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100 Capital Efficient Companies. 1 Cost-Efficient ETF.

Why are you being pitched private equity and private credit funds?

Take a breath, I am in favor or private equity and private credit being a part of the opportunity set. This isn’t going to be a negative screed. That’s an old and tired point of view. I’m going to be constructive instead, with a pinch of cynicism, two sprinkles of caution and a scaramooch of concern. I’m still me after all. Don’t get mad before you read the whole thing.

Okay, let’s start with the obvious.

Wall Street can no longer outrun the math on actively managed stock-picking mutual funds. Everyone has seen the SPIVA Scorecard by now. There is no persistence of outperformance across meaningful timeframes. A fund that crushes its benchmark and peer group over one five year period is equally likely to end up at the bottom of its peer group over the ensuing five years as it is to perform in-line. Which means track records aren’t helpful. Which means what are we betting on exactly? It sucks, because in most other endeavors off of Wall Street, prior success is usually a good indicator of future success. It just doesn’t work that way in stock mutual funds.

And because of the internet and blogs and social media, this is now well understood by financial advisors who, in a prior era, would pride themselves on steering their clients into the highest quality, best of breed managers. They’d rely on past performance (despite the standard disclaimer) and rankings from the mutual fund data providers. This is a dying concept amongst professional allocators because it’s been proven not to have worked in a zillion different ways. Which is why ETFs ran away with all the money, to the tune of $17.5 trillion, most of which is allocated into plain vanilla index funds.

You might think the executives at asset management companies have meetings about “How can we come up with better products that will beat their benchmarks?” and you’d be right - they really do want to do that. But they also have meetings about “How can we launch funds that people will want to buy?” and “If they won’t pay one and a half percent for stock picking, what will they pay one and a half percent for?” These are for-profit companies, after all, and profitability hinges on selling people things they want and are willing to pay for. For a long time people were willing to pay up for mediocrity and now they’re not. It’s not my fault, it just is this way.

Coming out of the Vanguard and ETF era into the post-pandemic investing boom, the idea of selling people funds that don’t benchmark to the impossible to beat S&P 500 was a revelation. Better yet, what if there were an asset class where the investors routinely pay higher fees - layers and layers of higher fees - where there’s no publicly known benchmark at all?

Eureka.

Everyone pivots to the private markets. Higher fees mean higher profits. Higher profits mean an impetus to invest in advertising and marketing that can actually be justified. No widely accepted or known benchmark means anyone can imply anything. It’s a Renaissance for the fund industry, which has been in the doldrums ever since the advent of the multi-trillion dollar hyperscaler stocks running away with the index. If you can’t beat ‘em, play a different game entirely.

It doesn’t hurt that both private equity and private credit funds have historically put up incredible performance numbers during the period of time when they were strictly the province of the super wealthy. The pitch practically writes itself:

“Up until now, an ordinary millionaire like you has never had the ability to tap into these asset classes and strategies. Only institutions and billionaire families have been invited to the party. But now, we’ve DEMOCRATIZED it all just for you, out of the goodness of our hearts. Now, you too can invest like Mark Cuban and Richard Branson.”

Fund companies love it because even at lower carry fees, incentive fees and management fees, they’re going to make a ton of money. The TAM is like $100 trillion. If private market funds garner just 5% of all retail assets, it’s a gusher that will spit out enormous profits for all involved for decades to come.

Buy-in from the wealth management channel has been critical. Financial advisors at wirehouses have been pitching private funds to their wealthiest clients for decades. It adds sophistication to their recommended portfolios with a dollop of exclusivity - “no one else can bring this to you, let alone explain how it works.” Historically, they were paid very handsomely for retailing these products and the banks they worked for were also paid for placement. With untold thousands of wirehouse advisors having left the banks behind to start or join RIAs, they have brought their enthusiasm for selling sophistication and exclusivity with them - hence, the ability of PE firms to see their products translate from the wirehouse to the broader world of wealth management. Private funds once struggled to gain traction in the RIA channel owing to that pesky fiduciary obligation and the requisite financial planner obsession with delivering low-cost, low maintenance, simple ETF models. The dam has now broken. The modern RIA is extremely comfortable with incorporating private markets as a sleeve of their asset allocation thanks to a deluge in “educational” efforts, primarily underwritten by the private asset management trade groups and the platforms.

