Rocket Dollar Performance Assessment Like A Pro
Most individuals tend to evaluate the quality of investments based solely on their performance numbers. However, performance returns are merely the starting point that should prompt further inquiries. In a recent discussion on Rocket Dollar, Chris Carsley, our Chief Investment Officer at Kirkland Capital Group, shared insights on how professionals assess investment performance. This will empower investors to pose relevant queries in order to make well-informed investment choices.
Video Highlights:
Why looking at performance is important when deciding between investment options.
The type of investment numbers to look at and what they mean.
The different aspects of performance assessment, such as measurements, attributions, analysis, benchmarks, and more!
“When you notice a disconnect between their “say” and “do”, you need to bring this issue to the manager and ask, ‘What went wrong here?’”
“Beta represents the return generated by the market. At a basic level, it is what the market generates. This can be obtained by investing in a liquid index. On the other hand, alpha is an additional return earned from exploiting inefficiencies to achieve excess returns.”
Watch the full video below.
Transcript
Brendan: All right, welcome everyone to another Rocket Dollar, this is one of the first ones of the year, but this is not the first for Chris uh, coming and attending from Kirkland. I'm really excited to have him back. Um, like I said for every Chris webinar, please do go back and if you like this one, go back and check some of our recordings of the previous ones.
Um, people really appreciate Chris's content and we're really glad to have him back. So, we do these for education on a number of different alternative asset types. But we also do some of these webinars just on general, um, alternative investing topics. You know, some people might have only done one or two alternative deals in their life or this is their first one that they're trying to do, uh, when they come to Rocket Dollar to do this in a retirement account. So, we're gonna have Chris give a presentation today, and as always, I'll try and be bringing up questions I hear people, um, say to us and the sales team on the phone all the time. But please feel free. We have Nick Gonzaga in the chat to type into the chat today.
If you have a question, I'll try and bring up a good moment to, um, interrupt, and we can bring that up live and talk about it. Chris, why don't you introduce yourself?
Chris: Thank you, uh, Brendan and Nick. Uh, yeah, it's great, it's great to be back. Um, it's actually one of my first webinars for the year. It's actually been a very busy year, but not, uh, on the, uh, a lot of people wanting education, but luckily, I've freed up some time, so very happy to be here.
Uh, as Brendan said, there's a number of things that I've done historically dealing with education, and I'll make reference to one of those as we dive into this subject matter. Um, we're going to be talking about performance measurement, uh, and assessment of performance measurement like a pro. Um, I actually worked for a fund to fund where we spent most of our time not really looking at the performance from a standpoint of, oh, is that good performance, but really diving in and tearing it apart, quantitatively and qualitatively, and so we'll talk about some of those steps. I'm not going to dive into a lot of minutiae. Um, this is just sort of an intro, and if people want to, uh, take it to the next step, uh, always send me an email, reach out. Love to jump on the phone and, uh, you know, talk further, um, because there is definitely a lot of layers underneath the conversation we're going to have today.
Um, let me, uh, really quick move some things around on some of my screens and I'll share my screen for the presentation. Um, let's see here.
Brendan: And just so everyone knows we do this so you can see Chris's pretty face right at the start, so you know who you are talking to.
Chris: I think I got my ugly mug in this presentation too, but we'll skip over that pretty fast. Um, as we said, performance assessment, like a pro, um, And, uh, yeah, well, there's, there's, there's my picture. There you go. You saw me earlier. Um, I am a CFA, CAIA, went through all those fun tests. If you want to talk about that and you're a student, uh, I do also talk a lot and work with students on introductions to their careers into Alt, um, if you're one of those people listening, uh, I have been I'm an asset manager. I've managed people's, um, you know, direct money for family offices and ultra-high net worth’s. I have been fortunate enough to work for a hedge fund doing a variety of different, uh, esoteric arbitrage trades. I worked in venture, angel investing, uh, still advise a couple different, uh, companies on the fintech side.
Obviously worked at, uh, uh, Fund to Fund that I mentioned earlier where I was on the allocation team, and we had to go through an immense amount of due diligence as we dove into a variety of different funds that were going to be in that portfolio. Um, and we'll end it from there and move on. Enough about that guy.
Um, today, we're going to talk a little bit about, you know, why do we look at performance, you know, beyond the point of, has this manager done well or not? Um, I know that's where a lot of people take this conversation and performance and kind of stop there. Um, you'll hear me say this later again, but I'll sort of take this point.
Performance to us at an institutional level wasn't an answer. It was a methodology to generate further questions to ask the manager. And I'll give you some examples of that as well. Um, the types of performance numbers. Man, there is no lack of way people can show you numbers. And you gotta understand who's showing you what.
Cause what you might see from, you know, a real estate equity investment versus debt, versus venture, versus something in the hedge fund world might actually all be different numbers. And so, you gotta have a general knowledge base of, well, what are they showing me? What does that really mean? And how should I interpret that?
And then the meat of what we're talking about here and getting into and adding this to the due diligence side. And when I say due diligence, uh, if you watch some of my other webinars, and I know there's some other people who talk about it as well, you got investment due diligence, you got operational due diligence, you got business due diligence and economic due diligence.
So, there's sort of four pillars to doing due diligence on alternatives. Performance really centers mostly on investment. performance, uh, and, and due diligence side of things. So, when looking at that performance, there's issues of measurement, there's issues of attribution, analysis, and then the introduction and the idea of benchmarks.
And then there's a number of things that have been going on recently, uh, with inflation now being a part, you know, I don't get, you know, credit for that little term, but someone said, hey, there's now this triple net return aspect that, you know, it's not just about. Gross, Net. It's now what does everything look like after inflation, um, and if you work for a family office, uh, like some of my clients, you know, there's even a further layer where they want to see about what, what does it look like after tax?
Um, so, um, let's move on. Let's, uh, dive in. Why do we look at performance? Um, and like I said, I used to be one of these people before it was my job. You looked at the performance and you said, wow, this guy's really done well. What does that mean? And, and, um, and there's gotta be more to it than that. And so, we want to understand not only has he done well.
