Technology Developments Facilitating RIA Access To Hedge Funds

High net worth individual investors have long been an early allocator to new and emerging hedge funds, even pre-dating the institutional boom of the 1990s and 2000s. But their access to hedge funds has largely been achieved through their network, with the opacity of the industry not lending itself to dispassionate screening and selection like in the ETF or mutual fund world.

RIAs haven’t really helped the cause. In some cases, that’s because of a lack of understanding of the nuances of an investment strategy. In other cases, it’s because of a lack of interest in them. But in most cases, it’s because of the sheer difficulty in getting everything set up for their clients.

The administrative wall stopping allocations getting through is coming down. And it’s not a moment too soon.

“There’s an ever-increasing number of individual investors in the United States that meet the criteria to be considered an ‘accredited investor’, said Brian Shapiro, CEO of Manchester, Vermont-based technology firm Altsmark. “And they want to allocate to hedge funds because they’re getting more knowledgeable about investing generally and the benefits that hedge fund allocations can bring. But it’s been a challenge for RIAs to help their clients with this due to the processes involved.”

This increased interest in hedge funds has, in a way, forced RIA’s hands. The recent Covid-inspired equity drawdown – however brief – is many individual investors’ first experience of a significant negative market event. The current conflict in Ukraine is their second. Shapiro says that RIAs his firm speaks to are reacting to client demand but due to the nature of their job – an advisor and facilitator - are more focused on process pain points than anything else.

“I’d argue that most RIAs understand a wide range of investment strategies and it’s not that which is holding them back. It’s the operations and the reporting side of managing private investments for their clients. Technology providers have largely focused on larger, institutional clients. It’s not been particularly easy for wealth managers to get a single view of a portfolio that contains public equity, mutual funds, ETFs and private investments at a reasonable fee,” he said.

Compliance is, of course, a big piece of the private investment pie. Institutional investors have the internal resources to manage the compliance aspects of a private markets’ allocation – or the money to pay for it. Not all wealth managers do. And not all have expertise in it.

“It’s the second biggest issue we see,” said Shapiro. “And it puts off RIAs. That’s understandable but technology is now enabling a more time-efficient way of ensuring compliance whilst providing the certainty that RIAs need for their clients.”

There’s an added compliance issue. The pandemic and associated lockdowns caused SEC audits to be delayed, creating something of a backlog. As restrictions in the United States ease, and travel and in-person meetings resume, examiners are getting back on the road.

“It’s been a while since many RIAs last had an SEC exam,” said Shapiro. “The examiners want to know that RIAs are doing what they say they’re doing in print. But they need to be able to show how they’re monitoring their client’s investments. It’s not just the onboarding process that RIAs need support with. It’s the entire customer journey, which includes monitoring the entire allocation across a range of strategies and asset classes.”

The next challenge RIAs face is connecting the dots between the myriad products and investment platforms available for their clients to access alternative investments.

“Not every fund is on every platform in the mutual fund space, and in hedge funds, there’s even more decentralisation. Some funds aren’t on platforms at all, so if one of their clients really likes a particular fund, on the RIA side, there’s multiple inputs into the pipe, which creates more admin and headaches for them. So, for RIAs, anything that helps them reduce admin – and potential errors – is key,” Shapiro said.

Shapiro says that RIAs that can solve for these issues will create a competitive advantage versus their peers. But they also need to know which hedge funds are available, what their expertise is, and how they can add value to their client’s portfolio. And a big part of that responsibility falls on the hedge funds themselves.

“Most hedge fund managers know most of the institutions, or at least know what they invest in and what they don’t, and why. RIAs are seeking out alternative investments more and more, and technology is now available to help them screen, manage and facilitate those allocations,” he said. “From a capital raising and a portfolio fit perspective, RIAs are the next great opportunity for small to mid-sized hedge funds.”