Venture Debt: Double-Digit Income With Upside Potential With Chris Osmond, Chief Investment Officer, Centura Wealth Advisory

 

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Chris Osmond has extensive experience in investment management, including market and economic analysis in the United States, alternative investments, private equity, and asset allocation recommendations for individual, corporate, and institutional investors.

In this episode, Zack and Chris discuss:

1. Maximizing Your Wealth With Above-the-Line Planning
2. How to Remove Emotion From Investment Decisions
3. The Pitfalls of Buying High And Selling Low
4. Raising Capital in a Market Without Venture Debt

 

Venture Debt: Double-Digit Income With Upside Potential With Chris Osmond, Chief Investment Officer, Centura Wealth Advisory

Everybody, welcome to the show. In this show, we always talk to the best CIOs and wealth managers across the country. I’m very excited to have Chris Osmond, who is the CIO of Centura Wealth Advisory based in San Diego. Chris is also a fellow of CFI and CHI charter Holker and graduate in 2004, which is also when I graduated. We consider that a very good vintage year in the history of wealth advisory. Chris, it’s awesome having you here. I’m really excited to talk to you about your views on the markets and investing. Before we dig into those seven questions, if you could just tell us a little bit about your background of how you got there? That’ll be great.

Thanks, Zack. It’s great to be here. I really appreciate it. I’m happy to be a guest. My background, as you said, I graduated in 2004. I was a little bit of an odd duck. I knew what I wanted to do since I was a little kid. My grandfather gave me an IBM stock when I was born, and I found out about it when I was 8 or 9. I just remember thinking that was the coolest thing. “I’m the owner of this worldwide company.”

Of course, 9 or 10 shares means nothing. At the time, I just thought that was so cool. I remember grabbing the business section. I couldn’t understand every tenth word or whatever, but that’s just going to force my passion for investing. Ultimately, I chose my undergrad because of their investment management program. I just know I wanted to manage money.

I spent the first two-thirds of my career in private banks, in their wealth management, constructing custom investment portfolios for high-net-worth individuals, foundations, endowments, corporations, and things of that nature. I spent the last third of my career in the RIA world. That’s where I served as a chief investment officer for a Kansas City-based RIA, joined at $3.5 billion. I departed them just under $18 billion. Over that time, I really grew out their investment platform, both on the public as well as the private side. Now, I’m the Chief Investment Officer at Centura Wealth Advisory.

That’s amazing. Your background is really impressive. I’m curious, what made you want to focus on the wealth advisors and lead the huge firms that you worked at previously?

Not to talk bad about banks, but a lot of times, they tend to manage to what was common denominator. Oftentimes, I found myself telling clients or giving them this custom portfolio when, in reality, its mandate was sent from above. If I deviate so far from the large-cap core relative to the target allocation, I get slapped on the wrist or have to explain why I am overweight. I’m like, “Is this really in the best interest of the client?”

Oftentimes, I had this push-pull reaction and it just didn’t always feel right. I was looking to have more autonomy and the ability to really build a platform that served the clients in their best interest and gave them the tools and resources that they needed to help achieve their objectives. I’ve really enjoyed working with advisors themselves to help implement those strategies.

It seems to me like there’s a lot more that you can do as a wealth advisor in a smaller firm, albeit still large, but smaller than the mega shops where you can have a more customized approach and really get closer to your clients and really meet their needs in a way that you probably couldn’t in a mega institution. The first question of the day, the first of the seven, is what can wealth advisors do, in your view, to provide differentiated value for their clients? You’ve already touched on a little bit, but I’d love to hear more.

Differentiated Value Through Wealth Planning And Alternative Investments

At Centura, like every RIA, we lead with planning. I would say that what’s different in how we lead with planning is that when we look at other RIAs, they tend to focus on what we call below-the-line planning. That’s doing cashflow planning, goals-based planning, maybe some asset location, then they’re going to wrap a pretty little bow on it and do some Monte Carlo analysis. We do that, too. It’s all very valuable, but we feel that that value is really marginal at best, and unless you do the work above the line, it doesn’t really move the needle for our clients.

