MDPLX: A Genuinely Alternative Asset

Whether they believe it or not, nearly every active manager claims there’s something unique in their special sauce that will allow them to consistently produce alpha over the long-term.

Our view, supported by a mountain of academic studies, is that the promise of alpha is generally a misleading sales pitch that most investors have failed to adequately scrutinize. While there indeed have been funds that have been able to consistently produce alpha in specific market environments, or when their fund size remains small, or by cheating, none have been able to meet the important criteria of scalability or long-term viability. One breed of alpha peddlers, however, has had more success than any other in perpetuating the myth of alpha: private equity funds.  

There’s no denying that reported private equity returns have, broadly speaking, been stronger and more consistent than those of public equities. That said, PE cheerleaders who say this trend is destined to continue have failed to acknowledge two key sources of the asset class’s supposed outperformance. With a tailwind near-zero interest rates for two decades, PE returns have been heavily juiced by leverage, or as we like to call it, the veiled selling of downside protection against tail-risk.

Put another way, private equity has been racing faster than the cars around it on bald tires without spares.

Without any nails on the road in the post-Great Financial Crisis world, PE was able to establish itself as the go-to asset class for alpha generation.  

Under the new interest rate regime and the dramatic slowdown in deal volumes, the PE complex has been forced to adapt its marketing strategy from one that emphasized earning excess returns to one that highlights a resistance to outside market pressures. By most accounts this sleight of hand has been a success. Private equity continues to be perceived as the low-risk and low-beta asset class even though PE-backed companies are almost always more levered than comparable public firms. The average buyout transaction in 2021, the year before the Fed began its current tightening regime, had a leverage ratio of a whopping 7x debt-to-EBITDA. Despite this, the belief somehow persists that private equity valuations should fluctuate less than their less-levered public counterparts. As risk managers, we can’t help but sound the alarm.  

We’re nostalgic for the time when the illiquidity and lack of marking-to-market associated with private equity investments was considered a flaw of the asset class. More recently, with amplified volatility in public markets, this once widely acknowledged flaw has been rebranded into a feature. In a late 2022 publication, Institutional Investor went so far as to argue that sentiment driven fluctuations that exist in public markets result in “frivolous” pricing compared to the more objective, informed, and long-sighted nature of PE valuation methods. An impressive level of mental gymnastics is required to reach the conclusion that pricing in public markets is somehow more emotionally driven than it is in private markets. We think the opposite. Every PE manager we know tends to talk about portfolio companies as though they’re his or her own children.  

In an entertaining article from one of our favorite PE critics, Cliff Asness aptly coined the term volatility laundering to underscore how absurd it is that PE fund managers, when discussing valuations of their assets, can tell their investors with a straight face that the public markets are flat out wrong. Those of us who operate in public markets wish we could enjoy such a luxury. In other cases, private fund managers have resorted to limiting redemptions as another means to preserve a facade of stable and predictable returns. In June 2023, Blackstone’s BREIT received redemption requests of $3.8 billion and only fulfilled requests worth ~$628 million, amounting to a mere 1% of the fund’s net asset value.  

Investors who value risk management and have an appetite for a smoother, equity-like return profile can look beyond private equity and find a safer and more suitable alternative in MDP.

With our proprietary four quadrant strategy, our goal is simple: to provide investors with S&P 500 returns with 35-50% less volatility. Our investors benefit from liquidity, transparency, and genuinely predictable returns in a vehicle that is both scalable and sustainable. What separates MDP from others who employ options-based hedging strategies is our differentiated, disciplined approach to portfolio construction that was born out of decades of experience building efficient hedging strategies for our clients.  

Please reach out to us if you’d like to learn more about MDPLX. 

To explore how your portfolio may benefit from efficient and liquid hedging strategies, contact MDP CIO/CEO Dennis Davitt today at 828-499-7223.

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