Mastering Market Cycles With Chad Smith, Managing Partner, Reveille Wealth Management

 

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Chad Smith is one of the founders and managing partners of Reveille Wealth Management, based in Atlanta, GA. His background as an investment analyst and consultant spans over 25 years, serving institutional, corporate, and individual investors. He serves on Reveille’s Investment Committee and is one of the Portfolio Management Directors.

In this episode, Zack and Chad discuss:

1. Capital Market Agility: Riding Highs, Avoiding Lows
2. Simplicity Always Works
3. Innovation Fuels Value Creation
4. Venture Debt in Rising Interest Rates

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Mastering Market Cycles With Chad Smith, Managing Partner, Reveille Wealth Management

Welcome to the show. I have with me, Chad Smith. Chad is the managing general partner of Reveille Wealth Management based in Atlanta. Chad and I met a couple of years ago. We were on a panel together at an investment conference, and I was just really impressed with his views and the way they do things at Reveille. I thought I’d love to have him on the show. Of course, he was gracious enough to come on. Chad, thanks so much for joining. I really appreciate it.

Thank you, Zack, for having me.

Career Journey

I’d love to start off with a little bit about your background. Tell everybody about how you got here. How Reveille was built and anything else you left at.

Thanks. I appreciate it, Zack. My career spans over 25 years now. I started in the business back in the early ‘90s. I studied finance. I have always had a passion for the markets. I started doing that in college and just developed trading systems and models at a young age. Got into the business early on in the institutional side in Atlanta with a firm that was a quantitative research firm, and all our clients were institutional investors. Focusing on market analysis, stock selection, and sector and cycle work.

That led to a little bit longer career as an analyst with that firm and then also with a firm in New York. An investment bank called Coffman Brothers, doing equity research and some market strategy work for them as well. That was great. My wife and I were married early on back then and basically started to have kids and so we came back to Atlanta. In 1999, I started my own firm, and we’re partnering with the gentleman. For the next eleven years almost, we developed an independent firm and eventually became an RIA.

Did competence of wealth management, and portfolio management for clients, mostly individuals. That led to actually joining Morgan Stanley in 2011. At Morgan Stanley, that’s where our team today came together. We formed the Reveille Group at Morgan Stanley back then and started to work together as a team and came up with the core of what we do today, our investment strategy, our investment discipline, and methodology taking background that I had from the institutional space and what I had developed in my firm, and then also my partners and what they had developed. That became the Reveille Group. In January 2021, we left Morgan Stanley and started our own firm called Reveille Wealth Management, and that’s how we arrived here today.

Georgia, Bulldogs, And Gators

You’re somebody who graduated from Georgia State, and you spent a lot of time in Georgia. I have to ask, are you a fan of the Bulldogs because there’s a little bit of backstory there? Another thing to add to that after this question.

I would say this, anybody who’s from Georgia, and I’m actually not from here originally, I wasn’t born in Georgia, but I grew up here. I think there’s a little bit of that natural leaning toward the dogs. What’s funny is I started to stay. Back then, there was no football team. I had the luxury of being like Switzerland is neutral. I actually did some coursework in Georgia Tech as well. I worked with a professor doing econometric modeling through that professor, so I got into the business. I had a bit of an interest in Georgia Tech sports at the time, especially basketball back then. My partners were all Georgia Tech guys. Not all, but mostly. We definitely have a leaning here at Reveille toward a bias toward tech, I would say.

In terms of my background, we’ve talked about this offline a little bit, but I was a big Georgia Tech fan growing up because I was a point guard in basketball and Georgia Tech used to have the best point guards. Mark Price, who played in the NBA for a long time, was a great shooter. Kenny Anderson, who was probably my favorite player of all time as a college player. Of course, Stephon Marbury and others since then. I was always a big tech fan growing up, but my cousins grew up in Athens, Georgia, so they are Bulldogs fans.

Of course, I’d go down there and I became a Bulldogs fan by extension because I lived in Boston where there wasn’t really much good football in Boston College, but not really, not SEC caliber. I was always a Dog’s fan, but now I have to switch allegiance because I’m doing a doctorate at the University of Florida at Gainesville. I do that part-time. I go down there every other month and I love it. Now I cannot be a Dog’s fan anymore. I still respect them.

You get pushed out of town down there.

The Gators are not on top right now but we’re going to be back. I’m not worried about it.

Good luck on that one.

Rules-Based Investment Discipline

It might take some time, but we’re coming back. In terms of the investing side, back to why we’re here. Reveille is growing very fast. I think you guys are in 37 states now. You’ve got a number of offices in Florida. Go Gators. This is why we should definitely work together in the future. The Florida market’s booming.

It is for sure.