We focus above the line and we do income tax planning, very sophisticated, complex income tax planning, whereby we’ve been able to eliminate and reduce even from 20% to 80% of someone’s tax liability in a given year depending on their tax pattern. It’s pretty remarkable stuff. We do a lot of wealth transfer planning and then balance sheet optimization. We feel that once we do that work, then we can do that other stuff, and that’s how we really drive value. Additionally, taking that output from the planning and driving the investment portfolio construction whereby we adopt more of an endowment model. We subscribe to using a heavy dose of alternatives in private market investments.

Your focus on alternatives that we’ve talked about offline, I think, is a big differentiator on the investment side, along with all the other stuff that you’re doing. What are some core investment principles that you live by in general?

I’ve got a few. I’d say, first off, that emotion is the root of all investment, and it’s to say you’re making evil. It needs to be removed at all costs from the equation. I found the best way to remove emotion is to create a process and follow the process. Do not invest in something unless you fully understand it. That means the mechanics, the opportunity, the terms, the risks. I think often what is underappreciated is the risks of an investment and really fully understanding what those risks are.

Emotion is the root of all investment and marketing evil. Therefore, it is important to remove emotion from the equation as much as possible when making investment decisions. Share on X

Once you understand all that, do your research and do your due diligence.  I’ve also found that a quick DQ or disqualification is oftentimes just as valuable as actually moving forward with an investment. I’d say lastly, follow your gut. I know that it almost conflicts with not letting emotion into the decision-making process, but oftentimes, if something doesn’t smell right, it probably isn’t, so follow that gut instinct and listen to yourself.

When you were saying that, my first thought was the sniff test in the sense that you’re not investing with emotion, but you’re saying, “Something’s not right here.” It’s almost like a downside more so than upset.  You can get excited about shiny objects and then high-flying potential investments. I think the behavioral aspects really come into play on the downside where your subconscious sometimes knows something’s not right here. The key for me, at least, is to really avoid investments that have yellow flags because afterwards if things do go wrong, you’re kicking yourself because you knew they were there, but you ignored them.

I think a lot about behavioral finance, which you do as well. It’s amazing to me how many people buy the highs and sell the lows. It’s like every time there’s a downturn in the market or a crisis, we learn lessons from it. We say, “Next time, we’re not going to do that,” and then it happens. We do the exact same thing over and over again. That’s unbelievable to me. Right now, there are some really interesting opportunities in the market that we can talk about.

People are pretty scared, I think. They’re missing a lot of good opportunities. Quite frankly, if there’s a big recession and a big sell-off in the markets, I think you’re going to see that history repeat itself and there’s going to be folks that are like, “I’m just going to the treasuries right now,” when they should be buying.” When they should be selling and the things like where they were in 2021, all they want to do is buy more when they should have been taking profits.

It’s crazy to me. I think what you’re doing is you’re providing, amongst other things, a sanity check for your investors as well and say, “Don’t let your emotions sway you.” Obviously, do trust your gut, like you said. Do make sure it passes the sniff test, but don’t get carried away with emotions. Stick to a process that has worked consistently. It’s not always going to be right or always get you the perfect outcome, but over time, if you stick with it, you’ll get the results that you’re looking for.

I’d say continue to evolve your process too, because hopefully, you learn from your mistakes. When you do, you go back and adjust the process to account for those mistakes. Hopefully, next time when you’re faced with that same decision, it’s an easy bypass, right?

Yeah. That leads to my next question, which was going to be about risks and learning from mistakes and things that keep you up at night. Really, the question is what are some risks that are forming now that clients should be aware of that maybe they’re missing?

