Show V/O:
This is Alternative Allocations by Franklin Templeton, a monthly podcast where we share practical, relatable advice and discuss new investment ideas with leaders in the field. Please subscribe on Apple, Spotify, or wherever you get your podcast to make sure you don't miss an episode. Here is your host, Tony Davidow.
Tony Davidow:
Welcome to the latest episode of the Alternative Allocations podcast series. I'm thrilled to be joined today by Michael Bell from Meketa. Welcome, Michael.
Michael Bell:
Thanks for having me here, Tony. I really appreciate it.
Tony Davidow:
So Michael, we've been having this discussion a while and we're really excited about infrastructure, which is an area that we've started to provide some research on.
You guys have been doing a lot of work on it. Maybe if you can start by giving us a little bit of your background and what you've been doing at Meketa, and then we'll delve in a little bit more on infrastructure and maybe some of the lessons learned from the institutional marketplace.
Michael Bell:
Sure. What we have done over the last three plus years, and you know this industry from the whole democratization trend in alternatives to begin with, starting five, six, seven years ago, the evolution of that has really gone through product proliferation to education. And now we're seeing movement into execution of that. And so what we've done at Meketa, we have looked at migrating the best of the institutional process and really bringing that into the wealth management space.
And so whether it's product development, whether it's manager review and selection process or asset allocation and bringing educational materials from the Meketa institutional business into wealth management. So, it's really been that dynamic shift to help drive that market and help expand the market. So, what we've seen as a nascent market three, four, five years ago that we viewed was an educated bet of the expansion and democratization trend has really become much more mainstream over the last several years or so.
We've seen that mainstream shift really embed from an embrace of education, which has been proliferated, for example, with books in the marketplace and educational materials in the marketplace, which you've been a huge proponent of that, Tony, which I think is the foundation of the expansion of this market. Now we're seeing that shift that advisors and the wealth space has embraced that education. They've learned the new product types that are out there.
They've learned the benefits of those product types, the limitations of some of those products. And now they're executing.
It's not so much what's out there anymore. It is how do we execute on that. And so I've been the lead proponent in the Meketa organization to drive adoption into the wealth management space.
So Meketa has been around for coming up on 50 years in the institutional space, primarily servicing endowments, foundations, pension plans and the like. And we're now taking that expertise that we've developed in private markets, in public markets, packaging that and using those resources to go into the wealth management space. And that's really what I've done for Meketa over the last three plus years.
Tony Davidow:
And it's great because I think you and I have been doing this for a long time. And I think often when we introduce new things, we try to leverage what are the great lessons learned from institutions. And because Meketa's DNA is really in the institutional marketplace, I think there's that natural sort of lens that you can look through, understand what's different and unique about the wealth channel and package and bring those solutions.
I did want to drill down on infrastructure because, again, that is something that I think is relatively new to the wealth channel. And I think oftentimes advisors think of infrastructure as maybe building bridges, tunnels, roads, as opposed to the way that you and I might think of infrastructure. So maybe if we can just start there, what is infrastructure? How do you define it? And then maybe I'll get into some of the research that you've done. I know you've published a number of papers on it, which I thought were really, really well done and really enlightened how we maybe should think of infrastructure as something a little bit different than the traditional sort of source.
Michael Bell:
Sure. Infrastructure, as we view it, they're durable assets that really are the underpinning that drive our economy. They have a different characteristic around them in which a lot of the revenues underlying some of those assets are contracted revenues. So it's something that you don't see in the wealth management channel.
You traditionally haven't had access to. But now, whether it's institutions or sovereign wealth funds, they've been the traditional capital sources for infrastructure investments for the last 30 years. Now it's opening up for wealth management, retail investors, really for the first time.
So those durable assets with contracted revenues, where we've seen some of the most significant growth in infrastructure assets being made available in the wealth space has really been through energy transition assets, which are maybe a quarter to a third of what we're seeing come through the pipeline. We've also seen the whole development of data centers and AI, and that theme has really driven the adoption and need for capital in infrastructure. And then finally, the other driver has been the democratization of the asset class.
