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Each episode will feature insights from our Chief Investment Officer, Doug Walters. Hello, and welcome back to the Life By Design podcast.

I'm back again with Doug Walters. Hello, Doug.

Hey, Jay. How are you?

Um, and so we're gonna dive later into alternatives again. We're gonna get a little bit deeper.

We covered a little bit on private equity, gold. We- we've covered some of the alternatives, but we're gonna, we're gonna take a deeper dive into that today.

But first up, a little bit of your insights from this past week, things that you're looking ahead to, and, uh, yeah, just anything you got. All right.

Sure. Well, we've been saying for a while, and we're not the only ones, that tariffs are, are very important.

But the other thing that seems to be taking a backseat lately is the Fed and its decision on whether or not to, to reduce rates, and what's driving most of that is inflation. And we had an important inflation read last week, so CPI inflation came out, that's the Consumer Price Index, and it was a bit lower than expected.

It's not quite down to the Fed's 2% target, but it's continuing to move down into that, you know, towards that range. So, that gives the Fed something to think about this week, because on Wednesday we have a Fed rate decision.

It's not expected to change the calculus currently. Markets are not expecting a cut this time around, but it certainly starts to make that, that case for a cut.

And I think where the hesitation lies is the impact of tariffs really hasn't been felt or seen yet in the inflation number, so the Fed is still probably in a wait and see mode. Right.

So, technically, in regards to tariffs, a lot of the reactionary things that we've seen in the market is more to the news of tariffs than the actual consequences of them. Yeah, it's a bit of both, right?

Yeah. They were trying to infer what the consequences are, but we haven't actually seen those con- consequences in numbers yet.

Yeah. That is, you know, should be coming soon if, uh, if, uh, worst fears are, are realized.

Yeah. And I know, like, um, from my perspective, some of the things that I'm interested in, uh, there's already been announcements from some of the manufacturers of those that like, "Oh, hey.

We're, we have a little bit of a price hike because of X, Y, and Z." And I think some of, you know, is most likely tariffs are mixed into that as well. Right, right.

Yeah, and we do see, while the consumer price index is, is down, we have seen some data on the producer price side that is suggesting that these prices, you know, they're starting to see higher prices. Mm-hmm.

Okay. So, that is our insights from this past week and, and what we're looking ahead to.

Uh, so now, yeah, let's just dive right in. Uh, Doug wanted to come back on here and talk about alternatives again.

Yeah. So, here we are.

So, Doug, I'll let you lead it off, and, uh, I'll ask questions as we go. Yeah, sure.

So, you kind of challenged me this week by talking about barbecue in Insights, right? And, you know, I got to thinking about ingredients and good, good ingredients and bad ingredients, and it really brought me back to this topic of, of private equities as kind of bad ingredients for most of our clients' portfolios.

And the reason it's really topical today is, and we kind of mentioned this in the past, we're starting to see an influx in our email box of, you know, this fund or that fund being, uh, private funds being pushed down to individual investors. Yeah, sure.

So, it's really the opposite side of the equation from a public fund, and the public fund is what we are most familiar with, and we'll talk, or sh- let's, let's broaden it. Public investments, right?

Stocks. Yeah.

Everyone is familiar with, uh, stocks. Those, you are buying a public company, meaning it trades on, say, the New York Stock Exchange.

You can buy it and sell it intraday. It's, uh, regulated in a certain way that public companies are regulated in, and, uh, but really, you get that day-to-day liquidity.

You get, uh, a requirement from those public companies in terms of how they have to report- Mm-hmm. and, uh, be open about, you know, their business and their books.

The contrast of that is private companies, and private companies have decided not to list on a public market, but you still, there still are ways to invest in those private companies, and that is through, you know, firms like, uh, Apollo, uh, Blackstone, who will b- um, basically buy a piece of these private companies and then bring investors in to own a piece of those private companies. And so, I guess, to, like, distill it down to its simplest form for me is that the public, the stocks, all that is, uh, you have knowledge available to you, and there's a known there.

Right, right. you know, the, the regulation has allowed to sort of take a step back, if you will.

You have to be an accredited investor or, you know, meet some investing threshold- Mm-hmm. in order to invest in them.

Uh, the SEC doesn't want someone, you know, spending their last dime- Mm-hmm. on a private company that is less regulated and ha- you know, we have less information about.

Yeah. And we had talked in the past that, like, certain th- like, having a certain dollar amount in the bank is, like, a requirement, or, or available assets to invest, stuff like that.

Right. There's multiple criteria and there are different, depending on the investment, there's 2 different types of accreditation.

Yeah. But typically, it's income-based or net worth-based.

Okay. All right.

And, uh, yeah. So, you were kind of talking before we started that one of the, the things that kicked off this for you and, and kind of thinking about this was that you s- you said that Harvard and Yale were forced to liquidate some of their private funds.

Right. Right.

So they're dealing with their own issues in terms of some federal funding being cut and one of the ways they're managing around that is to exit some of their private equity, private investments within their endowments. So, is that private investments that they had their money invested into or is that private investments that people could invest in them?

It's that they had their money invested. Okay.

Okay, yeah. Right, okay.

So they had, uh, you know, a portion of their portfolio, very large portion of their portfolios tied up in private investments, and the one thing we've mentioned in the past i- you know, one of the risks w- with private investments is they're not very liquid. Yeah.

