When it comes to investing, is more choice better than less choice?
The stock and bond markets were down by double digits last year and there were few other public investment options to pick up the slack. Yet, some advisors took the sting out of the year by investing in non-publicly traded securities that had different return and liquidity characteristics.
Historically, investing in alternative investments (alts) was a paper-intensive, time-consuming, high cost, and illiquid endeavor that caused many advisors to shy away from allocating to them. Today, technology and new investment structures are addressing these shortcomings and democratizing access to opportunities that were once reserved for the ultra-wealthy.
To find out how far the alt space has come in the past few years, I recently attended the CAIS Alternative Investment Summit in Beverly Hills, CA and spoke to advisors using alts and the companies packaging up the investments.
From my conversations, I reached three conclusions:
1. The investment opportunity set for the average investor is much larger than ever before even though the number of publicly traded companies has dropped dramatically over the past 20 years.
2. The process to invest in alternatives has become much easier over the past five years—although there’s still room for improvement and efficiency.
3. In addition to offering the ability to create more effective and efficient portfolios, advisors who use alts typically become more attractive to higher-net worth investors who are used to getting “special access” to things not normally available to the general public.
Let’s look at each of these conclusions in detail.
Larger Opportunity Set
Around the world, there are approximately 10,000 publicly traded companies with $100 million or more in revenue, according to Steve Brennan of Hamilton Lane as reported in this Financial Advisor magazine article.
By contrast, Brennan said there were 95,000 private companies with $100 million or more in revenue.
Now, as an advisor, would you rather start your investment opportunity set at 10,000 companies or 105,000?
Let’s get even more specific about the equity opportunity set.
Michael Fosnaugh, Senior Managing Director, Co-Head of Flagship Fund at Vista Equity Partners told me, “By 2025, it’s estimated there’ll be north of a hundred thousand software companies in the B2B space, and of those, 97% are private. And so for folks that want to get exposure to the high growth software business, you gotta have a way to get exposure to those private companies.”
On the credit side, it’s a similar story. John Christmas, Co-Head of Business Development and Investor Relations at HPS Investment Partners, a global investment firm with approximately $92 billion of assets under management as of September 2022, told me that over the past decade or so, “The private credit market has grown from about 300 billion to $1.3 trillion. It is now the same size as the liquid loan public market that most investors only have exposure to.”
To underscore the growth in private credit, year-to-date 2022 through December 8, there were 262 leveraged buyout deals financed by private credit versus just 56 financed by the broadly syndicated loan market, according to the Wall Street Journal.
Again, as an investor, would you rather have access to $1.3 trillion of liquid loan income streams, or double the opportunity set by adding exposure to the fast-growing private credit side?
Private real estate is no different. Moving from just publicly traded real estate firms to private markets dramatically expands your options.
When I started in the business 30 years ago at Securities America, one of my jobs was to screen limited partnerships and determine which ones we wanted to vet for inclusion on our approved product list.
As you can imagine, in those pre-internet days it was a laborious job doing the research and for the advisor, it was time-consuming and paperwork intensive to get a client signed up for the product.
Today, the internet and technology tools make the process much easier.
Going back to the 105,000 companies with over $100 million in revenue, of course, no individual can keep track of that many companies. That’s one reason why in recent years, alternative investment platforms like CAIS and iCapital have sprung up to fill the gap in filtering and due diligence.
These companies have raised hundreds of millions of dollars in venture funding to build out platforms that give advisors access to a wide variety of alternatives. In particular, these platforms deliver three important services for advisors.
1. They cut through the clutter of the thousands of potential private investment opportunities, select what they deem to be the best, then make the due diligence available to advisors to confirm for themselves.
For example, CAIS uses Mercer as its independent third-party due diligence source and all funds on the CAIS platform must successfully undergo Mercer’s independent due diligence process before they get listed. And those due diligence reports and fund ratings are available to financial advisors for their own research purposes.
2. These platforms offer, essentially, a one-stop-shop for all your alternative investment needs. Specifically, you can use these platforms to access products, learn about them, and allocate to and transact in them at scale. And their digital subscription processing systems free your time to focus on education and the investments, instead of chasing down signatures.
3. They offer continuing education on alternatives so advisors can speak confidently to clients about this part of the portfolio.
For example, iCapital has teamed up with CAIA Association to offer AltsEdge, an education program where advisors can earn up to 10 CE credits and receive a Certificate in Alternative Investments.
CAIS offers CAIS IQ, which, according to the company, “is an industry-leading learning system to help advisors learn faster, remember longer, and improve client outcomes.” Advisors can also earn CE credits on select courses from both CIMA® and CFP®.
Attractive To HNW Investors
It’s no secret that for decades, wirehouses have prided themselves on having access to alternative investments. And that’s one reason why wireshouse brokers typically ended up with the highest-net-worth clients. The reality is, many wealthy folks like having investments that are not available to everybody.
In fact, some of the most successful independent advisory firms proudly hold themselves out as offering access to private investments as part of their “differentiation” strategy. Firms like Cresset Capital, Bradley Wealth, Seven Mile Advisory, and Strategic Wealth Partners, come to mind.
As public markets continue to become more efficient and the alpha turns to beta, these advisory firms realize that the alternative space offers expanded opportunities to completely personalize their clients’ portfolios.
Few investors want you to stick them in one of your 5 model portfolios. Instead, each investor has a unique risk tolerance, set of values, time horizon, liquidity needs, and a unique desire to own certain types of investments…and not others.
Alternatives expand your ability to create “portfolios of one” to meet the specific needs of your clients while alternative investment platforms make that process doable.
What Advisors Say
“I would say historically, most of my clients come to me already having experience with privates, especially if they’re in the fifty to one hundred-million-dollar net-worth range,” Pam Perskie, founder of Seven Mile Advisory said to me.
Now, how many advisors have clients that wealthy? Not many.
The good news is, Perskie said firms like CAIS now make it possible to “go down to $100,000 to $250,000 with a private investment that historically you haven’t been able to access. So even with my clients who are still building liquid wealth, investment wealth, they can still invest in alts. We just have to size it appropriately and make sure the liquidity is appropriate for them.”
Do alts really help with diversification and downside protection? Yes, according to advisor Michael Bradley of Bradley Wealth.
“I have to say during this economic cycle that we’re in and all the damage that’s occurred, the alternatives have really been the shining star for Bradley Wealth.”
Further, he said, “When I think about our top 10 or 15 relationships in the firm, every one of them has embraced alternatives in different flavors and different forms.”
David Copeland, founder of Strategic Wealth Partners, has been using alts for decades with a particular goal in mind.
“We’re really trying to complement the expected volatility of the stock market by something with low volatility. And in order to get that low volatility, you’re gonna have to make some sacrifices. In many cases, it’s paying higher fees. But if you’re getting results on an after-fee basis, why should you complain?”
He’s not looking for home runs by using alts. Rather, by selecting the right managers and using the right strategies, David’s team can often get mid to high single digit returns with modest volatility and little to no correlation to traditional stocks and bonds.
The ability for independent advisors to access alternative investments—at reasonable investment minimums from some of the top alt managers—has never been easier. As we enter 2023 with the markets and economy still in turmoil, now could be the time to expand your investment opportunity set and rethink your portfolio construction. Doing so could put your firm on a new growth path and expose you to new clients who historically would have never given you a look.
Steve Sanduski, CFP, is a financial advisor business coach and the co-founder of ROL Advisor, a discovery process technology system. He’s also a New York Times best-selling author and host of the Between Now and Success podcast.