New Ways Of Accessing Alternative Investments For Financial Advisors To Align With Clients Are Proliferating, But The Devil Is In The Details
Private equity or private credit? Hedge funds or venture capital? Alternative investments are fast becoming a new favorite asset class among investors looking for significant value to add to their portfolios. But how are fintech firms and their platforms selecting the alternative investments that are being bought and sold in today’s marketplace?
If market changes are driving opportunity even as financial and economic challenges lie ahead, it makes sense that more high net worth clients and their financial advisors turn their attention to asset allocations that can protect them from the risks associated with the traditional 60/40 portfolio.
For this class of investors, there are now more digital marketplaces than ever for advisors, asset managers and banks to interact and select from a range of well-recognized alternative investment funds. Unfortunately, not all alts platforms are created equally, and many contain potentially damaging traps that can harm investors and, by extension, the advisors who propose these solutions.
The Risk For Financial Advisors
It’s not uncommon for some alts platforms to give shelf space to funds that pay more for distribution. This practice inherently creates a conflict of interest within the platform that could interfere with an advisor’s fiduciary responsibility to provide objective advice. This could happen if an alts platform is motivated by the distribution fee when providing access to a fund.
Ultimately, if the investment goes awry, these outcomes can potentially create legal, regulatory and compliance risk for the advisor who was not aware of or did not give enough consideration to this type of conflict.
Conducting due diligence is key in differentiating platforms who get paid for their manager selection versus those who follow an independent analysis. Oftentimes, platforms will purport “industry-low management fees,” fees that are being paid to the platform by listed funds. Other fees aren’t disclosed upfront and sit in the fine print: whether it be feeder fees, in and out fees or sales load fees.
There also platforms that take a share of an alt fund’s management or performance fees. Advisors who look under the hood can see exactly what they’re being charged. It is relatively easy to compare and contrast the fees proposed by multiple platforms and examine figures such as the net-net return figure – a figure that should account for the aforementioned fees – to calculate the return on their investments.
Check For Scope
Second, check for scope. The best alts platforms should offer access to a wide range of funds that can provide diversification across business, strategy and vintage risk. Lack of range may indicate shelf space is being limited to quid pro quo arrangements.
When checking for quality, advisors can look for funds from institutional managers with proven track records in navigating multiple market cycles. These firms often do not enter into pay-to-play schemes and have a well-honed reputation in risk management, computing power, disaster recovery plans and much more.
While institutional managers denote quality, emerging managers are newcomers to the private fund space who don’t have the same safeguards and risk management infrastructure in place that institutional funds have developed over time.
Emerging managers, particularly those with a track record of one to three years, will allow platforms to partake in the management fee or performance fee – oftentimes in exchange for distribution and shelf space. Needless to say, this impacts platform neutrality, and raises the chances of certain products being promoted over others.
Ultimately, pay-for-play relationships are just one example of a potential conflict that can exist within alts platforms. Advisors should be aware that there are other inherent risks and conflicts that can exist and may take many forms – due diligence is key in choosing the appropriate alts platform for your advisory business.
Alignment Of Interests
Warren Buffett famously coined the phrase “skin in the game” to refer to a situation where executives take a major stake in their own companies. There’s an alignment of interests when the most powerful decision-makers commit themselves to a company’s success. Similarly, platforms distributing funds should stand shoulder-to-shoulder with their clients as investors.
A platform that takes a stake in the funds available stays on the path of focused investing. It’s another way to minimize unnecessary risk in the long run. After all, if the platform is not putting its own capital at risk in the funds being distributed, why should clients?
Delivering a best-in-class alts investment experience to clients requires an alts platform that functions as a one-stop destination for shopping, comparing, buying and managing alts – an experience that doesn’t nickel and dime investors with hidden fees that can affect the return on their investments.
Conducting due diligence on a platform’s fee structure, checking for a wide range of funds that include funds from institutional managers, are all requirements in our brave new digital world of alternative investments. If a platform does not offer diversification across risk categories, advisors need to keep looking.
Steven Brod is CEO of Crystal Capital Partners, an alternative investments platform for financial advisors