It’s become a virtuous cycle wherein everyone seemingly wins - the asset managers can wholesale higher margin products via an increasingly “educated” army of advisors. The end customer of the advisor feels similarly enlightened and included in what had previously been the province of the ultra-rich. Add in a new wave of advertising dollars for the publications who cover the space and this virtuous cycle spins faster. Now consider the ever-increasing percentage of wealth management firms that are actually owned or invested in directly by the private equity firms themselves! And and and - with a dearth of liquidity for exits from prior private equity and credit investments, this nascent category of buyers provides a new source of dollars to get traditional private investors out of their long-held positions. Literally everyone is winning. The funds get their fees. The platforms get their fees too. The advisors get their hook for why they’re smarter than the advisor down the street (plus, the sort of illiquid asset that makes the client stickier and less likely to leave). The momentum of this thing is overwhelming. It’s a veritable jubilee.

You can fight it, but you will be run over. There are too many layers of people and platforms and dollars all rowing in the same direction for this not to continue. It’s permanent now. Learn to love it.

I have some statistics for you.

There’s a platform called iCapital which claims to have over 10,000 Advisors and RIAs who serve millions of high net worth retail investors looking to gain access to PE and PC funds. From what I hear they do a great job. And iCapital is not alone. They are one of several platforms catering to this business of connecting PE/PC funds with advisors who want to recommend them. We had Joe Lonsdale, founder of the Opto platform, on The Compound and Friends this spring if you want to go deeper on this.

iCapital, Opto and their competitors are now joined by the juggernauts Fidelity and Schwab, both of whom have recently launched or partnered on platforms that allow retail investors with as little as $75K to $100K minimums to access private equity and credit. This used to be the purview of the Morgans and the Goldmans of the world, but now it’s everywhere and for everyone.

It’s been reported that retail-focused private equity funds have seen an increase in subscriptions (allocations) of 3X over the course of 2023 and 2024. Funds like KKR’s DPLF (Direct Private Lending Fund) and Carlyle’s Global Credit Income Fund saw subscription growth triple year-over-year. That’s retail money coming in, much of which is being directed by the financial advice community.

According to McKinsey, the retail share of private market fundraising hit 17% in 2024. Once again, this has been driven by financial advisors, wealth platforms and the wirehouse representatives. It should go without saying but 17% is a new record.

Cerulli notes that private market allocations in model portfolios are up 5x Since 2020. Model portfolios are the domain of the financial advisor. In the 2010’s, these models were being stuffed with 3 basis point iShares and Vanguard index products to the exclusion of nearly everything else. In a world where the S&P 500 now sells at 22x earnings and the five largest publicly traded companies are equal to the bottom 400 or so, the desire for diversification is opening up advisors’ minds to the possibility that privately held companies make more sense as investable opportunities now that they’re more accessible via fund structure. I won’t get into a conversation about how the valuations of private companies are now also at record highs, paralleling what’s happening in the public markets - I don’t want to shatter anyone’s illusions about becoming the next Mitt Romney.

Semi-liquid private market funds targeting a retail investor audience are also on fire. They are commonly referred to as “evergreen” funds, meaning the subscription period is open-ended as people add to and withdraw capital to them supposedly forever. Cerulli says this category has now exceeded $375 billion in assets now from a standing start of a dollar figure that essentially rounds to zero just a generation ago.

As you have probably read about, there was a slight hiccup with Blackstone’s incredibly popular BREIT product a few years back as suddenly investor redemption requests began to come in faster than the fund could liquidate real estate holdings to meet them. This resulted in the company “gating” these redemptions so that an orderly process would protect the rest of the holders while funds could be sent out to those who wanted an exit. You would have thought this would have curbed the market’s enthusiasm for private real estate assets in a liquid wrapper. You would have been wrong. It’s been reported that BREIT has raised another $10.4B from retail in 2024 alone.

One of the more explosive categories of retail-focused private investments is the interval fund. Traditional private credit funds typically do their fund raising all at once and then are closed as the bonds they buy are allowed to mature and pay out. You get your capital back as this process plays out over years. Private credit interval funds can be thought about more like a carousel, with periodic stops for people who want to get on or off the horsies. These funds have grown their assets by 10x since 2017 - from $4 billion to more than $40 billion by the end of 2024 according to Morningstar.

Private credit has become so popular that Cerulli estimates a whopping 25% of US financial advisors are now using this asset class in client portfolios, mostly thanks to the ease of mutual fund-like wrappers.

One of the fastest-moving and most successful players in the space, Apollo, has truly set itself apart from the competition. Their retail platform has now topped $50B in assets under management. A few years back, Apollo completed a merger with Athene, a retirement services company, which is a massively scaled provider of guaranteed income (annuities) to retirees. The cashflows here represent endless billions of dollars for Apollo to fund private investments.

