According to Proteus’ Chief Investment Officer, Eric Knauss, the coming years could experience a wave of capital pouring into alternative investments – potentially making 2023 one of the most pivotal periods in market history. Additionally, alternatives offer substantial opportunities to provide performance, diversification, and risk management benefits to traditional investment portfolios.
But is our industry prepared with the infrastructure, software solutions, and regulations to handle the demand volume in a streamlined manner? Has our industry created stratified products to allow a more inclusive cross-section of investors to participate in alternative and private investments?
The short answer. Yes, and no.
Ideally, investing in alternative markets would happen with the same ease and clarity as public markets, as well as being able to access a broader range of private capital. Though there has been significant progress in this area, there is still more to do to create an industry-wide standard of access that allows for the maximum degree of participation in this growing market. In this article, we will examine what is currently working, what needs to be improved, and how to reach a common agreement on this issue.
[Read the full MMI Spring Journal featuring Proteus CIO Eric Knauss’ article, Is the Industry Ready for Alternative Investing?]
Industry Snapshot
Currently, the segments that comprise the investment industry demonstrate varying degrees of awareness and readiness where alternative and private investment is concerned. We believe that the groups involved on the buy side (the investor, their advisors, and advisory firms) and the sell side (investment managers) have made notable strides. However, further effort is necessary to reach an agreement within the market on what an alternative investment is and how it might help investors to reach their goals.
It’s All About Regulation
The regulations that govern securities in the United States were created nearly a century ago and have been changed to match developing requirements, forming a complex web of rules which are difficult to decipher – even for seasoned professionals. These regulations, combined with various organizational and investment approaches, present difficulties for advisory firms, advisors, and investors comprehending the pros and cons of different alternative investment options.
Investment Managers Seek Innovative Solutions
Investment managers continue to seek better ways to provide the benefits of their institutional investment strategies to the wealth advisory community. For many decades, alternative and private investment opportunities belonged exclusively to ultra-high net worth investors.
But Hybrid 40 Act Funds created enhanced pathways to offer alternative investments to a wider range of participants in the retail and the lower range of the high-net-worth community including:
- Interval funds
- BDCs
- Non-traded REITs
- Tender Offer funds
- SPACs
What is an Alternative Investment?
The lack of a single, widely accepted definition of alternative investments has caused a certain degree of confusion and hindered adoption of these types of investments. Financial advisors must be aware of the criteria for eligibility in order to determine which alternatives are suitable for their customers. This is perhaps one of the more significant challenges we currently face in our industry.
Advisory Firms’ Top Priorities
Many advisory firms want to incorporate alternative investments into their client portfolios and are searching for solutions. In theory, they may seek a solution with the following characteristics:
- One solution across their entire client base
- The capacity to utilize their existing technology and processes
- Access to the best investment managers and strategies
- The ability to invest directly on behalf of their largest clients
The reality, however, is that there is no single solution to support investing in alternatives across the entire spectrum of investors.
Advisors Face a 3x3x3 Challenge
Alternatives can be classified into three main categories: liquid, semi-liquid, and illiquid. Furthermore, advisors must also cater to three types of customers: retail, high net worth (HNW), and ultra-high net worth (UHNW). Advisors must possess a set of three skills when constructing and managing portfolios of alternative investments, depending on the liquidity of entering and exiting the asset.
- The advisor must be able to decern what their client is able to invest in
- What specific alternative investments within that sub-set are appropriate on a risk-return and liquidity basis
- Be able to build long-term portfolios with allocations that complement existing portfolios of traditional investments
Advisors and others need the tools, technology, and educational support to incorporate alternatives into their investment practice.
The Alternatives Ecosystem Is Making Progress
While we believe the alternatives ecosystem has made good progress, specific areas will require a great deal of effort to meet investor expectations including:
- Enhancement to legacy reporting systems
- Upgraded technology to support bi-lateral integration of data Improved manager selection and portfolio construction tools
- Transparency and access to information to better evaluate and compare managers and strategies
- Performance measurement – combining different performance measurement regimes (time weighted vs. IRR)
In Conclusion
It is anticipated that the year 2023 will be a turning point for alternative investments. Despite the progress made in the investing industry, there is still significant work to be done to create an optimal atmosphere for alternative investments in the future.
We believe that by working together, regulators, investment managers, advisory firms, advisors, and service providers will be able to provide investors with access to opportunities that have previously been unavailable, such as lower minimums, more accessible entry points, and simplified processes that encourage participation in alternative investments.