It's like, well, okay, that historical capability of skill and what I really want to home in on there is, is that return performance over a cycle of time of where maybe there was hardships? How did they do during what you'll see like, oh, how did they perform through a cycle is, uh, you know, sort of a catchphrase that a lot of people will use.
And that means, well, when times were difficult, were they an agile enough manager to maintain or meet the performance guidelines that they'd expressed to their investors?
Brendan: And you'll hear back test a lot, Chris, um, back test of just, maybe your strategy is new, but you're putting it through old data just to see how it would do.
And a very convenient thing is, oh, well, I'm going to cut off this back test and put it in 2009, or I'm going to specifically put it in, um, you know, 2006, because that will dramatically change or make me look better. Um, and how,
Chris: and Brandon, that is a, that's a great point. I have literally seen presentations that show you a time period that worked for a strategy and I was like, yeah, I was like, I was like, wait, wait, wait a second. Why don't you show the years, expand that out? And all of a sudden when you expand it out or you request to have it expanded out, all of a sudden it doesn't look so pretty. Um. That is a good sign. Like right, if I find a manager doing that, I might dive further just to torture them and, and cause pain and suffering because that would entertain me.
Um, but in reality, as an investor with a limited time, um, uh, you know, uh, of, hey, I have a job, and this is my side job of where I'm looking to invest in alternatives. That should be a non-negotiable for you and just move on. Just close the book, move on from that person. Because if they're playing tricks with numbers, they're going to be playing tricks with a lot of other things.
Um, so.
Brendan: That is a financial industry, uh, I think poorly kept secret. I think a lot of the smart clients know that very well, but it's, if you're working with someone professionally and you see them playing tons of games with the charts, It's a, it's something every financial professional who's honest and tries to be on that side has seen some employee try and manipulate charts to try and get a sale or trying to make themselves look better.
You have to be your own advocate and try and know what you're looking at outside of the balance of what's on the edges of the chart rather than just what does the line look like.
Chris: And, and as you'll see, as we walk through this. You'll see a lot of different opportunities that people could apply gamesmanship to performance measurement.
So as I mentioned, repeatability through cycles, you know, here's one thing that we really found, you know, I helped build an entire operational due diligence program and integrated across a fairly large billion dollar allocator, uh, you know, uh, group of funds and everyone was like, Hey, you're building operational due diligence to better find fraud.
I'll let you know, in my history of looking at hundreds and hundreds of funds, we actually found frauds and found problems, not really from the operational or business due diligence side, but that third point of really looking into the performance and saying, wait a second, here's what they did number wise.
Here's what they, the investment strategy and the objective stated, and that, that those are not matching. I mean, it's very obvious something is wrong, and like I said, that generates that next level question of when you find that separation of say and do, from a number standpoint, you can just basically take that back to the manager and say, what happened here?
Why did this number dislocate from the strategy? Um, and you'd be amazed. You either find that the person was just making things up or they had a massive style drift. They're willing to go way outside what they tell investors, um, and take risks that you're unaware of. Um, and that's something to be really worried about.
Um, and you can actually see that by going in and looking at the numbers. Uh, if they're not matching the investment strategy, where one of the things that we saw was everyone else in a like strategy went down during a certain time period, but we found a manager that went up. Okay, same investment strategy.
What did this person do specifically differently? And when we dove in and finally got the person to tell us the answer to what happened, well, he just got out of everything that he was supposed to be doing and went into something else. Well, it worked out great. You made money, but from an institutional investor standpoint, that's a, that's a no, no.
You just took a bunch of risks that I was unaware of. You went into a series of investments, and we view that as luck might've been skill of some sort, but from institutional standpoint, that, you know, it was like 80 percent of their portfolio style drifted and they got lucky in our opinion. And so, they were fired pretty much as fast as we could get out.
Um, uh, but you know, and there again, here's the next thing with performance. Does it match what you're looking for as an investor? And this, this is where it gets individualistic, you know, when you're doing this assessment is what are your expected returns? Are you looking at the equity side of the equation?
Are you looking at the fixed income? What do you expect to earn? What are your goals for this investment? And does the performance match what you're looking for? Because sometimes, you know, if you sit on an endowment board, it's not always about trying to put up the biggest return. You have a certain expected return with a certain level of liquidity.
You have other goals and objectives from an investment standpoint. And does this investment match what meets your plan? Um, it may not always be about trying to knock it out of the park. Um, you, you could already be wealthy, and you have an idea of more about capital preservation. You know, so the returns might be something you're looking at, or they're not, you know, top court or performance, but they're also taking a lot less risk to get that performance.
So that's that next level of where meshing performance really with you is equally as important when you're looking at it. Um, yeah, go ahead.
Brendan: There'll be a lot of people, I think, and part of this performance talk is. You know, we'll talk about benchmarks and stuff, and we'll get to that, but people compare everything to the S&P 500 and that is both helpful sometimes and also not helpful.
So like, if you're trying to make a decision on what to invest in, that is good, you know, you should be looking that, but make sure like the S&P 500 is like fitting your goals. So, for a lot of investors, it totally does. Um, sometimes, you know, you'll even see retirees and investors, they'll, they'll tell their advisor or their professional manager, like, I'm trying to not take risk.
I'm, you know, right on the cusp of retirement, um, you know, I cannot have any loss of capital of certain percentage and they're like, well, I want to go all S&P 500 and then I want to go even more in a Magnificent 7 or something like that. So just make sure that the benchmark that you're talking about with your manager, make sure you understand how that compares to the S&P 500 and how it might be different.
And also, like, what are your goals?
Chris: Yeah, and, I mean, that's a good point. And we'll talk more about benchmarks, but yeah, there's a lot of apples and oranges comparisons, and you can have a mindset, and I don't want to ruin all my future, uh, talk on benchmarks towards the end of this presentation, but you can look at something and say, wait a second, I'm comparing a number of aspects maybe of correlation to an investment that I'm looking on the fixed income side and how does that really relate with things that I might be doing on the equity because if you're at that level.
And you're looking at, hey, what are the entire quantitative aspects of my portfolio management plan, like cross asset risks and correlations? Okay, well then, yeah, you're naturally making a comparison. If on the equity side, you own the S&P 500, then that's okay to look at a new investment and say, well, how does that actually correlate with things I already own?