What are you thinking about right now? What’s top of mind for you in terms of the business and growing the business and the opportunity set?

As an organization, we’re really focused on telling our story to investors and other advisors around the country actually, to really promote our approach and get further adoption of our distinct methodology for how we go about doing investment management for clients. That’s a big focus of ours right now is in that regard. I would also say top of mind in terms of the economy and society and all that, there’s so much news flow going on right now. It’s such a dynamic environment with so many different things happening swiftly.

The rapid adoption of AI seemingly, not in nowhere. The constant conflicts that are arising around the world geopolitically, an incredibly new inflationary regime that we’re going to be facing. We are facing this now, of course, and probably likely for a long time versus what we have been accustomed to for 40 years. All of that is top of mind and how to navigate through that. How to manage our clients’ portfolios and investment strategies through that and advise them properly. We can get into this in a second, but one of the beauties of Reveille and our approach, our investment strategy is that we have adopted or developed a methodology.

We call it our rules-based investment discipline that is focused on identifying prevailing trends and prices in every area of the capital markets. Our objective, our focus, and our passion really is constantly, actively aligning our clients’ portfolios and investment strategies with those price trends. The beauty of that is It allows us to really press mute on all the noise, on all the news, on all the things that cause people to have anxiety or uncertainty or be in many ways perplexed about what to do with their money. It really helps us to answer the question, what should I be doing with my money right now? That’s what our focus is day to day.

You hit on something that I think is important, which is the amount of noise in the market right now. It’s only going to get greater. I mean, everybody’s producing content, most of it’s garbage. Everybody thinks they’re an expert because they have a platform now. I think that having a mute button is probably one of the most important things investors can have right now. Having that process-based approach that you have is most important. It’s crazy to me because I’ve seen just so much lack of discipline over the last couple of years.

Fundamentals Based Approach

It seems like people aren’t really investors anymore. They’re speculators. They throw money at whatever they heard about on some social media platform and luckily they’ve been in a bull market. A lot of these assets have appreciated in value. Quite frankly, I think a lot of them will wind up being zeros in many cases or close to it. At some point, we need to go back to what I’d consider a fundamentals-based approach which, when I say fundamentals, that can mean different things.

I’m talking about having a rules-based approach like you have, because if you’ve got the process right, and you run that process consistently. The outcome’s not always going to be what you want, but you’re likely going to have pretty good outcomes over time, especially over the longer run. You might miss some of the speculative pops here and there, but ultimately over the long run, you’re going to have great performance. That’s one of the things I really like about what you guys do is that you’re really grounded in that discipline of having a process. What I call the mute button.

I agree with that of course. I’m a little biased, but in general, I would say this, you’re exactly right. Having a process and being disciplined in how you approach investing is so important in any market environment. Like you said, in the current one that we’re in and that continues to rapidly progress in this direction of everybody’s got an opinion, constant chatter, and noise. It used to be just the financial news networks that were out there that needed to create content. Now it’s everybody needs to create content.

They are looking for folks who have opinions and that’s fine. Everybody’s entitled to their opinion but the problem for investors that we find is, if you really go back to the basics of investor psychology, we as investors are very prone to being affected by or swayed by these extreme emotions of fear and greed, especially fear. As we all know, I think many of your readers know that there’s a tremendous bank of research on the effects of investor psychology on outcomes. People tend to get caught up in groupthink. They get caught up in both fear and hysteria and chasing fads, etc.

That results in doing sometimes the wrong thing at the wrong time and being driven by emotion. We can get into it briefly if you want to, but our discipline really helps to minimize all of that. The effect of emotion, the need for prediction, like what is going to happen tomorrow or next year or a few years down the road? What cycle is going to be prominent and how is this all going to play out with all these different things that are going on in the world? Rather than trying to spend so much time and energy on trying to predict that, trying to figure that out. If you instead focus on identifying what is actually happening in the markets today, where are the price trends today?

When we think of things that we say is the market’s going to do what it’s going to do regardless of what any of us think or predict or project. Having an approach that actively aligns with what’s happening in the capital markets, and that is important on both sides. When things are in uptrends, we want to align with those uptrends and ride those. When things are in downtrends, we want to step back and take exposure off the table and avoid those downtrends and the impact that it has on capital drawdown in investment portfolios. Having a process and a discipline for how to do that, I think is essential always, but especially going forward with what we think’s on the horizon.

The market will do what it will do regardless of what people think, predict, or project. Prepare an approach that actively aligns with what is happening in the capital market. Share on X

Uptrend And Downtrend

When you give a couple examples of your process in terms of the discipline around it, in terms of how you might ride an uptrend, but also cut losses in a downtrend.

