When is an alternative not an alternative?

The widespread use of alternatives could lead to erosion of the very elements that make them alternatives, according to EY, as fund managers make them more palatable to retail clients. 

In recent years, there has been much discussion about retail and wholesale clients including alternatives in their portfolios for diversification beyond equities and bonds. This is particularly the case for private equity and private credit which have experienced growing popularity with the intermediary market.

According to Praemium and CoreData research, nearly 70 per cent of high-net-worth-focused advisers have cited the asset class as a necessity for meeting client demands in the future, while advisers managing client portfolios above $20 million typically have an average of 14 per cent allocated towards alternatives.

This has led fund managers to consider how they can get these products into this target market, potentially by tailoring their remit to suit an audience who may be nervous of their original characteristics such as illiquidity, longer holding terms and infrequent trading.

Over half of alternative managers say they are looking at new types of investors over the next five years, and over a third say they are looking to the retail and wealth channels as new sources of capital.

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A good example of how this is being achieved would be the development of semi-liquid products which are open-ended, diversified and provide ongoing access which allows for more frequent redemptions by investors and the ability to exit if economic conditions change. They also allow investments of smaller ticket sizes which are more suited to a retail market rather than the large sums invested by institutional players.

But consultancy EY is concerned that this frequent tinkering of products to make them more “palatable” for a consumer audience can erode their very alternative nature and the benefits they provide to portfolios. An alternative will typically have a low or negative correlation to traditional investments which can enhance returns, generate income or protect against inflation.

Speaking to Money Management, Elliott Shadforth, EY Asia-Pacific wealth and asset management leader, said: “At a high-level, the idea of creating a more liquid alternatives market would involve adding features that would enable them to be traded more frequently, for example through the use of tokenisation, or enhance liquidity, which could change their risk profile and return potential. 

“By altering what is essentially one of their initial primary features, this may run the risk of also altering the alternative assets and having them converge with other asset classes.”

Not only will the nature of the fund change, the alternative product provider will also have to adjust its operating model with the potential high for miscommunication between channels. 

It flagged concerns that fund managers have raised about working with the retail market, including liquidity expectations, availability of data for risk monitoring, “significant scope” for miscommunication between alternatives and wealth management, and the lack of standard definitions. 

Almost half of managers surveyed (48 per cent) said they were worried about managing liquidity expectations for individual investors. 

Money Management previously covered the “culture clash” for managers working in the public and private markets amid rampant M&A activity. This included variances around operating structure, compensation structure, time horizons and decision-making protocols.

EY said: “Addressing the potential risks of liquidity and suitability will add to the cost and complexity of alternative managers’ operations. Individual investors, drawing on their experiences with traditional asset managers and self-directed accounts, will typically expect frictionless onboarding, real-time reporting, and access to experts as a matter of course.

“Serving more investors with higher service expectations, via a greater range of channels and intermediaries, will require firms to deliver a far wider range of customer journeys – as well as incurring additional costs such as placement agent fees. Firms will need to adjust their operating models accordingly.

“Changes to systems, processes, training and culture will be required. While investment performance will always be essential, managers should also consider their ability to deliver holistic experiences that meet the needs of the new investor types they are targeting.”

Adviser opinions

From a financial adviser perspective, they welcome the introduction of more semi-liquid or evergreen products to the market by fund managers to mitigate the typical problems with alternatives, proving there is a market if fund management firms take the leap.

Findings from Natixis show that 49 per cent of advisers said private assets are more attractive given high corrections to public markets, while over 50 per cent said private assets have improved outcomes for their clients. Meanwhile, PwC has stated wealth managers are looking to illiquid and alternative products to broaden their service offerings which may result in direct investments or involve partnering or strategic alliances to launch advanced platforms with a focus on emerging asset classes.

However, there is a universal acknowledgement from both sides that greater investor education is needed on the intricacies of alternative products if they are to be introduced to the consumer market. 

Roger Perrett, financial adviser at FreshWater Wealth, said he believes his clients should hold exposure to private markets but flagged concerns around rebalancing portfolios, withdrawing funds, timing market access, and the lack of liquidity affecting superannuation contribution strategies.

“I believe it is important for clients to have exposure to the private market’s asset class and the lack of liquidity can create real issues when withdrawing funds,” he said.

“I believe having semi-liquid vehicles is very appealing and I would use the asset class more if there was greater liquidity as these above-mentioned issues would then potentially reduce.”

Dylan Pargiter-Green, director at Bold Wealth, said: “We think that for a retail adviser, having access to these markets in smaller investment sums can be very appealing and that the additional liquidity that an evergreen fund offers allows for some peace of mind for smaller sums. 

“However, even though these funds are open-ended, the underlying assets are often long term in nature, so the restriction on capital is important to a degree to ensure the investments are able to.

“They’re a great option to give clients who may not have been able to access them in the past, however there is a steeper learning curve for some of these clients who need to understand the additional valuation risks of investing in private unlisted businesses.”