October 28, 2026

Stop Asking What Bucket It Goes In

A manager and an allocator on what Seth Klarman gets right about risk-adjusted return, and why attractive asymmetry can be found in overlooked credit markets.

Bill Healy | Partner, Chicago Atlantic
Rodrigo Lopez Buenrostro | Investor at KuE Capital

“A lot of people will look at historic returns and say the expected return for owning private equity will be mid-teens or upper teens, the expected return for venture capital will be better than that. We don’t do that. We really don’t know what asset class is going to do, because we think that’s very time-specific and very valuation-dependent.”

— Seth Klarman, Masters in Business, Bloomberg Radio, June 23, 2026

By: Bill Healy | Partner, Chicago Atlantic

Klarman put it plainly. Much of the asset management industry does the exact opposite: backward-looking, asset-class-first, anchored to historic averages—as if mid-teens private equity returns were a law of physics rather than a product of specific low-rate, high-leverage vintages.

This isn’t just a philosophical debate; the institutional market is already adjusting in real time. Major pension systems and endowments are increasingly abandoning fixed asset-class targets in favor of a Total Portfolio Approach (TPA)—a framework in which every investment must compete for capital on its relative, forward-looking risk-adjusted merit rather than its assigned “bucket.”

The alternative to rigid bucketing is the posture Klarman describes: a portfolio built to respond to structural opportunity wherever it shows up. Returns aren’t a fixed property of a category. They depend on the price you pay, at a specific moment, relative to the risk you assume. I’m borrowing Klarman’s principle here, not suggesting he would endorse where I take it.

If that’s right, the challenge isn’t picking categories. It’s identifying the conditions that produce an attractive risk-adjusted return and judging whether those conditions will last. Four decades in global capital markets—predominantly credit—have left me with four principles for making that judgment.

The Four Principles of Structural Alpha

1. No Immunity to Competition: Strategy and pedigree matter, but they don’t repeal the laws of capital supply and demand.
2. Pre-Institutional Timing: Look for opportunities before institutional capital arrives, broadens coverage, and competes away the excess return.
3. Asymmetric Risk/Reward: Invest where capital scarcity creates structural room to negotiate pricing, terms, and downside protection.
4. Structural Durability: Ensure the advantage is created by persistent, enduring forces (regulatory moats, complexity) rather than recent returns alone.

That fourth principle has sharpened for me over the past seven years in private credit. But it was forged much earlier. I started my career in the mid-1980s in what nobody yet called emerging markets. Back then it was “LDC debt,” for Lesser Developed Countries. The paper traded at deep discounts among a handful of banks. There was no index or dedicated fund and almost no institutional buyer base, largely because the institutions that might have bought it weren’t permitted or equipped to do so.

Then it got rebranded, which is often the first step toward institutional acceptance. “Lesser Developed Countries” described what those countries didn’t have. “Emerging Markets” described where they were going. Same paper, better story.

With the better story came a benchmark, consultant coverage, dedicated funds, and a line in every allocation model. An asset class doesn’t get its own bucket until someone gives it a name worth selling. By the time it has both, some of the original scarcity premium has usually been competed away.

That arc is why I’ve become far less interested in asking, “Where are returns the highest?” and far more interested in asking, “Why do those returns exist, and how durable are they?” The first question invites you to chase a number. The second forces you to underwrite the structure behind it.

It’s also why I’ve spent the back half of my career in niche, lower middle market direct lending. Non- sponsor borrowers. Companies too small or too complicated for mainstream banks and larger credit managers. Owners with no private equity firm standing behind them. Situations where a lender must underwrite the business rather than price off a comparable loan.

A compelling theme isn’t necessarily an equity play. Often the better risk-adjusted expression sits higher in the capital stack, in the debt.

Sponsor direct lending, meanwhile, has become one of the most crowded and thoroughly institutionalized corners of private credit. A decade of enormous fundraising has put pressure on spreads and terms, turning what was once a scarcity trade into a more competitive market. That’s my second principle playing out in real time. I’m more interested in niches where an underlying imbalance still gives a disciplined lender room to negotiate.

The Four Principles in Practice

Which brings me to what I consider one of the most attractive risk-adjusted expressions of these principles today: senior secured credit to non-sponsor-backed U.S. lower-middle-market businesses in areas where traditional banks and mainstream private credit providers are often unable—or unwilling—to participate.