That’s great. Our rules-based investment discipline is very interesting and distinct in that if you take the merits of diversification, we believe in diversification, and also asset allocation. Don’t put all your eggs in one basket. Asset allocation is putting your eggs in different kinds of baskets. Traditionally, that means finding things that are non-correlated or not highly correlated to allocate into on a long-term basis. From there, the traditional approach in our industry is to optimize this asset allocation based on a few factors, your tolerance for risk, your age, etc.

Your need for cash flow, whether that’s an individual that needs distributions off a retirement portfolio or an endowment or foundation or pension plan that needs to pay out benefits to their constituents over time. Just tailoring that or customizing that, and then focusing on the long-term, it is all about time in the market and markets cannot be predicted, they cannot be timed. Simply keep that long-term strategy and then rebalance occasionally, quarterly, whatever. That’s the traditional view most people think about or pursue in our business.

Institutionally as well as individually. How we’re different, Zack is we do believe in the asset allocation component, but you think about the pie chart that everybody is accustomed to looking at. We have a series of model strategies that we develop where we have target allocations and all the different broad asset classes across the globe, across equities, fixed income, real estate, cash equivalents, etc. Our view of the world is we don’t want to own everything all the time. We only want to own those asset classes that are in uptrends, confirmed intermediate to longer-term uptrends in price.

We don’t want to own them when they’re in intermediate to longer-term downturns. For us, it’s not about time in the market, which is what the majority of folks in our industry do really talk about. Actually, for us, it’s about not timing the market, but identifying when is the right appropriate environment to be in, and the right appropriate landscape to be invested. When it’s not, simply just back away and move into a defensive position. We developed an algorithm that is a trend-following mechanism. There are a lot of unique, distinct, and proprietary elements to it, but very simply it identifies the prevailing price trend in every asset class and importantly the turning point or the inflection point in those cycles or in those trends.

For every asset class that we’re exposed to, it’s either on or off. If it’s on, we’re allocated into that asset class according to our target weighting. If it’s off though, we move that to cash. Conceivably, that means that every one of our various strategies can be 100% in cash if the environment warrants. There have been distinct periods of time over the last few years where that has been the case. It has been wonderful to be able to step back, and think about just rough water, so to speak, or dangerous waters. When whatever that danger is that starts to come into the waters, we just want to back out of the water and be on the bank here for a while and then redeploy, go back in when the environment has improved.

I had a previous guest on that said something along the lines of the best gains are losses that aren’t incurred in a selloff. The mathematics of loss are such that if you lose 50% in your portfolio, just to get back to break even, you need to gain 100% on the amount you have remaining. That could take a decade just to get back to break even. Being defensive, sometimes you might be wrong and get defensive a little bit too early, but that opportunity cost is worth it if you’re saving yourself and preventing those big losses that are ultimately the portfolio performance killers.

That’s exactly right. In an environment like we have been in over the last many years where we’ve been in such a volatile market landscape, during 2020, utilizing our discipline, we actively navigated around what happened starting at the end of February in the US and then manifested fully in the month of March in 2020. Once things bottomed out, even at that time, it wasn’t clear. We were in no man’s land. We were in an unknown, unchartered territory in the markets in terms of forcibly shutting down the economy globally, not knowing what ultimately revenues and profits for companies are going to look like and who could service debt, etc.

The markets were quickly discounting a lot of that and then quickly discounting what was coming behind it, which is the Fed coming to save the day and poor record amounts of liquidity on the cap or markets and ushering in zero percent straight skin and all that stuff. The market’s bottom and at the time there was so much uncertainty, a lot of people were left just stuck, not knowing what to do because there was such uncertainty. Going back to what we were saying earlier about market psychology, if you’re a buy-and-hold investor and you endure that loss, you absorb that market decline. We all know a lot of times there’s a pain threshold.

A lot of people were preaching back then, hang in there, look at the long-term, etc. This is just a short-term dislocation. If you’re hearing that, and that’s fine to talk about that theoretically, but when you’re in the throes of experiencing that decline, and you’re now down 20%, 30%, 35%, 40% for buying hold investors exposed to equities and even some parts of the fixed income markets. A lot of people tend to throw in the towel because they cannot take it anymore at the wrong time. Once they do that, then they’re hesitant to go back in when they should be.

It’s going back to the old adage of you should be buying when most people are panicking and selling when everybody is celebrating in the streets probably. With our discipline, rather than trying to predict all that, by identifying these price trends and these important turning points, we wait for confirmation of trend change. Once the trend begins to roll over, that’s it, we get our signal. By doing that, we avoid that big decline. We’ve taken the influence of that negative emotion that investors could experience off the table. Now we’re being objective. We’re looking at it with cash and we’re saying, “Where are the opportunities now?

