Hello and welcome back to the life by design podcast. I'm here again with Doug Walters, our Chief Investment Officer at strategic. And today we're going to start with a little weekly recap and from Doug's weekly insights and then we're going to get into another topic that I have a lot of questions on that. Hey I have I keep hearing another word Doug and I have no idea what it means. And so we're going to.

Deep dive. All right. Yeah, we'll be probably both learning a lot. No way. Yeah.

I hope I do. Yeah. OK, so first. Up, Doug, if you will just kind of recap the week, any, any high points that we need to talk?

About yeah, I think it's, you know, it's for a while now, it's been about tariffs. It's been about fed. It's been about interest rates. And every once in a while we get a new data point. On that front, and this week, we had the Fed making their rate decision, which which was to keep rates on hold. So the market seemed to absorb that reasonably well if we. Sort of looked. Back from the last time we were talking, the market had been showing a. Bit of strength. That strength continued through the rest of last week. This week was a little bit more flat, but anyway seems to be absorbing that the Fed is really in wait and see mode. They're concerned. That the tariffs are going to drive up inflation and if you lower rates, you're also going to be potentially driving up inflation. So they're staying on hold for. Now so when they.

Stay on hold is. There a timeline or like, uh, like how long? It just until they determine or like when they say where. Hold. What does that? I don't know. What that means, right? Right. Well. Yeah.

We are expecting and I say we I'm talking about the market as as a whole. You can look at indicators which will show what we expect for rates, rates for the coming year and they are implying that we are going to see some rate cuts this year. So when we say they're on hold for them, that's until. Next time, but for the market we're seeing that for this year, we do expect some rate cut cuts to come.

Through. OK, alright. Yeah. I was just. I was like I on hold. Yeah. What? OK, so so that was kind of the hot topic of from this week. The other thing if you guys haven't had a chance, we we do a weekly article. Doug, does the royal we weekly insights and this week was a topic called Alternatives and I frankly don't. Know what that means?

Right. Well, it is a incredibly broad topic. So the idea that at alternatives is one thing is. Is false, so alternatives can be anything from the gold that we hold in our portfolios to private equity hedge funds. You've probably heard some of these terms private credit, private real estate, all of these things are classified under this big umbrella of alternative investments. Almost anything other than traditional stocks. And bonds. OK, that's what I.

Was going to ask like what? Alternative to what? Yeah. So so. When we say alternatives, it doesn't include stocks and bonds. It's basically anything else. You could invest in pretty much.

Yeah, for this part, you know, it's not an official term. It it you know, it is a a colloquial term that we use to capture all these. Other. Potential investments cryptocurrency, we didn't mention cryptocurrency. If you consider that investment and investment which. Right, don't. It's you know, alternative.

Or based off of our last podcast, A Star Wars figure. Exactly that is an alternative investment that I'm way ahead of the game. Exactly. So an interesting quote from the article that I really liked of yours was once the domain of institutions and the ultra wealthy. It's not the best. We've seen alternatives increasingly push down market to the mainstream.

Right. And that's. Yeah. So that's really why. I thought it was worth writing something this week. We generally don't. Uh, we don't suggest that our clients get internal, get get into alternatives, but we are increasingly seeing marketing pushing down to the the retail investor, the you know. The wealth investors like you and I. Like. To invest in these alternative investments that are sort. Of. Packaged up in a way that's maybe a little bit more digestible for a retail investor.

And and is that the reason why it was kind of not part of something the mainstream would know about? Is it the packaging or the complexity of what it was before and? You know. These firms or investment are packaging it in a way so that I can understand what this.

Is right. Understand maybe not understand but have more have more. You have more access, more easy access and I should say upfront. Say two things. Number one, I'm not an alter. Relatives expert right and it's it's as we start to talk about private investments, this is something that I don't consider myself an expert in. From a practitioner standpoint, I do consider myself very well read on the academics and evidence of it, which is what is important to. To us and our investors. But it it should say a lot of these investments. Uh. Or have a bar that you must clear in order to even have access to them, so you have to have a certain amount of net worth or you have to make a certain amount. You might hear terms like accredited investor or qualified investor qualified client. These are all legal terms that. These private institutions. Have to. Allow you know their their clientele have to meet these criteria in order to invest in these. So they just to sort of put it into perspective these, let's and let's narrow down what we're talking about with alternative. OK, let's talk about private equity and hedge funds, private credit, the more traditional what you think of with altered.

Yeah.

This. There is much less legal oversight over these that you know they are not governed in the same way that an ETF for mutual fund stock bond are right and.

OK.

That allows the issuers of these to. You know, not have the same sort of regulatory bar, but what they do have to ensure is that the person on the other side of the transaction has the wealth to absorb this. You know the the. The. Challenges that could come with this investment. So what the regulators have said is OK. You don't have to meet all of the you know, same requirements of ETFs and mutual funds in terms of disclosure, but you must make sure that you're selling this to someone that has a lot of money and can afford to lose and can afford to lose a lot of money.

