The Paper Trail: Back to Basics

Greetings from Newport Beach, CA!

Closing out January with some work travel out west. I can think of worse places to escape the frigid temps of Chicago.

February won't be any warmer back home, but at least we have some birthdays in the family to celebrate - my son will be turning two and my wife will be turning [REDACTED]!

I'm kicking off The Paper Trail this month with my latest Cliffwater research paper, "Back to Basics: The Five Ws of Private Debt," where I demystify some of the recent credit-related headlines and introduce a simple framework for evaluating any lending strategy that answers the following questions:

🧑 Who is borrowing?
💰 What supports repayment?
⌛ When does capital return?
🥇 Where does the lender sit in the capital stack?
🎯 Why does the borrower need the money?

Other topics featured in January's research roundup include:

• Moving beyond the "Agg" for core bond exposure
• Fund size growth as a potential red flag in PE
• Trend following performance in 2025
• An examination of frontier markets
• Expected returns of major asset classes
• The electronification of fixed income trading
• Liquidity management in interval funds
• Understanding market (in)efficiency
• AI capex and the U.S. economy
• Biotech investing
• The outlook for hedge funds
• A record year for the secondary market
• Small and mid-market buyout tailwinds 

Why does the financial press continue to conflate private debt and broadly syndicated loans (BSL)?

"Private debt has been here before. Periods of growth have historically been followed by warnings of excess and predictions of widespread losses. Yet many of these warnings have failed to materialize as anticipated. The most recent slew of private credit critiques stemmed from comparisons to the broadly syndication loan (BSL) market that blurred important distinctions, generalizing lending as a whole. This conflation matters. Private debt is not simply a private version of the public loan market. It is a distinct lending model with different incentives and tools for managing risk."

Back to Basics: The 5 Ws of Private Debt (Cliffwater)

Is the "Agg" index sufficient for core bond exposure?

"Because fixed income indices are inherently inefficient, particularly the Aggregate Index, index allocations are a commitment to the bottom. When comparing the Aggregate Index to the universe of core managers, the index is in the third to fourth quartile over five-year periods. It is worse in the core plus universe with the index falling in the bottom quartile and frequently in the bottom decile over an extended period."

 
Where Should Investors Land on the Aggregate Continuum? (Marquette Associates)

Should LPs be concerned when private equity GPs increase their fund size?

"Fund size growth is not inherently a red flag, but it is a meaningful signal. Larger successor funds typically bring increases in deal size, team demands and execution that may not be obvious in the fundraising narrative, and these changes warrant careful diligence. Still, the data does not support the idea that an increase in fund size, on its own, mechanically leads to weaker returns."

Is Fund Size Growth a Red Flag? (StepStone)

How did trend following strategies fare in 2025?

"2025 was a year marked by extraordinary market shocks and shifting macroeconomic landscapes, challenging the effectiveness of traditional price based trend-following strategies. The dispersion in returns among managers underscored the idiosyncratic nature of system design choices (such as trend speed, market selection, and volatility adjustment) in navigating turbulent environments."

Themes of 2025 (AlphaSimplex Group)

Is there a case for allocating to frontier markets?

"Despite their strong expected GDP growth rates, frontier markets have not translated that economic momentum into equivalent corporate earnings performance. Earnings per share growth has stagnated even as valuations have remained low relative to developed and emerging markets. This combination presents both opportunities and risks. Value-oriented investors may find attractive entry points, but persistent structural inefficiencies and volatility underscore the need for careful analysis."

Frontier Markets (Meketa)

Have expected returns moderated following a period of strong equity performance?

"In 2025, equity markets rallied for a third consecutive year but our 5- to 10-year expected returns – based on current valuations – continue to imply risk premia are compressed. The expected real return of a global 60/40 portfolio is 3.4%, around 1.5% higher than the all-time low reached in 2021, but still well below the long-term U.S. average of nearly 5% since 1900."

