A Deep Dive Into Alts Industry Research, With Daniil Shapiro

Financial markets have faced significant headwinds this year, some of which headwinds haven’t been seen by investors in several decades. But the alt industry has barely skipped a beat, and a new whitepaper from Cerulli Associates and Blue Vault details why the current moment may be ideal for alternative investments to shine.

Daniil Shapiro, director of product development at Cerulli Associates, joins the show to discuss some surprising insights in this new research on the alts industry.

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Episode Highlights

  • A summary of the headline findings from Blue Vault / Cerulli’s latest research on the alts industry.
  • Background on why alts sponsors are targeting retail investors and financial advisors to raise new capital.
  • A deep dive into intermittent liquidity products, and how these products have changed the perception (as well as practicality) of the alternative investment universe.
  • The top goals that financial advisors are targeting with their allocations to alts (and whether these advisors are in fact meeting these self-stated goals).
  • Daniil’s insights on the importance of brand in the world of alternatives.
  • How smaller alts sponsors can achieve success in an industry that is dominate by a few well-known heavyweight players.

Today’s Guest: Daniil Shapiro, Cerulli Associates

About The Alternative Investment Podcast

The Alternative Investment Podcast covers new trends in the alternate investment landscape. Hosts Jimmy Atkinson and Andy Hagans discuss tax-advantaged investment strategies to help you grow your wealth.

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Show Transcript

Andy: Welcome to “The Alternative Investment Podcast.” I am your host, Andy Hagans. And today, we’re talking about an inflection point for alternatives even as the markets are in turmoil. They’ve had a very rough year, in 2022. As new research is showing from Cerulli Associates, alternatives are doing just fine in terms of, you know, the industry.

So with me today, I have Daniil Shapiro, who is director of product development at Cerulli Associates. And we’re going to be talking about some of your research, Daniil. Welcome to the show today.

Daniil: Andy, terrific to be here.

Andy: Yeah, and you know what, let’s just dive right in. So I’m going to link to this white paper in the show notes for all of our listeners and viewers so you all can download it. And the title of the white paper is “Alternative Investments in 2022: Capitalizing on Markets in Turmoil.”

So Daniil, what are the major headlines here? So we know that the financial markets have had a rocky six to nine months, but alternatives are doing just fine. Can you walk us through the major points of the white paper?

Daniil: Yeah. So a few months ago, when this market drawdown began in earnest, we were watching CNBC every day, and there is this consistent Markets in Turmoil special that just keeps running and running. And we gave it some thought and we realized we have all this great data. We should do some calls with advisors, understand how they’re using alternative investments at this particular point in time.

We’ve seen assets in alternative asset classes spike. We were seeing advisors use a different range of products. And we said, “Look, this is a great time to get folks on the phone and to see how they’re handling this particular market stress and how alternative investments are playing into all this.” And what we learned from advisors, the first takeaway was that advisors were absolutely not panicking. They’re prepared for tough times.

They, for many years, have been guiding their clients to understand that, “Look, market drawdowns happen sometimes. It’s just something you have to be aware of. It’s something that you have to prepare for via your asset allocation, and really also a bunch of behavioral factors.” So that was the first thing that we learned. The next thing that we learned is, yes, advisors are looking to allocate more to alternatives. They’re using a greater variety of alternative investment products, and they’re using them for diversification away from publicly traded markets, both public equity and public fixed income.

It’s been a really difficult time for both of those this year with both equity and bond markets down at the same time, and they’re using these alternative products for diversifying away from that. They’re also using it for downside protection. They’re using it for inflation protection.

They’re using it for generating income, which is really difficult to do elsewhere. So we spoke with advisors and we got this really interesting picture of how they were using this greater variety of intermittent liquidity products that has become available to them. And Andy, if it helps, I’ll dive into what intermittent liquidity products are and how they fit on that liquidity spectrum if that’s helpful to your audience.

Andy: Absolutely. So I know these intermittent liquidity products have been all the rage in the alternative investment landscape. But why don’t we walk through the spec… Your choice, Daniil, which end of the spectrum you want to start on, but walk us through them.