So a new channel, okay, that's opening up. And so those are some of the themes that we've seen across what we look at as infrastructure assets and opening up that space.
Tony Davidow:
And I think the AI data center is certainly the one that gets a lot of attention in the media. We've published a paper on it. I know you've published a couple of them, and I think you start to drill down and understand all the way that that impacts the larger ecosystem.
We talk about data centers and the growth there. And then when we start to think about this investment in infrastructure, it could be equity, it could be data, it can be various different forms. But if that is a growing source of opportunities, and I think a lot of advisors and investors recognize that, they can now invest in it and they can actually participate in it.
And again, as you mentioned, these are relatively new investments for the wealth channel.
Michael Bell:
Absolutely. And that trend is overtaking the overall investment arena is digitization of our economy. And the underpinnings of that, whether it's energy, energy transition, energy infrastructure that's needed to support that, data centers that's needed to support that. And we have seen in a very short period of time, the massive amount of capital that's needed to support that growth.
This transition to this next leg of the evolution of business in digitization is going to need a massive amount of capital. So, we're seeing a quarter to a third of the new deals come through that are really in decarbonization or energy transition. About the same amount, a quarter to a third of the assets and the deals are coming through are in the digitization realm. So, two huge trends that I don't see abating anytime in the next decade and it’s a massive need for capital.
Tony Davidow:
And we're a hundred percent aligned on that. We think these massive trends that will transform the way that we think about, and we think of the same sort of opportunities that digitalization and energy, clearly one of the big ones, decarbonization. Again, that's a global phenomenon as we have to think about that.
Demographics, people are consuming things differently and we need to think about that. And of course, we can think about changes in the supply chain and how that will ultimately play out over an extended period of time. So, the case for infrastructure is really, really exciting.
And I think a lot of advisors are waking up to that. Maybe again, going back to the way institutions think about this, there's a lot of different roles that we can think about for infrastructure. So, if you're an advisor sitting out there and you're saying, yeah, this is a great opportunity. I want to think about playing it. How do institutions think about using these tools and portfolios, specifically what roles do they play?
Michael Bell:
Infrastructure is an interesting asset class in which it spans an income yield component, but also a growth component. And it's really where you invest along that segment, whether it's a greenfield early-stage infrastructure investment in which the capital is going to be resourced back into the investment. So it's going to be more of a growth-like investment.
So, infrastructure can really be viewed as almost an equity investment with bond-like features. And so you have that strong growth component based on where you are in the development cycle of that investment. And then once it matures, it really becomes much more of a yield investment vehicle.
But the difference in that yield, it's not highly susceptible to inflation or rates. It's very much protected because most of the revenues that are generated off of infrastructure investments are contracted revenues. And you will see that in many of the investments that we view, for example, that you get 100% of your revenues or 80% of your revenues that are contracted revenues.
Those contracted revenues are not short-term contracts. These are 10- and 20- and 30-year contracts with inflation hedges built in. So, a very different type of revenue stream, a very different type of asset class, again, combining the best of a growth asset in an incredibly dynamic and growing industry right now, the vast need for capital and infrastructure. So, you need that growth component, but it also has a yield component, an income component that is contracted or regulated yield, if you will. So, something that most retail investors haven't had access to previously.
Tony Davidow:
So, I get growth, I get income, I get inflation hedging, and I also get defense because it has historically had low to negative correlation to traditional investments. Kind of a perfect tool in today's market environment.
Michael Bell:
Absolutely. And one of the only limitations to that hasn't been in a package or a structure that the Wealth Management Channel retail investors could get access to previously. But now really for the first time over the last three, four, five years, that has started to proliferate in new fund structures, in new vehicles that are now being made available for the first time.