2026 Capital Market Assumptions for Major Asset Classes (AQR)

Will the continued electronification of bond trading lead to greater adoption of systematic fixed income strategies?

"The combination of increased liquidity, reduced transaction costs, and an expanded tradeable universe opens the opportunity set for quantitative approaches that can rapidly process vast amounts of market data and execute at scale."

Systematic Credit: A New Frontier (Man Group)

Why is liquidity management so crucial for interval funds?

"Private assets are illiquid—period. In a basic framework, a fund manager would hold cash alongside private assets as a liquidity buffer. However, this presents a clear trade-off: Cash reduces exposure to private assets, and as a result, it can act as a long-term return drag. To mitigate the potential drag on returns from cash, some interval funds opt to hold a “liquidity sleeve” of publicly traded assets. The liquidity sleeve can be composed of listed equities or tradable debt assets that are aligned with the investment strategy. However, interval fund investors need to understand that some of the pure-play exposure to—and, importantly, expected returns of direct private assets—are diluted in public asset proxies. Interval funds live in constant tension between exposure purity and the safety of liquidity."

Sink or Swim: Interval Funds Liquidity (PitchBook)

What forces drive market (in)efficiency over time?

"Markets cannot be fully informationally efficient because there is a cost to gather information and reflect it in asset prices. The degree of efficiency is a function of how difficult it is to acquire information and the friction associated with buying and selling securities to capture value."

Who Is On the Other Side? A Framework for Understanding Market (In)Efficiency (Counterpoint Global)

How will the AI capex spend affect the U.S. economy in the years ahead?

"The labor required to build or operate data centers is quite small relative to the dollars of capex spend. In fact, AI capex is at risk of creating negative pressures for the labor market, as the tremendous amount of financing required drives up the cost of capital, creating headwinds for other, more interest-rate-sensitive sectors that are also more labor-intensive, such as residential construction. These dynamics also have the potential to offset some of the inflationary elements of the AI boom, like higher power prices, through softer wages and services inflation, creating a mixed picture for inflation overall."

The Macro Implications of the AI Capex Boom (Bridgewater)

Why has biotech been such a cruel sector to invest in?

"Biotechs are perhaps the most promising and most heartbreaking companies in the small-cap investment universe. They enter public equity markets for the purest of reasons: to raise capital at the scale necessary to fund the enormous expenses necessary to deliver life-changing drugs. When they succeed, they can achieve huge valuations in a short period of time. But they fail at a rate that is much higher than in other industries."

Biotech Investing: Investment Approaches that Work in a Challenging Industry (Verdad)

Are hedge funds suddenly en vogue again?

"We believe today’s investment landscape presents an interesting paradox: markets appear orderly on the surface while underlying dynamics grow evermore complex and fragmented. Technological innovation, deglobalization, and less predictable policy shifts are contributing to a rapid pace of change, with meaningful implications for the economy and the potential to deepen the divide between the haves and have-nots. Meanwhile, equity valuations are relatively high, benchmark indices are increasingly concentrated, and credit spreads are nearing historical lows."

2026 Hedge Fund Outlook (Evanston Capital)

What factors led to another record year of volume in the private capital secondary market?

"Venture and credit secondaries experienced heightened investor activity in 2025; venture volume accelerated meaningfully as the proliferation of AI and revitalization of broader technology markets reignited investor appetite, while credit secondaries volume witnessed exponential growth given the influx of dedicated capital targeting the strategy."

Global Secondary Market Review (Jefferies)

Why are small and mid-market buyouts well-positioned for future success?

"Whereas large-cap deals depend heavily on IPO markets and strategic trade sales to multinational corporates, the small and mid-market benefits from a broader and more stable exit landscape, including sponsor-to-sponsor sales (secondary buyouts), strategic sales to a wider range of trade buyers, continuation investments, and in rarer cases, management-led buybacks."

Small and mid-market buyouts: 10 structural and cyclical tailwinds – and how to invest for success (Schroders Capital)