Risks In Commercial Real Estate And Potential Market Bubbles

I think you hear on the news nonstop every day right now, just the bank’s financial stability. There’s a lot of emphasis put on deposits and liquidity and so forth, but we’re not hearing a ton about what is happening within the commercial real estate portfolio books, on the lending portfolio books within banks, and to me, there is a huge potential bubble looming. You look at office real estate, specifically, $46 billion is going to mature in floating rate, commercial office space debt. Vacancies at 18% and only increase. Look at San Diego, where we’re headquartered in downtown, vacancy is up to 35%.

Chicago is approaching 45%. You start looking, is this a longer secular trend that’s forming from this work-at-home atmosphere, work environment now, is office real estate going to be ever what it was once it ever be what it once was? To me, that’s a really big risk. It’s not gaining a lot of press right now or a lot of attention is this potential bubble in office real estate, as well as the contagious effect that it could have on than retail. If there’s no one coming down to work downtown, there is no one buying and shopping downtown and there are less people dining downtown. What impact does it have on other sectors and industries within the real estate within real estate that may be impacted from contagion?

I think that’s a great risk factor to point out. I’m in the same boat and I think commercial real estate’s going to be in for a horrendous ride. People don’t realize it yet because a lot of these leases are long-term and they haven’t run off yet. To your point, Chris, people aren’t going back to the office five days a week, probably for the rest of our lifetimes or ever. It’s not going to happen. The world’s changed. The paradigm has shifted. You might see people in the office 3 to 4 days a week. What that means is, and mathematically, if they’re in the office three days a week, that means you need 60% of the space, roughly 40% vacancy, which means that building is not going to be nearly as valuable.

You made a great point on the correlation to other areas of the economy, like retail spending. It’s all correlated. When you’re losing money in one area, it affects how you think about other areas and doing those other areas. I think there’s a general trend towards risk-on-risk-off type thinking, which is bearish, greedy, and fearful. It’s all up in synonyms for the same stuff. Ultimately, right now, I think we’re still in a very positive mindset, which I don’t understand. I’m very bearish. I think the markets are hammered. Do you agree?

I think what’s interesting, this is the most anticipated recession ever, but yeah, the NASDAQ 100 is in a bull market like what is going on? It’s almost an irrational exuberance and I get the markets forward-looking, but to me, there are so many risks out there right now that if one shoe were to drop, they all could drop. Commercial real estate’s one. I think there’s a potential consumer credit bubble that’s forming on the heels of COVID. A family of four got about $20,000 in their pocket from the government. They paid down debt. These subprime borrowers got this artificial bump to their credit score and then these algorithmic lenders buy now, pay later lenders are just giving out credit.

All those rates are floating rates. I just saw that the rate on credit cards are at all-time highs because it is a floating rate. If the Fed is successful at increasing the pain of the labor market and we start to see unemployment take up, that bodes well. That does not bode well for the consumer. I just feel there’s a lot of tail risks out there. I’m nervous. I’m a hopeful optimist, but I’m also a realist, and I feel there are a lot of tail risks out there that keep me up at night. If they happen, it could be very troublesome.

I 100% agree. I think people are irrationally exuberant right now, given where we’re at. There are so many things that could go wrong and that I think probably will go wrong. Very little that I see as an upside catalyst and yet the market keeps going up, which means it’s harder the fall. I’m in the same boat, which shut down. It was a nice segue to the next question, which is given that public stocks and bonds are probably likely to underperform, you have to do something with dollars.

The Benefits Of Alternative Investments

Alternative investments have become really the place to go for smart money. You’re one of the leaders in the space and in being thoughtful about investments outside of traditional stocks and bonds. Talk broadly about why alternative investments are attractive and what they do to help optimize a portfolio.

Of course, I think there’s always the scholastic response. In order to push that efficient frontier up into the left, you need to incorporate new asset classes and what better asset classes to do that are most effective asset classes than alternatives or private markets, given their lower correlations to public markets. There’s that response, the immediate benefit from an increased risk adjuster return or optimal portfolio. You’re getting more juice for your squeeze. I also think that when you look at the value you can add to a 60-40 portfolio, and let’s be honest, it’s marginal.

