November 2, 2016
Low interest rates and a fully valued equity market have resulted in an unprecedented flow of individual investor assets into alternatives. According to McKinsey, the alternative investment market has doubled in size from 2005 to 2015 and retail alternative assets have grown 16% annually over this ten-year period. By 2020, McKinsey predicts alternatives will comprise about 15% of global investment industry assets and produce up to 40% of industry revenues, as these vehicles continue to siphon flows from traditional products.
For the retail segment to continue growing, there is a need for access to more product and a better understanding of alternatives. Individual investors will need to understand more than just the specifics of products; they need to work with informed financial advisors to make decisions about alternatives that align with their investment goals.
We are not quite there. We have an education gap created by distribution economics and inertia. Distribution platforms and their manufacturing partners have not invested in broad-based quality alts education. But that will need to change.
The issue for investors is how to stay educated on the myriad of alternative strategies and structures. It is only in the last decade that alternatives have become accessible to investors who have little or no knowledge about or guidance to invest in them. The complexity of this highly fragmented investment category is daunting, yet education has not been a priority. Even today, with money pouring into retail alternatives, education is focused narrowly.
Avi Sharon, principal at Blackstone Group, says, “Most education around alternative investments misses the real mark – it either speaks in jargon to the academic community or is form-fitted to support product. Rarely does it provide useful context, objective discussion on how to define alternatives, or how to position them intelligently across the portfolio.”
Alternatives are simply more difficult to address than equities and fixed income.
“Broadly speaking, equity beta is equity beta and fixed income beta is fixed income beta, with most products subject to similar macro risk factors. The same is not the case for alternatives,” says Jeff Holland, president at Everest Medical Core Properties and formerly head of the private client group at Carlyle Group. There is also nothing simple about the structures or the wrappers these strategies come in, including limits on who managers can market and sell products to, whether they are accredited investors or qualified purchasers. Holland adds, “Given this complexity, advisors may need to invest a substantial amount of time to get up to speed on an alternative product that may only apply to 10% of their client base.”
Though education will be critical as a marketing tool and may well provide a key differentiator as alternative and traditional asset managers compete for space on the shelf of wealth advisor platforms, economics and inertia have kept most alts firms from adding education to their marketing arsenal. Bob Rice, CEO at Tangent Capital, says, “Neither manufacturers nor distributors have had adequate monetary incentives to undertake the expense and work of broad spectrum alternatives education.”
That’s even as the retail market offers private fund managers a sizeable new target for their capabilities without restrictions on the number and size of the investors. Distributors are eager suitors due to the current gap between alts allocation targets in retail investment models and the actual allocations. According to Morningstar, some advisors and brokerage houses are recommending weightings of up to 30% or more in alts versus the actual 2% to 5% allocation on average in portfolios.
More broad-based alternative managers and traditional managers indeed are pushing into the retail alternatives market. Commodities, long-short products, market neutral strategies, closed-end funds, MLPs, ETFs and mutual fund formats can provide many individual investors access to alternatives while providing liquidity.
But many private fund managers are struggling with the cost and size of sales and marketing resources required to compete effectively for individual investor assets. Holland says, “Sales are driven at the financial advisor level, which requires training, effective marketing messages, and compensation programs that reward ongoing support of financial advisors rather than one-time sales.”
High-profile fund managers enjoying a first-mover advantage – such as AQR Capital Management, Blackstone, Carlyle, KKR, and TPG Capital – have pursued different distribution strategies, some with a few product-savvy professionals focused on the home office, and others such as Blackstone with a field sales force.
But a big budget is not necessary to be effective. While in-person instruction can be powerful, other less expensive methods that are scalable – such as videos, podcasts, curated and archived source material, and even social media – can be utilized effectively.
Still, there are common ingredients in challenges and success stories.
“The up-front costs – not to mention firm compliance constraints – are real impediments. But the real barrier is finding a firm and a leader with the commitment and vision to pursue a true educational initiative,” Sharon says.
As alternative investment strategies rise, so will the demand for better education among advisors and clients. “The battle needs to won on the front line. Advisors need to have the resources on hand to effectively educate their own clients. It’s this ‘last-mile education’ that is the biggest need right now,” Rice says.
Cornelia Kiley is a partner at Judson Partners, a financial services executive search firm specializing in alternative investments, real estate, and asset and wealth management.
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