Daniil: So it really depends on who the end client is, how much they have to invest, what their ticket size is, and how much liquidity risk they can take on. But you have this…first off, you have this plethora of liquid alternative products. These are mutual funds, ETFs, closed-end funds that have daily liquidity. And this could be something as simple as a commodities ETF, something like GLD or IAU.

So these products trade daily, very inexpensive, very easy to access. You just buy them through your broker. Then you have…and, of course, you have more complicated strategies that are also available through these mutual funds and increasingly ETFs. So a wide variety of alternative investment products already are available in these liquid structures.

Andy: So liquid alts, you know, not really what we cover on this show, but obviously a huge segment in their own right, you know, the precious metals ETFs, energy ETFs, all these commodity ETFs.

Daniil: The big challenge with liquid alternative products is that you can’t put every strategy into a liquid structure because you have some strategies that require greater management activity and they require greater manager discretion. They may be something that just doesn’t…if you don’t have daily liquidity, you can’t put it into that type of structure.

So that’s why you have a… Well, you previously had these liquid alternatives, then you had illiquid offerings. So on the illiquid side, you have managers that are managing either hedge funds or they’re managing private equity funds. So that was kind of your illiquid spectrum. But the idea is that you write this check and you don’t really know when the money comes back to you, because it’s really dependent on the underlying businesses.

But what we’ve seen in the last few years is this really incredible trend of advisors increasing uptake of what we call Intermittent Liquidity Products. These are offerings that have maybe monthly or quarterly liquidity and they’re structured as non-traded REITs for real estate, maybe non-traded business development companies, BDCs, you have interval funds, and you have tender offer funds.

Now, what has happened is that you, at first, have Blackstone come in and create this NAV REIT structure, which was kind of you had existing non-traded REITs but what Blackstone did was they added maybe slightly better fees to it. And also they have increased liquidity.

So that’s where the monthly and the quarterly liquidity comes in.

Andy: Now, can I stop you right there? Can we actually discuss how that works? So normally, let’s say for an illiquid reach, or a DST, Delaware Statutory Trust, or some of these private equity, private placement offerings, it’s like a five-year to seven-year going full cycle or even 10 years in the case of an opportunity zone fund.

So that’s at the one end of the spectrum, highly illiquid. So with this kind of REITs, is Blackstone providing the liquidity? Like, are they the buyer? Are they the middleman for the next buyer? So when you actually get that liquidity, how does that in practice work? Who’s the buyer on the other side?

If I buy that product and want to sell in 30 days, who am I selling to?

Daniil: Blackstone would offer you that liquidity. So there’s obviously a subscriptions process, there’s a redemptions process. But there is an assumption that if an appropriate amount of investors ask for their money back in a particular period of time, the manager will come in, and they will because it’s an intermittent liquidity product, they will have some liquid assets on hand, potentially, or maybe they’ll have a cash sleeve which is able to provide a redemption.

Andy: Got it. So the sponsor there, they’re kind of like the buyer of last resort. Like, ideally, at the same time, if I’m cashing in, there’s someone else coming into the product. But you also need the sponsor to sort of provide that extra float or that extra liquidity, in theory, in case a lot more investors decide to cash out at once and relatively fewer buy in in that time period?

Daniil: I think it’s a good way of thinking of it. Unlike an exchange-traded product where there’s always a seller on the other side and they have to be matched and you have to figure out the price, over here in the intermittent liquidity space, you would have a manager figure out the NAV for the fund. But, at the same time, investors are lining up and they may be saying, “Well, we want to redeem at this particular time,” and then they will be able to redeem at the NAV at that particular time.

Andy: So you need a sponsor that has, you know, a significant amount of resources to even offer something like this. Like, obviously, they need to have a decent amount of liquidity on hand or a way to have cash reserves to support that kind of liquidity.

Daniil: It really depends on the underlying product. So a lot of the interval funds, they will hold publicly traded securities alongside their illiquid positions. But I think to your point, it’s certainly important to invest with a manager who you trust to manage that liquidity in the right way so that if you did have some kind of severe event and you had a lot of redemptions, you first want the fund to hold quality assets. And you certainly want a sponsor that has…and this is why reputation is really important, you want to have a sponsor that has a brand that they will want to defend and therefore provide that excess liquidity.