You’re either doing 100% passive or if you’re trying to pick active managers in any efficient public market asset classes, the manager dispersion is razor thin. You could pick the best public mid-cap growth manager, and you’re probably not going to get rewarded much more than if you pick the work. However, you go into a private market asset class and that dispersion, you could drive a Mack truck through. You’re rewarded for finding top-core managers, but you’re also equally as punished if you don’t pick good ones.

I think an asymmetric return profile can really pay benefits to the overall portfolio construction. That’s where we tend to focus. We try to add more value by thinking outside of public markets. I think it’s also just the pure opportunity set. You probably remember, Zachary, when the Wilshire 5,000 was 5,000 stocks. Now it’s less than 4,000. You’re seeing companies not as many public companies. The opportunity set to outperform as much loss. You’re seeing companies go private and stay private longer. Of private companies, there are over 80,000 US private companies and less than 4,000 public.

I like the opportunity set, trying to find any efficiencies in 80,000 versus 4,000 and then trying to provide alpha. Everyone might say, “They’re smaller.” That’s not necessarily true because those companies have over $100 million in revenue, 83% are private, and 17% are public. When we’re looking at trying to add alpha, trying to find inefficiencies in various asset classes, we feel that opportunity set is much greater in alternatives and then that’s how we’re going to deliver a superior risk adjust to return profile. If we want to minimize peak-to-trough drawdown,  that’s how we’re going to do it. We’re going to do it through the inclusion of alts.

What are your favorite alts right now?

Opportunities In Secondary Markets And Venture Debt

If I had to pick two favorite asset classes and this was before you asked me to come on the show, it’s secondaries and venture debt, hands down. I look at secondaries, you have the denominator effect because public markets got destroyed by private markets in 2022. They’re overallocated. Institutional investors going in, trimming exposure to alts, needing liquidity. You have a lot of disruption and dislocation forming, and there’s going to be a significant demand for liquidity. You’re going to have a lot of LPs just banging at the door to get out.

Last year, public markets were devastated by private markets. This has led to widespread disruption and dislocation, creating a substantial demand for liquidity. Share on X

A lot of opportunities in the secondary market, in my opinion, not just in private equity, I think in private debt, I think in private real estate, and perhaps private real estate, even more so. There could be a lot of great secondary opportunities that we look back on, and we can say that 2023 and 2024 have advantages, and they are probably some of the best in a long time.

Looking at venture debt. One, in general, I’m a fan of venture debt. I love the income production, double-digit income, the consistency of that income production, and the ability for some upside through the investment of getting granted warrants and things of that nature, typically better-coveted packages and things like that.

Now, I really liked the opportunity set, just given the biggest venture debt lender is gone. Silicon Valley Bank, they’re out. You also look at banks’ willingness to lend to private companies. That’s going to be diminished. You factor in potential regulation coming down, that’s also going to further diminish their ability to lend to private companies. Someone’s got to fill that gap. It’s going to be private lenders. I like that. Additionally, given the valuation adjustments we’re seeing in venture capital and in growth equity right now, it creates a much lower valuation to get into the door at.

You’re getting big, bigger warrant packages and lower strike prices. The IRR potential here, you probably know better than I would, but I’m putting well over 20% IRR expectations on venture debt right now. I think additionally, which I didn’t mention, because there’s so much demand and you can probably speak to this more, Zack, but the ability to increase the quality of loans and create a more covenant, heavy loan package. Right now, it also feels more beneficial for the venture debt lender.

You nailed it. Those are really the key points. It was always a very good strategy and, in my opinion, one of the best in terms of risk adjuster returns. To your point, when you have a market event like SVB as the largest supplier of venture debt in the space basically being taken offline, it just creates an immense imbalance between demand for capital and supply.

Just to put some quick numbers around it, from 2020 through the end of 2022, there was roughly $750 billion deployed by VCs into startups in the US and there was about a hundred billion of debt, maybe a little bit less, but so roughly we’re finding $850 billion of capital deployed over three years. Most of these companies come back to market to raise funds every 2 to 3 years as startups because they’re reliant heavily on external financing.

