The Paper Trail: Rebalancing Act

It's been an action packed month full of travel - Miami for the inaugural Future Proof Citywide event, spring break with the family as we ate our way through Charleston, and off to NYC this week for some time with the Cliffwater team. Hectic and awesome all at once.  

A few photos from the recent festivities...

Top-notch crew for dinner in South Beach

Hanging with my pals Brian Portnoy, Ted Seides, and our mutual editor at Harriman House, Craig Pearce

The Cliffwater booth at Future Proof was stocked full of goodies. 

Nostalgia trip in full effect - enjoying the All-American Rejects concert w/ the Ritholtz Wealth crew (and Doug)

Dinner at The Obstinate Daughter in Sullivan's Island, SC. Best gnocchi I've ever had by a mile. 

Charleston sunset with the little man. Memories were made. We'll be back!

Now, on to the March 2025 edition of The Paper Trail. This month's research roundup features:

• A possible growth-to-value rotation
• State pension plan asset allocation trends
• Drivers of private equity outperformance
• Decomposing the last 10 years of equity market returns
• Options-based buffer strategies
• Lower-middle market PE opportunities
• Economic regime detection in the investment process
• Real assets and inflation hedging
• Parallels between the AI boom and the Dot-Com bubble
• The role of NAV loans in fund finance
• Alternative property types in commercial real estate
• Spending shortfall risk and illiquidity budgeting

Is now the time to rotate from growth to value?

"While the U.S. megacaps may find a way to extend their remarkable run, we believe tech earnings growth will likely moderate from here and that broadening economic growth should benefit cyclical sectors like financials, industrials and energy, and value stocks more generally."

Rebalancing Act: Rethinking Growth Versus Value (Neuberger Berman)

How have allocations to alternative investments for state pension plans changed over the past decade?

"Though private equity has taken the pole position from real assets, it appears that private debt is gaining ground quickly."

State Pensions Lean into Private Debt, Right-Size Private Equity (Cliffwater)

Why has private equity outperformed public markets over time?

"A natural question that arises is how has private equity consistently achieved superior operating performance? We believe this is enabled by a fundamentally stronger operating model compared to public markets, primarily driven by (i) deeper engagement, (ii) sharper focus, and (iii) better governance. In our view, these advantages not only position the asset class to respond more effectively to market shocks but also enable stronger long-term value creation potential."

Why Private Equity Wins: Reflecting on a Quarter-Century of Outperformance (Dawson Partners)

Have differentials in equity returns over the past decade been driven by fundamentals or multiple expansion?

"A breakdown of equity returns uncovers differing reasons for underperformance: small-cap and low-volatility stocks have delivered solid earnings growth but lagged due to stagnant valuations, while Emerging Markets equities have suffered from weak earnings growth despite rising valuations."

Decomposing Equity Returns: Earnings Growth vs. Multiple Expansion (Robeco)

Have option-based "buffer" strategies lived up to the hype?

"To be blunt, these “buffered funds” are a marketing success, a success for the managers selling them, and a failure for investors lured in by the overpromise of magical equity returns without equity risk and then overcharged for the pleasure."

Rebuffed: A Closer Look at Options-Based Strategies (AQR)

Is the Lower Middle Market (LMM) the sweet spot for private equity investing?

"This illustration may be sufficient to end the discussion on whether small and medium-sized funds can outperform their larger brethren. Historically, data suggests that top quartile LMM funds have outperformed their larger peers, with a greater upside for the strongest managers. However, the efficient frontier has taught us that there is no free lunch, and that with the possibility of higher returns, there is also the potential for higher losses, reflected in the wider dispersion of returns."

U.S. Lower Middle Market Opportunities (Abbott Capital)

Is it possible to detect the current economic regime in real-time and use that information to predict returns?

"Knowing where we stand today in terms of the prevalent economic regime is important information for the investment process. Often, we discover we were in a regime well after the fact. The classic example of this is the NBER’s dating of recessions, where it is sometimes the case that the beginning date of the recession is declared after the recession is over. Many have tried to overcome this issue using various types of rules. For example, the Sahm rule gives us early identification of recessions (historically only three months late) but is based on a single variable. It is risky using a single variable because it is subject to false signals (as evidenced by the false positive in 2024)."

Regimes (Man Group)

Do real assets actually provide diversification and hedge inflation risk?

"Real assets merit consideration for inclusion in a balanced portfolio of stocks and bonds due to a “trinity” of characteristics: diversification, return enhancement, and inflation hedging. However, no single real asset embodies all these virtues."

Real Assets, Inflation & Portfolio Performance (PGIM)

How strong are the parallels between the current AI boom and the Dot-Com bubble?

"The current economic and technological landscape differs from that of the dot-com years, but the same risks still loom large. To capitalize on the upside without being blindsided by the downside, investors must position themselves with an eye towards the narrative’s potential vulnerabilities, and for that, the lessons of the dot-com are instructive."

The AI Boom vs. the Dot-Com Bubble: Have We Seen This Movie Before? (Research Affiliates)

Are critiques of NAV Loans warranted or are they just the next logical evolution of private market financing?

"For all the controversy about NAV Loans, the reality is they are just another liquidity tool – one that gives private equity managers more flexibility and efficiency in how they manage their portfolios. We believe that new, innovative financing structures are not inherently bad; if anything, they are additive to the market, giving GPs an extended toolkit to manage investments in a thoughtful and controlled way."

NAV or Never (Felicitas Global Partners)

How have alternative property types impacted commercial real estate (CRE)?

"Since 2000, alternatives’ share of total allocations increased from less than 10% to more than 30% among the basket of real estate investment trusts that make up the FTSE NAREIT Composite REIT Index. Although shifting at a slower pace, private markets, as represented by the NPI, have increased their allocations to alternatives from minimal in 2010 to approximately 10% in 2024. These allocations are likely to continue increasing as managers reposition funds away from the office sector and toward sectors and subsectors that have the potential to generate higher levels of income growth. Additionally, it’s important to note that private markets allocations to alternatives could be larger than the data suggests as nomenclature and subtype categorizations catch up with market realities."

Advancing real estate portfolio construction expansion into alternative asset classes (Manulife)

How does spending shortfall risk impact a household's ability to invest in private assets?

"We found that households with greater than $1 million in financial assets generally have a lower risk of liquidity shortfall during most recession scenarios. For investors concerned about worst-case tail events, such as the 2008 financial crisis or a personal crisis, $2 million in financial assets may be an appropriate threshold for introducing allocations to private assets. Those with $1 million or less in assets were at a high risk of a shortfall in almost all scenarios."

Evaluating the impacts of illiquidity on portfolios allocating to private assets (Fidelity)