Across these underserved markets, scarce financing can give a disciplined lender room to negotiate pricing, structure, and protections. Each loan must still stand on its own underwriting.

The U.S. legal cannabis industry is a particularly clear example. All four principles converge there, and that’s rare. Many of the conventional lenders that would normally compete for these loans remain constrained by federal law and related compliance concerns.

That leaves the field to a handful of experienced lenders. Those entrenched incumbents have room to negotiate pricing and protections. Their competitive moats go beyond scarce capital: underwriting history, borrower relationships, and operating knowledge that takes years to build. The imbalance is structural rather than simply cyclical. And although federal policy is changing, the process remains incomplete. The conditions limiting the supply of capital may persist for some time.

The same constraints that create the opportunity also make the work harder.

My four principles get you there. Is the opportunity genuinely uncrowded? Is the potential reward disproportionate to the risk? Is the downside protected by the terms of the investment? And are the forces producing the opportunity likely to endure?

That last question—durability—deserves a word, because durability means something fundamentally different in credit than it does in equity.

A private equity investor may need a growth story or a regulatory window to remain open for years to achieve an attractive exit multiple. A direct lender operates on a different timetable. We do not need the “cannabis regulatory window” to remain unresolved for ten years to seek attractive risk-adjusted returns: the objective is to earn contractual cash income and recover principal over the loan’s shorter life.[1]

Because loans are structured with conservative 2- to 4-year maturities and active monthly or quarterly amortization, a lender is able to capture contractual cash income and systematically recover principal over the life of the loan. Whether federal legalization eventually occurs five years from now and compresses credit spreads is largely irrelevant to existing loans. The contractual returns and principal recovery are already locked in by the terms of the note, independent of where the macro environment trades at maturity.

Any future narrowing of the opportunity window certainly could affect originations, but it would not erode the economics of an amortizing senior loan already on the books.

Recent regulatory developments put this thesis to a direct test. In May 2024, the Department of Justice proposed moving marijuana from Schedule I to Schedule III. In April 2026, it placed FDA-approved marijuana products and qualifying state-licensed medical marijuana in Schedule III; that action did not extend to the entire adult-use market.

For credit investors, the most critical aspect is a distinct decoupling of borrower cash flow from lender competition:

1. Cash Flow Relief (Section 280E): For qualifying activities moved to Schedule III, rescheduling generally removes Section 280E as a bar to ordinary business deductions and credits. Lower cash taxes can materially increase after-tax cash available for debt service and improve cash-flow-based debt service coverage. The benefit depends on each borrower’s activities, tax position and applicable implementation rules.

2. Persistent Institutional Scarcity: Rescheduling does not fully legalize cannabis at the federal level or automatically resolve the compliance, anti-money-laundering and regulatory concerns that constrain conventional lending. Many commercial banks, institutional funds and conservative allocators may remain unwilling or unable to participate, even as qualifying borrowers benefit from tax relief.

The Result: Borrower debt-service capacity can improve before the pool of competing lenders expands materially. Tax relief strengthens one side of the credit equation without necessarily removing the capital scarcity that supports lender pricing and protections.

That lag—where borrower cash flows expand before institutional capital arrives to compete down yields—is a clear expression of risk/reward asymmetry. It can allow specialized senior lenders to continue earning premium, complexity-driven yields while the same borrowers have more cash available to repay them. The improvement must still be underwritten loan by loan; it does not eliminate business or credit risk.

Underwrite the Investment, Then Assign the Bucket

In my discussions with allocators who have the flexibility to invest across traditional asset-class boundaries, I encourage them to ask where their next marginal dollar can earn the most attractive return for the risk taken, before deciding which allocation bucket should hold it. None of this is an argument against portfolio construction. It’s an argument against giving an asset class’s historical average returns more weight than the underwriting of the specific investment.

I’ve applied these four principles across forty years. Most opportunities fail at least one. Selected areas of non-sponsor-backed lower-middle-market credit can satisfy all four.

Cannabis is a particularly clear example; the same framework applies across other underserved markets.

The opportunity is to earn a premium for providing scarce capital while retaining conservative leverage, meaningful collateral, and control over the lending terms. That is the asymmetry we seek: attractive contractual cash income paired with protections that reduce our exposure if the business falls short.