You’ve got more demand for capital coming up in the back half of 2023, 2024, and 2025 combined with this diminished supply. The supply on that side is also lower because valuations are lower. It’s a lot more expensive for companies to raise equity capital. The check sizes are smaller and the deals are taking a lot longer to get done.

Combine that difficulty on the equity fundraising side with half or more than half of the debt supply being taken offline, because, to your point, it’s other banks that are going to be pulling back, not because of anything having you in venture debt, but because of just broader risks heightened regulation.

There’s just this amazing mix of factors going on at the aggregate level where you’ve got super high demand and very low supply, which even folks that aren’t sophisticated investors can understand that equation. Great points on that. I also want to ask you if there is anything you’re thinking about now that you think others are missing? It’s something that’s off the radar. You brought up a couple of things already. Is there anything else that we should be thinking about, but for some reason, just not getting any press?

I know about that, but it goes back to the investment principle I didn’t mention. That is stay the course. Don’t make any knee-jerk reactions. If you’re going to make changes, change it at the peripheral. Don’t react to an event and sell out. It’s impossible to time the market. That’s why we say you can’t time the market. It’s not about timing the market’s time in the market. If anything, it’s don’t make knee-jerk reactions based off of one data point or multiple. Take a step back, try to see the forest through the trees, sometimes easier said than done.

If you're going to make changes, make the changes at the periphery. Don't react to an event and sell out. Share on X

Don’t think, “What is going to happen in the next day, week, month,” but rather, “Is this really going to be impactful over the next 3 or 5 years?” Try to make your decisions based off of that. Marginal changes. It’s not about saying, “I’m a 60-40 portfolio. Market is down twenty, I’m going to sell everything.” Maybe that’s the thing you want to get aggressive. I’m just kidding. Stay in the course, stay invested, and trust the partners that you work with.

The Importance Of Long-Term Thinking In Private Markets

You brought up a point there that I think ties into some other things we’re talking about earlier, which is the short-term nature of the public markets leads to inefficient decisions because everybody’s thinking on a quarterly basis. I had this conversation with somebody and I said, “One of the reasons I love private markets, in general, is because the capital in the private markets is much more long-term focused a lot of funds are 5-year funds, 7-year funds, 10-year funds.”

People are thinking through cycles as opposing thinking about what we are going to do in the next month so that our P&L are maximized so we can get paid. Ultimately, yeah, I’ve been on both sides of the fence, and I used to be a bond trader and a portfolio manager of corporate bonds. That was much more short-term focused. Especially trading, it’s really like, what’s your P&L?

In the private markets, though, I think there’s a greater opportunity to outperform because you’re not worried about now. You’re worried about long-term performance. I think the quality of decisions is better in general, and it fits better into a portfolio management context in a portfolio constructing context when you’re thinking in the longer-term. That’s the same with your principle of being patient and making changes on the margin but sticking with your core strategy.

I would add one thing. I forgot to add about the value of alternatives. I think that goes on the behavioral aspect of investing. I think investing in alternatives also instills good investor behavior because they can’t get out. They’re forced to sit in and experience the ride, and they see that it’s actually a smoother ride and that the results are typically better at the end. I feel that it naturally instills good investor behavior through investing in alternatives.

It’s so funny because people talk about investing in longer-term closed-end funds, like a private equity fund or private credit fund that it’s almost being married essentially. I saw somebody who’s invested with us and he told me half-jokingly, “I did more due diligence on ARI than I did on my wife.” In the sense that we’re going to be locked together for a long time. It’s easier to get a divorce than it is to part ways with a private manager.

To your point, there are these better decisions being made because of many reasons, but one of them being that you’re going to be together for a long time and when you find the right partners, it creates almost magical returns over time because you’re seeing opportunities that others don’t see. You’ve got that track record of working together and that trust that you build that happens over the years. You never get that in the public markets because it’s so transactional.