So, you're making an apples and oranges comparison, but you're doing it for a reason for portfolio structuring. Um, if you're going to get down to true benchmarks, is this manager outperforming something? Um, and using it as, uh, you know, a line in the sand to say, is this guy worth the management fees? Well, then yeah, you need to be very, very careful you're comparing yourself to the right thing.
Um, otherwise it's an unfair comparison. Or you might be going into an investment that's not right because you compared it to the wrong thing and said, oh, wow, look at it performed so well during this difficult time when everything else went down. Well, okay. Maybe that was, you're looking there again at fixed income that did, you know, exceptionally well versus equity in a time period.
Okay. Well, you're going to be misled by your own analysis. Um, so, but, uh, types of performance numbers. And most of these you've seen before. I just want to mention them here. I want to make note that, you know, okay, a simple return. Okay, you know, and I'm not going to walk through all these. You guys, the deck is totally available.
If you want to reach out, Rocket Dollar can send it to you. I can send it to you. Whatever works. Um, you know, you've got your compounded returns, you know, for most funds that I am aware of, there's a certain compounding aspect, um, to their return, you know, unless you're in venture or something of like that nature, annualized returns, these can get a little tricky.
And I've seen some people with some really questionable marketing materials, where they come out and they say we're up 12% annualized, and they're showing like a four-month period. And so, what they're doing is the four-month period was okay, but they turn it into a number they know is exciting for people, and that's what they put out there.
So be careful when you're looking at marketing material and really understand what made up that return and annualized return. Unfortunately, I've seen it misused. Um, total return. Well, okay, great. Uh, if you're looking at an investment and there's multiple components to the investment, um, we'll talk about that because that leads into attribution.
Well, that makes up, you know, what would be deemed a total return. Um, and all these might be gross. I mean, they don't necessarily have to be net. So that's another factor you're going to have to look at. And we kind of mentioned that here. Um, trailing returns. Yeah, go ahead.
Brendan: We had a question come up about IRR (Internal Rate of Return) versus total return.
So, Luke wanted to know kind of what the difference was between those two terms.
Chris: Um, well, right here, IRR, um, total return, uh, really is, uh, backward looking. So it is, uh, a series of numbers, say income and equity appreciation, that's actually achieved in something that's already potentially occurred. Um, most of the time when you're looking at IRRs (Internal Rate of Return), and people are saying, now, they can be the same thing if you're talking about historical numbers.
Because the IRR should capture all of the aspects of a return number, but where you'll see most performance measurement and sort of forward-looking aspects is where they're talking about internal rate of return and an expected forward looking and you can see here in this slide it is an estimate. So, your point of if you're looking historical Well, the IRR and the total return might be exactly the same number as they should be if everything's included.
Um, but, you know, and you're locking in the key point is IRR is based on a certain duration. So, if you're looking at the same time period of saying, Hey, what's my IRR for the last 24 months? And what's my total return for the last 24 months historically? Well, that number should be the same unless there's something, you know, wonky in the way they're calculating, but that's where you got to dive in and sort of understand, but where IRR goes in is like, well, I can't possibly know what a total return is, is in the future, I can have an expected return that would be total.
Like, hey, I think my future income and my future equity gain looking forward might be X. Um, but then you start getting into that notion of where most people use IRR as a You know, annual rate of return that is expected to be generated from a various project. Very common in real estate, very common in venture, because especially in those two, well, you don't really know what the future is going to bring.
You have an educated guess of what it might be. I think you have more of an educated guess in real estate than you do in venture. Um, But it's very common in Venture. They're like, hey, we're targeting this 20 IRR, and this is how we're going to generate, and here's our portfolio of companies. Well, if anybody's done Venture, especially in the seed angel level, like I've done, it is not a straight line, and you can take the best guess you want, but when you're looking seven, eight, nine, ten years out, forecasting becomes not very accurate.
Um, so, uh, that's why I always say is like, understand, you know, IRR. Um, and, you know, there was something that I ran into, I don't know, it was about a year ago. There were a bunch of people talking about IRR partitioning. And I, at that time, I was like, what the heck is that? Um, what are you guys talking about?
I kind of had a guess, obviously partitioning, you're breaking it into pieces. Um, and really it was just, uh, the real estate industry's way of saying attribution. It's like, listen, if I've got an IRR and I'm looking at it both historically or future, What is the manager's expectations of, well, how much of that is going to be, you know, cash and income, how much of that is going to be on the sale of the property, and then there's a number of ratios depending on, let's just stick with real estate as an example, depending on whether it's multifamily storage or a variety of other things, and People have ratios that they found historically that are a best fit or a target of how they want to see an IR broken down.
And we'll talk a little bit more about that as we dive into the measurement and attribution aspect. I think that's great. I think that, you know, the fact that people are, you know, you know, saying, hey, we need to break it down and understand how it was generated historically. That's what I'll talk mostly about.
But it's also equally as important to understand and get into the manager's head when they throw some big model out at you and say, hey, this is what I think is going to happen. We'll really have them go into granular detail of saying, okay, well walk me through the attribution of the return. Where are those returns coming from?
How much is coming from, you know, and you can get pretty granular. You could say, oh, how much is income? But it's like, sometimes that's not all rent there. There's other components and other revenues that can be generated. And you can actually. Have them dive into that granularity so that you can understand what expectation or what guesses they're making of that's going to generate this sort of forward-looking IRR.
Brendan: Yeah, and just another note too is what can complicate all this is do you contribute extra capital, you know, a couple of years, maybe one year in, three years, five years, every quarter. So, you know that there could be some way that makes this also harder for you, for you as the client, to figure out. It can sometimes be frustrating to look at a portal and you're like, well, I put 500 extra dollars and now I can't tell if I lost money or not.
So, it's good to understand if your current capital or future capital is included in that IRR.
Chris: Yeah, no, good point, because, um, you're, you're, you definitely want to make sure it's you know, computed, you want to make sure, okay, how are they calculating that? And so that you can have an effective model and understand how they're calculating that performance, which we'll get into.
That's part of the measurement aspect. So that you're like, wait, what money have I been making on what parts? Uh, you know, cause that's going to affect if there's a profitability and aspect and taxes involved, you're going to want to understand that number in a pretty granular way of, well. What, what am I paying taxes on?
