Dallas / Ft. Worth International Airport

Introduction to Alternative Assets

January 22, 2021

Dallas / Ft. Worth International Airport

1

Today’s Purpose

1. Provide an overview of alternative investments.

2. How the alternative investments fit in your portfolio.

3. How the alternatives investments are evaluated.

4. The outlook for alternatives in your portfolio going

forward.

2

Today’s Outline

1. Alternative Investments

a. Introduction

b. Role within DFW’s Portfolio & Risk/Return Profile

c. Implementation Considerations

d. Asset Classes

i. Private Equity

ii. Non-Core Fixed Income (Private Debt)

iii.Private Real Estate

iv.Real Assets (Infrastructure)

2. Alternatives Reporting and Evaluation

a. Challenges

b. Solutions

3. What’s next for the DFW Alternatives Portfolio

Introduction

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An alternative investment is an investment into an asset

class other than traditional stocks, bonds or cash.

Alternative investments can include:

▪ Private Equity

▪ Private Debt

▪ Private Real Estate

▪ Private Infrastructure

▪ Commodities/MLPs

▪ Hedge Funds

▪ Others

Types of Alternatives

5

Alternative Investment Characteristics

Advantages Disadvantages

Potential for better returns Less liquid (illiquid)

Potential for increased diversification Higher fees

Low correlation to traditional assets Difficult to evaluate progress

Potentially less economically sensitive Complex vehicle structures

Higher income returns

Inflation protection

The advantages and disadvantages of alternative investments versus

traditional asset classes can include:

Role in Portfolio & Risk / Return Profile

7

Equity Fixed Income & Cash Real Estate & Real Assets

Asset Allocation is the strategy of investing in multiple asset classes with the

objective to balance total portfolio risk and return.

Understanding the Investment Program

Domestic Equity20.0%

Intl/Global Equity17.5%

Private Equity12.5%

Core Fixed Income12.5%

Non-Core Fixed Income15.0%

Cash2.5%

Real Estate10.0%

Real Assets & MLPs10.0%

Current asset allocation targets

by asset class

8

The Investment Challenge

▪ Forecasted returns for some traditional asset classes are well below historical levels.

▪ Traditional asset classes tend to be highly correlated (1.00 is perfectly correlated).

▪ Lower forecasted returns make attaining expected rate of investment return challenging.

▪ Higher correlation reduces the benefit of asset allocation.

Category 10-15 Yr. Expected Return1,2 15 Yr. Historical Return

U.S. Large Cap Equity 5.1% 8.9%

U.S. Small Cap Equity 6.3% 7.0%

U.S. Core Fixed Income 2.2% 4.4%

U.S. High Yield Bonds 5.1% 6.8%

Expected returns and correlations are from the “2021 JPMorgan Long-Term Capital Market Assumptions” (LTCMAs) and rounded to the nearest 0.1%.

Expected return is shown on a compound, annualized basis.

*EAFE Equity

U.S.

Large Cap Equity

U.S.

Small Cap EquityInternational Equity

U.S. Large Cap Equity 1.00

U.S. Small Cap Equity 0.91 1.00

International Equity* 0.88 0.79 1.00

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Benefits of Implementing an Allocation to Private Assets

Alternative assets are anticipated to generate an attractive long-term, risk-

adjusted return relative to traditional equites and fixed income.

Source: Expected returns are derived from the “2021 JPMorgan Long-Term Capital Market Assumptions”

Equity Expected ReturnExpected Risk

(Standard Deviation)

U.S. Large Cap Equity 5.1 14.8


Private Equity 9.4 18.7

Debt Expected ReturnExpected Risk


Core Fixed Income 2.2 3.4

High Yield Fixed Income 5.1 8.3

Private Debt (Senior Direct Lending) 7.7 13.7

Real Assets Expected ReturnExpected Risk


U.S. Core Real Estate (levered) 6.5 10.9

U.S. Value-add Real Estate (levered) 9.5 17.5

Global Core Infrastructure 6.6 10.8

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Benefits of Implementing an Allocation to Private Assets

The correlation between traditional and alternative assets classes is expected to

remain low.

Source: Expected returns are derived from the “2021 JPMorgan Long-Term Capital Market Assumptions”

U.S.

Large Cap Equity

U.S.

