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:
Welcome to the latest episode of the Alternative Allocations podcast series. I'm thrilled to be joined today by my good friend Brian Ullsperger. Brian, welcome.
Brian:
Tony, great to be here. Look forward to the conversation.
Tony:
We've been talking about doing this for a while. I think you and I, maybe more than most, have had this investment discussion for years and years and debating the merits. And candidly, it's evolved. It's evolved because we now have more tools at our disposal. So let's start in the beginning. Talk a little bit about your career and how it informed the way you think about allocating capital, and maybe specifically what are you doing today with your team?
Brian:
Sure. Now, as I sit back and think 30 years in this business, my mentality about this has evolved because when I first started, you're trying to get clients of all different shapes and sizes, and you're starting with really small clients that you're working with through 30 years because their portfolios have grown and because of the fact that I've been able to engage with higher net worth individuals, families, endowments, institutions, et cetera.
My thought about a traditional asset allocation mix, which as you and I have talked about a long time, I am a huge believer in asset allocation. But I have seen the light, maybe from some of our conversations and maybe other things that I've just studied over the years, that it is really important to bring in alternative investments, however they're defined, and different practices define them differently. But it is something that I think is critically important to diversify portfolios, to add return to smooth out the ride, and really to generate alpha.
Tony:
We've had this debate for years about, is the 60/40 portfolio dead or obsolete, and however you define it, I think we would both agree that it definitely is an incomplete toolbox if we're only looking at traditional investments. And alternatives, whether you think of them as a standalone bucket or you think of them as part of the 60/40, definitely have become more prevalent and more prominent. And I think before we got on the podcast, you were talking about your clients are beginning to demand it or expect that you're gonna have alternatives. How do you define alternatives? What does your menu look like broadly?
Brian:
Yeah, so that's a great question and as you and I have talked about for years, man, I'm a big believer in asset allocation, but 60/40 needs revising, particularly when you are one, competing for new opportunities. Because other firms are out there presenting them, and they've generated returns.
So we need to be able to look at those, whether it's private credit, whether it's real assets, whether it's other alternatives. What we have done is we've taken the traditional 60/40 and brought in anywhere between, depending on how aggressive our clients want to be or how conservative, anywhere between 10 to 20%.
For the clients that I would call institutional clients, they could be institutions themselves or they could just be a very high net worth family who are entrepreneurs and sold a business. They want to see these alternatives in the portfolio again, to smooth out the ride. So the way we think about it, and again, we don't build our asset allocations through, I would say, the traditional way. We're not using optimization anymore.
We are thinking about how portfolios should be constructed intuitively. And then the way we look at alternatives is they should be investments that don't correlate to either equities or bonds, and they will move very differently, particularly based on interest rates.
And that's why that bucket now includes managed futures, event driven, real assets. It may have a hedge fund in it, and then we will carve out private equity. And the reason why we do that, and I've struggled with that, and I've talked to a lot of different advisors over the years, but we've carved that out because you can't rebalance from it.
I can't go to them when they do really well and say, Hey, can you give me some money back out of it? I can't pull it back out. So that's one reason why we've carved out a 5-10% allocation, but we are very disciplined in that it should be done every year. The vintages as they would be.
Tony:
So maybe I could redefine that. That's your patient capital. And that's the way family offices, institutions have often thought about it. My patient capital's long run, therefore I'm not gonna fool around with it. But you definitely consider it as part of your allocation because it's a key component in building better portfolios.
Brian:
Absolutely. No, no. It's something that we wanna try to bring into all of our clients and trying to find constructive ways to be able to do it. And to be, again, very consistent about adding to it. Because I do believe the vintages are incredibly important. In fact, I would argue that when you start to have more challenging investment environments, that's when you need to basically say, we are gonna be committed to this because that's when the greatest opportunities come.
Tony:
Yeah. Let me take a little bit of a detour here because I think one of the things that I think you do exceedingly well is you think about communicating to clients. And I know you and I have had this discussion over the years. It can be intimidating for clients if they hear this jargon that we all fall into, but I'd argue the same is true with a lot of advisors.
I think a lot of advisors struggle with the jargon and getting too technical, which sometimes scares clients away. Maybe if you could talk to me about, and more to our audience, about how you think about communicating to clients so they actually understand how you're using these tools. You talked a little bit about the role that they play in dampening volatility, but how do you describe it so they understand why we're adding these more complex tools?
Brian:
Well, one thing I would say that we try to explain to all of our clients when they say and they look at different investments is we want it there when we need it there. And that's a really important phase. You can look at something like managed futures, which I will tell you has some really challenging years because the trend may not be all that strong going one way or the other.