You are typically locked in for a period of time and, you know, for you and I, we'd be stuck for whatever the, the lock-in period is, 7 years, 10 years. For Harvard and Yale, they've got a little more sway.

They can find, potentially find secondary buyers- Hm. for the funds or the, the companies that they own, and so that's what they're in the process of doing, is finding some secondary buyers so they can liquidate a portion of their private, uh, holdings.

Okay. And so that kind of starts to affect downstream investors a little bit, right?

Yeah. But we do wanna prepare, and what we're doing is preparing for an increase in a push 'cause these have to go somewhere, and it's quite likely given there's a, there's a fair amount of lot right now in the private equity industry, that we're likely to see these being pushed down to individual investors in various funds that are trying to, to attract them through slightly different, um, structures that make them a little more accessible.

Okay. And so, uh, how does that structurally differ from things that, like, an ETF or something that we do?

Yeah. So an ETF, so which is an exchange traded fund, and as the name suggests, that means it is traded on an exchange just like a stock.

Um, these funds, uh, are going to be less liquid. Okay.

So a traditional, buying right from the source primary private equity, you're gonna be tied up for 7 to 10 years. What we're seeing is, uh, these companies getting creative, trying to say, "How do we get, you know, Jay to buy a piece of this?" Well, we're gonna try to create a little more liquidity, maybe give him, uh, the ability to sell some of it on a quarterly basis, and they do that by combining different ways, but one way would be to say, take these private investments, put them in a fund, add some more, uh, liquid public, um- Yeah.

securities in there as well. Maybe infuse some cash in there- Mm-hmm.

So, if you wanted to sell 5% on a quarter, you might be able to. So, they're trying to get creative to, a- again, broaden the universe of access.

Uh, now the problem with that is, and you're hearing what I'm saying, you're really diluting the whole point, right? Yeah.

If private investments are You know, can produce higher returns, well, why are you going to dilute it with public equities or even worse, with cash, to make them more liquid? Yeah.

And then, I guess one of the things too, in regards to that, is fees as well, right? So, I'm assuming that there's some sort of fee on these.

So- Mm-hmm. So- so, you know, when we look at, you know, from our perspective, being a fiduciary, we- we have, you know, our fee for operations, and then there's the fees for, for trading on ETFs and stuff like that.

So, like, how do they manage theirs in comparison? Yeah, so it is, um It's a loaded question.

Uh, good. And, uh.

'Cause there was a good study done a year ago, so this is relatively up-to-date data, looking at, uh, different, uh, private investments and the embedded fees that are in them. And the fees can come in the form of a management fee.

Uh, it can come in per- in- in the form of a performance fee. So, if the fund clears a certain hurdle, let's say, you know, if the- it goes up more than 5%, then the fund company might take 20% of everything above that.

And so, what does this look like in terms of numbers? It can range anywhere from 5% to 9% fees according to this study, with, um, you know, the private equities tending to have the higher fees, 8 or 9%.

And so, this is coming right out of what you would be taking home as the investor, so this is a big hurdle to clear. And c- let's compare that to an exchange-traded fund.

Uh, you know, one of our core funds is, um, a US multifactor, uh, fund. It's an iShares product.

Uh, LRGF. It has an embedded expense ratio of 8 basis points.

Yeah. It's a big difference.

Leaps and bound. Um, yeah, and so it's- it's interesting.

And- and so one of the things I hear a lot, and maybe someone at home has heard, is the word drag- Yes. when talking to fees.

And so, is that So, when you talk about that 8% versus the 0.08%, is that drag? Uh, one is a much bigger drag.

A- a, you know, a hundred times bigger drag. Yeah.

And by that, I guess it's- it's really, if you think about, um I suppose it's an engineering term. Mm-hmm.

Think about, uh, you know, a car trying to be aerodynamic. What it's trying to do is reduce drag, any- trying to reduce anything that might slow it down.

Okay. So, it's Uh, you know, think about that with an airplane is probably a better example.

You want to reduce drag as much as possible. That's the term we're using.

With investments, you want to reduce anything that's g- that's gonna slow down your performance. Mm-hmm.

And these fees are like a- you know, as direct as it gets in terms of slowing down performance. So, anything else you wanted to cover on the- on the alternatives?

The 1 the one thing we really didn't hit was performance. Yeah, let's talk that.

So Which is really important because, you know, these private, uh, investments have a lot of hair on them in terms of liquidity and maybe excess risk and- Mm-hmm. But are we getting more performance for them?

Right. And there's some good research out there.

It looked at pensions and endowments. How these are the biggest pensions and endowments in the country.

They have the best access to private equities. The best, uh, performer was private equity, which was sort of net neutral.

So, private equity didn't hurt or help their relative performance. Okay.

Everything else, um, you know, private, uh, credit, commodities, everything else that you might fall in- into that category of alternatives, was a drag on performance. So, uh, th- and these are, let's just put this in perspective, these pensions and endowments, they have big research teams.

They have big budgets. They have best access to these private equity firms.

They have sway over them. They probably have advantageous pricing, yet they weren't able to make it work.

So, the expectation of someone like myself, way downstream, probably even less likely. Right, right.

They're going to be, um, less potent versions of- private equity. Again, a little bit of speculation there, but- There's always exceptions.

I mean, I think that's a great place to end the conversation. Thank you, Doug.

All right. Thanks, Jay.

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