Small Cap EquityPrivate Equity



Private Equity 0.74 0.70 1.00

Core Fixed Income High Yield Fixed IncomePrivate Debt (Senior

Direct Lending)

Core Fixed Income 1.00

High Yield Fixed Income 0.18 1.00

Private Debt (Senior Direct Lending) -0.22 0.67 1.00

U.S.

Large Cap EquityCore Fixed Income

U.S. Core Real

Estate (levered)

Global Core

Infrastructure


Core Fixed Income -0.07 1.00

U.S. Core Real Estate (levered) 0.51 -0.08 1.00

Global Core Infrastructure 0.48 -0.03 0.42 1.00

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Alternative Allocation Comparisons

32.5%

27.8%

16.0%

26.0%

35.0%

16.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

DFW AlternativesTarget

TEXPERS TotalAlternatives

TX Chapter 801Plans

TX MunicipalPlans

TX StatewidePlans

AndCo AirportClients

Source: Allocations are derived from the PRB “2019 Guide to Public Retirement Systems in Texas” and TEXPERS “2019

Legislative Field Guide.”

Implementation Considerations

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Types of Alternative Investment Funds

Higher- Risk and Complexity - Lower

Lower – Diversification - Higher

Co-Investments Funds Direct Fund Investments Fund of Funds (FOFs) Secondary Funds

Investment

Diversification

20-50 underlying

investments

One fund with 10+

underlying investments

15 – 25 underlying

funds, each with 10+

underlying portfolio

companies (approx.

200+ underlying

companies)

Like FOFs.

Blind pool risk is

eliminated as

investments have

existing portfolio

companies.

Term Of

Investment

7 to 10 years

(plus extensions)

7 to 10 years

(plus extensions)

10 to 15 years

(plus extensions)

8 to 12 years

(plus extensions)

Time Until Initial

Distribution3 to 5 years 3 to 5 years 3 to 5 years As early as year one.

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Sample Cash Flow for Private Investments

Harvest Period

Investment Period

IRR

%

Capital Calls

Distributions

IRR %

“J” Curve Effect

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The Importance of Pacing

▪ Investors make a commitment to a

private strategy.

▪ The commitment is ‘called’ and invested

at the manager’s discretion – not the

investor’s discretion like with traditional

strategies.

▪ Investors need to estimate the timing of

future contributions and distributions to

ensure that allocations remain

consistent with targets.

▪ The forecasting of future cash flows and

the timing of future commitments is

known as pacing.

▪ Failure to use a pacing model can result

in large differences between actual

allocation and target allocation which

cannot be immediately rectified.

Larger but inconsistent commitments lead to wide differences

between target and actual allocation

Pacing may require smaller but more frequent commitments but

leads to better matching of allocation to targets.

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Sample Pacing Model – Private Equity

Private Equity

Vintage Yr /Investmen

t

Useful

HarvestGrowth Original Commitment Unfunded 2020 NAV 2021 NAV 2022

Yr CommittedPeriod

(Yrs)Period (Yrs) Rate

Commitme

ntFunded

Commitme

ntActivity 12/31/2020 Activity 12/31/2021 Activity

Glouston IV 2010 5 6 N/A 5,000,000 3,910,000 0 (274,486) 823,458 (274,486) 548,972 (274,486)

Lone Star CRA 2010 8 6 N/A 10,000,000 10,000,000 0 (1,880,997) 16,928,972 (5,000,000) 11,928,972 (1,988,162)

Capital International (CIPEF) VI 2011 6 6 N/A 5,000,000 4,168,679 0 (861,822) 3,447,288 (861,822) 2,585,466 (861,822)

Ironsides II 2011 4 7 N/A 7,000,000 6,630,206 0 (1,000,000) 429,954 (429,954) 0 0

Bay Hills II 2012 3 7 N/A 5,000,000 3,713,413 0 0 5,641,784 (1,128,357) 4,513,427 (1,128,357)

Lone Star V 2012 8 6 N/A 25,000,000 25,000,000 0 (11,750,000) 3,761,510 (1,000,000) 2,761,510 (1,000,000)

Altius II 2014 4 7 N/A 10,000,000 8,668,992 0 (1,000,000) 7,079,425 (1,011,346) 6,068,079 (1,011,346)

Ironsides III Partnership 2014 5 8 N/A 7,500,000 4,890,335 2,609,665 1,000,000 8,668,390 468,750 9,137,140 (1,305,306)