I got you so, so, so basically, you know, it's saying, hey, let's just I'll I'm going to put in simple terms for myself. If I'm going to go to the casino. I need to like dictate how much money I'm going to, or I'm willing to lose because it's a casino and. So I'm going to say, alright, I'm only bringing $100, right? Think that's it? That's what I'm willing to lose is $100 and I'm going to put that in and I know. $100. Hopefully won't make or break me for the week of the month and it sounds very similar to that saying OK whatever the dollar amount is, we got to make sure that you're OK. That you can absorb that, that it won't hurt you long term.

Right. Yeah, maybe the analogy. Is to the, you know, the High Rollers area. I don't know if this is the case, not a a gambler, but I imagine. I imagine there's, you know, for some, you know, to enter some, you know, high stakes poker game. You probably have to put up a certain amount of money or show that you have X amount of money that would be sort of the analogy.

MHM.

Yeah. And the mum to get it. OK, I like that makes. To me, so we kind of talked through the the IS that part of the transparency discussion too is like knowing how much you have and how much you're willing to. Bet quote UN quote on this.

Yes. Yeah, I think you know for for me when I talk about transparency with respect to. Alternatives. It does tie into that idea that they do not have the same reporting and regulatory requirements that other investments that more traditional investments do. So that does create transparency issues and that they the issuers. Do not have to disclose everything about what they're doing. A lot of these products you don't necessarily know. What they're doing? It's what they own or what they're doing at all. They can. They'll tell you what the strategy is, right. They have to entice you in somehow, but you won't necessarily know the details underneath the the cover.

OK, so like in the example of private equity? It's focusing on taking ownership stakes in private companies, is that? That's right. So. With that. Do we know would it from a transparency standpoint, do they necessarily tell you what companies or they're just saying you you have a stake in some high fluting company that's going to do well?

Right. Generally you wouldn't necessarily know in advance. But they generally do disclose what they own, so some of it is voluntary. Some of it may be required, but they generally they want you to know what you own. So it's not that you would never know what you own, but they don't necessarily have to tell you, and generally you're not finding. You're certainly not finding out in advance, but you just don't have the same, you know, there just isn't the same regulatory scrutiny on these investments.

So let me ask you this question. While we're on this, what is the difference between ownership stake in a private company and me owning stocks in a company?

In practice, well, sorry in. Theory. You're you're owning companies, right? And they're both companies. And there's no difference between. It doesn't have to be a difference between company A and Company B.

The.

Differences come in that what that ownership looks like in practice. So with a public company it has you have daily liquidity, meaning you can go to the stock market and sell that or buy more at any time you want. OK, right and some. Some securities are more tradable than others, but generally there there is a market there and you can go to it and you can ask for a price and you can go and and purchase and and sell with private. That. What you are usually agreeing to do is to lock up your money for a given period of time, sometimes up to 10 years. OK, so you're giving. The the the. General partner, which is what the term used for those issuing these, you're giving them your money and they're saying, all right, we're going to ask you to lock this money up for 10 years. OK, give us a long time horizon to make some investments. Buy some companies, try to make improvements, and then ultimately. You'll be able to cash out 10 years down the road. So you're locked in for a much longer period of time. And generally there are some ways to get redemptions. Typically there'll be a. You know, period, say a year or three years where you just can't get out at all without penalty. But at some point they'll say yes. You can ask for your money, but we won't distribute more than, say, 5% in a given year. OK. So if there's let's say something, you know the worst case, something's wrong right with the company and everybody wants out. Well, you're only getting. Yeah. Send right back. Quarterly typically is how they term.

That so the idea would be I put in a dollar amount and in 10 years, if the company does well that they think as well as they think they're going to do that I'll have a percentage on my return back. So whatever that percent may look like. If the company does well based on its results and how it how it does, right, OK, right. OK so. What about risk?

So the risks come in in a few different forms. One is again, you are tying up your money that is both a liquidity issue but also a risk in that you know personal risk if you need those funds. And you are forced to. Pull money out ahead of the a lot of timeline you could be facing penalties or just not be able to access. OK, that money, so that that is certainly a risk. Again the. The. Transparency is a risk that you are not necessarily. Be fully aware of what you're investing in, or what the the plan of those funds are. Often times for talking private equity, there's a typically smaller companies, and often there is leverage involved, meaning they're going to. Take on a bunch of debt to try to turn this company around or do something new with it and debt or leverage is always introducing an extra level of risk.

Yeah. And so it's just, it seems like a lot of things beyond your control, yes.

Yeah, it it's a leap of faith. It's a leap of faith and you are primarily. Investing in a track record of a management team that you trust, that's sort of the. Tends to be primary. The thing that you're looking for, right? Yes. Track record. This company has had success in. In turning businesses around, I'm going to trust that they're going to be able to do that with this latest. Tranche and go for it, OK.

So that makes sense. So besides the risks. What are what? Are the what's the cost of doing? This. Yeah, that's.

