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 Dana D’Auria of Envestnet. And Dana, you've got a really fascinating role. You're the chief investment officer of the solutions business and Envestnet’s a really fascinating company with a lot of growth going on, a lot of innovation. Maybe just share a little bit for our audience what you do on a day-to-day basis, and then we'll get into some specific areas of interest.
Dana D’Auria:
Yeah, happy to. And Tony, thank you so much for having me. It's great to be here.
My role at Envestnet is twofold. One, as chief investment officer, I get the great joy of working with all the investment people, being on the investment committee, the portfolio managers, the due diligence teams, et cetera. Envestnet is great as an ecosystem.
It's a financial services platform where we get to sit at the junction of 600-odd other asset managers, wealth managers, all the big independent insurance bank, broker, dealer wealth managers, big RIAs, our clients. So I get access to so much great information as it relates to investments and how people are thinking about investments. That's a fantastic position.
Then on the other side, I serve as the group president in the solutions department, which basically means running the business of the managed accounts platform, or TAMP, if you will.
Tony:
I know one of your big strategic initiatives over the last year has been focused on model portfolios. In my travels, it's something I hear about all the time, especially as we talk about private markets. It's pretty easy to understand the value of adding them in client portfolios, but the mechanics of it are more complicated than traditional asset classes because of some of the liquidity and other structural considerations.
Why are models so important to Envestnet? Maybe give us a little bit of a sense of how you think about the model construction process.
Dana:
Models are a crucial underlying element of how our managed accounts platform works. You can be a client of Envestnet and use us for data aggregation, performance reporting. You can use our SaaS tools, but the most sophisticated tools that we have for the advisory base is within the managed account chassis.
It's that turnkey asset management program. About $750 billion in assets sits on that program. And within that, a lot of that is a model framework.
When you talk about then adding alternatives to that model framework, you're essentially saying, look, I'm not only going to think about the context of this from an investment perspective and how these alternatives fit in an overall client allocation, but I'm going to think about, to your point, the mechanics of how I want to actually actuate that, how much of my time as an advisor I'm going to spend on actuating that versus kind of handing that off to an Envestnet to manage those aspects.
For example, things like windows in a lot of these vehicles, and then I'm focused more on the investment side or the client discipline side, the client engagement side. So, for us at Envestnet, it's really as a platform about figuring out how best to help the advisory and home office community use these types of instruments in a model context, and then actually, to your point, again, the mechanics, the implementation of that.
Tony:
I see so much value in that. Again, a lot of my discussions with advisors, they understand the merits of including private markets, but the how is very difficult. The other sort of element of that, of course, is having the due diligence to determine which are the right individual managers, and then ultimately, how do those managers fit together over time.
Maybe talk a little bit about how your team thinks about that.
Dana:
Sometimes I like to say PMC, which is sort of the investment arm underneath the solutions group, they are an investment management firm. We have our own model allocations within solutions as well. Sitting next to PMC, we have QRG, which is a quant group, create our own DI strategies, et cetera.
But the Envestnet platform is the biggest client of PMC, of QRG. As part of that, we provide all of the risk ratings. We provide asset class portfolios, capital market assumptions, et cetera, for use of the overall platform.
And as it relates to alternatives, and other instruments for that matter, also due diligence services. If you think about what we're building out, we just did announce that we're able to now have interval funds in a unified managed account, which is pretty differentiating, right? You've seen different announcements out there about various models.
Franklin Templeton has a great model on our platform that has interval funds. We have also opened it up so that an advisor building a model, they can either choose a model like a Franklin Templeton model, or they can build their own model and choose from a menu of interval funds to put into that model. It's completely open architecture.
Obviously, these funds have to get through operational due diligence, but then the advisor can kind of choose. What we're also adding on a layer is, do we have a list of qualitatively approved or quantitatively approved? I think we'll start with qualitatively interval funds that sort of pass muster where we are going to undertake due diligence for those funds on behalf of the advisors.
When the advisors are picking from that menu, they also have this layer of due diligence. They can choose one of those particular funds.
Tony:
It makes sense, right? You have flexibility for those who want somebody to make those decisions solely, or those who want to be the ones curating and putting it together on their own, but you're giving them a more efficient way of putting those together. I wanted to pick up on something that you and I were talking about beforehand, and you just mentioned interval funds.
