During the past couple of decades, institutional investors have steadily added alternative investments — hedge funds, private equity, commodities, real assets, etc. — to their portfolios in an effort to reduce volatility from public securities, while increasing returns above fixed-income dividend levels. Instead of the traditional 60/40 split often found in private investment portfolios, institutions now typically divide their portfolios into many largely uncorrelated asset classes, with a large percentage targeting alternative investments. Large endowments, such as Yale and Harvard, have more than 50 percent of their allocations in alternative sectors.
Sophisticated private investors have taken note of this movement — and the returns generated by alternatives — and many have begun to look for ways to access these large, often illiquid, opportunities. However, the hurdles to investing in the types of sectors and funds that attract institutional players have generally proven too daunting for most private investors to overcome. The process has just been too frustrating, with too much paperwork, too little transparency, high initial investment minimums and excessive hold periods. Even if an investor could overcome these hurdles, there was simply a lack of access because fund managers were not looking for or catering to private investors. It is easier to find five institutional investors who will each commit $10 million than 500 private investors with $100,000 to invest.
But all of that may be changing. Today, several technology-based platforms are offering investors and their advisers ways around the most common roadblocks, and some of the largest fund sponsors are actively courting private investors to grow existing funds and launch new ones. Some hurdles are easier than others for technology to overcome, but all can benefit from what technology has to offer.
The landscape of institutional private funds is evolving. Historically, investment fund sponsors launched, invested and managed one fund at a time, which meant they only had to find investors once every few years. It made sense to concentrate on institutions and their large allocations. Today, however, the largest sponsors are overseeing several funds at a time, and thus need a more diversified investor base. That means they are happy to welcome qualified investors — if those investors can find them.
Because there is no central clearinghouse for alternative investments, it is not easy for investment advisers and private investors to access even those meant for them, such as Regulation D offerings, 1031 exchanges, DSTs (Delaware Statutory Trusts), private funds and other similar investments. Finding appropriate institutional alternatives is even harder. It would be the rare financial adviser who would know the portfolio manager at Apollo or Blackstone, or the institutional reporting firms needed for objective third-party due diligence. And even if an adviser was able to access these offerings, how do investors know which ones are right for them, and how do they monitor them going forward? It is all just a bit too much.
Technology-based platforms to the rescue. Digital platforms have evolved to the point where they are helping to solve both the access and the due diligence problem, as well as mitigating other risks.
First of all, fund sponsors who are courting qualified private investors are finding it advantageous to be listed on these platforms, as it allows them to access investors that might not otherwise know the opportunity existed. And investors are finding the search and due diligence features particularly helpful. Now, they or their advisers can zero in on appropriate alternative investments in a fraction of the time — and with deeper insight — than was previously possible. In addition, they can read objective, third-party reviews of the offering to determine if the risk/return profile of the offering and track record of the sponsor meets their investment metrics.
Once an investor has found an appropriate offering, technology is particularly good at reducing the paperwork blitz.
“Operational hassle, which is solved through technology, is the No. 1 hurdle with a bullet,” says James Waldinger, CEO and founder of Artivest. “The difficulty of getting and filling out the paperwork, as well as getting accurate distributions and reports, has been overwhelming and discouraging to private investors.”
Unlike public securities and mutual funds, most alternative investments are still completed with paper documents being mailed back and forth between sponsors, investors, advisers and third-party participants, such as fund administrators and custodians. This process is lengthy, taking weeks to complete and prone to errors.
“We estimate that between 30 percent and 60 percent of alternative investment subscriptions must be sent back for corrections at least once before being completed,” says Bill Robbins, CEO, WealthForge. “This rework is frustrating, expensive and time-consuming. The good news is that we have seen NIGO [not-in-good-order] rates reduced to low-single digits with the adoption of subscription automation technology.”
Straight-through processing, similar to the technology that transformed the mutual fund industry, is now being introduced to alternative markets. This technology allows investments to be completed online, with electronic signatures, document tracking and information collection workflows that dramatically reduce error rates.
By reducing paperwork, technology might be able to reduce other hurdles as well, such as high embedded costs.
“Industry participants who adopt the use of straight-through processing technology may be able to automate and standardize their costly and redundant back-office procedures,” says Robbins. “The associated cost savings between sponsors, transfer agents, custodians and advisers support our ability to better serve the investor.”
Alternatives, by their nature, are typically illiquid, with five- to 10-year (or longer) hold periods. Institutions have no problem tying up their capital for this length of time because they have large portfolios that can cover any short-term capital needs. Private investors often do not have that type of flexibility.
Without the existence of a secondary market, investors may be unable to retrieve their funds during that set hold period. This means that even if an investment seems to be failing or if investors suddenly find themselves in need of cash, they have no way to liquidate. Easier access should grow the primary market, which in turn, should spur the creation of a secondary market, making these illiquid investments more liquid. A couple of the digital-based platforms are already working with outside partners to give private investors the ability to resell their long-hold investments before their maturity date.
Technology alone cannot overcome the large investment minimums typically required to invest directly into alternatives. Even accredited investors — those with a net worth of $1 million-plus or an annual salary of $200,000 plus — might balk at a $50,000 or $100,00 minimum investment. And that would be a low minimum in a sector where minimums typically run in the millions. But as fund sponsors look to attract private investors to diversify their capital base, and now that digital platforms give them an inexpensive and efficient way to do that, some are lowering those minimums to attract the private investors they need.
“Technology plays a critical role in delivery, but what has made alternatives an investible asset for individual investors is the same access as large institutions,” said Matt Brown, CEO and founder of CAIS. “Fund managers are offering investors lower investment minimums with the same pricing terms as large institutions. This has eliminated the use of feeder funds and the costs associated with them, unlocking demand and expanding the investor base for asset managers.
