– Andrew Macken
“…Big picture, as you know in asset management, we’re seeing on the liquid side, a lot of movement into ETFs and passives because they’ve outperformed… On the other end of the barbell, big movement into alternatives, again because our performance has been really strong, which is the Blackstone story. That is what underpins our success…”
– Blackstone COO, Jonathan Gray, 4Q19 conference call
CORE-SATELLITE PORTFOLIO CONSTRUCTION
One of the undeniable trends in the world of investing is the ongoing shift to “core-satellite” portfolio construction. Under this philosophy, a portfolio constructor will combine the characteristics of passive index funds (forming a “core”) with those of actively managed strategies (i.e. “satellites”). This “barbell” combination is carried out within each asset-class in said portfolio, as illustrated by the example below.
Three Key Steps to Core-Satellite Portfolio Implementation – Example
Source: Vanguard
The primary benefit of the core-satellite approach is cost savings for the owner of the portfolio. These cost savings are typically generated by the core. The rationale is that investors should not be paying active-manager fees simply for “beta” which can be extracted at very low costs today through passive index funds. Indeed, active-manager fees should be reserved for those active strategies that form the satellites around the core – those which are striving for true outperformance, or “alpha”. All of this is fair and logical.
AN EFFECTIVE SATELLITE
The characteristics of an effective core strategy are straight-forward: very low-cost and extremely diversified to ensure the target beta is achieved. The characteristics of an effective satellite strategy are less obvious, however. Below are three of the key attributes that we believe should be exhibited by all satellite strategies.
Alpha generation (or outperformance)
This is the primary value proposition of an effective satellite strategy. If the investment process of the underlying satellite strategy is not expected to deliver significant alpha, net of fees, over the medium and long term, then the strategy in question cannot be deemed an effective satellite strategy.
High-conviction
Significant diversification is the enemy of an effective satellite strategy. The higher the diversification of any given portfolio, the more it starts to behave like a core strategy that targets beta, rather than alpha. And as most would agree, paying active-manager fees such an approach makes little sense in a world in which core passive index funds can deliver beta-like returns at near-zero cost.
One way to measure portfolio conviction level is the average size of each holding. In our simple minds, an average holding size of 4-10% is truly high conviction. Strategies with many more holdings of a materially smaller average size fails to satisfy this criterion for an effective satellite strategy.
Satellite complementarity
Any satellite that is added to a portfolio should indeed complement the satellite strategies that already exist within the portfolio for that particular asset class. There are a number of dimensions across which complementarity can be evaluated. These include: (i) geographic; (ii) sectorial; (iii) style; (iv) size spectrum; and/or (v) correlation of returns.
BLACKSTONE: A PLATFORM OF SATELLITES
In 1985, two former Lehman Brothers bankers, Pete Peterson and Steve Schwarzman, started a new M&A advisory boutique called The Blackstone Group. Some 35 years later, Blackstone’s business model has evolved to become a platform of actively-managed strategies across a range of asset classes, including private equity, public equity, credit and property. Across these strategies today, Blackstone manages a staggering US$571 billion in assets, up by US$100 billion over the preceding 12 months.
Source: Blackstone
Blackstone’s vast array of non-core strategies across the major asset classes serves as a complete menu of satellites for selection by portfolio constructors. As Steve Schwarzman said on the company’s most recent conference call with investors: “With different return characteristics, Blackstone can become a single stop for limited partners…”
And perhaps surprisingly, Blackstone’s total addressable market still remains enormous and significantly underpenetrated. While there are around US$6 trillion in “alternatives” today – which includes hedge funds and private equity – this pales in comparison to the US$170 trillion out there in institutional, retail and insurance investable assets. As Blackstone has arguably become the global gold-standard for satellite strategies across all major asset classes, the prospects for continued growth in share of global investable assets remains bright.
A SUPPORTIVE ECONOMIC ENVIRONMENT
The business model of Blackstone, like all asset managers, is based on percentage of assets. The more assets from inflows, the greater the company’s revenues. And, of course, the company’s revenues also grow as asset prices rise. It is an incredibly valuable source of revenue growth that obviously requires little, if any, capital investment to achieve. Few business models exhibit such a highly sought-after characteristic.
And we believe there is a genuine case to be made for interest rates remaining lower for a much, much longer period of time. As articulated in our recent whitepaper: Low Rates, Assets Inflate, we see the structural drivers of long-term interest rates – including demographics, indebtedness and technology – only continuing to exert downward pressure on long term interest rates. And under such a scenario, asset prices are likely to continue to inflate – perhaps at an accelerated rate.
* * *
We believe that Blackstone is one of the world’s most valuable asset management platforms, which we believe remains materially undervalued today. Indeed, at the current share price, the market is failing to appreciate the extent of two structural tailwinds – both of which Blackstone is well-positioned to capture: (i) the ongoing shift towards a core-satellite approach to portfolio construction; and (ii) the asset price appreciation that continues to flow from the ongoing structural decline in interest rates. Blackstone satisfies the criteria we look for in an attractive long portfolio investment, as illustrated below. On this basis, we own Blackstone today.
Montaka long portfolio investment criteria
Source: Montaka Global Investments
Note: Montaka Global Investments owns shares in Blackstone (NYSE: BX).
Andrew Macken is the Chief Investment Officer of Montaka Global Investments.
To learn more about Montaka, please call +612 7202 0100.