I know for most of this audience, we've spent a lot of time talking about interval funds. We'll call them evergreen just from a nomenclature perspective, but the value that they've really provided and in many respects, they've helped democratize the access to the wealth channel because they can be scaled across practices. One of the things that I know you and I've talked about, and there's certainly a lot of discussion in the marketplace today, is understanding some of the structural trade-offs with evergreen funds, right?
First generation drawdown funds, long lockups only available to qualified purchasers and above, think of them as seven- to 10-year investments with very high minimums. All of a sudden, we have these new structures that are typically available accredited investor below, evergreen, meaning they're on your shelf all the time, 1099 tax reporting, quarterly liquidity provisions, but I would argue they're still illiquid investments. The underlying investment is illiquid, but the quarterly liquidity is there as a safety valve if there's a meaningful change of circumstances and all of that.
But there seems to be this tension in the marketplace of maybe not everyone fully embracing the fact that they're illiquid investments, but yet you want to have access to your funds. Talk a little bit about how you're tackling those sort of issues within your ecosystem.
Dana:
There's a few issues. You said it right. I think we're all sort of see the potential to bring these types of investments to the wealth community, the opportunity to maybe enhance returns or enhance diversification, go beyond what's been traditionally available, but there's also a huge educational challenge. And I would say the issues sit in large part under that.
One is liquidity. You said it great. These are illiquid investments, so they're called semi-liquid, but if you want your money out, they well could be illiquid, right? They go to proration.
Tony:
We hate the term semi-liquid because I think in many respects, we're actually fueling a problem because advisors think of them as being liquid like a mutual fund because that's what they're called.
Dana:
Five percent liquidity per quarter is sort of a meaningless number to the average person in that fund because it's all dependent on how many other people want how much more money out at that same time as you. Five percent a quarter could be more than enough to refund your entire investment. It could also be enough to get you not very much because the other investors in that fund want out at the same time.
Of course, it's in a dislocated market when you're going to want out. So if you are thinking in terms of, I'm going to hold these investments and then when it's time for me to sell, I can slowly draw it down, great. If you're thinking in terms of, well, if something goes badly, I can remove my dollars. Not so great. Not likely that you're going to get it out very quickly. It's probably going to go to proration.
So I think understanding the liquidity of these is obviously a big piece. Educating properly, making sure that the advisor base truly understands and then that they in turn can convey that to the client base. I also think in addition to the liquidity, valuation is becoming a serious consideration.
Not so much in interval funds because they value daily, but some of these other evergreen vehicles that are in the wealth space, these private BDCs, for example, where there's a lag there. It's not valued the way most wealth investors think about valuation. They think about valuation based on how all their public market equity and fixed income instruments operate, where the market decides the value.
These are not valued by the market. If you think there's impairment and you're waiting for the price, I guess, of the vehicle to reflect that, for example, is there impairment in these software holdings because of AI? This is an interesting open question.
The market in a publicly valued vehicle will reflect the latest, greatest thinking on that, the amalgamation of all the market participants. But a private vehicle, you have somebody valuing that based on what they think the value of those actual underlying holdings is. It's a very different structure.
It also lags. It gives rise to concerns around you can have a valuation today if you think that the fund manager is not reflecting the true value, or even if you think that the fund manager ultimately will have to mark it down at some point, right or wrong, you're incentivized to get out at the higher value, to try to get your dollars out at that higher NAV value before the markdowns happen. Some of these vehicles, there's education around liquidity for all of them, and some of them for valuation as well.
Tony:
Dana, you and I spent a lot of time thinking about this and talking about this, and both of our organizations, Envestnet and Franklin Templeton and so many others provide a lot of information to advisors. But I know when I travel around the country, people are always asking, where can I get more information? Where can I get better information? Where can I get the information about liquidity and valuation, so I can ask those questions in advance? What are some of the resources that you provide to advisors out there?
Dana:
I do think asset managers are actually a great resource. A lot of the big asset managers, Franklin Templeton case in point, have nice curriculums around this to teach you how to use these type, what are the differences in an interval fund versus a private BDC, right? I'm a proponent, and I think as you know of your book on this, I actually think it's a tremendous resource for advisors who just want to understand, why would I want to use these vehicles? How can I use these vehicles? What are the differences in the vehicles?
What are the different types of strategies that are available in those vehicles? So I'm a proponent and a fan, I will say. So asset manager resources, because I think there is actually a real tendency to give unbiased, just straightforward information about the asset class, because there's a recognition that you don't want people in these investments who don't really belong.