Andy: And we’re going to get to brand. I have another question about that. It’s a great point. Could you walk us through some of these other products because I know there’s multiple different types of intermittent liquidity products?

Daniil: Yes, so you have… Blackstone came in, they revitalized in that non-traded REIT structure and they’ve received tremendous flows into their BREIT product. And then they did something very similar with BCRED which is their private credit offering. So you have non-traded REITs, you have non-traded BDCs, and then interval funds have been around for a while just as tender offer funds have.

The key difference there is that with the tender offer funds, the manager has a little bit more discretion as to when the buybacks take place. With an interval fund, you have that assumption that it is happening on a quarterly basis, about 5% of assets are going to provide that liquidity. So you see a slight difference in the types of products that are going to be placed into one structure versus the other.

But we do see managers increasingly focusing on launching interval funds. And that happens…that’s just because interval funds are available for sale for both accredited and non-accredited investors in general. There are certainly some cases where it’s not for the unaccredited investors. You can package more solutions into the interval fund structure. So your interval fund structure can hold real estate.

It can also hold private credit type exposures to some degree, and it can also hold public securities. So that just makes it a little bit more flexible than the other structures.

Andy: Got it, yeah. And I understand that there may be some new regulations coming down the pipeline for REITs, non-traded REITs. So we’re actually talking with a representative from the IPA later this month about that. But, so interval funds, they’re kind of, I don’t want to say the winner here, but they’re very popular because of the flexibility that they give the sponsor, manager, and the ability to potentially allow non-accredited investors to invest, is that right?

Daniil: Flexibility in terms of what goes into the fund. I will say that for the purposes of managing liquidity, it’s possible that a tender offer fund actually has a little bit of an edge because it gives the manager more of the right to choose when they’re offering that liquidity.

Andy: So talk to me about tender offer funds.

Daniil: There are a lot of very high-quality, private equity exposures that are available through that tender offer fund structure and they’ve been in the market for a really long time. They’re continuing to gather assets. It’s an area that’s growing. And interestingly enough, I think that from an investor perspective, rather from an advisor perspective, they’re the ones that are doing the buying.

They probably don’t really know the difference between a tender offer fund and the interval fund just because the structures really are so similar in terms of what you’re receiving. So I think a lot of times when we pull advisors on and they tell us they don’t have such a significant amount of assets and tender offer funds, that’s probably because they’re confusing them with interval funds.

Andy: So if you’re listening to this show or watching the show, you don’t need to feel bad if you get some of these products mixed up sometimes because, yeah, Daniil, that’s something I want to talk about. Because, you know, if you look at the data in your research report and I have it open right now, so I’m bringing it up and I think this is on maybe page 6, and it’s a percentage of advisors that currently use, or plan to start using, or previously used, or do not and have not previously used all of these different kinds of alternative investments.

And you’ve made the point that with the tender offer funds, so I’m seeing 15% currently use, 3% plan to start using, 12% used previously but not currently, and 70% do not use or have not previously used, that a lot of advisors simply kind of get these mixed up or maybe aren’t totally clear on the nomenclature.

And I have to be honest, they are easy to… I mean, I’m an LP, I am the host of “The Alternative Investment Podcast,” a lot of these lines… I mean, legally, some of these products are regulated, right? You know when a REIT is a REIT because it’s a legal structure. I know a DST is a DST, it’s a legal structure.

But when you’re talking about private equity, real estate, and a lot of these products, I mean, you know, some of the naming, even alternative investments, different people have all kinds of different ways that they define that. So I can definitely forgive financial advisors for not necessarily being clear on what these are. How big of a problem do you think that is, Daniil?

Daniil: Well, the fact that alternative investments are really on their own a really complex asset class, that’s an incredibly challenging problem. It’s not just a challenging problem for advisors. Of course, for advisors, it’s incredibly difficult to understand these products, to learn about them, to know what their clients should be invested in, to understand the different fee layers that are applicable to alternatives, which is exceptionally important.