How did I get that tax bill? Or, you know if I lost money, how did that possibly happen? Um, backing up one step here, uh, trailing return is something else you'll see. Um, you know, pretty simple. They're just grabbing a off calendar period and saying, hey, for the last 12 months, this is what the return looks like.
Um, I think there's sometimes a lot of value in that as investors are not always investing on a calendar basis. You might be coming in off calendar. So, you know, from your aspect, your 12 months might be different than someone else's, even though most funds are reporting numbers monthly and then sort of like measuring it up.
Hey, this is how I did for the year. Well, your return may not be the same numbers that they're reporting, um, or putting up. So just kind of be aware of, you know, okay.
Brendan: Yeah. The year-to-date reports. The year-to-date reports in February, I, you know, I almost consider them completely useless. You know, you go back to the 6 month or the 12 months, um, but again, you as a client, be aware, is that little, is it digital or in a statement, is there a little 12 for the last 12 months, or is it, uh, YTD for year to date?
Chris: Exactly. Or, or is it annualized? Like I said earlier that one can trick you. You're like, wow, they're already up 13 percent this year. Oh, oh no. They're just looking at the last three months.
Brendan: They were down 30 on the 31st, but now there.
Chris: Yeah, exactly. Or they're omitting periods. Yeah. Um, yeah, all these things go into, you know, and I know it sounds ridiculous that people would do this, but I've seen it.
People have changed what they're showing to make it look as best as they can. Uh, you know, especially if they're still raising money. Um, and then, you know, gross return, net return, um, most funds that you run into should never be showing, you know, gross return unless it's well, uh, documented that that's what it is.
Um, you know, there's a, in the CFA's, institutes, um, and a lot of other, you know, GIPS compliance aspects of performance measurement, you know, it's now, legally, for most people, you should be showing net returns and, you know, explain it and disclose it accordingly, and if you're not, um, you better have a lot of disclosures, you can get yourself in trouble.
Um, I know now a lot of smaller funds and things like that are not trying to get to GIPS compliance, and they're not meeting all those, and they don't have to, there's no legal requirement to do so, but you want to work with a manager that's at least striving To meet most of those high level requirements of showing performance measurement so that it's not misleading.
Um, you know, those organizations put a lot of effort to not make it arduous to show performance. What they're trying to do is create some kind of consistency in the way performance is presented so that investors don't get confused or misled.
Brendan: We're approaching half an hour, Chris. So, it's your 26th, just giving you a check in.
Chris: Let's move on. Um, performance assessment. Okay. First step. So, this is the meat of what you got to get into, and performance assessment involves. You got to look at measurements. How are these numbers calculated? Who's, I mean, you can dive into like, well, okay, it requires a certain valuation. Then understand who's running that valuation.
Is it internal? Is it external? What are the parameters of how valuation is set? So, understand, you know, how they're calculated and who's calculating them. So, in an institutional world, most performance measurement is actually calculated by a third party and then reconciled by the fund. The fund doesn't actually calculate its own performance and that's the number that's prevented, uh, sent to investors. So, you might have a third-party administrator that's actually in charge of calculating performance measurement. And although, hey, I totally agree funds need to take the lead. You need to reconcile and run your own and be responsible for your fund because the fund admin is not the manager, but it's good to know that there are Eyes looking over the shoulders and calculating those numbers.
So, you should, you should understand who's actually calculating that. Um, performance attribution. This is the big one. And this kid that gets back to that IRR partitioning attribution is, you know, what's the breakdown of these numbers? You know, what made up this return? Where was it originated? What risks were taken to generate this return?
This is super important. And this is the where when you start thinking about attribution. And where and how returns are generated. This is where you're going to generate a lot of questions for the manager. Um, and it's okay. You should be asking questions about, hey, what happened this month? Why did you, you know, fall, or rise?
And this is the other thing. When you see a fund, like, have a big bump in return, That's, that, that is a point you should be asking a question. Because just putting up a big return may not always be a positive. Like my earlier example. Well, they went out and took a bunch of risks. And, you know. You know, went off the reservation.
And yeah, it was great that we earned the return, but we still fired them. Um, because we didn't think that was repeatable. Um, and then the next phase is analysis and appraisal. That's where you're meshing qualitative and quantitative aspects and saying, hey, does this, is this skill or was this luck?
And, you know, being a fund manager, this gets hard because that analysis usually takes time and you've got to have a number of months of performance. And so if you're an emerging manager, You know, this part, and this is why you don't see a lot of big institutions going into emerging managers because, well, they don't really have enough data to complete this third part of analysis and appraisal unless, you know, we actually had an emerging manager model, so we adjusted and said, hey, we understand you only have six months.
We're willing to step in because we really believe in the team and the trade, and we understand it. Um, but, you know, not everybody has an emerging manager platform. So, um, benchmarks. Well, this, as we said earlier, can be a couple of different things. It's a personal aspect of where I have a benchmark of what I'm trying to achieve from a return standpoint, my ex, my required rate of returns, or I might be making a comparison of, well, is this manager worth it?
And are they creating an excess return or generating some type of alpha? And I need to understand a benchmark. I'm not going to lie to you. I can do another two hours on benchmarks alone. It's super complicated to find best fits, um, in my world of, you know, private debt. It's hard to find a best fit, and most people just use a levered loan index, um, and you know, I'm not even that correlated to that, but that's the industry standard, and I always disclose, and I said, well, this is the industry, and this is what it uses, but I can show you mathematically, it's not the best fit for what we do, um, and you just kind of have to go with what's available, because in the world of alternatives, there is not always a benchmark just lined up for you.
of saying, hey, this is, uh, you know, this is what works best, but it's important to get an idea because you are hiring an active manager in Alternative Investments. And you need to understand, are they doing better than if I just went and bought a comparative public index? Seriously. I mean if I went and bought the, you know, Bloomberg Aggregate Bond Index.
You know, is that fixed income manager beating them? You know, if I'm in, you know, a long short tech fund, you know, okay, given assessments of that they're taking some short aspect, you know, how does that compare against, you know, the, the NASDAQ or the QQQ or whatever you want to compare that you own in your portfolio?
