Much ink has been spilled amid the drama of Blackstone’s BREIT outflows. The long story short is that BREIT (along with other non-traded vehicles) has powered Blackstone’s fee earnings over the past 3 years by promising investors stable yields and total returns by shoveling money into real estate’s hottest sectors (multifamily, industrial, etc.). It worked for a while, until public markets dumped in 2022, and comparable publicly traded real estate vehicles traded down 20%+ while BREIT curiously posted positive returns. Investors balked, and withdrawals started.
I like the legacy alternative asset manager business model a lot, mostly because it is a high return on equity business, requires little or no leverage, trades relatively inexpensively, and most importantly, has benefited during times of duress in the past. Alternative asset managers are one of the few business participants that have the ability to invest large amounts of money at the bottom of a cycle without having to explicitly overcapitalize their balance sheet (reducing returns to equity) during good times. This is because their customer base and funding base have largely been gigantic institutional LPs. These LPs have a constant stream of incoming cash to invest with less sensitivity to prevailing market conditions. And they are willing to agree to contractual commitments to fund capital calls even if market conditions materially deteriorate from when the contract is signed.
It is really powerful to have long-duration capital when capital has disappeared from the market. And growth into the non-traded REIT/BDC market trades that feature of its institutional LP base for the opposite among retail HNW investors. Thus if you follow me on Twitter, you’ll know that I’ve been negative about Blackstone’s business model quality for some time.
HNW investors, for the most part, react similarly to small-ticket retail investors. That is, they deploy the most capital at the top and generally withdraw it at the bottom. As an asset manager, that makes one’s business pro-cyclical vs. more all-weather.
Public companies exist to grow earnings. Today, companies that have limited growth runways and are solidly in the “cash cow” portion of their lifecycle get little love in the public markets. The implication is that companies are incentivized by investor preferences for growth to chase growth. In the case of asset managers, Blackstone and its public competitors have taken the red pill of growth in HNW channels, diluting their somewhat all-weather institutional funding base. During good times, the results have been nothing short of dramatic. However, given today’s market turbulence and uncertainty, the negative implications are on full display, with management playing firefighter to a barrage of negative press.
Other asset managers have taken different approaches in the past to mitigate the liquidity vacuum created by HNW investors during bad times. For well over a decade, Brookfield has used publicly traded vehicles to access the retail market. One can purchase a slice of its private equity, climate transition, renewable energy, or infrastructure funds with the click of a button. And by and large, it has worked well when the public narrative for the specific sector is positive. However, where the narrative is negative, Brookfield takes the public stock egging that many argue Blackstone’s BREIT is not showing up for but deserves.
Take Brookfield’s private equity vehicle as an example (Brookfield Business Partners). It holds classic PE targets, namely companies with low revenue volatility, modest growth, and high cash generation, which support strong amounts of leverage. Today, the vehicle trades at a nearly 50% discount to Brookfield’s estimated break-up value.While I’m not here to argue Brookfield’s assertions, they illuminate the discrepancy between the manager’s opinion of value and that of the public market. I’m inclined to believe that the private LPs invested in Brookfield’s private equity portfolio are receiving quarterly marks that do not match the publicly traded sleeve of the vehicle.
Furthermore, take Brookfield’s former publicly traded real estate vehicle as another example. It owned a large number of premier office buildings and purchased the second largest mall company in the United States. Both sectors sport narratives that have been highly out of favor with both retail and institutional investors for years now. Accordingly, the stock traded at a persistent discount to Brookfield’s estimation of NAV, and Brookfield ultimately used its balance sheet to take the vehicle private. No doubt, this outcome was a failure of its retail vehicle due to the difficulty in selling an attractive narrative in offices and malls (among other serious issues with the vehicle).
While most of my thoughts regarding pursuing HNW are largely negative, it doesn’t have to be all bad. At the end of the day, investing is about matching unique opportunities for excess returns with the right amount of capital. BREIT seemingly set an unlimited budget for investor inflows and entity size, reducing the “intellectual edge” of the fund (or alpha capabilities) to sub-industry beta selection (multifamily, industrial, etc.) versus a real estate index.
Brookfield’s now private real estate vehicle was similarly an office and mall sub-industry beta play. Is it possible for a non-traded vehicle to be a truly unique vehicle predicated on contrarianism, opportunism, or complexity (read: an alpha vehicle)? I think yes, but it must be size constrained to match a presumed consistent set of alpha opportunities—a strategy that is inherently capital-limited and does not support dramatic asset manager growth. Unfortunately, there is far more growth potential in sub-market beta selection, because of its ability to absorb massive amounts of investor capital.
This commentary ultimately aims to make the point that alternative asset managers have started or are well down the path of trading their advantage, all-weather funding, for the growth and fee potential of a pro-cyclical funding base. While I have primarily mentioned Blackstone, virtually every alternative asset manager is pursuing or has pursued copycat vehicles. Furthermore, these alternative asset managers consistently outline a low retail wallet share as a future opportunity. Looking forward 10+ years, if alternative asset managers succeed in penetrating this large “market opportunity,” one has to be aware of the change in funding base and thus style drift (towards universally attractive narratives that can absorb massive amounts of beta capital), which ultimately may result in lower business quality.
They may make today’s alternative asset managers look slightly more similar to today’s mutual fund companies, the black sheep of the finance industry, versus the barbarians at the gate of the past.