So this is all very difficult to advisors and advisors certainly have a problem here. There are many ways to remediate this, there are educational offerings, some of them are coming from distributors, some of them are going to come from platforms like iCapital, CAIS. They all have their own education platforms. So, yes, absolutely tremendous challenge for advisors. It’s also quite a significant lift for the firms that are issuing these products because they’re all going to market with offerings that, once again, are really complex, difficult to understand.

They’re placing a lot of chips on the table in terms of acquiring these capabilities and saying that, “Yes, there is a significant opportunity to gather assets here.” And, at the same time, they have to train their own internal staff in order to distribute these offerings and it’s really difficult.

Andy: So let’s talk about that. So, obviously, it’s a lot easier if I’m a sponsor of any of these different kinds of alternative types if I can go get institutional money and fill up my fund and do my entire capital raise with institutional money, or with a couple family offices or whatever, or sovereign wealth funds, you know, people with really deep pockets.

Obviously, that’s easier. But these sponsors are turning now to advisors and retail investors. Why do you think that is? Why now?

Daniil: There are several reasons for this. I think the base reason is that, yes, alternative investments now have a more important role to play in investment portfolios and this is happening after a really long period. You’ve had this tremendous run-up in both equity and fixed income markets, rates have been incredibly low, right, bond performance has been amazing.

And now look at this 2022, this has changed a little bit. So that’s probably…that’s one reason, it’s important for investment portfolios. The other reason is maybe a little bit more self-serving for asset managers. You’ve had…if I’m thinking about traditional managers…

Andy: Oh, no, let me stop you right there. I thought asset managers just did this out of the goodness of their hearts, right?

Daniil: It’s all about serving the client.

Andy: It’s okay, it’s okay to make money. We all want to make money. That’s okay. All right. Go on, go on.

Daniil: So, you take this from the perspective of a traditional manager.

Andy: Sure.

Daniil: You’ve seen ETFs come into the market and so fees on products have been declining for a really long period. This is a very asset management…

Andy: You’re talking about traditional mutual funds, because now they’re competing with Vanguard ETF, what is it, are we down to like three basis points of fee ratio yet? We’re down to 5, then 10, right?

Daniil: You could probably figure out a way to build a portfolio for free at this point.

Andy: Okay. And Daniil, you cover ETFs as well as alternatives, right?

Daniil: That’s right.

Andy: So you probably know all the ETF. Okay, sorry, back to… So, number one, just it’s from the sponsor’s point of view, alternatives are a higher margin product. They bring in more revenue. They’re more profitable than a lot of the traditional mutual funds.

Daniil: Precisely. They cost a lot more and they’re more attractive to offer. And the great thing about an alternative investment from the asset manager’s perspective is that once the money comes in, it stays there for a really long time. No one is sitting on the other end day trading in and out of it. So that’s the benefit for a traditional manager. But then you have alternative investment managers and these are venerable brand name firms.

We’re talking about Blackstone, Apollo, KKR, Carlyle. A lot of these firms are also looking for new client segments. So that’s also business diversification for them to be able to say, “Look, we’ve done a great job of servicing these institutional clients. Some of them are at the top of their private equity allocations and can’t go any higher. Let’s take a look at this high net worth segment. Let’s take a look at RAAs and see if there is a lot of interest there for these types of offerings.”

And what they’re finding is they’re building very strong private wealth groups that are aimed at distributing these types of exposures, maybe with a little bit more liquidity. But to that type of…to them, it’s a down market client to… But they’re still very wealthy investors.

Andy: You could almost see them look at it as public relations. I mean, some of the names that you named are, I almost want to say media whipping boys or something. You know, anytime that carried interest, or taxes, or private equity, or whatever is in, you know, like “The New York Times” or some sort of major mainstream media, they can kind of be the whipping boys. So, I mean, I might make an argument, it’s worth going after the retail investor just to get more folks on the team of private equity.

Daniil: You bring up a great point there, and this is something we’ve covered in our research. It’s just, yes, these firms will, as they are servicing a wider variety of clients, they should certainly be taking a look at the types of societal impacts they have and being a little bit more concerned with how they are perceived.

