports have been mostly strong with positive outlooks. Some might argue that the economic fundamentals offset the uncomfortably high valuations.
But even if you don’t believe that, to mildly misquote John Maynard Keynes, markets and meme stocks can stay irrational longer than you can stay solvent. In other words, it’s hard to call the market top.
So back to your question – what should an investor do in this market?
In general, it’s a good idea to have a target asset allocation, a default set of guideposts, for your portfolio. In markets like this one, it’s key to good decision making. So step one, find your target asset allocation, your default risk allocations. The reader posing the last question probably has a 60/40 target risk profile. A 70/30 risk profile is common among institutional investors. Whatever your target risk allocation, consider keeping your portfolio at that target. For someone targeting a 70% equity-oriented portfolio, it makes sense to maintain 70% equity exposure.
Step two, be thoughtful in diversifying within your risk allocations. Here, I need to make a few caveats - the following suggestions are for long-term investors. These suggestions reflect an institutional approach and may be unfamiliar to individual investors (this gap is the whole reason we created Ivy!), but bear with me anyway. If you have a 70% equity risk allocation, consider diversifying between public equities and private equity. Within private equity, consider strategies with tailwinds, such as secondaries. In the non-equity risk bucket, consider a mix of fixed income, private credit, capital solutions, real estate, etc. Diversification is the best way to reduce individual market risks. To be very clear, in exchange for diversifying market risk, these investments introduce other risks, such as liquidity risk. These decisions absolutely require an assessment of the tradeoffs and consequences, but in my experience, the benefits are more than worthwhile.
In summary, stay invested at your target risk allocations, don’t try to market time. Diversify within the various risk assets. That’s it - be consistent and diversified.
Putting on my E&F hat
What can emerging managers do to get the attention of institutional LPs?
I’ve fielded different versions of this question many times over the years, and I’m going to be more blunt now than I could be in prior roles.
Institutional LPs mostly fall into certain investor types: endowments & foundations (E&Fs), family offices, pensions, insurance companies, and sovereign wealth funds. As an emerging manager, it’s important to understand that it can take years before most of these institutional investors will be willing to invest. And by then, you likely won’t be emerging so much as you will have already emerged.2
Broadly speaking – and there are always exceptions – E&Fs, pensions, insurance companies, and sovereign wealth funds have an almost insurmountably high bar for emerging managers within their main investment program. Institutional investors that are keen to find and back emerging managers typically have a dedicated emerging manager investment program. Focus on these institutions and programs. Increasingly, these programs are managed in part or in whole by consultants and/or third parties, but the criteria to be considered in these programs is usually openly available.
Of course there are many examples of successful emerging managers that become part of institutional investor portfolios early and in size. These managers generally have at least one of the following qualities, if not multiple:
Strong pedigree from an established firm where the emerging manager was already directly known to LPs – if you ever want to become an emerging manager, get to know your LPs before you spin out;
Portable or verifiable track record from prior firm;
A strong team that includes a dedicated business partner, because running a business and managing a portfolio are two different skills; and/or
An anchor investor – an increasing number of investment firms and family offices are willing to serve as anchor investors, though the economic terms can vary widely
And sometimes, it’s a matter of being in the right place at the right time. Emerging managers with a truly different value proposition – creating a new investment asset class or pioneering a new strategy – will always stand out, so long as the risk/return profile is compelling.3
Thanks for joining us for week 1! We’re grateful for the questions so far, please keep them coming: askacio@ivyinvest.co. Look forward to sharing more next week.
All my best,
Wendy
Equity is basically a fancy term for stock, but it covers a bit more ground. All stocks are equities, but not all equities are stocks.
I’ll make a note here that family offices are as a group more willing to back emerging managers. But as the saying goes, if you’ve met one family office, you’ve met one family office. Family offices vary enormously from one to another, whereas other investor types share more common investment tendencies.
Someone once pitched me a genuinely novel investment strategy, but it guaranteed a fixed 5% return and required a long lock-up period. This person couldn’t understand why there were no takers.