The Paper Trail: Worth the Wait

Growing up in the Midwest teaches you to appreciate summer. After seemingly endless months of gray skies and icy roads, we are rewarded with our annual reminder of why we put up with these brutal winters in the first place. July came and went in a flash, with a few family trips to Michigan and Wisconsin, birthday celebrations for my daughter and me (41 this year - nothing special about the number other than being my favorite Dave Matthews Band song), some memorable meals, and plenty of outdoor time.. 

As fleeting as it is, summertime Chi is always worth the wait.

Speaking of "worth the wait," much of my own writing over the past month for Cliffwater has centered on private real estate, an asset class where patience has become an increasingly valuable trait. And before anyone gives me grief for featuring two of my own papers this month, remember: my blog, my rules.

Fortunately, there was no shortage of excellent research (in addition to my own) to highlight this month. Topics featured in July's edition of The Paper Trail include:

• Seasoned primaries in private real estate
• Private real estate's growing secondary market
• Analyzing AI defensibility for PE-backed software companies
• The impact of discounts on secondary returns
• Private credit's varied landscape
• Mega-cap tech's metamorphosis
• Index membership flip-flops
• Regulatory complexity in merger arbitrage
• Building a better portfolio hedge
• Independent sponsors in private equity
• The next phase of AI investing
• Venture capital's role in a portfolio
• Commodities as more than just an inflation hedge
• The business of sports

Enjoy the reading, and have a great rest of the summer!

Can seasoned primaries reduce the timing risk of investing in private real estate today?

"The broader real estate recovery also remains difficult to time. Seasoned primaries can make that timing less important. Investors are not relying solely on near-term appreciation. They also benefit from entering a partially invested portfolio, reducing the drag associated with a lengthy deployment period, and partnering with experienced managers after much of the early work has already been completed. That creates the potential to generate attractive returns even if real estate values remain range-bound for a period. If property markets recover more quickly, investors retain meaningful participation in that upside."

Worth the Wait: The Case for Seasoned Primaries in Private Real Estate (Cliffwater)

Do real estate secondary discounts reflect weak properties or liquidity-starved owners?

"The seller may need liquidity. The fund may be nearing the end of its life. An investor may be overallocated to real estate. A manager may believe additional value can be created through a longer hold period. In each case, the transaction is driven primarily by ownership considerations rather than asset impairment."

A Second Look at Real Estate (Cliffwater)

Can secondary buyers quantify a PE-backed software company's vulnerability to AI?

"Segmenting the dataset by AI defensibility score reveals a clear pattern: companies with lower structural resilience have experienced a far steeper decline in revenue growth, suggesting that AI disruption is already exerting a differentiated impact on fundamentals. The valuation data reinforces this, with GP marks appearing to embed a meaningful premium for more defensible businesses, implying that AI risk is at least partially reflected in current portfolio valuations."

 
Analysing the performance of software companies and their exposure to AI disruption (Clipway)

How much of a secondary investment’s return actually comes from the discount?

"While the impact of the discount is meaningful for the overall return outcome, most of the return is still being generated by the appreciation of the underlying portfolio companies and not the discount. Chart 3 shows the impact of discount levels between 0% (often called ‘par’ pricing) and 10.0% on the return of a secondary transaction that otherwise generates a 1.60x MOIC and 16.9% IRR at par, i.e., through value appreciation only. While discounts can enhance returns, the underlying value appreciation of the portfolio companies still typically represents the key performance driver."

Decoding Secondary Returns: Practical Implications for Investors (Abbott Capital)

What gets missed when investors treat private credit as a monolithic asset class?

"Whilst valuation quality, concentration risks and liquidity are important, the industry has done a poor job of distinguishing between its many segments in ways that can be meaningful for investors. This risks overstating challenges in some areas and overlooking resilience in others."

Private Credit is Not One Market (PGIM)

Does the AI buildout threaten the business model that made mega-cap technology companies so valuable?

"The combined capital expenditures projected for 2026 represent approximately a 200% increase over 2024. Furthermore, 2026 will almost certainly not be the peak, since all these firms expect an even higher level of spending in 2027. If the Morgan Stanley figures materialize, the 2027 year-over-year spending expansion will approach 50%. This is problematic, since the capital expenditures already consume most of the combined operating cash flow generated by these companies."

