Reordering radishes

Make space for the future – and catch up on the past

I have been trading lettuces for radishes, having a glut of one and none of the latter in my greenhouse. I have been so single-minded in the last few months, continuing to seed what had been growing well, that I ran out of space for anything else in my planters. There is some variety, from romaine to lamb’s lettuce and little gem to rocket, but it is still all lettuce. And for a change I now crave some sharp crunchy radishes.

Now transpose lettuces for fund iteration [5/6/7…] of an established buyout brand, and my lack of available planters for overallocation. I may have a somewhat diversified portfolio but that does not make for a balanced or satisfying diet.

Research is plentiful by now demonstrating how diversification is key to investment performance. Yet still seasoned investors seem to fall foul of this maxim all too regularly, shunning new commitments for long periods of time citing overallocation issues. Of course allocation targets are set precisely to enforce diversification between asset classes, but if their application results in stale portfolios they are not working toward their goal.
But just because one happens to have too much of one thing does not make it without value. In fact, my neighbour delights in the trade, and I now have space to seed my own diversified vegetables to harvest in the next few weeks. A true win-win.

A few years ago, the excuse of illiquidity in alternative assets was understandable. Once committed, capital was engaged for at least ten years, the official lifespan of the majority of funds, more often ending up at well over twelve years and in many cases much more. But the widespread use of secondary transactions makes this argument moot. Selling a portfolio or commitment is feasible at all sizes and stages of a fund’s life, with competition for assets from a multitude of potential buyers translating to levels of discounts that are not prohibitive.

With unprecedented levels of capital raised into secondary funds, waiting to be deployed, is it not time for investors to take a pro-active approach to managing their alternatives portfolio, in the same way we expect underlying fund managers to build and manage a portfolio of deals? Why not take this attitude one level up and trade in an out of fund positions more actively?

A large portion of the commitments made since 2020, at ever increasing sizes and pace to re-up with existing managers, are still uninvested. According to data from Pitchbook, an overhang of over $1.4tn has built up since 2020, of which 78% is stuck in funds over $1bn. The latter are still sitting on over 50% of the capital raised in 2020 and 2021 alone. Selling even a portion of these commitments would free up capital to gain exposure to current vintages while satisfying target allocation constraints.

Key to such trade is the ability to redeploy the freed-up capital efficiently, and today investors are spoilt for choice with funds in the market raising capital. We have made the point previously that emerging managers tend to outperform longer established teams, as demonstrated repeatedly in research from leading data providers. Agreed, this outperformance comes with greater risk, but there should be a space for it in a well-diversified portfolio.

Committing to new funds now would not only address the future, but equalise exposure to recent vintages as many smaller, nimbler emerging managers have been investing actively in the last 24 months yet are still open to new commitments due to extended fundraising times. In the meantime, they have also built a full pipeline of opportunities that are actionable as soon as enough capital can be secured. This is their reason for existing, and they do not have the luxury of being able to fall back on existing fee streams: they are motivated to do deals and will put any capital raised to work quickly, ensuring a constant seeding of opportunities to mature over the years to come.