Finally, investors who have been able to overcome everything the alternative investment space has thrown at them are still faced with the inability to easily monitor their investments. Public companies have regular reporting requirements, but private companies and investments are less strictly regulated when it comes to reporting.
Technology and databases, however, work on standardization. As these platforms grow, transparency should increase as fund sponsors find it easier to upload performance and other data to a single platform, where it is then automatically disseminated to investors.
GIVING ADVISERS AN ADVANTAGE
So, it is relatively obvious what technology can do for investors in making alternative investments more accessible, but what’s in it for the adviser?
“The RIAs and other financial advisers are realizing that they are not going to be able to support a high-net-worth practice if they don’t offer alternatives,” says Waldinger. “A technology platform can make sure your investors are qualified, as well as reducing the time they spend on paperwork. In addition, the adviser can do a search for the most appropriate and interesting investments for their client, saving everyone’s time and making meetings with clients more productive.”
One of technology’s primary strengths is its ability to standardize data, which means forms and reports can be consolidated. Consolidated reporting may help advisers receive their commissions in less time. If you cannot get the report, it is hard to get the commission. Standardized reports are automatically generated and, thus, help the adviser grow a more efficient business.
And then there is reach. To grow their business, advisers need to expand their universe. By using a digital platform, advisers can work with clients anywhere in the world. They are no longer limited to a few square miles around their offices.
“If you are a northern adviser but have snow bird clients, it’s easy to get on the phone, call the client and send the link to an investment opportunity,” says Brad Blazar, director of national accounts at Venture.co. “We’re eliminating the paperwork, which means the adviser can spend more time facing clients than filling out paperwork. This makes a more profitable advisory business.”
One of the primary reasons advisers avoid alternatives is that they do not have time to research all the options. Digital platforms have evolved to provide a searchable selection of vetted opportunities ranging from private partnerships to diversified funds, with sectors covering the spectrum from real estate and infrastructure to private equity and hedge funds. In addition, advisers can use the platform’s analytical tools to evaluate the investment.
“Every aspect of the subscription and investment process is automated for the adviser, removing the arduous, manual processing that has historically been associated with these investments,” says Lawrence Calcano, CEO at iCapital Network. “This provides advisers with a complete toolkit for efficiently offering a curated array of fully researched and vetted investment opportunities to their clients.”
Although technological platforms that offer searchable and filtered databases, downloadable and uploadable forms, standardized reports for better transparency and third-party reviews have lowered hurdles for private investors to access opportunities, a new roadblock has appeared — privacy concerns. This is not a completely unwarranted concern. Data breaches and misuse of data involving large retailers, banks, credit bureaus and social media platforms regularly make the news. Any entity that handles large amounts of data is constantly under attack.
“We have to be on the offense all the time,” says Aaron Pollak, CEO and co-founder of Venture.co. “Advisers want to know that their clients’ information is secure and that it will not be used inappropriately. Data security is a prime concern for any technology platform, and it is something we work continuously to provide.”
Because privacy concerns have been front and center in recent years, people often feel that digital-based transactions are riskier than paper-based ones. Yet, it is actually just the opposite. Technology can mitigate many of the risks that advisers face every day.
“Using a technology platform can mitigate risks associated with compliance and the transmission of data,” says Pollak. “In addition, the frequency that data is accessed or transmitted among parties is mindboggling. The more times it is touched, the more at risk it is. We are providing secure methods for data transfer and storage designed to mitigate against the security risks.”
In addition to security concerns, advisers sometimes resist offering alternative investments to their clients because they fear losing AUM if the client pulls capital from bonds or securities. With these new platforms, however, an adviser has the ability to use software to perform the same type of due diligence and monitoring that they do with more traditional investments and keep the alternative AUM in-house. In fact, some are finding this to be a good way to increase AUM because it increases the options they can provide their clients.
THE KEY TO DEMAND
If technology is making investing in alternatives relatively easy for a private investor and more profitable for the adviser, why isn’t demand spiraling?
“Arguably, one of the biggest factors preventing advisers and their clients from initially contemplating alternatives is limited knowledge of and information on these types of assets,” says Calcano. “As with all investing decisions, advisers need to be extremely well-educated about the mechanics of each investment and determine how it may fit into the construction of an overall portfolio.”
Efficiency does not create demand. You still need to find the people to buy the products.
“A lot of firms are solving the friction of buying,” says Brown. “But they are working with consumers who already want to buy. We have to increase the universe, and the only way you do that is through education. Without education, you will never see the demand needed to truly grow the technology platforms.”
To help advisers feel more comfortable with the sector, as well as more knowledgeable about its role in a portfolio, the firms that provide technology-based platforms also provide knowledge content. This can take the form of in-person seminars, but most often it takes advantage of the technology at the firm’s disposal. Reports, white papers, seminar videos and presentations are easily accessed any time of day or night. As investors demand more from their advisers, the education components of digital platforms will undoubtedly become even more significant.
Digital platforms are here to stay, and as they have gained acceptance they have also gained influence. Fund sponsors who want to access the lucrative family office and high-net-worth markets are feeling the pressure to restructure their products to be more RIA friendly, to have lower minimums and fees and to be easier to monitor.
“Alternative investment platforms are connecting wealth advisers and investment managers in unprecedented ways,” says Brown. “Advisers have a streamlined experience, their clients gain access to institutional-level funds and products, and asset managers benefit from a diversified shareholder base and efficient distribution.”
Investing will always need the human touch to understand the nuances among investments and choose the best for any specific client. But technology is enhancing those efforts.
As Calcano concludes: “Streamlining the process with technology allows advisers to focus on what they’re best at — investment management and client service.”
Sheila Hopkins is a freelance writer in Auburn, Ala.