10 East

A membership-based investment firm is a somewhat novel concept, here’s where we fit in the broader financial services ecosystem: High-quality access to private market exposures is resource intensive—it requires a dedicated team and institutional resources. Informal channels (investment clubs/personal networks) without a dedicated team often lack the requisite risk controls and due diligence procedures that these markets demand. Traditional private market access channels tend to exhibit scale and product bias, focusing on large funds that are in scalable categories due to the sheer size of their client base (and in some cases short-term pressures from shareholders). An inherent tension can exist between investment performance and asset gathering, hence the importance of aligned interests. This market dynamic leads to opportunity in capacity-constrained, below the radar exposures where there’s less competition (examples include litigation finance, aviation finance, niche funds, opportunistic one-off deals, etc.). For select institutions and individuals, 10 East is an access channel to these exposures, in a structure where members have complete flexibility by co-investing at their discretion alongside our principals and partners. It’s akin to having a family office, but without the headache/resource intensity. 👉 : https://app.10east.co/

In private equity, 6 firms control ~25% of industry assets under management, “the Big 6,” all of which are publicly traded, with multi-decade track records, and have institutional brands. And with PE’s market consolidation trend not seeming to show any signs of deceleration, I was curious to understand the effect on LP returns. From ’98 to ’09, 64% of Big 6 firms outperformed the industry benchmark (i.e., the Big 6, for the most part, outperformed). However, from ’10 to ’21, only 38% of Big 6 firms outperformed the industry benchmark (i.e., they largely underperformed relative to the broader asset class). Hard to tease out causality—particularly when private market data is rife with biases—but here’s a few thoughts around what might explain relative performance erosion for the Big 6: Risk aversion; being public subjects Big 6 to greater regulatory and public scrutiny. Preservation of reputation and brand rises in priority stack relative to pure performance optimization. Scale/market dynamics; law of large numbers counterweight, more competitive market, less agility, more bureaucratic, etc. Cost structure; becomes uneconomic to focus on sub-scale deal flow/sectors, constricting focus to certain market bands. In theory, the Big 6’s performance should have less dispersion going forward relative to smaller industry players. One could then make the argument that their return profile is similar on a “risk-adjusted” basis. Will be interesting to see how this evolves over time with major growth in private markets—suspect we may land in a place where Big 6 and emerging/niche exposures are more complements than substitutes.

Big news! We’re thrilled to share that Canoe has successfully closed a $36 million Series C funding round, led by Growth Equity at Goldman Sachs Alternatives with participation from existing investors F-Prime Capital and Eight Roads.  This milestone marks a significant step forward for Canoe, representing a more than 3x increase in our valuation since our series B financing round last year. This funding will enable us to accelerate our strategic initiatives, global expansion, and the continued development of our core AI-driven platform for alternative investors. Read the full announcement here: https://hubs.li/Q02FNK8q0 Goldman Sachs Asset Management

The asset gatherer flywheel: 1. Strong early performance in core competency 2. Scale core competency (slightly dilutes performance but accretes brand value) 3. Leverage brand value to expand across sectors (o.k.a style drift) 4. Solve for recurring revenue structure (shift % of fees from performance-based to mgmt.) to maximize EV of management co. 5. Monetize management co. End result is diluted performance w/ lower dispersion. LPs should consider what GPs are solving for and the relative impact on the risk/return profile of underlying offerings.

The denominator effect is leading to an acceleration of non-economic selling in private equity. We’re focused on strategies where there’s an attractive entry point via a substantial discount, interim cash yield, and strong fundamentals in overlooked corners of the market. The resulting risk/return asymmetry reflects a compelling arbitrage opportunity.    Learn more about how we’re playing this theme here: www.10east.com  

In our latest piece we discuss key person risk in private markets - with recommended LP diligence practices to assess specific risks and protect investors in the event of key person departure(s).

The ‘democratization’ narrative in private markets has been shrouded as an innovation problem that can ostensibly be solved with net new tech enabling broader access. While tech is certainly needed to minimize the significant operational and executional friction associated with investing in private markets—it’s not the root cause. Access barriers to private markets are predominantly driven by regulation and incentives. In the past year, ~81% ($2.1 trillion) of all private capital raised via the Reg D exemption (by far the most common) were by funds exclusively available to “Qualified Purchasers” (>$5M in investments).* Why? Limiting an LP base to QPs is less constrictive (effectively uncapped raise), lower cost (compliance, operations, etc.), and, generally, the ‘headache minimizing’ path of least resistance. Conversely, including non-QP investors in your LP base incurs incremental costs, a hefty regulatory burden, and, operationally, introduces greater complexity. The market structure and incentives are such that most high-potential GPs/strategies are then likely to restrict their funds to QPs…and, resultingly, capacity-constrained opportunities w/ strong or oversubscribed demand are highly unlikely to be made available to non-QP investors. As access to private markets continues to broaden, investors should be cognizant of the spillover effects of regulation/incentives on the investment opportunities they’re considering. The broader trend where retail investors have somewhat limited access to private markets through interval funds, tender funds, NTRs, etc.—scalable, evergreen strategies—is likely to persist, barring any major regulatory changes. Adverse selection can be a cruel beast.  

The paradox in investment management is that strong performance begets a larger asset base, which, in turn, is more likely than not to dilute future performance. This trade-off stems from the fact that raising larger funds and scaling assets vs. solving for performance is fundamentally more attractive from a business model standpoint (contractual revenue less tethered to performance lumpiness, etc.)…follow the incentives. Berkshire Hathaway provides a decent frame of reference (albeit imperfect) whereby stratifying performance by total assets highlights diminishing excess return as their capital base has expanded. Increased scale will generally have the benefit of buffering dispersion—though this may not matter so much for certain investors. "It is obviously true that if you have a smaller amount of capital, you have a bigger universe of opportunities. It's also true that large amounts of capital can act like a handicap."—Charlie Munger

Our Founder and Principal, Michael J. Leffell, on common red flags to look for when vetting potential investment partners. Listen to the full episode of Capital Allocators with Ted Seides at the link below or on your preferred podcast app. https://lnkd.in/esBF_gYX

Over the past several decades, private equity returns have been disproportionately driven by leverage and multiple expansion. Today, these markets are fundamentally different—more robust, more competitive, and thus, relatively more efficient. Looking forward, we expect to see a transition where performance is likely to be much more driven by value creation (specialization, hands-on execution, etc.).