Democratizing access to exotic strategies comes with challenges, according EY's Global Wealth and Asset Management leader
As demand for uncorrelated investments expands across the wealth spectrum, alternative investment managers are innovating to lower barriers that have typically hindered retail access to their strategies. But those providers looking to capitalize on the opportunity must also recognize certain challenges.
“The activity we’re focusing on in terms of firms taking alternative strategies into the retail markets is really concentrated on the lower end of the high-net-worth category, or what others may also call the mass affluent,” said Mike Lee, Global Wealth & Asset Management Leader at EY. “We're seeing both interest from those communities, as well as from wealth managers trying to pursue and open up new opportunities within those investor segments.”
According to Lee, the amount of retail money that’s going or looking to go into private capital markets versus public capital markets has increased significantly as the retail affluent seek access to returns that are uncorrelated to – and expected to be higher than – traditional asset classes like equity or fixed income.
The investors with an appetite for that type of exposure, he says, are the multimillionaires who would typically have several million dollars’ worth of investable assets, making them eligible for the label of “accredited investor” or its equivalent, depending on where they are in the world. While that level of wealth technically makes them eligible for traditional nonregulated products, the price of entry for those vehicles generally have investment minimums akin to a million dollars, which effectively limits their ability to properly diversify their portfolios.
“By creating products that provides lower investment minimums, and more frequent liquidity than traditional alternative products, firms allow diversity of access,” Lee says. “They’re effectively opening up that market to a group that otherwise could be limited because of the inability to deal with certain concentration and liquidity risks.”
While alternative managers may be eager to expand access to their strategies into the mass affluent market, they’ll also have to consider a few factors. For one thing, alternative managers have traditionally dealt with several hundred clients at the most. But as they look to create more liquid options for their strategies, they should prepare to serve an increased volume of customers, which will exponentially increase their need to deliver effectively on several fronts.
“As you're dealing with these increased volumes, you as an alternative manager have to rethink how you process reporting, client service, and all those other aspects of your offering aside from running the strategy,” Lee says. “That means having the ability to scale with technology, to be able to accommodate these increased volumes.”
Another key consideration centres on education. Alternative managers will have to inform potential investors about the potential risks of investing in an alternative product, including liquidity risk, complexity in the underlying investments, limited ability to access invested capital, and tax challenges in some jurisdictions, just to name a few.
“Just as an example, in the U.S. context, if you’re in a partnership and you receive a K-1 form, you’re probably going to have to file an extension to file your taxes,” Lee says. “That could potentially derail some aspects of their holistically optimized financial planning, so they have to be aware of that.
Liquidity is another concern. According to Lee, liquid alternative strategies offer more frequent opportunities to redeem investments versus a traditional alternative vehicle; a liquid alternative strategy might have quarterly liquidation opportunities, for instance, compared to private equity where investments are typically exited and payouts made at the end of a fund’s life. But investors should still be aware that they can only redeem a proportion of their investment from a liquid alternative vehicle, which is different from a more traditional regulated fund.
“There’s a huge need for these alternative managers to educate the advisor community they may be distributing through, as well as the end investors, to help them understand what it is they’re getting exactly,” Lee says.