Something to think about there. Um, performance measurement, as we said. How is it, how is it calculated? Observable risks, looking backwards, you know, understanding volatility and standard deviation. That's important within performance. You know, you need to not just look at the number, you need to look at the risk that was taken to earn the number.
You have got to take a risk to earn a return. But it's important in this level of performance measurement and assessment is, well, what risks did I take? Did I take, I mean, hey, great, I put up a 20 percent return, but I took massive amounts of risk to get there. Um, you know, and you'll see that it's going on the battle between debt and equity, you know, equity was king of the hill for so long because money was cheap, but now money's expensive and you've got a lot of people in venture debt and various private debts and CLO traders and things like that.
They're like, listen, the risk adjusted return in private debt. is, is now king of the hill. Um, okay, why? I mean, there's a lot of math that you can throw it there and say, wait, you know, maybe this equity trade is still making more money, total return or expected return than private debt, but the risk I have to take to get it.
Well, that might not actually be the best fit for my portfolio and maybe something in Alternative Debt is better. Um, you know, and that goes in.
Brendan: Also, I think something important to understand is, you can tell if a manager is giving you something typically. You can ask, like, was this generated for me or is this something you give everyone?
Um, because did you ask for it? Did you ask for something specific, or did they maybe hear you say something and now they're trying to give you a certain chart they think will play well with you? So that could be a difference of like, if three investors have meetings and three investors see all different things, because, um, you know, is it more of a sales presentation?
Um, and you know, that, that's not necessarily a bad or malicious thing. Just, just be aware of that. Um, you know, you could probably tell if anyone can put something nice in a header on a paper and make it look like they've worked on it for a really long time. But you could simply ask, like, hey, did you generate this for this meeting or something?
Chris: Yeah, exactly. Um, and lastly, there, um. In the part of looking at measurements, you'll see sometimes they, a lot of people have different, uh, return ratios and risk adjusted ratios, like the Sharpe, the trainer information ratios, uh, you know, omegas. I mean, they go on and on and on. There's lots of ways to look at a variety of different things.
Be aware. Um, of what those ratios were used for and why they were created. Um, you know, sometimes in the alternative world, you can see Sharpe ratios that look just out of this world. Well, okay, Bill Sharpe invented that ratio for public markets. You didn't invent it for some of the unique factors and the lack of, you know, volatility due to illiquid nature of alternatives.
So, you just need to kind of know a little bit more about those ratios, um, before just sort of leaning in and saying, oh, I'm going to make decisions based on risk adjusted ratios. You could be misled by that. So, uh, that's just part of measurement, um, attribution, um, you know, like I said earlier, this will show where the risks are, and that's important.
You need to understand, you know, okay, hey, how did we generate those risks? This is, this is the answer to how, how it all happened. You know, that's, that's the important question of attribution. And it also leads you down to where you're looking month to month, and you can see, hey, what happened? Why a return fell to a certain degree, or why did a return go up to a certain degree?
What generated that event? You know, for one of ours last year, we had a foreclosed loan that got solved and we captured a bunch of, uh, accrued and unpaid interest in May. So, we had a bump in May's return as that event occurred. Um, Now, I had a few investors ask, but my general view is try to be as transparent as possible.
I actually brought it up, you know, in our newsletter and our webinar of like, hey guys, if you didn't notice in May, things just kind of popped like 12 basis points. You know, well, this is what happened. You know, um, you want, you want to get that kind of transparency and understand those unique events when things are supposed to be consistent, or you see a massive, outsized return that didn't happen in other like funds you own.
You know, that's you need to go in, and you need to understand, Hey, what's the breakdown? What happened here? Um, you know, was that luck or was that skill or was it an event that had actually been explained to me? Did I have the proper expectation built for me that that would occur, whether it was on the upside or the downside?
Brendan: A really common fallacy is also like, sometimes there's just like a cyclical thing in what you're investing in. Like, you know, it could be oil based or whatever. And every March 31st. Something happens with OPEC or, you know, maybe it's a meeting. And if you're not aware of that kind of, um, cyclical event or what that, that kind of nature of that cycle, you could sometimes get really excited or also discouraged because you just don't know why that's happening.
So please like always try and find out a good thing is just look up why this happened, don't freak out, try and look up one news article, maybe it's written by AI (Artificial Intelligence) now and it's really poor quality, but if it's at least just three sentences This asset went up because of this, um, then you'll have a great understanding and might know if that's going to happen again, or if that is a more one time unique, uh, event.
Chris: And, and some of the other points here is, um, you'll see, you know, you'll have conversations about beta and alpha. Okay. Well, alpha is what you want an active manager to generate, you know, and one of the points that I mentioned on this, it's like, okay, well, how much was beta? You know, and there's ways to assess that.
And some of that's done through assessing via a benchmark. You know, if the S&P went up 10 percent and this fund went up, you know, 9%, yet it was highly correlated to the S&P. Well, you probably have a manager, it's like, well, wait a second, they underperformed. What happened?
Brendan: Can you just explain Beta and Alpha again to make sure everyone's on the same page?
Chris: Sure, sure. Yeah, Beta is um, really a return that's generated by the market. I mean, on this super high level, you can go into nuances of definitions, but at a super high level, Beta is Listen, this is what was generated by the market. This is something that could be achieved by buying a, you know, liquid index, and then alpha is an outsized return or earnings earned from some type of inefficiency that was captured by the manager to create an excess return.
That, at the highest level, that's what it is, and the reason you're hiring someone or going into an alternative investment, in my mind, is you are trying to find those managers that can create excess returns over a market return that you could just go buy for almost no cost at all, um, and, you know, obviously that, that excess return needs to be on a net basis, you know, can they, can they get me, minus their fees and everything else that goes into it, can they create an excess return, and so that's kind of that, That bullet point on the upper right there is talking about, you know, okay, once I understand what generated it, it's like how much of that was, you know, manager selection and how much it was just the market.
You know, sometimes you'll see that a lot in long, short hedge funds and a lot of other hedge fund strategies. The market just went the right way, and so they benefited. You know, obviously, long short guys have not been having that in their favor. They haven't had dispersion in the market between longs and shorts, so they've been suffering more than not.