But I will tell you, you get a year like 2022, and all of a sudden they can actually create a lot of return when both equities and fixed income are down and they're moving the opposite way. That's when we say, that's when we want it there. But I think the important aspect about this, and this goes back to this conversation that you and I have had about asset allocation.
I would say the other important thing is you also need to be rebalancing inside of there and be very comfortable taking money from there when it does do exactly what you want it to do. So we have a conversation that it just is a basic part of what we believe.
Tony:
I think one of the things you do is you actually simplify things for clients. So you and I may have a very different discussion, and we'll again, use this jargon a lot. You do a good job of simplifying it to your clients. So when your clients are in these complex strategies, they don't feel intimidated because they understand in simplistic terms, well, this is my life insurance policy, my buffer for when we get the bump in the road. That's why you have macro in your portfolio.
So you do that in advance rather than afterwards. And I think that's one of the things that I think is important. All advisors need to explain all of this in advance. They don't work all the time, but they're there for a specific purpose. And when you get the bump in the road, you're glad you have it there.
Brian:
Well, one of the things I'll say is that, and I've said this to our clients for years and I say to my team, is that a good plan cannot be something that they immediately turn away from or they immediately change from when the going gets tough. Every client is an aggressive investor when we're in a bull market and every client is incredibly conservative when the market's going down.
So let's just use real assets as an example. So inside our real asset strategy, which is private equity, our private real assets, we own farm, timber, real estate, and infrastructure. Well, it's pretty easy to explain a farm. Now, I will tell you, I have had to learn over the last 5-10 years that we've been using this vehicle, the difference between permanent crops and row crops, which I've probably known more about that than I've ever known.
And the importance, particularly on permanent crops of water. So clients understand that. And when you own timber, they understand the aspect of if the housing market's doing really well, then your timber is gonna do really well. And by the way, that's not tied to what the Fed's doing. Whether an almond farm in California is being profitable, it has nothing to do with what that interest rate environment or what the stock market's doing. It's really whether or not people are eating almonds.
Tony:
Yeah.
Brian:
Or almond milk.
Tony:
So it's interesting as you say that, because I often tell advisors if they're having a tough time getting started, maybe start with something that's easy to understand and easy to explain to clients like real estate. Real estate, or as you're pointing out, farmland, is something that's a little bit more relatable.
They get comfortable, and as they get more comfortable, then it's easier to introduce complexity as opposed to, again, falling into the jargon of infrastructure. Well, if you talk to them about building roads and tunnels. Oh, I get that.
Brian:
Or data centers.
Tony:
Or data centers. Yeah. So that makes an awful lot of sense and I think that's a roadmap that advisors should think about trying to replicate because it is very complicated. And we all know clients buy their behavior when they feel uncomfortable, or as it feels very unique to them, that feels risky.
Brian:
So one of the things that I think is really critical, and we live in a business of jargon, and I'm not gonna pick on other firms or other advisors, but I will say this. Oftentimes that what I've seen in my career is that there are complicated strategies in client's portfolios that are just that – they're complicated. And they don't understand, and particularly the client doesn't. They don't understand the rhyme and the reason why it's in the portfolio.
So one of the things that we think about and we talk about client select because I think the communication and understanding is critical, is explaining in advance here is why this is in the portfolio and when we think it will do well.
Tony:
Yeah.
Brian:
Because it won't always do well and it's gonna often move different than your equities. If your equities are way up, this may not, and that's okay. Because eventually what we're gonna do is we're gonna take money from the equities when they do really well, and we're gonna rotate it into other things that haven't done as well, which is the basic tenants of asset allocation. So we think about it the same way.
Tony:
You're doing a very good job conditioning your clients for the fact that things change over time. We have bull markets, we have corrections, as you mentioned with 2022, where both stocks and bonds were down double digit. You have periods of time where you're rewarded to have a little shock absorb in your portfolio, like a managed futures or macro strategy.
I wanted to shift gears a little bit and talk about allocation, and I recognize before I asked the question that all clients are different and all clients are solving for different things and different time horizons, but what's an average allocation for a client look like, and what are the variables that you use to determine what's the right appropriate allocation for each client?
Brian:
That's a great question. So about 10 years ago, we had five allocations that ranged from conservative to aggressive. And then in between we had moderate, and then we had moderate aggressive, and we had moderate conservative. And about three years ago I said, this is way too many. We don't need to be doing all this.
We can tilt tactically when we feel there's opportunities for our clients. But we ended up going to three, what I would call core models. And then we have what I would call an institutional model, which is really for those high-net-worth individual clients who don't need the liquidity and can have more alternative aspects.
And it's really tied to time horizon, obviously goals and objectives, and liquidity needs. I think those are the most important aspects of it that we consider when we're building our client portfolios. Obviously, required return is important. We still do a Monte Carlo analysis for our clients. We still do some of that stress testing, but it's really focused on a very simple conversation with our clients, and that's because of our practice.