Ironsides III Co-investment 2014 4 8 N/A 7,500,000 7,361,440 0 0 5,844,547 (1,168,909) 4,675,637 (1,168,909)

Glouston V 2015 5 6 N/A 10,000,000 8,000,000 2,000,000 (1,200,000) 3,896,191 (649,365) 3,246,826 (649,365)

Bay Hills III 2016 4 7 N/A 10,000,000 7,067,111 2,932,889 0 9,930,050 0 9,930,050 (1,418,579)

Capital (Global) Dynamics IV 2016 4 6 N/A 20,000,000 16,556,000 3,444,000 (1,500,000) 13,319,504 (1,500,000) 11,819,504 (1,969,917)

Ironsides IV Partnership 2016 5 7 N/A 7,500,000 3,471,322 4,028,678 1,250,000 6,631,311 468,750 7,100,061 (1,014,294)

Ironsides IV Direct 2016 3 8 N/A 7,500,000 7,882,969 0 (1,500,000) 8,174,898 (1,500,000) 6,674,898 (1,112,483)

Vista VII 2018 4 6 N/A 5,000,000 1,262,030 3,737,970 750,000 1,931,442 1,250,000 3,181,442 1,250,000

Veritas VII 2019 4 6 N/A 5,000,000 0 5,000,000 1,000,000 1,000,000 1,250,000 2,250,000 1,250,000

CVC VIII 2020 4 6 N/A 5,000,000 0 5,000,000 250,000 250,000 1,000,000 1,250,000 1,000,000

New Mountin VI 2020 5,000,000 0 0 1,000,000 1,000,000 1,000,000

Marlin VI 2021 7,500,000 1,500,000 1,500,000 1,500,000

BC Partners IX (Q1) 2021 7,500,000 1,500,000 1,500,000 1,500,000

TBD 2021 5,000,000 1,000,000 1,000,000 1,000,000

TBD 2021 5,000,000 1,000,000 1,000,000 1,000,000

TBD 2021 7,500,000 1,500,000 1,500,000 1,500,000

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Other Important Considerations – Manager/Strategy Selection

Qualities to consider when evaluating private managers/strategies:

▪ Team stability

▪ Experience

▪ Ability to add value

▪ Strong network for sourcing deal flow

▪ Strong balance sheet for financing

▪ Valuation policy in line with industry best practices

▪ Defined exit strategy

▪ Track record

▪ Terms and fees

▪ Other considerations

Asset Classes: Private Equity

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▪ Investments or ownership in companies that are not

publicly traded.

▪ Result in an ownership interest in the company.

▪ Take an active role in the management of a company in

order to create value, enhance returns, and exit

successfully.

▪ Exit occurs when the private equity fund sells its

ownership in the company to another company or investor

or, in some cases, the company may go public.

Defining Private Equity

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Defining Private Equity

* IRR – Internal Rate of Return, ** TVPI – Total Value over Paid-in

▪ Investments are

made early in the

life of the company:

seed stage, early

stage and late

stage

▪ Average investment

hold time is 8-12

years.

▪ 25-30% IRR / 3x

TVPI

▪ Provides

expansion capital

for small, growing

businesses, that

are generating

cash flow and

profits.

▪ Average

investment hold

time is 5-7 years.

▪ 20-25% IRR / 2.5x

TVPI

▪ Investments in

established,

performing

companies that

may require capital

to expand and or

restructure.

▪ Average

investment hold

time is 5-7 years.

▪ 15-20% IRR / 2x

TVPI

▪ Investments in

companies that

have poorly

organized capital

structures or failing

operations

▪ Average

investment hold

time is 3-4 years.

▪ 15-20% IRR / 2x

TVPI

21

Examples Private Equity Portfolio Companies

Any securities cited are for illustrative purposes only. References herein do not constitute a recommendation to buy, sell or hold such securities.

Asset Classes: Non-Core (Private) Debt

23

Defining Private Debt

▪ Debt held by private companies

▪ Involves non-bank institutions making loans to private

companies.

▪ Includes direct lending, distressed debt, real estate debt,

mezzanine debt and others.

▪ As with public debt, the borrower is expected to pay back

the lender the original loan amount as well as interest

periodically for the term of the loan.