Once it bottoms out, then we’re able to pounce and step back in.” For us, just to make this clear. With our strategy, we’re never going to buy the very bottom. We’re never going to sell the very top of any cycle of any asset class. Our objective and our goal, the way we’ve constructed our strategy is to be near it. When you put it together in a portfolio management investment strategy and a discipline, it allows you to capture on a consistent basis through a discipline the majority of these uptrends and ride them as long as they are unfolding. Important, to avoid the majority of those downtrends and take the negative effect of those off the table.

I believe that’s the best strategy. It makes total sense because where people get in trouble is with emotional decisions both on the downside where they get fearful and then also on the upside where they get too irrationally exuberant and they’re just throwing money at things at silly valuations. I’ve seen a lot of those just in the last 15 years or 20 years. I was a banker and credit underwriter during the financial crisis of 2008 through 2010. It’s amazing how many people missed the rebound.

They panicked and rightfully so initially, but then they didn’t get back into the market soon enough and they didn’t get back into the right assets. If you look back to 2010 and what performed from 2010 onwards, there were some huge opportunities there that were really like a blessing for people in the space, specifically private credit. That’s something I’m looking at now as an analogy and to what I think is coming up this time around. If we do have a big sell-off, which I think we will at some point in the next 18 months, I don’t know when it’ll happen, but I’m very confident it will happen.

Once that happens, where do you want to have your money? Thinking ahead through the cycle, I think, is what a lot of people don’t do. They’re very focused on the here and now and their quarterly statements. Whether they’re a producer who’s investing the money, who’s thinking about quarterly results, or the investor who’s looking at their statements every quarter. I think they’re too short-term focused. What you guys are doing makes a lot of sense because you’ve got the core strategy, but you’ve got the ability to be nimble around that.

I think that’s ultimately where alpha is generated. It’s by being just a little bit early. You don’t have to be appreciably early, you just have to be a little bit early and you’re going to outperform immensely at times. That trend-following model, it makes a lot of sense. Also, the other thing you said that really resonates is diversification. We had a guest on our previous show, Michael Nicks, who’s the deputy CIO at Pepperdine.

He had a good anecdote where the joke there is that they say you don’t have to be in Europe Tommy which basically means you don’t need to be everywhere all at once stick to what you know, stick to what you think is going to outperform. Of course, be diversified, but don’t be overly diversified, and don’t be naively diversified also. There’s a lot of folks that will say, “I own all these different assets and I own all these stocks and bonds, so I’m diversified.” That’s a naive approach because stocks and bonds have a very high correlation in this market, as we saw last year when both got hammered.

Investment Philosophy

Even within some of the other alternative assets, there can be high correlations as well. You have to be diversified, but you have to actually know what you’re doing. The art of education doesn’t mean just buying a bunch of stuff. Buying things that have correlations that make sense so that when some assets are underperforming, there are others that are going to be a ballast and a counterweight to that and outperform. Which leads me to the next question, which is what are the other key investor principles that you live by in addition to the diversification and really watching out for behavioral biases? What else do you make sure that you’re doing through all cycles?

First of all, so we think that every advisor and or investor should have an investment philosophy that in the case of advisors, is simple enough for their clients to be able to explain to someone else. That’s what we really promote is there are a lot of sophistication to what we do. At the end of the day for us, it’s about simplicity. For us, it’s simply actively aligning our clients with that which is going up in the markets and taking exposure away from or not being exposed to that which is going down. As a result, we think cash is a conscious investment decision.

Obviously, because of our discipline, we fully embraced the notion of using cash as a conscious investment decision at certain times in order to preserve capital. Last year was a great example of that. We were fortunate to be properly exposed in that regard. Being mostly in cash all year was fantastic. Broadly, almost every asset class was going down last year. Unfortunately, the 60-40 portfolio that most people are exposed to, really suffered dramatically. Those are primary principles. Financial planning, because again, take it back to what we do for our individual clients, and institutional clients, whether it’s an endowment, foundation, etc.

Cash is a conscious investment decision. Make conscious investment decisions at certain times to preserve capital. Share on X

The financial planning that we’re doing or the planning in general we’re doing for our clients is a central part of the value added to them. Helping folks to institutions or individuals to distill all of the things that they have going on in their lives down to a roadmap for how to achieve their specific goals. For many folks, it means what the time would look like. What amount of capital do I need to get to sustain the lifestyle that I want to have? What amount of distribution of my portfolio? That will likely be a supplement of what I’m getting elsewhere.