It's going to be problematic for everybody. So I genuinely think they're great resources. As you drill in, if you're looking at an individual holding, you have really got to look at that holding.
The asset manager community will provide you with an understanding of how these vehicles work. And by the way, you can get that other places too, right? A CAIA, for example.
I mean, if you really want to go down the path, a CAIA designation is a great way to get a third party understanding of how all these vehicles work. But as it relates to buying a particular fund, you really have to dig in on that fund. One thing I think has to be clear is that even if you know which type of vehicle, there are so many nuances with pricing, with fees, with how it may work in terms of liquidity and redemptions. Are there redemption fees? Some of these funds you think you can get in anytime. Some of them you actually can't. They're gated even for entry.
There's a lot of variation. And I do think you have to understand both the landscape of what's available, but then also when you've decided, you really have to dig in on that particular instrument and make sure you understand the nuances. And don't think, oh, well, it's an interval fund, so I know an interval fund is this, and therefore it must be. No.
Tony:
By the way, thank you for the plug for the book. That's precisely why I wrote it. I think I've shared with you and I've shared on this podcast, part of the reason I wrote it is I would inevitably walk off stage at speaking at a conference and I'd get a hundred questions on things that I didn't cover and I just felt there needed to be that comprehensive resource.
But I really like your comment too about leveraging the asset managers. And I would tell you that I know our team, when they're out in the field, they know what the competitive landscape is. So if somebody says they have a private credit fund, it may sound similar, but ask those questions and ask the questions of the asset managers.
What are the underlying holdings? How much leverage do they use? What is the fee structure? What is the experience that they may have in the marketplace? So we think growing up in this industry, like you and I have, we think of the four P's and I think the four P's still make sense. It's just, we need to dig a little bit deeper and then recognize some of the structural differences to ask different sorts of questions around liquidity and gating and all of that.
So leverage all of the resources at your disposal, but certainly those asset managers are well equipped to talk about what they offer, but maybe more importantly, what the competitive landscape looks like.
Dana:
A hundred percent. It actually bears repeating because what you said about how we grew up, I mean, most advisors are understanding how the standard mutual funds and ETFs and SMAs work, and there's standardization there. In and of itself, just recognizing that when you get into the alternative space, there might not be that standardization. There might be a label, this is a private BDC or a private REIT or a tender offer fund or an interval fund.
The label does not necessarily convey the same sort of standardization that you're accustomed to in the mutual fund space. You have to dig in and understand the liquidity provisions, fees, et cetera. I went through the list because that in and of itself is a difference.
Okay. I understand interval funds. I went through a curriculum. I get the drift. I'm going to buy XYZ interval fund and then it turns out there's some difference there.
Tony:
Big differences from one to the next. Dana, you and I started this year, we did an AssetTV masterclass, really talking about the opportunities in private markets.
And again, we're roughly midway through the year. We've gone through some volatility here. I'm curious if your views of the private markets have changed based on what has happened. And maybe for this audience, it would be worth sharing a little bit about where you see the most attractive opportunity, not for the next six months, but maybe for the next couple of years.
Dana:
My views haven't changed. I do think we have some work to do as an industry in communicating. And I thought that all along, I would just say my view on that has deepened.
It's the liquidity provisions, it's dispersion and return amongst managers. I think there has to be an understanding that, and we take this for granted, but I don't know how well understood this is in a retail client base, that the dispersion of return amongst managers in a particular alternative asset class, like private equity, tends to be much, much wider than in a public market asset class, like large cap or whatever. The liquidity, the dispersion and manager performance, and the need to really understand what you're getting and do the due diligence.
And then, as I said before, I think the valuation aspect is a real challenge that needs to be better communicated. I think in terms of a secondaries vehicle, for example, where something may be purchased at a discount, and then the fund benefits from an immediate bump in performance because it gets written up to the book value. This is not something people are accustomed to in terms of how return is conveyed or pricing of an instrument.
So I think there's all that education challenge remains. I haven't changed my view at all in terms of, we as an industry need to solve this. If your answer to these problems is, I just don't want to get into these vehicles, I think that's a little bit of a cop-out.
That's why we're here. That's why we get paid to do our jobs. It's to actually help advisors and clients alike to understand the pros, the cons, and make an informed decision.
It's not for us to say, this is too hard, so we won't go there. So I still have the view that I had. In terms of where I think it's most relevant, or maybe what I think is a good place to be, I don't think anything's bad or wrong.
