What Do We Need To Be Better LPs?

Ask a CIO #45

I was chatting with a friend recently, and he shared a perspective that I’m still unpacking.

His perspective was simple and straightforward: eventually, every investor will have access to every investment. That over time, the long-term trend is almost always toward democratization (across all goods and services, not just investments). And if the march toward everyone choosing from the full menu is inevitable, and there will be a day when anyone can be an LP in anything, then the obvious question is – where are the resources to learn how to be an LP?

I’ve actually encountered variations of this question in different places and in different conversations. For whatever reason, this was the first time it really clicked for me. Maybe it was his certainty about the trajectory of where individual investing goes from here. Maybe it was his clarity on the type of information that needs to exist publicly.

The question as it’s been posed to me previously usually takes one of two forms. Either, what can individual investors learn from institutional investors? Or, how do institutional investors learn and train others?

To some extent, this newsletter has been my attempt to address the first variation of the question: an assortment of topics aimed at sharing some of the learnings, frameworks, and thought processes used by institutional investors. On the second variation, my answer has been some version of, it’s an apprenticeship business, which is both very true and very unsatisfying. The implication being that there’s no path for an individual investor to fully get up the learning curve.

And as things stand today, as unfair as it might be, it’s also accurate – there is no path for an individual investor to replicate what institutional investors do. There is no path to replicate the knowledge that is accrued over years of market experience, coupled with learnings from other investors and candidly, investment managers.

How did I form an opinion on natural resource investments? By learning from many other energy investors. From private conversations with producers, royalty owners, and stock pickers. I’ve looked at opportunities in traditional oil and gas, renewable energy, carbon credits and everything in between. I still have scars from the 2014-2016 energy bust, picked up during my time as an LP at a prior endowment. Pick any asset class or strategy, and my learning process will look very similar.

Yet, my friend’s very good question remains – where are the public resources to learn how to be an LP? And the not very good answer today is, they don’t truly exist yet.

As the universe of investable opportunities expands to include more investors, a sizable and vocal contingent of investors/experts/pundits is adamantly against said expansion. They’re not wrong. Individual investors don’t necessarily know what they’re getting themselves into. There is a lot of noise alongside many suboptimal investment options to sort through. And there are ample misalignments of interest.

But what’s the counterproposal? Continue gatekeeping the broader universe of investments for exclusively institutions and family offices? That can’t be right. Besides, I think that ship has sailed. The trend is moving very quickly toward broader access, maybe even toward a landscape where, as my friend would say, everyone can just invest in everything.

And in that future landscape, there really should be a set of resources to guide individuals on how to succeed as an LP.

What might those resources look like? Would they be general and high level, with advice on how to think about various asset classes and strategies relative to each other? Or would they need to be more specific and tactical, with pointers on how to conduct due diligence on managers? And what might those pointers look like if an investor doesn’t have the option to meet the manager? Like I said at the outset, I’m still unpacking.

One thing I am more certain about – part of learning to be an LP includes learning how to assess the data shared by investment managers. Which, of course, requires investment managers to share the data in the first place. Individual investors will have greater odds of success as GPs offer greater transparency and standardization of information.

And that, in a roundabout way (thanks for bearing with me!), leads me to this week’s otherwise brief question.

How important is position level transparency?¹

If I were being flippant, my answer would be – very, obviously! Speaking for myself, but also many other LPs I know, more information is more information, and of course I prefer more over less.

But to answer your question more fully, I’ll answer the question you didn’t exactly ask, which is – why is position level transparency important? After all, it’s not like LPs can change any particular position in a GP’s portfolio. So why should LPs care so much?

As you know, institutional LPs invest across multiple strategies and multiple investment managers. Against this backdrop, position level transparency is exceedingly useful.

First, institutional LPs are rarely evaluating a manager in a vacuum. The decision to invest or not invest in any one manager is almost always considered in the context of the larger investment portfolio. At the most basic level, position level transparency allows LPs to gauge the degree of overlap, or lack thereof, with other managers in the portfolio.

Second, when LPs are able to observe overlapping positions, it leads to useful comparisons across managers. How are the manager theses the same or different? How did each manager source the investment? And, in the case of private portfolios, are there differences in how the investment is valued? If so, why? Like I said, incredibly telling and valuable information.

Third, position level transparency allows for better performance attribution analysis. Sure, managers can share a lot of useful composite data by sector, industry, geography, strategy, etc. But investors generally prefer to slice and dice the data directly. LPs can then organize and standardize the information the same way across managers, again allowing for better comparisons across GPs.

Finally, when LPs have adequate position level transparency across the portfolio, they can aggregate the portfolio by underlying holdings. This kind of transparency allows LPs to gather a much fuller understanding of what is in the total portfolio.

I’m sure there are other benefits I haven’t thought to highlight here, but I think you get where I’m coming from. On the surface, position level transparency might seem excessive and an unnecessary burden on GPs that might prefer not to share that data. But for LPs, the additional transparency is super valuable.

Thanks for joining this week! As always, please reach out: askacio@ivyinvest.co!

See you in two weeks,
Wendy

1. Position level transparency here refers to detailed information about the individual holdings within an underlying fund manager’s portfolio. It typically includes data on the name of each position, the position size relative to the overall portfolio, and depending on the context, the cost basis and current market value for each position.