During the December holidays, I watched an interview of Michael Vranos of Ellington Management. He’s often labeled as a structured debt wizard.
I’d encourage others to watch it to better understand the complex chessboard that is the structured securities market and how its complexity allows for so many ways to play during different market setups. It’s a game that I won’t play, or rather can’t play, but interesting to know about nonetheless.
What I found exceedingly interesting was how he framed up the business model differences of a liquid securities fund versus an illiquid private asset fund. Vranos likened the former to selling a put whereas the latter is figuratively like buying a call. How so?
During major drawdowns, liquid fund LPs utilize these allocations for liquidity because they either need the money or lose faith in the strategy due to the deeply discounted marks. Yes, these funds may have gates and other mechanisms to prevent capital flight but at most they are a few years. Rarely to fund managers have the LP base to increase capital when the going gets tough. Furthermore, a few years of underperformance can also trigger this downdraft on AUM.
In contrast, private asset funds typically have locked capital until they deem it fit to sell companies (e.g., 7-12 years). The investor agreements often also have clauses that force LPs to contribute capital if the manger deems it necessary or risk their stake getting diluted with a penalty (and bonus for those that do contribute).
To that end, I find it important to consider these business model differences as an LP, as well as when considering an investment in the GP (e.g., Sculptor Capital vs. TPG, for example).