Tony Davidow:
I want to go back on something you said. And you and I could have this conversation and we'd skip over some of the things that are really important for folks who may be listening for the first time to a discussion about infrastructure and that, as you mentioned, “Greenfield”. Can you describe the difference between Greenfield versus Brownfield?
Michael Bell:
A Greenfield investment is a brand new build from scratch. It is a new data center that is, you buy the land, you develop the land, you put the infrastructure in, you build the center, you bring the energy that you need to that center. That takes a tremendous amount of capital and investment to do that.
That's not going to throw off a yield for some period of time after the initial investment period, which may be five or six or seven years or up to a decade. A Greenfield operation may also be a cell tower in which it is a build from scratch cell tower. You're putting it up for the first time. You're putting your first cells on that tower. Massive amount of infrastructure to build out that entire network to actually work.
As you mature through that cycle, they become assets that do throw off yield. Cell tower, for example, after it's up and operational, you've invested the initial capital that you need in that to make that whole structure work. Then you add additional cells to that tower and that creates additional yield.
So you have the initial growth with that asset class in the Greenfield operation. And then once it becomes more mature and it's a brownfield structure, you get more yield running off of that.
Tony Davidow:
And they both have different risk return and income characteristics. So I think it's important for advisors when they hear this terminology to understand there are different stages of development. Michael, I know one of the things that you talk about in your paper, which I definitely talk to a lot of advisors about, and that is the difference between private and public infrastructure.
You've heard me say this before. I tend to look at the public equivalence as being more equity beta surrogates and the private more of a pure play. But you could make the argument that there's a role for both private and public.
Maybe just talk a little bit about that.
Michael Bell:
Sure. And I think you define it perfectly. In the public arena, you are investing in the equity of energy companies, for example. In the private arena, you're investing in the assets of those same companies. So investing in the equity versus investing in the underlying assets. A different return characteristic, a different profile, a different volatility characteristic. So when you're investing in the publics, obviously you have public-like volatility associated with those assets because those are public companies that have to report on a quarterly basis or maybe going to semiannual at some point. But they have a reporting obligation. They have the volatility built into that.
When you're investing in the underlying assets, obviously you don't have that same volatility. That's the most fundamental difference. Now, there is opportunity to incorporate both publics and privates into an overall portfolio for different reasons and different kind of risk return profiles.
Tony Davidow:
So there's a number of things that are unique about private. And thank you for starting that discussion. We certainly think of them as being somewhat quasi-monopolistic.
It's a handful of players because they're large projects, very expensive, and there's a handful of players that are really dominant there. Because they are illiquid in nature, we tend to view them as long-term investments, much like we do with all of our private market allocations. Think of them as 10-year investments and don't get in today and expect to have that long-term outperformance if you're trying to get out of it tomorrow or the next day.
But maybe just drill a little bit down on that. What is unique about that private infrastructure investment? I mean, how it's done. And again, as we think about this massive transformation that will be going on over the next couple of years, what should advisors expect when they're making that allocation in their portfolios?
Michael Bell:
So, any allocation to any private market asset, whether it's private equity, whether it's private credit, whether it's infrastructure, or whether it's real estate, it all should be viewed as a long-term allocation. Even though most of the structures are described as semi-liquid.
Tony Davidow:
You know I hate that term.
Michael Bell:
I know. They shouldn't be described as semi-liquid, okay? They are long-term investments. They have some regulated liquidity features in them, but it's not something that you get into and out of. Generally, the wealth management channel has now been educated over the last couple of years to, if they're going to dive in and incorporate privates into their portfolio, they're going to be making that allocation, and it should be with long-term assets. And if it's a 15% allocation across the board, or 20%, or 25%, or whatever that may be, that should be your long-term money.
You may rebalance or slightly tweak over time, but it should be something that from your capital stack, your capital need from an individual, that should be at the very bottom. So looking at it as a decade-long investment is precisely how we educate, and I think the entire industry should be educated on these assets.