Under the Hood Revived: What’s In Your Index? The Metamorphosis of the Mega-cap IT Company Business Model (Horizon Kinetics)

Does index reconstitution cause investors to buy yesterday’s winners and sell tomorrow’s recoveries?

"Most of the time, this process works reasonably well. Many successful companies remain successful for decades. But many do not. An analysis of flip-flops suggests that markets are noisier and their leadership less durable than cap-weighted indexing assumes. Added companies frequently struggle afterward, while many deletions later recover. The same price movements that drive index inclusion and expulsion can also amplify the risk of buying high and selling low."

Flip-Flops: When Index Membership Doesn’t Last (Research Affiliates)

Is growing regulatory complexity creating a measurable premium in merger arbitrage?

"Since 2021, median spreads for complex deals have increased by approximately 250 basis points (within the 100-to-220-day window) compared to the period from 2016–2020 due in part to higher interest rates but also because of the more complex regulatory environment. At the same time, the range between the 25th and 75th percentile spreads increased by 50%, indicating substantially greater variation in how investors price regulatory and deal-specific risks. We believe these wider spreads and higher levels of dispersion reflect the increasing regulatory complexity in merger outcomes."

Merger Arbitrage: Opportunity in Regulatory Complexity (Davidson Kempner)

Why does an effective risk-mitigation program require more than one type of hedge?

"There are many important design choices to consider when constructing and implementing protective portfolio exposures. The challenge allocators face when incorporating risk mitigating strategies is that they categorically deliver low expected returns in benign environments. This is why allocators should combine risk mitigation strategies (RMS), with procyclical portfolio exposures like equities. Doing so should meaningfully improve total portfolio compounded returns."

The Perfect Hedge (One River Asset Management)

Can independent sponsors unlock opportunities traditional private equity firms overlook?

"Overall, our findings have important implications for investors allocating capital to the lower middle-market and for understanding the evolving structure of private equity. Independent sponsors appear to represent a differentiated channel for accessing less intermediated deal flow while delivering attractive risk adjusted returns comparable to, and often exceeding, those of traditional buyout strategies. While the IS model entails greater heterogeneity, investment-level complexity, and reliance on sponsor quality, these same features may underpin its return potential."

Independent Sponsors: Investment Characteristics and Performance (Institute for Private Capital)

Which bottleneck could define the next phase of AI investing?

"Early in the cycle, scarcity centered on training compute and raw GPU capacity. That is no longer the full story. As AI deployment scales, the tighter constraints are becoming more physical. Data center infrastructure, memory, and advanced packaging remain important, but power is emerging as the clearest hurdle. Reliable electricity, cooling, transmission, and the ability to bring new capacity online increasingly matter as much as access to chips."

VantagePoint: Artificial Intelligence Investing After the First Wave (Cambridge Associates)

What diversification benefits does venture capital bring to a portfolio?

"The point is not that venture investments are inherently superior, but that they provide exposure to earlier-stage technological and business model inflection points that traditional public portfolios typically access only later, once a substantial portion of the value creation has already occurred. In institutional portfolio terms, venture thus introduces exposure to return sources that are not simply “equity beta plus leverage”."

Venture Capital: From the Strategic Case to Portfolio Execution (LGT Capital Partners)

Are commodities becoming more than just an inflation hedge?

"Looking ahead, these structural forces suggest that commodity demand may increasingly be influenced not only by traditional cyclical drivers such as industrial production or construction activity, but also by longer-term technological, geopolitical, and energy-related trends. As electrification, renewable energy deployment, and digital infrastructure continue to expand, metals such as silver, copper, and lithium may experience sustained demand growth tied to the global transition toward cleaner energy systems."

Commodities: An Overview of the Asset Class (Marquette Associates)

Are the most compelling sports investments happening behind the scenes rather than on the field?

"The real investable story in sports is not game-day performance, but the contracted, diversified cash flows that power the game. Professional sports have evolved into a capital-intensive industry supported by long-dated contracts, scarce assets, and loyal, engaged audiences. Stadiums have become multi-use infrastructure platforms engineered to generate revenue 365 days a year, while clubs, teams, and leagues increasingly resemble regulated operating businesses monetizing one of the last forms of truly live media."

Beyond the Pitch: Private Capital Funds Sports Infrastructure and Operations (MetLife Investment Management)