The alternative investment industry accounts for over $10 trillion and is expected to continue growing. And yet, many alternative investment sponsors have failed to effectively tap into a major distribution channel: registered investment advisors. Currently, alternative investments are mostly distributed by broker-dealers who sign selling agreements with sponsors in order to make their investments available to reps, who can only sell what their home office allows. RIAs, on the other hand, have access to the entire market of investments, but are lagging in their allocations compared to investor interest. We spoke with 41 registered investment advisors about their experience with alternative investments, what products they preferred, and what it would take to get them to increase their allocations.
The Current State of Alternative Investment Allocations
Of the advisors that we surveyed, 83% currently allocate to alternatives and 17% do not. While this ratio is not representative of the market as a whole, we were able to draw some inferences based on their experiences with alternative investments.
Modern portfolio theory advocates for a well-diversified portfolio of uncorrelated investments across many asset classes. Adding non-public alternative investments can provide another source of uncorrelated returns. However, there are tradeoffs that many advisors are still unwilling to stomach such as illiquidity and relatively high management fees. As a result, even RIAs that are currently allocated to alternatives only have a very small portion of their AUM in the segment. 39% of those surveyed had between 0 and 5% of client assets in alternative investments. Another 22% had between 5 and 10%. Only 8% of respondents had over 25% of their AUM allocated.
Of the advisors we surveyed who are allocating to alternative investments, every single one claimed to be allocated to some kind of real estate. Real estate makes up approximately a third of the overall alternative investment market with over $3 trillion.(1)(2) 80% of advisors allocate to private real estate, such as real estate funds or Private and Non-traded REITs, in client portfolios. 72% use public real estate, such as Public REITs. And 44% use tax-advantaged real estate like Delaware Statutory Trusts or Qualified Opportunity Zone Funds, which offer investors opportunities to defer or even eliminate capital gains taxes on their investments.
Outside of the real estate sector, over half of advisors include private equity and/or private debt in their portfolios. 48% allocate to energy investments, including renewable energy and oil & gas investments.
Hedge Funds, an enormous segment that covers a third of the market by dollar volume, was the lowest on our list of investment types, with 36% of advisors allocating to it. This suggests that, while the size of investments going into hedge funds may be large, they are coming from a smaller portion of advisors than assets of similar volume like real estate. This is likely due to high investment minimums. Many institutional investors with large portfolios have the financial wherewithal to invest in hedge funds.
When asked what asset types they would be interested in allocating to in the future, private equity took a sizable jump in the rankings, with 72% expressing interest. Energy, on the other hand, fell sharply with less than 30% indicating they would be allocating in the future. Interest in the remaining investment types remained more or less the same as current allocation trends.
Challenges Alternative Investments Present for RIAs
Once advisors step outside of the public markets, investments get a lot more complicated. Even those that are well versed in alternative investments run into roadblocks and hurdles. We asked advisors about the top challenges they faced when doing alternative investment business.
Interestingly, a lack of investor interest was cited the least, by only a third of respondents. We’ve written before about the gap between investor interest and advisor allocations to alternative investments. This stat further shows that if advisors are not allocating to alternative investments, it is not necessarily because their investors don’t want those investments.
So if demand isn’t the problem, then what is?
35% claimed they have difficulty sourcing investments. Even though RIAs technically have access to the entire market of alternatives, they lack a centralized location to source and diligence investments. Instead they must contact individual sponsors for information on what investments they have available. This inefficient process makes it difficult for advisors to keep up with current offerings and to make comparisons between investments. Other concerns are a lack of reporting, held by 46% of advisors, along with illiquidity and high fees.
But, the number one complaint regarding alternative investments is that the subscription process is too time consuming and laborious, submitted by half of all advisors we surveyed. Even today, most alternative investments are still made using paper subscription documents, which are made up of potentially hundreds of pages that must be filled out manually and then mailed or faxed for wet signature. If most of an advisor’s assets are in stocks and bonds, which can be traded in seconds at the click of a mouse, it’s no wonder they are frustrated by a process that requires hours of paperwork and can take weeks to complete from beginning to end.
Increasing Alternative Allocations with Electronic Trade Processing
Luckily for registered investment advisors, technology is in the process of modernizing the alternative investment experience. Electronic trade processing makes it possible to eliminate much of the frustration that comes with these investments, for RIAs and their clients.
The subscription process can be digitized with intelligent business rules and data validations that allow advisors to submit orders in as little as 5 minutes. Electronic signature features allow pre-filled subscription documents to be automatically routed to all stakeholders in order, instantly, shortening the cycle-time from 3 weeks or longer down to just a couple days or even hours.
For RIAs that have difficulty sourcing quality investments, alternative investment marketplace platforms can aggregate investments from many sponsors in one place, making it easier to identify and compare investments. And as more custodians and transfer agents start accepting digital alternative investment transactions, owning those investments will be cheaper and reporting on them will be easier and faster.
RIAs are craving this type of technology. 70% of respondents said that if there were technology tools to make sourcing, subscription processing, and reporting faster and easier, they would increase their allocations to alternative investments. Alternative investment sponsors who make their offerings more easily accessible and tradable have an opportunity to establish a foothold in the RIA channel.
Disclaimer: WealthForge provides this information for educational purposes only. It should not be construed or relied upon as legal or tax advice.