I think that is probably. I didn't mention as a risk, but ultimately. If we're talking about, you know, performance and getting your money back, the cost is very high, OK. And I think the average cost for for private equity is somewhere around 3 1/2 to 4%. And. If you compare that to, say, owning. The S&P 500 through you Know Vanguard index fund or something like that, where you're paying three basis points .03% versus 3%. Yeah, it is a very hefty fee and a very high bar for those that management team to jump over in order to get you. UMA return on your money.

Right. So they would at a minimum. Have to do enough good with this company to not only meet that 3 or 4%, but ideally succeed it. Right, right. So.

That's a lot of. Work. Yes. Yeah, it's not easy and. And three or 4% I would say is even on the low end, it's you know again do a lot of reading on this subject and you see different numbers out there. 3 to 4% is. Is a commonly quoted number. I've I've seen others depending on if you're talking about. You know a buyout or venture capital or or or some other type numbers as high as 8%. So 8-9 percent is not uncommon. And again we're now we're talking about an enormous bar to jump over before.

Hmm.

You're getting your. Yeah, your return. You know, a positive return.

So with everything we just heard. What's what's the track record Ben for? For, for these private equities?

Risk. It depends who you ask. OK, I have seen research. I would say on both sides of that answer, but for the most part, the research that I've been able to. Pull together and invalidate seems to show that most companies are not or most funds are not clearing that cost hurdle. In other words, you're not doing any better in these private investments. Than you would do in a equivalent public investment and. It also varies by type of alternative. So we've talked, we're talking a lot about private equity. Again, there's others. There's private credit, there's real estate, there's. Infrastructure funds there's also all sorts private equity actually is the one with the. Best. Track record. So we're going to focus on. Yeah, the one that has had the best track record then private equity is where you want to focus. And there are. Some studies that would that show that they have generated some outperformance overtime. The caveat to that is outperformance versus what, so yeah, OK, if it's versus and a lot of these studies are saying versus the S&P 500.

And.

You know, an investor might say great, I want to outperform the S&P 500. So give me some of that private equity that sounds great. The the problem is is that these again we talked about risk, the risk profile of these investments is a lot higher than the S&P 5. And there's a really interesting study out, at least I find it interesting. You can hold your judgment. But basically showed if you think about private equity as a whole, a lot of times they're looking for undervalued assets. They're looking for cheap value companies where there's a potential for turn around that. As I mentioned, they're going to raise a lot of debt. They're going to put that money into trying to turn this business around. So it's smaller companies, there's value involved and there's leverage involved, meaning they're they're raising a lot of debt to try to do this. If you were to buy a basket of smaller value companies and you introduce a bit of leverage to that, and I'm talking in the public space. You can replicate the return that outperformance of private equity. Without the excess fees, without having to lock up your money for 10 years. So this pretty interesting piece of research that I think is really. Puts it in perspective for me again. You know, private equity. There's a keyword there. It's equity. Yeah, right. You are just buying in the end. You're just buying companies and what you what profile companies generally you're buying small value leveraged companies. You can do that in the public space. So why tie up your money?

So it really sounds like. And I think, you know, I think you wrote something to this degree, it it it sounds like that the ones collecting the fees are actually the ones actually making the money out of these.

Yeah, they're doing, they're doing great. And there's there's just. You know, a subtle point to make as well as you know, four. Well, call the retail investors. You know, you and I, who might be looking to purchase one of these funds on these, you know, these platforms that are popping up, making them accessible. Is we're not necessarily getting the cream of the crop from private equity the you know the. Multi billion dollar pension funds, the you know, the $200,000 endowments you know think. Harvard, they have a level of access and a level of selection with these. With these private equity managers that the average person doesn't. So you have to understand that you know, we are not necessarily and I say we, I mean everybody outside of those biggest players. Are not necessarily getting the cream of the crop.

So based on that and our quote at the top, it sounds like there's still the domain of institutions and ultra wealthy we're just getting. Some sort of access to it, but it's still. Maybe a couple steps away from us.

Right. And if you're feeling, if you're feeling like, oh, that stinks, you know that. The you know these big players getting everything you know, I wish you know. Too bad we're not, you know. You know, we again, the collective, everybody else in the world don't have access to these that can make you feel a little bit better. So there's another piece of research that came out that looked at the correlation of. The use of alternatives by endowing these large endowments and pension funds. And performance. And it turns out. Is the bigger the pension fund, the more alternatives they use. And the lower their performance. So there was really high correlation between the use of alternatives and performance, but it. Was the wrong. One the more alternatives they put into their portfolios. The worse the worse. Their overall performance, and so if you feel like you're missing. No. You're not. You're not. You're not all right.

Well, I think that's a good place to end. So you know, for those of you listening, you know, hopefully we're going to keep doing these where? We pick, we pick these topics. That we have questions on there, but I don't know. What that means and. Hopefully we can explain it to. You. Well, Doug, can I'm just going to. Ask the question. We'll do our.

Best.

All right. Well, thanks.

Doug, alright. Thanks Jay. Take care.

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