But, um, something to think about there is, you know, yeah, I mean, you can Google, Alpha, and Beta. You know, like I said, you'll see lots of different definitions, but that's sort of the high level. Um, at the end of the goal, you're trying to understand and assess through performance measurement and attribution is, you know, how much was skill?
I want to work with someone that has some inefficiency that they're taking advantage of, and they have an edge to capture that on a repeatable basis. That's what you're trying to assume through this, uh, you know, through this attribution work. You're trying to discover what is that edge combined with the inefficiency that is that manager's skill or network or, um, they have a unique model, they have some type of informational advantage, something that's allowing them to achieve that excess return, that alpha, on a repeatable basis.
Um, and I know that some of the smaller funds, you might have trouble because some of these, some of these guys don't really understand their own attribution. Um, that kind of scares me, but the manager should have these numbers. This, this should be, this should be something you should ask for and they should be able to break it down.
Um, and you should be able to understand, hey, where were these returns generated? And sometimes it's super simple, like, you know, you got, you know, a venture debt fund. It's like, okay, well. Hey, I've got back-end warrants and I've got income collected off the debt. Okay. Well, how much was there? I mean they should be able to break that down for you.
They should understand that, and you know the monumental level of detail if they can't explain it. That's a problem. Yeah, they don't understand how their ship's running.
Brendan: Yeah I think a big, a big thing I see in a lot of managers is some managers and issuers will come to us and they have tons of data in their space, um, and, and, you know, it's, it's very, a data rich environment where they can compare themselves quite heavily, and they can quite quantify, you know, the inefficiencies that they're going after, and sometimes we'll get investors where they're performing quite well, but they're more mom and pop style.
Um, you know, they don't have nearly as a professional grasp of all the numbers. Um, but they can, those mom and pops can continue to do quite well, but other more sophisticated data hungry type competitors might come in and try and leech off their performance. And that seems like a constant battle with a lot of our issuers.
You know, there might be like a hot space and then all of a sudden, a lot more investors and funds and managers start all piling into it in euphoria. And, you know, those managers that are more, um, maybe numbers oriented or better at attacking those inefficiencies will slowly win out over time. And then they kind of crowd out, um, you know, the managers that cannot adapt and continue to perform.
Chris: Yeah, no, I mean, and with this said, being a small manager and had invest in, invested in small managers, you know, working for other shops, you know, just 'cause they don't have it doesn't mean, you know, they're doing something wrong or something's up. I, I mean, I, I think people just get really hung up on like, oh my God, I'm hunting for frauds.
Um, not everybody knows how to think about all this stuff.
Brendan: Um, you can look at our due diligence webinar in the past. That's very good. If you wanna go into that topic.
Chris: Yeah, exactly. Yeah, I mean, it's. It's, you know, it's, it's, there's a lot of education, not only on the investor side, but on the, you know, the, the small and the, and the new emerging manager side as well.
Um, but the last phase is analysis. Great. I now understand how everything's generated. I understand the story. Great. Now can we all take this puzzle and create a mosaic that now I've got all the pieces, and I can understand, hey, does the say match the do? And as I said earlier, this is literally the step that we found more shady managers and frauds in that process than any other due diligence aspects, business or operational.
This is where you've really, once you understood the trade, you understood the numbers, and you just, you apply logic. Don't try to outthink yourself. If you can't understand it or something just doesn't make sense, probably has something wrong with it. So, either get your questions answered or walk away and find the next fund.
Um, it's really as simple as that and you'll hear me say this time and time again in due diligence. Before you even start due diligence, you should identify a series of non-negotiables, like things that you just like. If a fund does X or I see X or Y, I'm just done. Otherwise, unless you like really reading 80-to-100-page PPMs and really diving in and, you know, torturing, uh, yourself and managers, um, great, that, that's what you can do.
But if you're, you know, this is new to you and you're looking to like, how do I best get this done, uh, in the most effective way, knowing that, you know, I already worked. 10 hours today. Um, you know, these are the things you have got to think about ahead of time. Uh, and this is that next level dive of once you invented those non negotiables for you, and you've found the fund that you have a passion about, this is that 200 level analysis.
You completed your 100 level, identified the fund, this is your 200 level to 300 level analysis of let's dive in and really start tearing this person apart and understanding how it ticks. Benchmarks. We talked a little bit about this earlier. So, um, we'll just kind of run through. Um, it is. Very complicated.
Uh, like I said, uh, I've had people come to me and say, hey, can you do a whole webinar just on benchmarks? I created something and I realized, Oh my God, it's like a class. It's not a 45-minute talk. Um, you know, you're trying to find relative performance. That's what you're trying to get at. You're trying to understand, like we'd said earlier, you know, how much of it is beta.
Or is this manager producing value, um, relative to a best, best fit benchmark? Now, I'll be honest with you, best fit, you can see that's, that's a statistical, um, you know, phrase that says, okay, great, I've run a series of regression analysis, and I've understood that these indices as a combination, they're all public, let's say, so it's an investable benchmark.
Um, I can actually put that together and have a really a best fit and run that as a comparison against this manager. It's what we used to do on hundreds of managers. It is not an easy task. That is not what I’m going to dive into today by any means because that is a lot of math. Um, and you've got to have access to a variety of different indices, a lot of it you can get publicly.
Um, you know, but If you happen to have access to a Bloomberg or something like that, well, that's where we used to get, you know, over a thousand different indices to compare across, you know, hundreds of different, uh, alternative investments, um, to find investable, you know, best benchmarks and create custom benchmarks for assessments.
Um, and that's, that's, that's what benchmarks are for. They're super important. Maybe more applicable to, you know, your work as, you know, a small family officer or retail investor is more, hey, let's come up with a benchmark of, you know, instead of owning something traditional, like, I'm just going to go buy the Bloomberg Ag or some REIT (Real Estate Investment Trust) index.
How does this compare to, you know, you know, this manager, how do they compare to those indices of, you know, what would my portfolio look like if I add this alternative manager to this portfolio and, and do they create an excess return over, you know, an index that's easily purchased and relatively cheap?