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Understanding Risk Premium

1 While considered illustrative, the yield premia shown are not expected to be precise. Each loan represents the outcome of a negotiation that involves many other important

factors, such as the risk and operating history of the borrower’s business, which will cause portfolios of loans also to have divergent specific yields. The study was conducted

using yields of business development companies’ loans due to their transparency, but their holdings may differ from the loans made by private limited partnerships. Some

terms also have different meanings among market participants, such as the EBITDA, revenue or capitalization ranges that define the “lower middle market.”2 In the source material, the “Subordination” factor is called “Second-Lien, Subordinated Debt.” Its name was changed, and the risk factors were reordered for clarity.

Source: Nesbitt, Stephen L. (2019). Private Debt: Opportunities in Corporate Direct Lending (1st ed.). Hoboken, NJ: John Wiley & Sons, Inc.

A higher expected return associated with a pervasive type of risk (factor) is

called a risk premium. Investors wanting more return, less risk or to diversify

other holdings may prefer taking different risks.

▪ Broadly Syndicated Loan (BSL) Yields –the yield of

tradeable bank loans.

▪ Direct Origination – illiquidity premium for non-

traded loans of similar capitalization.

▪ Lower Middle Market – size premium for lending to

smaller borrowers.

▪ Non-Sponsor Borrowers – value premium for

lending to companies not owned by a private equity

firm.

▪ Subordination2 – credit premium for lending junior

debt, pronounced factor in mezzanine.

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Private Debt: Risk and Return

Senior Loan

4.0x EBITDA

$200.0M Loan ($50.0M x 4)

5-Year Stated Term

Often Repaid After ~3 Years

Mezzanine Loan

1.0x EBITDA

$50.0M Loan ($50.0M x 1)

5.0-7.0 Year Term

Equity

Enterprise Value of Company

Minus More Senior Obligations

Remainder is 4.0x EBITDA ($200.0M)

LIBOR + 6.0-8.0%

+ 1.0-2.5% One-Time Fees1

11.0-14.0% Fixed Rate2

+ 1.0-2.5% One-Time Fees1

+ Equity participation

>25.0% Target IRRCre

dit L

osse

s

Capital Structure Yield

Risk of corporate investments is affected by borrower risk and seniority. Investments in

the more senior (junior) part of the capital structure have lower (higher) expected returns

and risk.

Hig

he

r-R

isk

an

d E

xp

ec

ted

Retu

rn -

Lo

we

rAssumptions

▪ Company with $50.0M EBITDA

▪ Trades at 9.0x EBITDA

▪ Enterprise Value = $50.0M * 9.0

EBITDA is a measure of cash flow equal to a corporate

borrower’s annual Earnings Before Interest, Taxes,

Depreciation and Amortization.

Enterprise Value Illustrative Liabilities + Equity=

1 One-time fees include items like origination fees and original issue discounts. Borrowers may also pay other types of fees for items like early repayment and loan

amendments.2 Mezzanine coupons often comprise cash and payment-in-kind (PIK) interest. PIK represents increases in the principal balance owed. Receiving PIK in lieu of cash

increases the investor’s risk but may also increase return multiples due to compounding.

The above represents a hypothetical scenario and is intended for illustrative purposes only, reflective of a sample capital structure for a mid-sized company.

Asset Classes: Real Estate

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Defining Real Estate

▪ Composed of investments involving the acquisition, financing and

ownership of real estate properties via a pooled vehicle.

▪ Two categories: primary and specialty.

▪ Four primary property types: office, multi-family, industrial and retail.

▪ Specialty property types include hotel, self-storage, student housing,

senior housing, medical office, among others.

▪ Returns in private real estate consist of income from rents and price

appreciation.

▪ Can be “evergreen” or can be “closed-end” with a pre-defined ending

date.

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The Phases of a Real Estate Market Cycle

▪ There are six phases to a full real estate market cycle: recession, bottom,

recovery, expansion, peak and contraction.

▪ Each geography and the property types within each geography can be at

different phases in this cycle at any given time.

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Real Estate: Risk & Return

There are three primary types of real estate funds with varying risk and return

profiles that an institution can utilize to construct a real estate portfolio.

Non-Core

Core Value-add Opportunistic

Target Return (net) 6% to 8% 11% to 13% 15%+

Primary Return Driver Income Appreciation Appreciation

Exposure to Development Limited Moderate Highest

Loan to Value (LTV) 15% to 25% 40% to 60% 60% to 70%

Vehicle Type Open-end Closed-end Closed-end

Lower - Risk and Complexity - Higher

Asset Classes: Real Assets (Infrastructure)

31

Defining Real Assets

▪ Physical (tangible) assets like commodities, real estate, infrastructure,

equipment and natural resources.

