Please enjoy J. Womack's blog post. --- JDA
As a child of the 1980s, I can vividly recall the jingle “Like Mike, if I could be like Mike.” It could be heard from many people, young and old. What did it mean to be “like Mike?” Michael Jordan, tongue out, sailing through the air, was the epitome of basketball talent. If you hummed the jingle, you were in some way saying “I want to achieve excellence.” No matter what you wanted to do, wanting to be like Mike meant wanting to deliver results that stood out among all others.
David Swensen, who developed and then popularized the “Endowment Model” for investing, was similar to Michael Jordan in the investment community. His investment results spoke for themselves and spawned a movement among investment professionals seeking to mimic his performance. While he was a talented investor, he benefited from capital markets that were themselves evolving and creating new opportunities.
Capital markets have changed
In 2018, the CFA Institute published the paper “Capital Formation: The Evolving Role of Public and Private Markets,”1 an interesting read that discusses how markets have changed over time. Its commentary on recent history outlines the impact that private capital markets and other changes have had on how companies choose to fund their growth. The paper points to research published by Ewens and Farre-Mensa2, which indicates that the number of publicly listed firms peaked in 1996 and has since declined. A key driver of this shift is an increase in the availability of capital for private investment, itself driven by the move among institutional and high-net-worth investors to seek returns in alternative asset classes. The growth in private capital has affected not just equity investments, but other asset classes like debt, real estate, and infrastructure. In addition, private markets have undergone their own evolution as managers have specialized over time. The funds that we see now have evolved from general venture and buyout funds, to seed early and late stage venture, early and late stage growth equity, buyout, distressed, and so forth1.
In the United States, one of the major sources of capital for many of these specialized funds is the retirement savings of U.S. workers. Defined benefit (DB) plan sponsors, investing on behalf of both public and private workers, have been instrumental in the ongoing evolution of private capital markets.
The retirement landscape has changed — what about asset allocation?
Defined benefit retirement plans played a primary role in securing the retirement for a number of U.S. workers over time. In the 1980s and 1990s, defined contribution (DC) plans became a key component of employee benefits and the assets in those plans grew. By the late 1990s, DC plan assets had eclipsed those in DB plans3. This is important because it not only marked a shift in the type of plan U.S. workers relied on for retirement savings, but it also marked a significant risk transfer. In a DB plan, the sponsor bears the primary risks of inflation, longevity, etc. In a DC plan, the saver bears those risks. Given that defined benefit plans have delivered reliable retirement incomes for a number of U.S. workers, and that workers are now responsible for securing their retirement, what can we learn from how DB plans have invested that might be relevant for DC plan participants? More importantly, what does it mean for investments moving forward?
The Defined Contribution Institutional Investment Association published research4 that showed the prototypical asset allocations for DB plans and DC plans, and their respective returns over the period ranging from 1997 through 2011. There are some differences that stand out:
- DB plans have an average 3% allocation to private equity, while DC plans do not have an allocation
- DB plans have a 4% allocation to Real estate, REITS and other real assets, while DC plans do not have an allocation
The impact of these and other differences costs savers approximately 140 basis points in annualized performance over time. While this may seem insignificant, over a 30-year investment horizon it equates to approximately $5,175 more per $10,000 dollars invested5. That is a meaningful difference and represents a potential lost opportunity for savers. How can we in the financial services community help individual investors to address this gap?
The importance of advice in a changing investment landscape
There are a number of new technologies available for everyday investors to consider, as well as several regulations that have created opportunities and access to markets that traditionally were only available to institutions. Given the changed regulatory landscape, innovations like interval funds, and now auction funds, as well as technology marketplaces, are viable avenues that can broaden access to traditionally illiquid investments that, again, were reserved for institutions. These are positive changes that can benefit the wider investing public.
Therein lies a potential problem. With so much choice, and so many options, where do we invest? It’s easy to try to be “like Mike” (or actually more “like David” in this case), trying to deliver exceptional results that help our clients meet their goals. How can clients, and advisors, avoid the pitfalls and potentially capture the benefits?
For advisors, 3 things to keep in mind are:
- Aligning the right investment strategy with your clients’ goals – despite the additional investment options available to investors, it is important to align the liquidity profile of these investments with the time horizon of the goal they will fund
- Knowing what these investments will (and will not) do – illiquid investments, if suitable for the client, can deliver benefits to a portfolio if you understand their role and are able to select the right investment managers
- Caveat emptor – picking managers is risky business.With the growth in access comes growth in the number of providers. Knowing how to select the right manager to implement a particular strategy in these non-traditional markets, monitoring that manager, and holding them accountable is critically important.
For investors, the key is getting good advice. That can mean working with an advisor who understands the importance of co-planning and leverages a goals-based wealth management framework to align the right investment strategy to their clients’ goals, in a personalized way.
Investors face a lot of uncertainty and take on significant responsibility when it comes to saving for retirement. Capital markets have changed over time and, in combination with regulatory changes and innovation in investment vehicles, investors have expanded access to a range of options that were previously unavailable to them. This has the potential to help savers meet their long-term needs for retirement investment, but also comes with some risks. With expanded access and options, the importance of advice increases.
Here at SEI, we have been selecting managers for over three decades. We have provided multi-manager investment products across a range of both private and public markets. We all want to be “like Mike.” Thanks to changes in markets and regulations over time, there is an array of opportunities available today providing a number of avenues to do that. The key is to choose wisely.
1 CAPITAL FORMATION: THE EVOLVING ROLE OF PUBLIC AND PRIVATE MARKETS, https://www.cfainstitute.org/-/media/documents/article/position-paper/capital-formation.ashx, Sviatoslav Rosov, CFA
2 Ewens, M., & Farre-Mensa, J. (2018). The deregulation of the private equity markets and the decline in IPOs. Retrieved from https://finance.eller.arizona.edu/sites/default/files/ ewens_paper_10.26_0.pdf
3 The Shift from Defined Benefit to Defined Contribution Pension Plans - Implications for Asset Allocation and Risk Management, https://www.bis.org/publ/wgpapers/cgfs27broadbent3.pdf
5 Assumes $10,000 initial investment using simple compounding at a rate of 1.40% over a 30 year period. This is hypothetical, and past performance is not indicative of future performance.
Information provided by Independent Advisor Solutions by SEI, a strategic business unit of SEI Investments Company. The content is for educational purposes only and is not meant to provide investment advice or as a guarantee of any specific outcome. While SEI welcomes comments, SEI is not responsible for, and does not endorse, the opinions, advice, or recommendations posted by third parties. The opinions expressed in comments are the view(s) of the commenter(s), and do not represent the views of SEI or its affiliates. SEI reserves the right to remove any content posted by users of this site in its sole discretion.