Um, that's probably a more applicable. Um, aspect of benchmarks, um, rather than saying, I'm going to go in and get extremely mathematical about it and break down alpha generation over time for a variety of different strategies. You know, you got a multi manager in the hedge fund space. They got seven things going on.
You're running seven multivariate regressions to find the best fits and then understanding what generated positive or negative impact to the portfolio for all their trade, you know, silos. I mean, it gets pretty heavy, and that's not where we're going, and that's not where I want to dive, but I just wanted to mention, you know, that's where the bigger shops use benchmarks and math to kind of get to that idea, so you can apply that mentality to this assessment without having to, you know, really do the math.
Um, so, um, differences in assessments, um, we've kind of hinted at a lot of this as we've gone through, um, you know, you know, it's, it's methods of assessing, you know, hedge funds, venture, single asset, real estate. They're all, they're all different. You can't say, I'm going to go look at a real estate syndication and use a lot of the same mentality to go look at, Secondaries and Venture.
You've got to understand what you're looking at, understand what makes that tick and change how you're assessing that performance and the performance numbers. Obviously, they're going to, they're showing you are going to be different as well because they don't use a lot of the same ratios and the same performance measures.
So, you've got to look at, well, what investment type am I looking at? And how do I need to change my performance assessment to meet that investment type? Um, investment styles. I mean, high turnover versus long hold. Well, okay, that, that creates a very big difference. It's like, well, if I've got a low latency or high quantitative trading, well, okay, there again, that's going to lead me to a different view to performance than I've got a long only manager that's specializing in, you know, small cap tech.
Okay. Um, you know, set, set your sights in line with the fund you're looking at because they will create very different, um, performance assessments and also very different, you know, benchmarks. Um, and here again, it all comes down to a little bit of who you are. Individuals are going to look at the world differently than, you know, maybe a multi-billion-dollar fund to fund that.
You know, I had endowments and pensions as clients, or you're a family office. A lot of family offices, um, they have very different objectives. You know, just not all family offices are on the same path, nor are they looking for the same thing. So, if you run a family office, coming up with your performance assessment and how you're looking at the world might be totally different than, you know, a doctor who's looking at their first alternative investment, you know, and endowments and pensions.
They're in their whole nother world of how they look at things because, well, they're immortal. They have an infinite lifetime. So, for them to look at an investment that is going to be around for 30, 40 years, well, okay, that actually works for them. Um, but it creates an entirely different assessment profile of performance and what they're willing to take into their portfolio.
Um, so just understand what bucket you sit in, understand the investment type you're looking at, and understand some of the nuances that can change how you would look at it. Like I said, you know, high turnover versus long holds, and there's lots of other, you know, scenarios in that as well.
Brendan: Um, I think a good part is I think if you're a lot of our clients struggle with thinking about their performance and they also struggle, um, to like imagine their whole portfolio. So, if they have like high-risk equities on one side, and then they were placing something like lower risk, and they're like, hey, I want to go into Rocket Dollar and do something high risk as well. And, you know, we don't give financial advice here, but it is just a very good idea to make sure your performance goals and your risk goals line up in your overall portfolio. So, if you're like a 70 30 person or whatever, or you're like a 90 10 person, try and at least, you know, if you have to work with a professional or work with an advisor to recreate that same risk level in your alt's portfolio. You don't want to go into alts and just totally skew off your risk level just because you get excited about one or two deals.
So, know how doing Alt's deals, which are not very liquid, might skew out your portfolio over time. You might have to adjust back.
Chris: Yeah, it'll definitely affect your liquidity profile. And I mean, I always tell people in Alt's, um, there's three things you're looking for. One, I'm looking for a return enhancement for whether it's equity or fixed income.
I'm looking at a risk diversifier. I'm looking at something that's not, you know, as volatile and, you know, that can appear both in equity and fixed income as well. And sort of the golden grail, the holy grail is like, well, um, can I find something that's doing both? Can I find something that actually is a return enhancement in my portfolio, say fixed income, but is also a diversifier of risk, not only within the bucket of fixed income, but perhaps an impact across the entire portfolio. Um, and you know, one of the things that we've definitely seen as thanks to the Fed and their massive rate increase and, you know, the shifting of where, you know, some of the pain and suffering that comes in the equity world, and we all saw this in, you know, 2022, where You know, fixed income had its worst year in history, uh, due to these moves.
And one of the other big problems that affected portfolio managers on a professional level was, wait a second. All that diversification aspect that came from being in fixed income, that went right out the window as well. All of a sudden it became very correlated, everything was going down, and you were getting punched from multiple sides.
Um, and now in the alternative space, you're like, wait, you know, maybe I want to look at private equity because historically it's outperformed public equity. So that's kind of a little bit more of a return enhancement. Um, but on the fixed income side, well, wait a second. I mean, I can go get 5, 6 percent or 7 percent in a, in a basket of, you know, govies and corporates, uh, you know, maybe a mix of high yield.
But also, you can look at venture debt, real estate debt, corporate debt, you know, there's a lot of other alternative aspects that all of a sudden, you know, these guys are putting up high single, if not double-digit returns, yet they're not taking a lot of volatility. So, you've got this unique occurrence right now for a lot of people to look at, uh, private debt and go, wow, I can actually kind of get a twofer.
Uh, I can get a return enhancement over my other fixed income investments, yet I can also find things that are not highly correlated to the other fixed income that I own the other, you know, say REITs (Real Estate Investment Trusts) or ETFs or other things that you own that are income generating or even across into, you know, the equity portfolio.
So, the dynamics of what you're creating for a portfolio, you know, right now are pretty interesting. Um, you know, if you've got the time to do the homework and find, find, find the, uh, find the investments, um, we talked a little bit. I'm not going to dwell on this. This is, these are some just return ratios I had mentioned earlier.
Um, obviously a lot of you are probably well aware of the return on investment. The very popular risk adjusted return of, you know, return over standard deviation, the Sharpe ratio, trainer ratios, information ratios, um, you know, one that we used a lot institutionally was the information ratio. If you've got a really clear method of forming benchmarks for yourself, well, you can now then take the return beyond a set benchmark over a standard deviation, um, and a relative standard deviation of the benchmark, and you can assess, well, Hey, if I can actually, I really have a positive information ratio, it's an indicator of, uh, alpha generation of a particular strategy. Um, so that's one of the ones that I threw in there and I used. But, um, you know, it takes, takes a little bit of data and access to the information to kind of create that ratio. But, you know, they, they, they can be helpful if you've got the data and the time and that's the thing that you're looking for to kind of be that icing on the cake of a decision of, you know, hey, I'm, I'm going to make this investment or not.
