A Rock or a Stone? It Pays to Know the Difference | Denewiler Capital

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A Rock or a Stone? It Pays to Know the Difference

Written by Greg Denewiler, CFA® // February 24, 2023

If you need a conversation starter at your next party, you might ask the stranger next to you: What’s the difference between a black rock and a black stone? If they don’t immediately excuse themselves to get more chips and dip, or another drink (which they will need after talking to you), you now know this new acquaintance is just another boring person like you. According to Dictionary.com, the definition of a rock is: a stone of any size. The definition of a stone is: the hard substance, formed of mineral matter, of which rocks consist. They appear to be the same thing, and in our case, they are both black. In the investment world, a rock and a stone are entirely different. Some investors have found out the hard way.



Both Blackstone and Blackrock are two of the largest money managers in the world. However, Blackrock focuses more on the individual investor side, offering mutual and index funds with a total of $8 trillion in assets under management. Blackstone is one of the largest institutional managers with about $1 trillion under management, but they focus more on larger investments designed for long-term institutional ownership. Institutional investments are often less liquid, and they take more time to sell. You can’t sell a $100 million building tomorrow. The appeal of the institutional side is that they typically offer higher returns in exchange for the ability to sell quickly. On February 13th, 2023, the Wall Street Journal wrote an article regarding a private fund that Blackstone had opened in 2017 that allowed smaller investors (you and me) to invest in real estate that normally is only available to large institutional investors. Both Blackstone and Blackrock have been extremely successful and carry a lot of creditability in the financial world, so when Blackstone introduced an investment for the “little people”, one that normally only large institutions have access to, it was an immediate success.



In 2022 the fund, BREIT (Blackstone Real Estate Income Trust) had assets of $70 billion and was paying a 4% dividend in a 0% interest rate world. It offered stability and a strong long-term track record. It seemed the fund was everything an investor could want, except for one small hitch – only 5% of the fund could be redeemed by investors each month. In a normal investing environment, the standard response tends to be “no problem.” However, secretly investors seem to always assume they will be the lucky ones to get out ahead of the pack when things start to look more challenging. This is where knowing the difference between a rock and a stone is huge. With most of Blackrock’s investments, you can sell whatever you want whenever you want because almost all of its offerings trade in public markets. Those rules don’t apply to many of Blackstone’s investments including BREIT, and as an investor, you better understand the difference.



You can read the WSJ article which goes into detail as to what happened to the fund last year. The short version is that as interest rates moved higher and recession fears started to build, investors started to fear the worst and much more than 5% wanted out in the same month. Blackstone claimed the fund was performing well, but still had to temporarily suspend redemptions. When investors start to panic, what comes next is a “classic run on the bank.” To prevent Blackstone from selling properties in a fire sale, they offered the University of California a special deal. In exchange for adding $4 billion to the fund and agreeing to not sell for six years, Blackstone gave the university a preferred return of 11.25%. It’s amazing how you and I never get that deal. Deals are made to try and save the ship and the small investor once again finds out that things were not as they appeared. There are a few lessons here.



First, if you are ever offered an investment that has a restriction as to when you can sell, think twice. In times of stress, it never goes well, and you may be stuck with few options if any. Wait and see what happens when BREIT experiences a real recession and the FED isn’t throwing free money everywhere. Second, Blackstone seemed to think that because of their record and creditability, they could manage through a rush to sell. Investors are not always rational, and they don’t care about explanations when times are tough. They sell first and ask questions later. Third, when it appears there is a free lunch, investors need to ask more questions, nothing is free. A 4% return with “less volatility” from a well-known firm appeared to be a free lunch in 2021. It was not. Blackstone did offer quality cash flow, but if you must sell assets to meet redemptions, quality doesn’t matter. Owning a quality company with no conditions attached is an advantage because if it declines in value, you still have the option to hold for a recovery. When you are forced to liquidate your stock or real estate, there is no recovery. A stone and a rock are the same to almost everyone, but in this case, there is a significant difference. Investors didn’t realize that until it was too late. Do your best to avoid surprises.


Observations On The Market No.380