In some cases, it’s everything. Most people don’t have big pensions or whatever anymore. Using your portfolio, your nest egg as the means for distributing income or cash flow off to sustain your lifestyle or whether it’s like an endowment that’s going to be giving or allocating capital on an annual basis. Developing that plan and then at the center of that plan is a projection of what returns we need to get on a reasonable basis consistently over time. Now that means that everything comes back to that. Everybody is always about, how am I doing versus X, Y, or Z benchmark. That’s important.

As an organization and within our discipline and our strategy, our objective is to produce, think about the upper left-hand quadrant, better return and less risk results for our folks relative to a specific benchmark. By the way that we actively navigate around market cycles, we’re able to traditionally do that. That really isn’t the be-all end-all. The be-all end-all is achieving the goal that you have for the plan that you’ve established for your family or your organization. We think that’s incredibly essential, a primary principle that we really promote.

Again, just simply having an active approach to how you allocate capital across market segments, across asset classes, with a process that drives that. Especially going forward, and maybe we’ll touch on this in a second, but an environment like we’ve been in the last three years or so, an environment like we think we’re going to be in for many years to come. Your portfolio being just exposed to the whims of the market, I don’t think is wise and I don’t think is going to cut it for a lot of people going forward.

You think back to those financial plans, a lot of financial planning that’s been done over the years is built around capital market assumptions that have been utilized for, let’s say, the last 40 years that may very well be vastly different going forward. If inflation is structurally higher and returns out of the traditional bond market are structurally going to be lower, then normal capital market assumptions used to drive buy-and-hold strategies, it’s probably not going to be sufficient.

Alternative Investment

Those are all great points. It brings you to my next question, which is when we think about a diversified portfolio that will perform well in this next cycle coming up, how do alternative investments fit into that? A lot of RIAs, I would say most actually are not involved in alts. If they are, it’s only marginally. You’re doing a lot of smart thinking, I would say, around alts and how to bring that to your clients, and are one of the smarter folks in the space in terms of where the market’s going for sure. How are you thinking about ALTs as part of a diversified portfolio? Also how to create access to better strategies and better managers for your clients?

Alternative investments, I think traditionally have been used to help foster lower correlations within a portfolio versus the broad market indices. I think traditionally that’s been true. As we think about going forward, taking a few data points. From a market valuation perspective, so equity market valuation perspective, whether you look at it price to book, price to sales, long-term Capi ratio, whatever valuation measure you want to use, arguably we’re at the higher end of those historical ranges.

When you look at what does that equates to on an expected return basis, within the U.S. market especially means presumably lower expected rates of return going forward over the next 3, 5, 7 years on an annualized based on just valuations. Couple that with, even though there’s been a lot of negative investor sentiment in the last, let’s say, few months based on after 2022, what’s interesting is investor sentiment versus investor positioning are different. Investor position, people may say that they’re negative or may act like they’re negative, but the allocation to equities versus other asset classes is at a traditionally high range or level as well.

All of that, you bring that back to we think the expected returns out of the U.S. equity market are going to be likely muted and most likely with a lot of volatility over the next 3, 5, 7 years versus what we saw maybe during the sweet spot of the previous 5, 6, 7 years. On top of that, fixed income. We’re not at low zero percent interest rates anymore. The bull market that we’ve been accustomed to in bonds for the last 40 years, we think obviously it’s probably over. It’s been over for a year and a half now, but maybe longer term it’s still at risk.

I think Zack, what that means is you’ve got to think outside the box. You got to look at how to minimize the publicly traded capital markets, volatility in cycles, and the impact that has on our investment portfolio. Utilizing alternative investments going forward is going to be a very much viable part of that. Looking at potentially higher returns and of course, traditionally and also potentially lower volatility or lower correlation than a publicly traded market index that you might compare to it.

Now, in terms of private credit and the space that you mentioned before, and you and I have talked about it separately. I think what’s interesting there is you think about the dislocation, I guess, that’s occurred, or especially the void that has been created in many traditional funding markets. Obviously, most recently that’s been acutely more of a focus because of the banking situation, and a lot of banks now. Silicon Valley Bank, as I know you know, is now out of the market, so to speak, and some of the funding solutions that they provided are in many ways just gone.

In general, that’s going to cause or has already caused a retrenchment by a lot of banks. That’s going to create a void in the market in general for someone to come in and fill that gap from a lending standpoint. People who are doing private credit or direct lending, etc. can come in and meet that need or fill that void. I think that creates also an opportunity for potentially higher relative returns for people who are able to do that. That’s going to be, and it already is an important, but probably growing part of the capital market structure and then just the investment options that investors can look to diversify away from just pure public trading markets.