Um, you know, I want to talk a little bit also, um, because this does affect returns in the performance measurement, uh, is leverage. It's uh, I know everyone is very, very anti leverage, especially when things get difficult. Um, you know, because it is a double-edged sword. It swings and cuts nicely in front of you, but you can also plant it right in your forehead.
Um, if it turns against you, which, you know, a lot of people in the multifamily syndication world are learning that lesson for the first time because they've never seen this before. Um, they didn't, you know, they weren't around in 08. Um, they were, they're new to the idea of using leverage and they got a little out over their skis.
Um, it happens. Um, but leverage in itself is not necessarily a negative thing, but from a performance measurement standpoint, you need to understand how much they're using and what was the impact of what was generated, you know, by that leverage. Um, there's also another, uh, aspect that I always say it's people always think about the math and the impact of the return, both positive and negative, the use of leverage.
There is a further risk to the use of leverage, and it falls more into the operational due diligence side. When you take money from an institution, uh, you are, that's now your business partner, so they can have something idiosyncratic happen to them that's really bad, had nothing to do with the manager, and the manager can suffer due to the use of, you know, they took their money.
Um, I'll give you a perfect example. Um, I'm, we borrowed money, billions of dollars from a large French institution, um, you know, back in 06, 07, and we hadn't done anything necessarily wrong, but they called up in late 08, uh, and said, hey, I'm going to need my, my 2 billion back. Okay. That's a material problem for us is we now have to think about unwinding and finding new counterparties to maintain our business.
Yet we didn't do anything wrong. Um, so that's another thing I'd just like to mention about leverage is make sure your manager understands the use of leverage. Why is it being used, and do they assess, and have they done their research on the counterparty that they took money from? You know, is it highly rated?
Are they relatively stable? Are they taking money from somebody who's got balance sheet issues? That's a big problem because they've got
Brendan: All of that term, in the last, uh, two years,
Chris: so. I'm sorry, what was that?
Brendan: Uh, the crypto world, every single crypto investor, whether they're sophisticated or not, knows what counterparty risk is.
Chris: Well, it's good, because, um, it's been a while since it was a big issue, but that was the big issue in 08, 09, was understanding counterparty risk. It's like, holy moly, what is this? I didn't know I could get blown up for somebody else's mistake. I didn't do anything wrong. Yeah, well, it doesn't really matter.
Um, so that's something that I would definitely make sure you're assessing that when you're looking at performances. Well, okay, how much of that return is attributable to leverage? And I always like to ask, can this strategy actually meet my expectations without leverage? So, it's something to think about if a strategy requires leverage to meet my goals.
It doesn't mean a no, but it definitely, you know, for me, it puts it in a different bucket of like, well, wait a second, these guys need to have leverage to meet what I need or what I expect for this type of risk I'm taking. Um, so, um,
Brendan: Right about the top of the hour, a few minutes left.
Chris: Yeah, that's great.
We're coming to an end here. Um, this is what I mentioned earlier. Um, we're in a new realm. Uh, Inflation is here to stay. I think if anyone reads the news even this morning, it's here to stay for longer than we think and it's going to be at a higher level and that's fine. We're going to have rates that are at a higher level.
So, as an investor, looking at performance, it's okay to understand gross. It's good to look at gross from a standpoint of, hey, what's the whole fund make? Okay, well, net of management fees and everything. Okay, what does that look like for me then? Net of fees. Okay, are they gouging me or are they in a line with me?
Does that make sense? Does that match other investments? Okay, now we've got this new, you know, for me personally, it's like, okay, now I've got inflation. Um, you know, what is that going to mean? What is my return into? And like I said, I even work with family offices that take it one level further and say, well, okay, I got to understand tax efficiency of my investments.
And so, what's my after-tax return? So, um, if you're one of those guys, um, I get it. Um, oh, there was a quick little, uh, bit about, you know, I mentioned it a few times, you know, I do run the Kirkland Income Fund. We do, you know, private debt in real estate. Uh, we run a portfolio of, uh, you know, Mortgage, uh, Mortgage Loans on Commercial Real Estate in the Microbalance space.
Um, if you're interested in something of that nature, please, you know, reach out. Love to talk to you more about that. We think it's a super inefficient space and, you know, we've been doing that for now going on four years and it, it's, um, it's been a, it's been a, been a, been a great space and generated some really great returns without having to take a great deal of risk.
Um, there's a QR code. Um, we put that on there so you can scan that, you can download the deck, if for some reason you're having trouble with that, obviously you can reach out to me or Rocket Dollar, we have access to the deck, we can get that in the hands of people, and um, I just want to thank you everybody, and um, yeah, that's the last slide, so if there's any questions or anything else we want to cover, or Brendan, if you have, you know, some other comments, um, Yeah, Thank you for the time.
I mean.
Brendan: Thanks for coming again, Chris. I am posting, um, uh, the old other old webinars we did with Chris. Um, I always think they're good. If you enjoyed this 1, 2 to do the trifecta. of them. Um, and thank you so much for coming, Chris, and giving us another great talk.
Chris: Thanks for, thanks for having me. Um, you know, I, I love this stuff.
It's very important. I always tell people the best weapon I can hand you is education and the way to think about things. Um, and you know, if you want to carry it to the next level and have further questions, I would love to chat with you.
Brendan: All right. So, this is, um, I'm going to stop the recording now. I'm going to put this up on YouTube.
Um, if you'd like to share it with anyone, you can feel free to send that over, uh, on YouTube or it'll be on the Rocket Dollar resources section. We have all our webinars and also, you know, other blogs and really all the other content that we post. We kind of put it in one section on the resources page and then YouTube, we put it simply because it's super easy.
One click, you can get there as quickly as possible. Thank you, Chris, for stopping by today.
I appreciate it.
Chris: Thank you. Thank you, everybody.