You might be asking “Wow! What’s next?” Your mind should have already gone to the $8 trillion 401(k) market by now. And if it hasn’t, I’ll help you get there. A rule change in 2020 allowed for the first PE/PC investments in corporate retirement accounts for everyday investors - more of that democratization sauce everyone is looking for. So far, providers haven’t done much with it, but you can bet that this will change in this new era of deregulation. According to Business Insider, “Trump’s current administration is preparing an executive order to actively open the door to private equity (and other alternative assets) in 401(k) plans, directing regulators like the DOL and SEC to clear the path.”

Adoption of private market funds within 401(k)’s has been slow primarily because there’s no great incentive for plan sponsors to risk having their asses sued off by angry employees should something go wrong or someone question the fee structure. As of this year, less than 1% of all plans are currently including private asset funds although some plans administered by Fidelity, Empower and Alight are currently piloting something where target date funds can contain a sleeve of these products. I don’t think 1% is going to be the ceiling given the across the board enthusiasm for this movement.

If just 5% of that $8 trillion 401(k) market is allocated to private market mutual funds, we’re talking about another $400 billion coming into the industry. One of the largest untapped honeypots on the planet. Now you understand why every asset manager is racing to launch a suite of these products for the general public - how will the management teams of these companies tell their boards of directors they got left behind or didn’t see it coming? That’s fireable. I mean, for god’s sake, even Vanguard has gotten into the game - their recently announced partnership with HarbourVest will allow Vanguard customers with over $5 million in investable assets to allocate to the private fund, which has so far garnered $2.4 billion in commitments. Vanguard’s newish CEO Salim Ramji (formerly of BlackRock) has already announced a strategic alliance with Blackstone and Wellington to build interval funds to hold a mix of public stocks and bonds along with as much as 40% in private markets. You’ll likely see this launch by year-end and financial advisors who’ve come to trust Vanguard’s reputation for low-cost pragmatism all over it.

So Josh, what do I do about it?

Well, if you’re an investor, I’ve just handed you the Rosetta Stone to decode the motivations behind the endless pitches you’re now receiving in your inbox and at the meeting with your financial guy or gal. Keep this in the back of your mind when approached with an “opportunity.” I’m not saying you won’t make money or that any particular private asset investment is unsuitable or destined to disappoint. Some will work out great and some will be outright debacles and the vast majority will end up somewhere in the middle of the distribution - just like anything else in this world.

If you’re an advisor with responsibility for making allocation decisions and talking to clients, you’ll probably want to begin boning up on this stuff, either so you can join the herd or argue against it, depending on your degree of enthusiasm or skepticism. Even if you don’t believe in the need for investing in private markets, you will be coming across prospective clients who own these things and you’d be smart to be in a position to understand how they work.

I would remind you (everyone) that if you think it’s hard to select traditional actively managed mutual funds (and it is), well, that’s going to look like child’s play compared to the private markets. Just think of all the new dimensions of things that could go wrong - illiquidity, fiduciary mismatch between sponsors and holders, asset class opacity, the impossibility of due diligence on underlying investments, credit quality, etc. If selecting stock mutual funds is chess, private equity is a 12-sided Rubik’s Cube. Happy hunting!

There is, however, a third route to go if outright abstention or whole-hog bandwagoning aren’t attractive options. You can do what I do when I see an “activity bubble” whipping itself into a frenzy off in the distance. You can grab a seat at the party as an owner of the funds themselves rather than as an investor in their products. I think of this as being a GP (General Partner) rather than as an LP (Limited Partner or end-investor).

I’d like to conclude this piece with something you’ve probably never seen before. When Blackstone (BX) came public right into the teeth of the Great Financial Crisis in the mid-aught’s decade, their timing could not have possibly been worse. The stock - which represented shares in the partnership prior to their having converted themselves into a regular C-Corp, was absolutely thrashed upon arrival at the New York Stock Exchange. Things eventually got better and Blackstone ended up being one of the biggest winners in the financial sector over the next fifteen years.

Below I have annotated a brief history of Blackstone in the public markets:

Subsequently, we got a handful of IPOs from other players in the private equity / credit space and those stocks have done quite well as the industry hit its boom time over the last half-decade.

If you’ve concluded, as I have, that we ain’t seen nothing yet, one strategy worth considering is allocating directly to the stocks of these companies and skipping their fund products entirely as your tactic for capturing the private market investing bull market. So far, it’s been an incredible bet to have made (I currently own shares of Carlyle Group and have for a long time).

