U.S. RIAs Showing Increasing Interest in Liquid Alternatives but Process Challenges Remain

In the United States, the take-up of alternative investment products by wealth managers advising their accredited investor clients has been slow. The classic 60/40 stock/bond portfolio model has been the God that these firms’ worship, and with good reason; that model provides a hedge, diversification, liquidity, and low cost.

Except that now, fixed income is in a tough spot. Whilst larger, institutional investors have the spending power to allocate to a range of products to hedge or diversify from their public equity exposure, the individual investor does not necessarily.

The issue is not simply the size of one’s chequebook. The process an investor must go through to allocate to an alternative investment product like a hedge fund is as much of a barrier, according to Daniel Harms, CEO of Chicago-based Third Wire Asset Management.

“An RIA makes the recommendation to a client that they should allocate to alternatives, and then their client is inundated with 100 pages of subscription documents, accredited investor questionnaires, fund formation documents, private placement memorandums, etc. The physical paperwork can be intimidating and send RIA clients running in the other direction,” he said.

Key to improving access to alternatives for individual investors means streamlining that process.

“Getting rid of the paperwork by way of digital documents and providing a solution to having your investment data be piped directly into a performance reporting platform – so no human contact – are just two things that can help. Frankly, anything that can be done to make a RIA client’s investment process as painless & secure as possible will make RIA usage of alternative investments more commonplace in the independent investment advisory universe,” said Harms.

Education is a buzzword perpetually thrown around the investing space and it’s as relevant to individual investors as it is institutional ones. Harms’ experience is that many RIAs in the U.S. have a pre-set notion of what alternative investments are, which means that education plays a significant role in firms like Third Wire’s efforts.

“Generally, the knee-jerk reaction a lot of RIAs have to hearing the term ‘alternative investments’ is to think private equity, multi-year illiquidity, and heavy fees. Knowing that the alternative investment world is made up of so many more additional strategies to private equity, getting RIAs smarter and getting them the essential information that they need to explain the benefits of alternatives, in plain terms, to their clients is necessary to get RIAs and their clients up to speed and ultimately protect their clients’ net worth,” he said.

Third Wire helps RIAs in the U.S. get their clients exposure to liquid alternatives like managed futures strategies and public equity hedge funds. Whilst he believes strongly that much more education is required, the questions he’s fielding from those who are showing an interest in this subset of the alternative investment industry are indicative of the challenges he describes above.

“We get the basic questions around fund structure, manager selection, research/due diligence, and performance stats of the managers we work with, obviously. But we get the ‘How did you solve for the complex and tedious investment process?’, and ‘How do you convey the performance data to the RIA without manual labour being involved?’ all the time. In the end, the RIA has to go to their clients with the why’s and how’s. They know what their clients like and don’t like and the process issues are a real thing in this industry,” he said.

Processes aside, what else needs to happen for liquid alts to be truly a ‘mainstream’ part of an individual, accredited investor’s portfolio, like they are for institutional investors today?

“Individual investors are not perpetual existence entities with infinite time horizons like many institutional investors are. We believe a 50-60% allocation to alternatives is too risky for any individual investor. So, overcoming the mindset that alternatives are used only in that scenario and are outside their reach is important. Also, accredited investors are dealing with their livelihood, so there are more emotions involved than on the institutional side,” said Harms. “But if an RIA can get their clients comfortable with the terms, the strategies, and provide a more streamlined investment process to allocate to alternatives, I believe RIAs will hear more stories about how their clients were chatting with their neighbour at last Saturday’s backyard BBQ about how their metals manager and long/short strategy are performing, alongside discussing what Apple or Netflix is up year to date.”