And I say that because our practice are primarily high-net-worth individuals and families. If I was building practices where I was looking to help a client retire, and then that portfolio was gonna be needed to help them for the next 20, 25 years, that would be a little bit different. We're gonna focus a little bit more on the required rate of return as well as the drawdown that they have out of there. I would argue that for our practice, 80% of our clients fit into this moderate allocation because they're never gonna run outta money and it's more about wealth transfer.
Tony:
And what's that rough percentage allocation?
Brian:
It is approximately 40/40/20.
Tony:
40/40/20, okay.
Brian:
Yeah. And we can tilt. And the reason I do it like that, and we decided to do that as a team and an investment committee, is because we felt that at any given time you could always tilt the portfolio to be more aggressive or more conservative based on market opportunity.
Tony:
I think that makes sense. I wanted to go back on something that you touched on, because I think it goes to your focus on communicating with client and that is illiquidity. And I've argued for a long time that illiquidity is just a feature. It's actually what makes private markets special because you're giving the manager an extended period of time to execute their strategy.
But I know that that is something that clients often feel, I think it's part of this behavioral element, they often feel very uncomfortable with because they lose control of that asset. They need to think about it as that 7- 10 year time horizon. You talked about private equity, you bucket that and treat that separately.
Do you have similar discussions with them about private credit and private real estate and the fact that the underlying investment is illiquid and do they react the same way?
Brian:
We do, and we talk about the fact that whether it's private credit, we use a lot of interval funds in our client's portfolios. We use LP structures and things of that nature, but it is helping to explain to them that this investment will actually have less volatility, smooth out the ride, and potentially get higher returns because it's illiquid. Because you can't tap it in it, because it can't be sold in the marketplace. Now there are times when we've run into the gates a couple times with some of these investments, but I would say for 90% of our clients it doesn't matter, and they do understand that aspect of it.
And I would also add that again, and you and I have talked about the whole idea of the institutional approach, which I think failed because everyone thought, oh, you can put all this in client's portfolios and they didn't understand, didn't comprehend what it meant.
And I do think that explaining to them about that illiquidity, and I would argue that most high-net-worth individuals, their portfolio is designed to be in perpetuity. It's just you have a wealth transfer aspect of it that's gonna happen versus truly being a foundation.
Tony:
So I'll make one clarifying point, and that is, I don't think the institutional model, and by that I think you mean the endowment model or the Yale model.
Brian:
Correct.
Tony:
I don't think it failed Yale, Harvard…
Brian:
Oh, no, no, no.
Tony:
…Princeton, but it failed individual investors.
Brian:
Correct.
Tony:
Because they failed to take into consideration and advisors failed to take into consideration. One is, at that point in time, they weren't getting access to private equity. And that's a big part of the premium that you see from the Harvards and the Yales of the world is they're investing, they're making big commitments to private investments and they're rewarded over the long run.
I do want to just take a little bit of a step back. Brian, you and I have both been involved in the organization, not just in the work that we do individually, but we've given back to the organization either in writing and speaking and sharing and all of that. And you have a pretty evolved practice, partly because you focus so much on the investment side of it, you know the numbers.
The industry's roughly a 5%, 6% allocation to alternatives. You talked about in your portfolio, a 20% allocation. You do the math on it, a 20% allocation, you really move the dial. You have a 5% allocation, you don't make that much of a meaningful difference over time. What do you think we need to do as an industry to get more advisors comfortable like you are, to get them a little closer to where they should be on that journey?
Brian:
Now, I'm not sure it's necessary as much as the industry, as it's going to be, the markets themselves. So let's look at where we sit today. We look at a market that's much more volatile than we've experienced in a long time. We were for the majority of the last, I'll just say 20 years, because it's a very easy number to use, in a zero interest rate environment. We were in a market that, what else did you need to do in hindsight than put your money into extremely low cost beta oriented index funds? I think that is starting to unwind, just a personal opinion, and I do think that you're starting to see the benefits of having more diverse portfolios, of having asset allocation.
And I'll even go back to 2022. In 2022, the bucket that provided the most benefit to our clients, it wasn't bonds. They were down 18%. It wasn't certainly equities, which at one point was down 35%, but we finished down, I think 20% for the year. The bucket that added the most value was alternatives. And it allowed our clients to protect and preserve more of their assets.
So again, going back to rebalancing, you could rotate money back into equities, and you can participate in what happened in 2023 and 2024. So I think we have to go back to this idea of advisors need to look at the value, not just of the asset allocation, but the value of rebalancing client portfolios. And really selling high and buying low, or some people will say trimming high and buying low. And I think that's the most important thing is getting back to some of the core concepts of investment principles and then talking about how these vehicles work and how they can fit in and add value inside of portfolios.
