The Paper Trail: Less Efficient Markets

That's a wrap for Q3! The highlight of September for me had to be the 3rd annual Future Proof Festival in Huntington Beach, CA. 😎

Every year I go and every year, somehow, the bar continues to be raised. It took over a week just for my voice to come back 📢

Some highlights of this year's event included:

• Sharing the stage with Danielle Poli, CAIA and Michael Sidgmore to discuss our respective private credit vantage points. Standing room only crowd! 🎤
• The countless conversations my Cliffwater colleagues and I had with advisors and investors from all over the country seeking to unlock private markets in their portfolios 🔓
• Signing copies of The Allocator's Edge at the Harriman House tent. 📚
• Reliving my junior high days rocking out to Third Eye Blind (with an In-N-Out burger in hand) 🤘 🍔

Hats off to my friends Matt Middleton, Josh Brown, Michael Batnick, and everyone from Ritholtz Wealth Management/Future Proof for a spectacular week. Until next time ✌

Now, please enjoy the September 2024 edition of The Paper Trail. This month's research roundup features:

• Investing amid election season
• Yield curve dynamics
• Equity market rotation
• Negative sentiment and private debt
• The private equity return premium
• NAV Lending
• Less-efficient markets
• Sizing alternatives allocations
• Secondaries and the efficient frontier
• Japanese small caps
• GP-Led Transactions
• And much more!

Should investors consider altering their portfolios ahead of the U.S. presidential election?

"Looking ahead, investors should remain focused on long-term drivers of asset prices rather than getting swayed by political noise. While we expect higher volatility near the election, it should subside once the immediate uncertainties are resolved. "

US Election Anxiety: Keeping Calm Amid Political Uncertainty (Cambridge Associates)

Is now the time to begin rotating away from U.S. stocks?

"While the US market has dominated over the past decade, an encore may not necessarily follow over the next decade. Growth narratives that previously seemed inevitable can quickly change when faced with reality. "

The Great Rotation (Verdad)

Is the negative sentiment surrounding private debt at all warranted?

"In light of this analysis based on the available information, we believe the concern over potentially rising default rates— understandable, perhaps, given uncertainty within the market—is not as magnified as portrayed by headlines."

Private Debt: Few Facts Behind the Fears (Neuberger Berman)

What message is the yield curve sending us?

"The big picture is that the Bond market is orthogonal to the Stock market.
Unless history has been rewritten, one of these two markets must relent."

Forests and Trees (The Convexity Maven)

Is there more to private equity's excess returns than an illiquidity premium?

"Private equity should be thought of as an active management allocation with uncommonly high dispersion of active returns—i.e., more as an “alpha opportunity” space rather than a “beta exposure return” space. Investors often mistakenly think about private equity expected performance as a single return number. In reality, relative to public markets performance, investors will experience somewhere between deep underperformance and dramatic outperformance."

The private equity return premium: It’s not just due to illiquidity (Verus)

How large is the opportunity set in NAV Lending?

"NAV loans offer private equity funds a flexible source of capital that’s
non-dilutive (the fund isn’t required to give up any ownership or equity in its portfolio companies to obtain the capital); this feature has been a key factor in the growing adoption of NAV loans. As this form of financing becomes more widely accepted, and as the private equity market grows, NAV lending opportunities will likely expand."

Funding Flexibility (AllianceBernstein)

Where are we in the private equity market cycle?

"The increasing valuation “pop” at exit would suggest that private equity valuations became increasingly conservative as public markets rallied and private equity valuations did not keep pace. As more liquidity events occur, we believe private equity returns may continue to benefit from these valuation upticks at exit."

The Beginning of a Private Equity “Super Cycle”? (Dawson Partners)

Have markets gotten less efficient over the last 30 years?

"The bottom line is speed of information has consequences and can make the market more efficient in one sense, but it is largely irrelevant to the medium-term hypothesis I’m arguing here."

The Less-Efficient Market Hypothesis (Cliff Asness)

Can managed futures investors just "buy the index"?

"A CTA index is a managers index, while a stock index is a markets index. In a stock index, the constituents are stocks chosen by the index composer. In contrast, a CTA index comprises the CTAs themselves, not the futures contracts they may trade. This means that the returns of a stock index are directly derived from the underlying stocks, regardless of the positions held by the largest equity funds. On the other hand, the returns of a CTA index are fully determined by the actual positions of the largest CTAs, as these returns are derived from the programs of these CTAs."

Just Buy the Index (Transtrend)

How should investors size their allocations to alternatives?

"Constraints and beliefs drive real-world asset allocation, especially where alternatives are involved."

Broad Strategic Asset Allocation (AQR)

Are small-caps the place to be in Japanese equities?

"The MSCI Japan Small Cap Index is trading on a P/E of 13.5x compared to the MSCI Japan Index P/E of 15.4x. The spread of -1.9x is the largest since 2010. Small caps are trading at a P/B of 1.1x compared to large caps at 1.6x. The -0.5x spread is the largest going back to 2007. Small cap dividend yields exceed those of large caps by 0.5%, a level unseen since 2001. From a relative and absolute value perspective, small caps are looking extremely attractive."

Small Wonders (GMO)

Are the high risk-adjusted returns of PE secondaries sustainable?

"While the Secondaries asset class has delivered historical, median returns comparable with Private Equity and Venture Capital, the standard deviation of these fund returns is significantly lower. Fund returns data from Preqin dating back to 1987 demonstrate the unusually low loss ratio of Secondaries funds versus other private market strategies."

How Secondaries Defy the Efficient Frontier (Seine Capital)

Can GP-led secondaries provide value to all stakeholders?

"GP-led transactions, in our view, have the potential to provide mutual benefits for both limited partners and financial sponsors alike, including access to early liquidity, and the ability to remain invested in high-performing “trophy assets” for longer than would otherwise be feasible."

Expanding the Toolkit: How GP-Led Transactions Can Enhance Secondary Strategies (Apollo)