The long-term performance of US public pension funds remains a subject of vigorous debate, particularly regarding the value added by alternative investments such as private equity, real estate, hedge funds, and private debt.
Do you agree with Verdad Capital research suggesting private equity can be replicated more efficiently within public small cap value?
Cliff Asness also isn't a fan of what he calls private market "volatility laundering".
BTW let's say pension funds and endowments follow the advice of AQR and Verdad and switch to factor investing in liquid public markets. Any guesses to how it will impact factor premia? Will factor premiums shrink?
1. Yes and no re replicating. You can get the same type of factor exposures at lower costs, but three things on other side: you lose the illiquidity premium, you don't have exposure to the smallest/fastest growing companies as they are staying private much longer. 25 years ago were 8k+ companies public, today <4k, and you can access secondary privates with significant discounts especially during times of distress. And I would add costs of come down significantly so no need to pay 2/20.
2. Re volatility laundering, as I told Cliff, he is right on private equity and laundering but much less right on private credit. Empirical research shows that PE lags 3-6 months so you get serial correlation and lower vol which is way understated. But private credit, at least in case of Cliffwater's fund (CCLFX) a paper showed lag was just one month, so vol is only slightly understated (and it is very low even with the lag). Note in their PE fund CPEFX, Cliffwater addresses this issue by DAILY marking the fund whenever any asset is marked by the sponsor, and they apply a beta adjustment daily as the market moves.
One other thing important, public markets are more volatile than private markets as you don't have panicking retail investors and FOMO investors driving valuations, and you don't have margin calls, etc which can lead to forced sales. If you look at the historical data valuations move much more in public markets than in private markets. This is true in both equity and PC. You see much wider highs and lows in public PE ratios than you do private equity EBITDA and same for PC where see much less swings in interest coverage in private than public. And btw see same thing in private real estate (where 90% of all trades are done) than public markets. So when you see say public RE returns go down 25% and private RE down say 10%, the 10% might be lagging some but trades are not occurring down 25%.
3. Re if investors switched to factor investing: Depends on what all investors are doing, but just considering those switching to factor investing their cash flows would logically impact spreads and thus expected premiums. Certainly don't see any evidence of that yet.
Do you agree with Verdad Capital research suggesting private equity can be replicated more efficiently within public small cap value?
Cliff Asness also isn't a fan of what he calls private market "volatility laundering".
BTW let's say pension funds and endowments follow the advice of AQR and Verdad and switch to factor investing in liquid public markets. Any guesses to how it will impact factor premia? Will factor premiums shrink?
1. Yes and no re replicating. You can get the same type of factor exposures at lower costs, but three things on other side: you lose the illiquidity premium, you don't have exposure to the smallest/fastest growing companies as they are staying private much longer. 25 years ago were 8k+ companies public, today <4k, and you can access secondary privates with significant discounts especially during times of distress. And I would add costs of come down significantly so no need to pay 2/20.
2. Re volatility laundering, as I told Cliff, he is right on private equity and laundering but much less right on private credit. Empirical research shows that PE lags 3-6 months so you get serial correlation and lower vol which is way understated. But private credit, at least in case of Cliffwater's fund (CCLFX) a paper showed lag was just one month, so vol is only slightly understated (and it is very low even with the lag). Note in their PE fund CPEFX, Cliffwater addresses this issue by DAILY marking the fund whenever any asset is marked by the sponsor, and they apply a beta adjustment daily as the market moves.
One other thing important, public markets are more volatile than private markets as you don't have panicking retail investors and FOMO investors driving valuations, and you don't have margin calls, etc which can lead to forced sales. If you look at the historical data valuations move much more in public markets than in private markets. This is true in both equity and PC. You see much wider highs and lows in public PE ratios than you do private equity EBITDA and same for PC where see much less swings in interest coverage in private than public. And btw see same thing in private real estate (where 90% of all trades are done) than public markets. So when you see say public RE returns go down 25% and private RE down say 10%, the 10% might be lagging some but trades are not occurring down 25%.
3. Re if investors switched to factor investing: Depends on what all investors are doing, but just considering those switching to factor investing their cash flows would logically impact spreads and thus expected premiums. Certainly don't see any evidence of that yet.
Hope that helps
Best wishes
Larry