Tony:
Yeah. So Brian, I think one of the things you and I have spent a lot of time talking about is a lot of the value of an advisor, not outperforming the market, but a lot of the value of the advisor is one, understanding the psychology, which you've certainly talked about.
And then two, really leaning into this investment. The ability to really understand the market environment, understand how to allocate capital, and understand how to adjust and tweak as the market conditions change over time. I think you're probably right that you got into this trap where a lot of advisors did when you had 2009 to 2020, almost a 20-year period of time that 60/40 portfolio worked just fine.
As we stand here today, I think you're right. I think we're gonna have some challenging periods of time. Why wouldn't you take advantage of this expanded toolbox? And now through product innovation, you actually can allocate like institutions, you can have access to private equity, private credit, and private real estate, which you couldn't in the past. Even if you wanted to, most clients couldn't get exposure to that. So, to me, I think it's going back to basics. A theme that you and I have talked about, and I know you've been preaching for a while, going back to basics, which is the value of an advisor is actually providing advice.
Brian:
Well, one of the things that you've mentioned in different conversations that you and I have had, and in presentations is the idea that more and more companies are staying private.
Tony:
Right.
Brian:
So if more and more companies are staying private and there's not liquidity, and eventually they're gonna have to have some sort of liquidity, it's gonna create a secondary market. Well, that secondary market might create a tremendous opportunity that you can buy really good companies at discounted prices. But if you're not there looking at it and wanting to participate in it, you're gonna miss it.
And again, the clients that we're working with, you have a business owner who their whole career, their whole entrepreneur life has taken risk. And they're used to private equity. They're used to venture capital. They're used to private credit. Most of those clients I talk to, they're like, well, why aren't we here? Why aren't we doing this? And we're like, well, okay. We should be there. We should be in that space. And they don't wanna buy bonds. At least they didn't for a long time because rates were so low. So we had to look to other places like private credit and things of that nature. But interest rates obviously have come up now, but it certainly creates more opportunities. But those clients, as we said in the very beginning, they're demanding that because that's the market they're used to being in.
Tony:
And in my book, it's one of the things as I was writing the book and I was sharing my experience, how it shaped the way that I looked at the world, and one of the comparisons I drew was the fact that when I worked with those founders, many of whom were banking clients of Morgan Stanley, their expectation was, well, of course you're going to be a private enterprise and we're gonna be richly rewarded for it.
So for them, they were very comfortable having significant capital allocated to private markets because they understood the long runway and they understood being a private enterprise allowed them to execute their strategy as opposed to coming to the public markets. And I think more and more, as you say, those companies are staying private longer. Some will never go public. We now need to change the lens to say it's not either or. It's not public versus private. It's how much public and how much private should I have. The private pie is growing, the public pie is shrinking, so of course we should evolve and think about how to allocate differently.
Brian:
Well, and one other thing is that I think for years and years you saw the M&A was you saw companies buying other companies. Whatever company you want to name was buying another company because it was gonna help them expand. But now you're seeing private equity coming in and buy those companies. So the only way you're gonna get participation in those great companies is you're gonna need to be in the private side so that you can participate in the growth of that company over time. And again, it's just how it's evolved for different clients.
Tony:
Yeah, Brian, we could go on forever. I always love the conversation with you. I wanna leave you with one last thing, and that is, you're obviously a big consumer of alternatives broadly in private markets specifically. What are the things that you would like to see? Are you looking for more products, better products? Is access important? Is education important? What are the things that are important to you as we continue to expand this large and growing universe?
Brian:
Yeah, it's a great question. For me, one of the things, and I've done this throughout my career with both the long advisors and now I'm trying to do it with our alternative investment vehicles, is as an advisor using these, and this goes back to the educational piece, is access. And I don't mean access in the way that I want to have more strategies. It's access to the management of the strategy so that we can clearly understand it so that we can explain it to our clients. Because if I can't explain it to my clients, mean the old adage, if you can't explain it to a five-year-old, if I can't explain it to my clients, how can I recommend it to a client?
So for us, it's being able to get access to at least what they're thinking about and what they're doing. And that's really critical to our ability to incorporate it inside of a portfolio. So first of all, my advisory team and my investment committee can get comfortable with the vehicles, and then the client can get very comfortable with what we're doing and why we're doing it.
Tony:
Brian, thanks so much for joining us here today. Great insights as always. A lot of great things that I think advisors can take with them, start to incorporate with their clients and in their practices. As always, we encourage our listeners, rate the podcast, let us know what you'd like or if they topics you would like for us to consider.
Brian, thanks so much for joining us here today.
Brian:
Thanks, Tony.
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