▪ Limiting discussion to Infrastructure because it’s the future focus for the

portfolio.

▪ Essential public services and facilities like toll roads, airports, water

treatment facilities and ports.

▪ Return is made up of a combination of income and appreciation.

▪ Open-end or closed-end structures.

32

Infrastructure: Risk and Return3

2

There are three primary types of strategies with varying risk and return

profiles that an institutioncan utilize to construct an infrastructure portfolio.

Core Value-add Opportunistic

Target Return (net) 6% to 10% 10% to 12% 15% to 17%

Primary Return Driver Income Appreciation Appreciation

GDP Sensitivity Low High High

Brownfield or Greenfield Brownfield Both Both

Operating Complexity Medium High High

Geography OECD OECD / Non-OECD OECD / Non-OECD

Lower - Risk and Complexity - Higher

Private Asset Reporting and Evaluation

34


What are the challenges of private asset evaluation?

▪ Different/unfamiliar

▪ Lacks traditional comparison like peer group or benchmark.

▪ Results lag public market investments.

▪ Hard to evaluate until late in the life of the investment.

▪ “J” curve.

▪ Heavily impacted by when capital is called or returned.

▪ IRR calculation can be manipulated.

35


There are several different tools that we use to evaluate private

asset strategies. They include:

▪ Time-weighted return (TWR)

▪ Internal rate of return (IRR)

▪ Total Value to Paid-in Capital (TVPI); also called Multiple

▪ Public Market Equivalent (PME)

▪ Private Asset Barometer

36


Time-weighted return (TWR)

▪ No cash flow or market value impact.

▪ Best for determining manager skill versus a stated benchmark.

▪ Not ideal for situations where the manager controls cash flows (closed-end vehicles).

▪ Available benchmarks may not be a good approximation of strategy expectation.

Strategy

Benchmark

37

Private Asset Reporting

Internal rate of return (IRR)

▪ The size and timing of cash flows has a material impact on return.

▪ Not suitable for determining manager skill.

▪ No peer group or benchmark.

38


Multiple (TVPI)

▪ Total value as a multiple of the cost basis.

▪ Cumulative distributions + residual value / paid-in capital.

Public Market Equivalent (PME)

▪ Converts public market returns into an IRR-like metric.

▪ ICM/PME spread is the difference between the IRR of the fund and the IRR of the

hypothetical public portfolio.

ICM/PME spread

Hypothetical

Public Portfolio

39

Additional Strategy Detail – Quarterly Report

40


Private Asset Barometer

▪ Produced annually based on year-end values.

▪ Uses TVPI/IRR.

▪ Peer comparison by vintage year.

▪ Factors in percentage of capital called/returned.

▪ Anticipates the likelihood that results will change in the future.

▪ Assigns a classification

▪ Provides a commentary.

41


Private Asset Barometer (cont.)

42



43


Multiple (TVPI)

▪ Total value as a multiple of the cost basis.

▪ Cumulative distributions + residual value / paid-in capital.

Public Market Equivalent (PME)

▪ Converts public market returns into an IRR-like metric.

▪ ICM/PME spread is the difference between the IRR of the fund and the IRR of the

hypothetical public portfolio.

ICM/PME spread

Hypothetical

Public Portfolio

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46



47

Summary

In summary, investment in alternative asset classes can offer solutions to

current investment challenges by providing:

▪ Potentially higher returns

▪ Increased diversification

▪ Lower correlation

▪ Inflation protection

▪ More return from income component

▪ Potentially less economic sensitivity

48


Questions?

This Photo by Unknown Author is licensed under CC BY-SA-NC

http://www.exploratorium.edu/snacks/proprioception

https://creativecommons.org/licenses/by-nc-sa/3.0/

What’s Next

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Final Thoughts and Recommendations

▪ Allocating an institutional portfolio to alternative investments should be beneficial

to DFW, based on your objectives.

▪ Alternative investments are a component DFW’s long-term strategic allocation,

not a short-term trade idea.

▪ Consistent allocation to alternative investments in DFW’s portfolio has added

diversification and increased returns.

▪ As the portfolio grows and current investments mature, new allocations to

alternative investments with larger contribution amounts will need to be

considered.

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