You nailed it with the supply and demand imbalance. That’s ultimately econ 101 and it’s ultimately what drives a lot of outperformance in any asset. When there’s more demand for something than there is supply, the price is going to go up. In this case, we’ve got banks retrenching, and less capital to deploy. Bank lenders like my company and others within the private credit space and venture debt space that have dry powder are able to get much more advantageous terms. We get a look at many more deals. There are many more opportunities to lend to companies because they cannot get financing elsewhere. It’s really that simple.

Venture Debt

Almost every guest I’ve had on the show has mentioned diversification and they’ve mentioned either explicitly or implicitly the supply and demand function. How ultimately those two things, if you do them right, will almost always lead to good results over time. Be diversified and then allocate your money to where there’s more demand than there is supply. Be that provider of capital to folks who need it and who are willing to pay for it. Since we’re on this show and we’ve talked about venture debt, I’d love to hear your thoughts on why venture debt has an interesting opportunity set and very attractive outlook potentially.

Again, part of it goes back to the demand side. I think there is from what I observe and the research that I do and then we do, growing demand for capital and financing needs in that segment of the market. What’s interesting to me is obviously the potential for higher yield should come in and lend in that space. You can justify the structure, and terms with a higher yield than a traditional, just think about public traded fixed income as a solution. The fact that you can set these terms the way that you can with the venture debt structure because you’re meeting a need in a space where there is still risk, that is posed by you as the lender to that organization.

You structure these deals with not just the lending component, but also warrants. Some equity kicker that helps sweeten the deal and address the risk that you as a lender are taking on. I think that results in even greater potential upside as well. The fact that you’re coming in a senior position as a lender and you’ve got that component, a little bit more risk mitigation there and a lower risk profile by being typically able to come in, and you know this better than me, of course, Zach, but stuff that I’ve looked at is you come in and land in a senior position. You’re higher on the priority of payments Totem Pole, so to speak, but yet able to still get a very attractive yield on that loan structure you’re putting in place and then get the equity kicker as well.

If that private company does eventually do something great and go public, you can have that upside as well as the lender. I think that is very attractive. It’s the way that a lot of sophisticated larger investors have done things over many decades. The fact that for individual investors, clients that we work with, for example, middle of the high net worth, and even of course institutional as well. The accessibility to come into a fund of some kind whether it’s a private fund or a feeder fund or whatever, and tap into that opportunity and have those risk-return metrics available is I think going forward going to be fantastic for investors to look at as another viable option, especially needing to be creative going forward in the environment that I think what we’re going to see.

Well said. I think of it in very similar terms. Big picture, I just think that innovation is what drives value creation. There are really two ways to fund innovation, equity and debt. That model we know very well, whether it’s the VC model or private equity or public markets that large-cap tech that have done great over the last couple of years. The debt side of it hasn’t really evolved as quickly, which is normal. Now it’s starting to evolve pretty quickly. There are a lot more founders that are aware of this funding option. They’re really attracted to it.

Investors, I think, are starting to see things, the way that you just described, in terms of just a niche differentiated offering that offers access to innovation as the asset class, but in a safer structure than equity. Also, one last thing I should mention on it is that you don’t have to wait to get paid. You can be involved in a venture equity investment and wait 7 to 10 years or longer before you monetize it. That’s a long time to wait. Yes, we’re getting access to the same exact companies because we’re lending to the best venture-backed companies, but we’re getting paid immediately in terms of the coupon on the loan, but we still participate in that upside.

Advice To Wealth Advisors

I think that the way you said it makes a lot of sense. It leads me to the last two questions. These are big picture questions and we’ve touched on all of these already, but one is to just summarize what you think the best wealth advisors will need to do in the future to serve their clients and what you guys are doing. That could touch upon how you’re dealing with technology and AI and how that might impact the industry. How you’re thinking about ALTs and getting more exposure for clients? Big picture stuff. The last question will be investment themes that we should all be thinking about over the next couple of years. Let’s start with the wealth advisor segment.

As a wealth advisor, it is incumbent upon us to obviously put our clients first, be focused on actually creating value for our clients. I think the best wealth advisors absolutely do comprehensive planning. That’s what we focus on. I think there are many other folks in our business that are doing a great job at that. That involves knowing your client well, looking at their situation holistically, and comprehensively, and developing a detailed plan that is going to put them on track to achieve their goals that they’re striving for.

I do believe very importantly is within the framework of that plan is coming up with a solution or addressing the likely reality of a growing set of challenges that investors are going to face in the future. It goes back to what I said, the traditional approach of how we look at historical asset returns and we develop, but we come up with a financial plan or we just do it on a financial calculator online and we say, “Let’s plug in the assumed rate of return that we need.” There you go. You can just bank on it that you’re going to over time get some assumed rate of return.