I tend to think in wealth, it's hard to sell something like hedge funds, generally speaking, because even though they are diversifying, I've encountered the problem where if it's not beta, and it's not going to do as well as beta, and it's not providing income per se, right? It's a middle ground diversifier. I think advisors tend to struggle with getting the value of that across.
I may be a little bearish on that versus, say, private equity, where it's very straightforward. What is the goal set here? I'm getting access to companies that I can't get in the public market space. There's a potential for higher return. There's also risk of underperformance, but there's the potential there for higher return or private credit. There's a potential there for higher yield versus what I can get in the public market instruments that were available to me before.
When I think about how this disseminates out to a wealth audience, I tend to focus there. I also think real assets, it belies my comments a little bit before about that diversifier, but I think it's more of an understandable diversifier for a lot of folks, real assets. I think it's easier to understand how to harvest that maybe from the equity and fixed income piece.
That's what I would say about the main asset class.
Tony:
We're incredibly excited about the opportunities in private markets. I agree with you. I can't remember the last time anyone asked me about hedge fund strategies.
I think many advisors were burned with liquid alternatives, many of which didn't work well. Even though it's harder, it's worth the work to spend the time to understand how these unique strategies work. We all know what the long-term data tells us.
We all know that markets are more highly correlated today than ever before. The value of private markets is too much to pass over just because it requires a little bit more time and effort. I think it's part of the reason that we do the podcast series.
It's part of the reason that you guys have spent so much time and effort in building out your curriculum at conferences to make sure that these sort of topics are being discussed with advisors. I think at the end of the day, for an advisor to be relevant, you have to bring new and different things to your client. Otherwise, you can be commoditized and replaced by a robot.
I'd argue with the private markets as a way of enhancing your value proposition to your clients because it's unique, differentiated, and it does require some explaining to individual investors.
Dana:
When I hire an advisor, I'm looking for somebody who's going to give me access in a lot of ways to parts of the market I'm not going to be able to negotiate myself. It's hard in public markets. I mean, certainly the advent of passive investing has sort of made it clear. And we're proponents of both active and passive. But there's an element at this point of just the average person can buy an S&P 500 or an MSCI ACWI and call it a day.
I think the advisor's value proposition is around other areas, right? Financial planning, estate planning, keeping the client disciplined, but having that access and being that conduit with education and understanding that the client doesn't have time to, you know, they may have time to source an S&P 500 fund. They're not oftentimes going to be at all able to look across private equity vehicles and say, oh, which one of these should I be in?
That's the advisor's space.
Tony:
And I'll maybe just kind of turn it back to where we started our discussions with models, which is an advisor has so much they're responsible for and so many families that they're working with. If there's a way of scaling it, making more efficient so they can actually spend their time where they're adding value and leverage other people who can help in the development of models or sourcing a lot of that information for them, it seems to me that is a way of scaling their business, growing their business over the long run. And ultimately, I think serving their clients well, right?
You're accessing the expertise that exists in the marketplace.
Dana:
You know, in the model framework, when you think about Envestnet, we're trying to manage basically the administrative and trading tasks for that advisor so that they can, to your point, spend the time on the true higher value add services that they're providing. If I'm an advisor running accounts for hundreds of clients and I have hundreds of models, I want to outsource the rebalancing of that, the trading of that, the windows. So our capability to put interval funds, really the value add there is that the advisor is outsourcing to us managing those windows.
So if there's a rebalance and some of that interval fund needs to be sold, we will manage that window and selling it during that window. If you don't get the entire amount that you needed, we'll manage holding onto that order and looking again next quarter, that sort of thing. These are areas of tasks that we just think the advisor can be freed up from and focus on the more important task of talking to the client about what's going on in the market. Is this the right solution, et cetera?
Tony:
Dana, thank you so much for joining me today. I thought we covered a lot of ground, very relevant. I'm very interested in the growth of models.
Be curious to have you back in the not too distant future to see how that is developing. I do think that is addressing a real need that I hear from advisors over and over again in the marketplace. Thank you again. This has been fantastic.
For all of our loyal listeners out there, thank you so much for joining us. If you haven't already done so, please subscribe, Apple, Spotify, or wherever you get your podcasts and let us know what you like. Rate us. Let us know if there are topics you'd like for us to consider in future podcasts. Dana D'Auria, thank you so much for being our guest today and thank you so much for joining us.
Dana:
My pleasure. Thank you.
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