Tony Davidow:
Yeah. I hate the term semi-liquid because I think it gives the wrong inference. They're clearly long-term investments. That's where you get the illiquidity premium that we all talk about all the time. But they have liquidity provisions for if there's a change of circumstances and there's a mechanism to get out. But I think positioning them as a long-term investment is absolutely important.
I did want to talk about something that I certainly get a lot of questions about, whether it's for infrastructure or any private market investments, and that's due diligence and how to evaluate the strategies. And again, your long-term institutional lens, I think, is very helpful here. What are some of the things advisors should look at?
Because all of these things will sound the same, and many of the strategies describe their edge in the marketplace in a very similar sort of fashion. But there are unique sort of things that we should be looking at when we do due diligence and we're evaluating a fund or a structure.
Michael Bell:
I think you're hitting the primary issue in the industry. That is manager selection. Manager selection matters.
In the private market space, there are 20,000 reporting private managers out there with 60,000 funds that are out there. Many of them are looking at how to appeal to and introduce their products into the wealth management channel. That is a ton of firms and products that are out there.
So how do you pick and choose and understand and do the diligence with all those firms? If you look at a corollary in the public market space, over the course of 50 years, there have been developed a lot of data sources and resources, whether it's Morningstar or Bloomberg. But you can go and find a lot of research on public market vehicles, whether it's mutual funds or ETFs or stocks and bonds.
In the private markets arena, that has not yet developed, except for the providers that have been in that space for decades. OK, that's one thing that we have done at Meketa. We've been covering off the private market space for 30 plus years.
We look at and review, of that pool of 20,000 private market managers, we review about 1,000 managers a year. Do deep dive diligence on those 1,000 managers a year, understanding the characteristics of those managers, where they generate their returns from. We know what their strike zone is, because we have a massive database that we have created over 30 years to develop that.
That's not available to the investing public, if you will, or most wealth managers. So, if I look at this, this is a new mountain to climb. It's not unchartered territory. But you would be well-served to have a sherpa lead you through that. You wouldn't approach Mount Everest. And it's doable. It's not the first time it's been done. But you wouldn't do it alone.
So until this market matures, until there are the data resources that are out there, the databases that start to proliferate, that give advisors the tool set to be able to fully understand where returns are generated, how they're generated, the managers and the personnel that's actually delivered that performance, what their strike zone is, how they've done it. Until that's happened over time, I think most wealth managers are best served by utilizing teams that have been there, that have done that, that can really help them understand manager selections, as well as allocations of investment vehicles.
When you look at manager selection, one of the profiles that jumps out to me the most. If you spend time in the public space and, say, large cap equity, the manager dispersion between top quartile manager and bottom quartile manager may be 2% or 3%. You want to get your top performing managers. But if you miss and you get a bottom performing manager, it's not going to be a disaster. In the private equity space, for example, the difference between a top quartile manager and a bottom quartile manager is not 2% or 3%. It's 15%.
Tony Davidow:
Or more.
Michael Bell:
Or more. And so you guess wrong. That's a long-term miss. As we talked about, these are long-term investments. This is not something that you can unwind over the next three or four months. It may be something that takes a decade to unwind.
So anyway, manager selection is probably the most important dynamic of investing in a private space.
Tony Davidow:
We certainly recommend leveraging whatever resources are available, you know, and for a lot of the advisors, their headquarters is doing some level of due diligence. And we try to provide some comfort that that's not just looking at numbers on a piece of paper. That's really going through a pretty exhaustive process and understand what's going on.
There are certainly third-party providers in the marketplace who do that. But I also try to bring them back to something that's more familiar, which is think about the four P's when we think about doing due diligence on traditional investments: the people, the process, the philosophy, and the performance.