We think that’s likely going to be challenged. If you think about historically, there are periods of time, 1969 to the late ‘70s, 2000, and 2012. The buy-and-hold approach of just owning a market indices did not get you your goals, did not help you accomplish your goals. There’s some data that we show. Clients often say, “If you were to buy and hold the S&P 500 back in 2000, and you endured what occurred then or unfolded, the internet bubble bursting.” The improvement all during the mid-2000s, and then of course the housing bubble collapsing. From there recovering, or the great financial crisis, I should call it.

Finally, the recovery back eventually around 2012. That buy-and-hold approach over twelve years produced almost no return. If you’re drawing against a portfolio, whether you’re an individual who’s retired or an institution that’s paying out distributions of some kind or benefits of some kind, that portfolio got dramatically drawn down over that long timeframe. If in the future we’re in an environment that’s similar, and we think it’s likely that that will be the case over the next many years, there’s going to be a cycle like that that will unfold likely. You’ve got to address that issue.

You got to know how to deal with that risk and protect against the potential for a dramatic drawdown. Protect against the potential that higher assumed inflation is going to have a meaningful negative impact on the outcome. Think about this. We talk about this with clients a lot. The traditional financial plan assumes, let’s just say a very reasonable, I should say, I think it’s a reasonable rate of return that we can assume a six percent rate of return. Keep it simple. You’ve assumed a two percent inflation rate. That implies a four percent real rate of return that is driving that financial plan. Let’s assume that the financial plan is successful based on that.

Now, you have an environment where you’re at more than four percent inflation. If you assume the same rate of return, six percent, now your real rate of return is likely going to be less than two percent. When you adjust a financial plan for a different inflation environment, it dramatically changes the potential for success for anybody, an individual, or an institution. The best wealth advisors are dealing with or focusing on addressing that issue, addressing that challenge. It’s going to have to involve a more proactive approach to portfolio management, actively managing risk exposure, and thinking outside the box, and looking at unique investment strategies to do that.

When you adjust a financial plan for a different inflation environment, it dramatically changes the potential for success for anybody. Share on X

You hit on one of the key themes for the next couple of years, which is inflation. You not only answered the first question, but part of the next question as well, and that reminds me. One of the things that I should mention is that part of the reason that private credit and venture debt in particular are poised to do so well is because they’re floating-rate loans. As interest rates went up last year and fixed-rate securities were down anywhere from 10% to 25% depending on their duration, venture debt actually performed brilliantly.

We got more coupons as rates went up. I think the average venture lender last year was knocked out about a 16% cash return, not including the equity component. Total returns north of 20% potentially once the equity component is kicked in. Compare that to other fixed income that was down 15% or 20%. You’re talking if 40 points of spread, that’s almost like a decade of performance. It’s unbelievable. When people say like, “I’m not really that interested in venture debt because it’s fixed income and I’m trying to play for big-time returns.”

Sometimes I wonder if they’ve done the math because if you’re in a fund and it’s compounding at 15% to 20% annually. At 15%, it doubles in five years. Doubles again in the next five years. You wouldn’t have a ten-year fund, but if you roll your exposure in venture debt, for instance, in like to five-year funds, you’d actually get 4X return with almost no volatility and very low correlation. It completely optimizes your portfolio too because of the low correlation to other investments. People that tell me, “I’m only interested in things that are going to give me a 3X to 5X return.”

I laugh at them because you’re not going to get any money for ten years in that VC fund that you’re in. You might wind up with less than your initial investment. The likelihood that you’re going to get a 4X to 6X return is actually like not that high unless you’re a performing VC fund. In the average venture debt fund over the last 20 years, you would have gotten a 4X return over ten years. In a top-performing fund, you would have gotten a 6X to 8X return over 10 years. Anyway, I just wanted to mention that.

Those are significant metrics. The return side is wonderful. The risk side is what I think really stands out. Of course, that’s not to say that there’s not risk associated with activities on the private credit on the venture debt and private credit side. In general, the look at it from just a pure statistic standpoint based on averages, the lower volatility, the lower correlation, etc., and the fact that, like you said, a lot of the returns coming through cash flow is meaningful. I think for many clients, it fits well as a complement to a portfolio strategy.

Mine, I’ll just tell you, I think from our perspective, with the fact that we’re managing clients for families and institutions, our focus is on developing strategies. Primarily utilizing the publicly traded capital markets. Employing our discipline that I’ve described is this trend following active allocation methodology that’s striving to align with intermediate to longer-term price trends in these asset classes. By doing it that way, striving to produce a better risk-adjusted return, a more consistent return dramatically takes the uncertainty, take fear, take emotion, take the need to predict off the table.

