The Paper Trail: Capex Boom

Happy Halloween (eve), readers!

I'll be dressed as iced coffee for trick-or-treating this year, which should pair nicely with my daughter's donut costume.

A quick note for any financial advisors heading to Denver next week for the Schwab Impact conference - I'll be out there along with other members of the Cliffwater team. We'll be at Booth #1136 in the exhibit hall if you want to come say hello! I'll be giving a presentation on Wednesday (11/5) at 11:30 a.m. MT titled "Beyond Direct Lending: An Enhanced Approach to Private Debt Investing." Full session description below:

Now, let's dive in to this month's spook-tacular edition of The Paper Trail! October's research roundup features:

• Best practices for structuring evergreen PE funds
• International small-cap value stocks
• Music royalties as an asset class
• Strategies for diversifying concentrated stock
• Factors influencing the shape of the yield curve
• The middle market as the "sweet spot" in private equity
• Implications of lower base rates for direct lenders
• AI's capex boom
• Evolution of the global market portfolio
• Tail risk in modern markets
• A primer on GP Stakes investing 
• Gold's recent hot streak and expected returns 
• Transitioning to a Total Portfolio Approach (TPA)
• Bond fund common risk exposures

What are best practices for structuring an evergreen private equity fund?

"To an observer, the motion of a duck gliding calmly across the water seems effortless. Beneath the surface, however, the duck is paddling furiously to maintain direction and momentum. We think evergreen funds operate in much the same way: accessible on the surface for investors but requiring constant work behind the scenes to deliver that experience consistently."

Evergreen Private Equity for the Long Run (Cliffwater)

Are international small-cap value stocks the best way to diversify a U.S. large cap growth-centric equity portfolio?

"International small value, in particular, stands out as a rare combination of high returns, moderate volatility, and low correlation to US equities—an especially valuable mix for investors seeking true diversification."

Opposing Ideas (Verdad)

Are music royalties a viable diversifying asset class?

"For music to mature as a true asset class, pricing models will need to move beyond financial history and incorporate measures of musical quality and cultural relevance. Ultimately, the drivers of over- or under-performance are not just financial, but artistic: how good the songs are, and how likely they are to expand their audience over time."

Music as an Asset Class (Cornell University)

What are the tradeoffs involved with the various strategies investors use to tax-efficiently diversify concentrated, low-basis stock?

"Rarely can a single solution solve a problem as complex and burdensome as the one faced by those with low-basis concentrated stock positions. We break the problem into two distinct, but related, issues: risk and tax. The overweight size of the position may create an outsized risk concern that, while related, is separate from the tax liability that restricts flexibility in diversifying away from the concentrated position."

Diversifying Concentrated Stock Positions (Neuberger Berman)

What factors determine the shape of the yield curve?

"The yield curve (YC) reflects some mix of the market’s expectations of future changes in interest rates and required term premia (also called bond risk premia, duration premia, or maturity premia). The YC is steep if the market expects rising short-term rates and/or requires a large compensation for bearing interest rate risk. The YC is inverted if the market expects rate declines and/or is prepared to pay a negative term premium (for example, because long bonds are exceptional safe-haven assets or are required to match pension funds’ long-duration liabilities). In practice, the YC tends to be upward sloping but its slope varies over time and sometimes is inverted for prolonged periods."

Bond Market Focus: Yield Curves and Mean Reverting Rate Expectations (AQR)

Why is the middle market the sweet spot for private equity?

"That’s because middle market investments give fund managers access to a wider range of exit options, not available to mega deals that often depend on IPOs and a limited number of strategic buyers. Potential exits in the middle market include a much larger set of strategic and financial buyers, including sales to larger GPs, yet these investments are still sizable enough to consider IPOs as well."

Smart Capital, Strategic Returns: The Case for Middle Market Private Equity (Hamilton Lane)

Are lower base rates bad for direct lenders?

"For direct lending investors, lower SOFR means lower yields, but it also means potentially healthier borrowers, more M&A activity, and lower cost of liabilities."

Fed Rate Cutting Cycle Implications For Direct Lending Returns (Antares Capital)

Will the AI capex boom result in a bust?

"Despite our conviction in AI as a technology, we believe that, ironically, its heavy capital requirements and competitive market structure are actually reducing the quality of the very firms responsible for its creation. So far, investors are still constructive on these AI investments, but if the arms race does result in severe overinvestment, pain could lie ahead."

Surviving the AI Capex Boom (Sparkline Capital)

How has the total world market portfolio, inclusive of all asset classes, evolved over time?

"Currently there are three major trends visible: (1) the equity weight relative to bonds has increased materially since the GFC but it remains below levels from the 1990s, (2) both in equities and bonds the US has accrued a larger weight and is very dominant and (3) alternatives such as private markets, Gold and cryptocurrencies have grown relative to public equities and bonds (but remain relatively small)."

Investing in Everything, Everywhere, All at Once (Goldman Sachs)

Should investors expect tail risk events to happen with greater frequency due to modern market structure?

"Ultimately, the erosion of traditional portfolio foundations does not mean that resilience is unattainable; rather, it demands a reorientation of both theory and practice. If investors accept that crises are not anomalies but structural features of the market landscape, they can design portfolios that not only endure shocks but harness instability as a source of opportunity."

Tail Risk as a Structural Feature of Modern Markets (Graham Capital Management)

Why are allocators attracted to GP Stakes as an asset class?

"For many investors, this approach has characteristics of both income and growth. Management fee streams create near-term cash flows, often in the 5% to 8% range, while carried interest and GP ownership offer participation in the growth in the firm’s value. In a maturing private markets landscape, the appeal of owning a slice of the “house” to complement betting on individual funds is increasingly clear."

Owning the Owners: A Primer on GP Stakes Investing (Allocate)

Can Gold's hot streak continue?

"This places us right at the heart of the Golden Dilemma. Based on past performance, expected returns should be very low or negative over the next 10 years. But that may be pessimistic if demand for gold has, in fact, undergone a structural shift that has caused significant price appreciation. The baseline or average may have shifted upwards."

Understanding Gold (Claude Erb & Campbell Harvey)

How do institutional investors shift from the traditional Strategic Asset Allocation (SAA) framework to a Total Portfolio Approach (TPA)?

"The organizations furthest along the path aren’t chasing perfection. They’re building better systems – ones that align capital with purpose. Not because they’ve reached “One Fund” nirvana, but because they’ve built the right scaffolding: strong governance, shared incentives, and a mindset that puts the total portfolio first."

From Vision to Execution: How Investors Are Operationalizing the Total Portfolio Approach (CAIA Association)

Are most active bond funds exposed to the same common risk factors?

"For Aggregate and Corporate funds across the US, Global, and Euro regions this co-movement is driven by significantly negative exposure to duration risk and significantly positive exposure to credit spread risk, consistent with funds having a structural underweight in government bonds or high-grade credits and an overweight in more risky, higher-yielding credits. Exposures to common risk factor risk are highly correlated with the amount of active risk and also explain over half of the cross-sectional variation in average active returns."

Common Risk Exposures of Bond Funds (Robeco)