I asked my researchers Sean Russo and Max Frank to put the below table and chart together for me depicting the returns for shareholders of the Blackstones and the Carlyles of the world versus the XLF ETF (Financial Sector SPDR) and to include some numbers from a mainstream benchmark for the private markets. There are other benchmarks out there and some may say that none of them accurately reflect the returns of this or that specific fund, but let’s not miss the point I am trying to make here:

If you believe this bull market is going to continue, why not bet directly on the very best companies who are finding ways to profit from it?

As you can see above, the publicly traded universe of private asset managers has done incredibly well in the current period. The median annualized return for these ten stocks since 2022 was 31%. Median!

A hypothetical market cap-weighted index of these ten stocks returned 38% annualized while an equal-weighted returned 36% annualized.

The Bloomberg PE Index (represents PE fund performance, net of fees) returned an annualized 4% over the same period. According to Bloomberg, their PE index “represents the average NAV-based return private capital funds, as defined by the bloomberg private equity classifications. This index is inclusive of every PE strategy these firms deploy: Buyout, Venture, Secondary, Debt, Real Assets, Real Estate, Fund of Funds, Coinvestment, and Growth.” 

Now, this doesn’t comp perfectly with private credit funds, of course, but you get the idea.

The financial sector index (represented by the XLF ETF) returned 20% annualized, which is respectable, but the stocks of these companies blew that away.

Since each of these company’s individual inception date going back beyond the three year period, we looked at them from their IPOs just to make sure we weren’t overly emphasizing the last 36 months in our analysis. The median return for the ten largest PE firms back to inception for each was an annualized 22% vs just 6% for the XLF (thanks, GFC) and 11% for the Bloomberg PE Index Benchmark.

If you invested $100 in the market cap weighted top 10 PE index, the equal weighted version, or the XLF you would have $264, $251, and $174 respectively since 2022. If, on the other hand, you gave a PE fund manager that same $100 (in the aggregate, per Bloomberg index), you would have $113 today.

The data-driven conclusion is that investing directly in private equity CORPORATIONS as a shareholder over the last three years would have delivered 151% more than investing in the PE fund strategies themselves, with less fees, more liquidity, and far more dollars in your account. Now, of course, it could look very different in the next three years, but I would rather bet on the bettors placing their bets than on the outcome of the bets themselves. In Vegas, they refer to this as being the house. I can’t predict which private equity funds will be standout performers. I can predict that private equity as an asset class is going to be much larger in five year’s time than it is today.

A few points worth considering here… One, I am only including the ten largest “pure play” alternative asset managers in the United States here in my table. No BDCs (Business Development Corps) and nothing European. Additionally, I understand that BlackRock is going full tilt into private equity and that many Wall Street banks like Goldman and JPMorgan are also shoulder-deep in private asset management products. I’m trying to get as close to the heart of the matter as I can without complicating it so I excluded those.

Two, you might be saying “Josh, these are company’s stocks, not funds, so this is apples to oranges.” No, this is comparing bushels of oranges with an ownership stake in Tropicana instead. It’s absolutely fair if the question is “Where might an investment dollar be treated best?” KKR, Ares, Blackstone and their peers will launch hundreds of funds in the coming years. I can’t pick among them with any degree of confidence. But I can absolutely tell you that more people are going to try and that the fees will be paid regardless of which fund does what.

Three, you’re going to start talking about risk-adjusted returns and sharpe ratios and the like. And then, inevitably, my eyes will glaze over and I will become sleepy. And then I’ll need a nap. And probably a snack when I wake up. How long must you be on Wall Street to learn than nobody gives a fuck about risk-adjusted returns? Did you make money or lose money and how much? Save the footnotes for your memoirs.

So I ask myself why not be a GP rather than an LP? You think all those $20 million homes in Greenwich that John Hamm has been robbing are occupied by lottery winners? Probably not. These people are among the best and the brightest in the industry. Read the Steve Schwarzman autobiography to understand the level at which they operate. They have figured out how to sell their strategies to institutional investors and now they’ve broken through to an even larger audience who asks even less questions.

If presented with the opportunity, you want to be on their side of the table. You want to be the house.

August is Portfolio Review Month

Thanks for reading the piece above. At Ritholtz Wealth Management, August is Portfolio Review Month. Consider this your official invitation to speak with an expert about any and all holdings in your current portfolio, including any and all private equity products. We use cutting edge software to x-ray brokerage accounts and determine things about people’s asset allocation mix - down to the individual holdings - that they otherwise wouldn’t know. It’s likely we can tell you a few things about the fees, tax consequences, overlaps and non-obvious risks to your portfolio. If you’ve been meaning to get a second opinion, now is your chance. Go to ritholtzwealth.com and talk to us right away. Tell ‘em Josh sent you.