That is, we believe, a great core strategy and should be a fundamental building block to how you approach managing an investment portfolio. On top of that or in addition to that, if you complement what I just described with a smart approach to utilizing alternative investments. In particular, what you described as private credit means your debt. I think it could serve many folks, individuals, and institutions very well and create a nice little optimal mix.

Inner Market Analysis

To me, that’s the model. You just nailed it. That’s the model. People have different models and there’s a lot of different ways to skin the cat, so to speak. Your model makes sense. I think part of the reason why you guys are growing like a weed is not just because you’ve got the Florida and Georgia sunshine. I think it’s because you’ve got the model right. It’s clearly paying off. The last question of the day to leave everybody with is in terms of just the key investment themes over the next couple of years, you’ve touched on a lot of them already, but anything that we either didn’t touch on or that you just want to emphasize before we go?

Short term, in the recent, last few weeks, let me give you a little backup real quick. We started scaling back into the markets after being mostly out last year. We started scaling back in December. Late November, a little bit in December, and a little bit more in January. That’s across broad asset classes, equities, and fixed income, but not every asset class, not everything turned back on in our discipline. As we’ve been doing that, where we’ve been overweighted has been in international. A lot of our inner market analysis that we do helps us to identify, do we want to be in the markets, plural, or the broad asset classes.

If we do, the answer is yes, and they’re turned on our discipline. How do we want to be exposed? How do we want our clients to be exposed? Where are the areas that look more favorable? Some of that looks at a lot of relative ratio analysis. For example, and we all know this, I think, but the cycle of domestic equities outperforming foreign or international equities and vice versa goes in these traditional cycles. Sometimes between three to on average seven years maybe. We’ve been in now, I guess, almost fourteen years of the U.S. outperforming international equities.

We think, based on all the analysis that we do, that long-term trends are changing. The first question is, do we want to be, let’s say foreign developed markets or small cap, large cap, or even emerging markets? Are they turned on in our discipline? Yes. If so, do we want to be overweighted there? That’s been playing out nicely this year so far with foreign markets outperforming on a broader sense the U.S. market. You look below the surface, not just the S&P 500 where you got seven stocks that are driving it, but broadly speaking that’s been the case.

We think that may be in the early innings of a longer-term cycle of international equities, international assets in general, playing catch up and performing on a relative basis better versus the U.S. than has been the case for many years. That’s a big theme we think is going to play out in the future. That plays into just, there’s been a lot of foreign capital parked in the U.S. for many years and there’s a lot of repatriation of capital going out now to other foreign markets again.

We think that’s going to be a longer-term trend. Now we do think that higher yields on cash because of structurally higher inflation rates and structurally higher interest rates in general is going to likely persist for a while. The bigger other, I guess, comment on market expectations is just really muted return of expectation and potential for continued volatility. Actively navigating around that, I think, is going to be important.

Episode Wrap-Up

Great themes. I think we set the record for longest show that I’ve had to. That’s because there’s so much to talk about. We took it’s not a bad thing. Chad, it’s been great having you on. For our readers, Chad Smith, managing partner at Reveille Wealth Management in Atlanta. They’re one of the best out there, growing really quickly. I think they’ve got great processes and great great outlook in terms of where the market’s headed. I’m looking forward to watching you guys continue to excel. I’m thinking maybe we can get together for Georgia Florida.

I think it’s October 28th if I’m not mistaken.

I might have to circle that on the calendar.

We might have to choose a neutral spot to do that though.

That’s why I usually have it in Jacksonville. I don’t know if I’m going to wear my Florida hat and I guess it’ll be all Florida. I used to have a great Bulldogs jacket that was like my go-to during business school because it was cold in Chicago. Everybody else in Chicago has had a dog’s jacket. I’m the only guy in the city, but I’ve had to shutter that now. Now replaced with Florida Gators, hoodies mainly, which surprisingly you can wear in LA all year round because it never gets above 60 degrees here anymore.

I know that’s crazy weather patterns have changed like crazy. Nice.

It’s nuts. It hasn’t been over 65 degrees in months here. I don’t know what’s going on. Chad, it’s great having you on. We should get together again soon. Thanks, everybody for reading to the show and we’ll see you next time.

 

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About Chad Smith

My primary goal is to serve our clients with excellence and help them achieve their financial and life goals. I strive for this objective everyday by combining my vast experience in investment analysis and portfolio management with a passion for stewardship of what our clients entrust to me and our team.

 

 

 

Chad Smith
Financial Advisor, RJFS

Reveille Wealth Management
525 Westpark Drive, Ste 100 // Peachtree City, GA 30269
O 678.489.7314 // TF 866.980.3230 // www.reveillewealth.com

Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Reveille Wealth Management is not a registered broker/dealer and is independent of Raymond James Financial Services.

Any opinions are those of Chad Smith and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification.

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