It’s all about what can you do for me now. It’s very much a zero-sum game, in my opinion, whereas longer-term private markets investing to me is it’s not a zero-sum game. It’s really much a synergy between the investor and the fund manager that helps both sides. We’re almost out of time. I want to ask the final question, which is on a going-forward basis over the next couple of years or through this next part of the cycle, what are the key themes you’re thinking about that investors should do as well?

I think the obvious one, the race to digitization, AI. Our preference is to play that through the private equity markets. Feel that’s where a lot of the innovation is taking place. Yes, the large mega-cap public companies are investing in that, but they’re also acquiring a lot of private companies that have already created this software and creating this innovation.

We tend to look to the private equity markets to really leverage that race of digitization AI and playing on that. I know that we mentioned a lot of risks forming in commercial real estate, but I think those same themes can also be leveraged on the commercial real estate side as you’re looking at different supply-demand imbalances, such as data centers and chip facilities.

Those that are going to be required as we shift more to AI and digitization, we need some real estate. I think one other one that doesn’t get a lot of press in real estate is cold storage. There’s a huge supply-demand imbalance, probably more so than housing, that just doesn’t get a lot of press. We tend to focus on that and look at real estate. I think obviously there’s this climate shift to green and climate protection, and so ways to capitalize on climate tech or agri-tech, your technology for clean agriculture and things of that nature.

The cold storage was the question of something that you’re thinking about that most others are. I rarely see people talking about that. What’s interesting is all the feeds you talked about, venture debt touches. What’s great about what we do is we get to look at the themes that we believe in, invest in those themes, and be industry agnostic but have the opportunity to invest in innovation as an asset class, but in a safer wrapper than you would as an equity investor.

That’s how I think about it, but yeah, those are great things. I’m so glad you came on. I learned a lot and I feel like I learned stuff talking to you. I’m very happy that you joined. Thanks, everybody, for reading the show. Reach out to Chris Osmond at Centura Wealth Advisory out of San Diego and hopefully, you’ll learn a lot in terms of what he can do for you and what the firm can do for you in alts and also in broader planning. Stay tuned for the next episode and see you soon.

 

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About Chris Osmond

Chris began his career in the finance industry in 2004. Before joining Centura Wealth Advisory, he served in leadership roles in some of the most prestigious Trust Wealth Management departments, including Northern Trust, US Bank Private Wealth Management, and BMO Harris Private Bank. Chris was responsible for creating and managing custom investment management solutions on behalf of high-net-worth and successful families, ultra-high-net-worth families, foundation/endowments, institutions, and various trusts in these leadership roles. More recently, Chris served as the Chief Investment Officer for the Overland Park-based Registered Investment Advisor (RIA). He was responsible for overseeing the firm’s investment strategies and guiding investment policy for the entire organization. Additionally, Chris was a significant contributor to the firm’s substantial growth from $3.5 billion to more than $17 billion during his tenure, where he was responsible for developing both traditional and alternative investment platforms.

Chris is a regular speaker at industry-specific conferences and a frequent contributor for media outlets like Bloomberg, CNBC.com, Reuters, Yahoo!Finance, CheddarTV, Fox Business News, T.D. Ameritrade Network, and U.S. News & World Report, to name a few. Chris is not only quoted and published for his insights on investments, the economy, capital markets, alternative investments, and sustainable and responsible investing, he provides expertise on the way technology is shaping the asset management industry.

Chris obtained his Bachelor of Science in finance from the University of Arizona and is an avid Wildcat fan. He is passionately committed to being an industry expert in all major elements of the finance industry, as such, Chris is a Chartered Financial Analyst®, a Chartered Alternative Investment Analyst, and is a CERTIFIED FINANCIAL PLANNER™.

Chris grew up in Denver, CO, and now resides in St. Augustine, FL with his wife and daughter. Chris enjoys golfing, snowboarding, spending time with family, reading, and barbecuing in his free time.

Chris’ North Star is being entrenched in the financial markets and creating investment strategies that meet the unique and specific needs of clients, all while serving clients in the highest fiduciary capacity.