I asked Rodrigo Lopez Buenrostro, Co-CIO of KuE Capital, to read this from the other side of the table. As this piece is written for allocators, it seemed appropriate to let one answer.

An Allocator’s View

By: Rodrigo Lopez Buenrostro | Investor at KuE Capital

When I read Bill’s title, I thought of the difference between an investor and an investment officer.

An investor wants to find, evaluate, and own great investments, wherever they come from and whatever label they carry. An investor looks for ideas that make sense across macro environments. And an investor knows that a good company, or a good manager, isn’t automatically a good investment.

An investment officer has a different challenge. Allocation targets, committee expectations, and legacy relationships can make an unfamiliar investment harder to approve than a familiar one.

A good idea needs a case. An unusual idea often needs a defense. Even capable people can find themselves protecting the process rather than questioning whether it still serves the portfolio. My advice is Bill’s title. Stop asking what bucket it goes in. Is it a good investment? Would you buy it for your children’s portfolio? Have you done enough work to be convinced? If the answer is yes, make the case for owning it.

What happened to the Swensen model? Klarman’s point has a human explanation. When people see great results in an asset class, they move mountains to get in. More capital chases the same opportunities. Entry prices rise, the margin of safety shrinks, and future returns compress. It doesn’t happen on a schedule, but the direction is reliable.

Private equity is the clearest example. For decades, David Swensen’s endowment model was institutional nirvana. He built exceptional results in private equity, venture capital, and hedge funds while most endowments were still thinking in terms of 60/40. He was a pioneer, and he institutionalized how to diligence managers. Since then, nearly everyone has tried to replicate him—with far less success. His model also assumed low interest rates and a stable geopolitical backdrop. Neither holds today.

What’s replacing it is called the Total Portfolio Approach. Instead of asking which asset class an investment fits into, it makes every investment compete for a place in the portfolio on relative merit. In November 2025, CalPERS voted to adopt it in place of fixed asset-class targets, effective July 2026. I think it hits Klarman’s point exactly. A meritocracy across the whole portfolio beats a set of silos, each defending its own allocation.

Why capital stays scarce. Bill argues for investing where the reward is disproportionately large relative to the risk. He explains the structural reason conventional lenders stay away from cannabis credit.

Fear takes many forms. Fear of looking foolish when you bring an unusual idea to committee. Fear of losing your job over it. Fear of seeing a position down 20%. Fear of the discomfort of a first meeting with a new manager and an unfamiliar strategy. And the plain adult fear of trying something new. The best investors know their fears and use them as a reason to learn, going deep until they understand. The average investor lets fear decide, avoids the new manager or strategy, and ends up with an average portfolio.

The second reason is the work. Fewer investors are willing to spend the time to understand a business model, an investment process or the culture inside a manager. That’s the only way to build conviction in an unconventional idea, and the only way to earn returns that look different from the index.

You can’t beat an average portfolio by behaving like the average investor.

U.S. cannabis credit is a good example. For many allocators, the first reaction is the headline, not the underwriting. When we did the work, we found something different: senior secured loans to cash-generating businesses, conservative leverage, and terms that capital scarcity allowed the lender to negotiate.

The label made people nervous. The structure is what mattered.

That’s why Bill’s two questions matter. Why do these returns exist? How durable are they? The first identifies the opportunity. The second shows whether there’s a path to capturing it. Few institutional investors take the time to ask either.

Resilience. Why do these returns exist? Sometimes capital is scarce. Sometimes the risk deserves a high return. Sometimes both are true. The allocator’s job is to tell the difference. That is where a manager’s underwriting history, borrower relationships, and lessons from past mistakes matter. Can the business service the debt? What protects us if it falls short? What can the lender actually do when things go wrong? A high yield is easy to recognize. A well-protected loan takes work to understand.

That is the conviction worth building, whatever bucket the investment eventually goes in.

[1]Chicago Atlantic Credit Opportunities, LLC, which focuses on directly originated, senior-secured loans to established U.S. cannabis operators in state-regulated markets and is now in harvest mode, reported a 17.8% net IRR from inception on April 30, 2021, through June 30, 2026, and paid cash distributions quarterly at an approximately 12% annual rate. These historical fund-level results are not a forecast of future performance. Past performance is not indicative of future results. There can be no guarantee of any future outcomes.

This document is provided for informational purposes only. All investments involve risk, including the risk of loss.