Passive investing, index funds and modern portfolio theory are poorly suited to help investors achieve their future goals, according to institutional investor and podcast host Ted Seides.

Institutional investors have made clear that traditional, public asset classes will fail to deliver returns moving forward, a message that the rest of the investing universe has been slow to react to, said Seides.

“This is a belief now held throughout the world that flies in the face of the index fund movement in the U.S.,” said Seides. “The bond yield is now over 1.5%. It was zero for a long time, and stocks are priced to earn maybe 4% to 5% per year. So index funds and asset class buckets don’t get us to the 6% to 8% returns that we need to cover our spending.”

As a result, more institutional investors have moved away from traditional allocations towards three different solutions, one being to include more alternative investments, another to simply hold more equities but allow managers to be nimble and opportunistic within that allocation, and the last being to focus more on manager selection rather than asset allocation itself as a driver of investment decisions.

Seides, who may be best known for  the losing bet he made with Warren Buffet in 2008 that a set of hedge funds would outperform the S&P 500 index over a period of time, recently published “Capital Allocators: How the World’s Elite Money Managers Lead and Invest,” a book based off of his “Capital Allocators” podcast.

Seides took note of a marketplace where most experienced investors have followed a shift away from publicly traded securities and into private equity, private credit, venture capital and other alternative asset classes.

“Valuations have become expensive in the private equity and leveraged buyout space, and people know that but they’re plowing money into those asset classes anyway, and it’s because all of these pools of capital have challenging governance issues,” said Seides. “It’s difficult to implement the decisions that they want, but an asset class like private equity can help to remove layers of decision making.You make a decision once, you’re in for 10 years, and nobody can really change it.”

Family offices see asset classes like private equity and private credit as natural extensions of their clients, who are most often families who have built a fortune from founding and/or owning a business.

While valuations are high in both public and private equity markets, Seides does not necessarily think that a bubble is forming.

“The problem with trying to identify, time and pop a bubble is that the opportunity cost is high if you’re wrong,” he said. “I’m a deep believer in everyone’s inability to time markets. Markets are historically expensive, but I don’t know what it means for the future. Let’s take private equity as an example – valuations and PE deals are now so high, last year, 70% of all deals went down for more than 11-times EBITDA. On the other hand, we have to note that there’s still $1 trillion of dry powder on the sidelines looking to transact. Is it a bubble that will prick? Unlikely.”

Seides was also skeptical about the move by institutions into the cryptocurrency space. Though cryptocurrencies make sense due to potential monetary debasement through the printing of money in response to the Covid-19 pandemic, it’s still too early to go beyond “dipping a toe in,” he said.

Seides sees ESG investing, which has only recently come to prominence in the U.S., as another long-term secular trend.

“There is demographic interest as millennials come out to play, they are interested in a much broader constituency than shareholder returns,” he said. “We’re still at the very early innings of investment managers understanding how to integrate that interest. Skeptics are still asking if that detracts from returns, and it will be a long, long time before we can really know the answer to that question.”

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