And I would argue it's more important in the private markets than the public markets in some sense, and people in particular, because you want seasoned players who've been doing this for decades and decades. You talked about the dispersion of return, and I like to use the same sort of chart. And the reality is with the public markets, when you look at it, not only is the dispersion of return very narrow, which means finding the best and missing out on the best isn't that big, often you find the best become the bottom. There's that natural rotation that goes on.
What we find in the private markets, though, is we do find more persistence of the top remaining the top. So again, identifying those best managers based on what they've done over decades and decades, allocating capital with them is a little bit of a more known sort of bet as opposed to somebody who might be newer to the space, and maybe they're coming to the space because there's a lot of money there.
So it is daunting for advisors. We always say, don't go on this journey on your own. Leverage headquarters, third party, leverage the asset managers.
Ask them the really tough questions about who do they see in the space? Who are the best managers? What's your edge in the marketplace?
But I think you're 100% right that once you get past the intellectual discussion, which is relatively easy when you look at the data, the daunting process becomes, well, how do I select the best ones?
Michael Bell:
There's a reason that I think some of that performance persistence that you referenced is there. And there's a reason for the difference in the public space. In the public environment, there's not as much of an information arbitrage because information is readily available and the information readily flows. It's available. It's required to flow every quarter from companies. Some managers maybe have a different take on a company. And so they have outperformance for some period of time, but then that doesn't persist.
In the private arena, that information is more opaque. OK, one of the things that we're trying to do, I think all of us in the industry, is pull back the curtain and make it less opaque. But there'll be some period of time where there is a significant information arbitrage in the private market space. And those managers that have the recipe dialed in, they have done that for years and sometimes decades. And there is a likelihood that they continue to have that advantage until there's more infrastructure built up around the space and more information flowing from that. So, there's a reason for that persistence.
Tony Davidow:
Michael, I'm going to get out of here on this last question. And I think you're uniquely suited to help us think this through. So we know institutions have been allocating 30%, 40%, 50% to alternatives for decades and decades, and partly because they've had a good experience. They've got a network that they've been working with. And we know in the wealth channel, that number has been 5% to 6% broadly, maybe 3% to private markets. And I think you've teased a little bit about this already.
But how do you think we get from, let's say, 5% to 10% to 20%? Because we know at that 20% level, we're starting to change the complexion of the underlying portfolio. We're getting different risk and return and income sort of characteristics.
How do we get there as an industry?
Michael Bell:
I think the best corollary to maybe look at is viewing it through a lens of where we were from a new segment of the industry 20 years ago in ETFs, for example. That 20 years ago, they may have been $300 or $400 billion of AUM. And now they're $13, $14, $15 trillion of AUM. That's happened over 20 years. It didn't happen overnight. It happened over 20 years.
It happened with education first, and then a level of comfort, and a knowledge base, and an infrastructure that's been built up around that industry. I think you'll see the same thing in the private markets industry. You're seeing that education proliferate with some high, high-quality stuff that's been put out that really help advisors understand what we're doing.
Now, once they understand what we're doing, they get comfortable with it. They can then explain that to their clients. Their clients get comfortable with it. As long as we continue to have quality providers, quality managers in the space, quality products in the space, you will continue to see that grow. We're seeing this shift from education to execution. So right now, we're starting to see that 2% and 3% grow to 4% and 5%.
But we're of the same view, Tony. We see that 2% to 3% going to 20% to 25%. That's a tenfold increase over the next decade or 15 years or so. But I think it's led and driven by education and quality providers in the industry.
Tony Davidow:
And we agree 100%. It is a journey, and it's important to do it the right way, lead with education. Michael, you've been a terrific guest today.
Thank you so much for sharing your insights, your experience. We'll have to revisit this in the not-so-distant future and have you back. As we always do, we encourage all of our listeners to rate us, tell us what sort of areas you'd like us to cover in the future. Michael Bell from Meketa, thank you so much. We'll do this again.
Michael Bell:
Thanks for having me, Tony. Appreciate it.
Show V/O:
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