So I think that that is certainly very important to these firms. That’s not necessarily the key reason for why they are going a little bit down market, but the role that their perception plays in the industry certainly becoming more front and center for them. It’s becoming more important because not only are they now managing money for institutions, they are managing money for a wider variety of investors.

Andy: Yeah, and, you know, it is about perception. It’s even beyond actual societal impact from a PR standpoint, from a marketing standpoint. What ultimately matters there is the perception. And, you know, it’s interesting. Like you hear about funds or you see funds that are investing in, for instance, single-family homes and are buying up large amounts of single-family homes, and for a lot of people that’s a very emotional type, you know, political type subject.

So I agree with you. I think it would behoove these firms to pay attention to that and, I mean, ultimately, if investors have a way to buy in, they have skin in the game, that probably helps them to have just a wider base of people, of human beings nationwide that have a little bit of skin in the game and are investors in their fund, right?

It’s not just AUM. It’s also, I don’t want to say people under management, but, you know, the number of human beings who interact with your company and have a positive experience. I do think that matters.

Daniil: I think long-term will be very important for these alternative asset managers to stand up very strong public relations functions to have a broader variety of stakeholders who understand what they do.

Andy: Absolutely. That’s a good juncture now to talk about brand because you and I, we talked a couple of weeks ago and we talked about this research off the record. And I think it’s okay that I mention on the record, you know, that brand is really important to advisors and that was one of the points that you made.

So do you think, you know, looking through this research and seeing the types of products that advisors are using right now… So 68% are currently using liquid alternatives, 61% are using non-traded REITs, 47%, private real estate, 45%, non-traded BDCs, 42%, interval funds. So even just taking that, you know, the most popular types of wrappers in this stack, how much product research do you think advisors, most advisors, I should say, are actually doing?

Are they digging into the PPMs, or into the DAX, or into the details looking at the assets that these funds hold, versus they’re just going with that safe, trusted brand name? You know, nobody ever got fired for buying IBM type of thought with their asset manager selection.

Daniil: The answer to this is that it depends. It really depends, first off, even with some of the stats that are in our report, it really depends on the channel that the advisor is in. So RAAs, for example, will use a lot less NTRs than broker-dealer channels, for example.

You have all these intricacies that we dig into but that depends on the type of products they use. It also depends on the advisor’s own knowledge of the underlying alternative investments. So there are certain advisors that we speak with. There was an advisor that we got on the line who was an absolute expert in these types of exposures. He probably knows these funds just as well as the most seasoned executives and he’s going to be able to pick the best product for his investors.

He doesn’t have to stick to the largest brands, for example, because he really knows the differences between these products. He knows the specific exposures. But then, you’ll have a lot of other advisors that maybe are being sold on a particular product by a wholesaler that they are comfortable with. So it really depends. The amount of research that they’re doing is really going to depend on who the advisor is.

It’s going to depend on their home office and what they have access to. So there are a lot of factors that come into play. The role of brand is certainly exceptionally important here. And the first few times that we heard this, our theory was that, well, yes, advisors want to turn to their clients and say, “Look, we gave you access to these venerable asset managers,” almost in a way that it serves the advisors.

And that may certainly be one of the pieces of the story of why advisors are really gravitating towards specific brand names. But there’s another aspect to this and that’s that there have been very significant blow-ups in the intermittent liquidity space before. So we’ve seen…historically, we’re going back decades, we’ve seen things go wrong and fraud risk has been a very significant issue.

So I think that advisors are certainly turning to some of these firms that they know have a reputation to uphold and will be less likely to run into some sort of either outright fraud or an accounting discrepancy or something like that. I think that’s really important to advisors and I think they have a good reason for at times aligning themselves with specific brands.

Andy: Well, that’s interesting. I’m sitting with that and I’m just thinking that through. So you think that, you know, some of the size of these companies like let’s take a Blackstone, obviously, they’re under a little bit more of, let’s say, a microscope, than a tiny little sponsor that most people have never heard of would be. But, I mean, certainly looking at the history of these sorts of systemic blow-ups or fraud or, you know, all these types of events, I mean, I feel like it can happen on a small level and it can happen on a large level.

Do you think that trust in the big brand names is warranted?

Daniil: This is going to be another “it depends” answer. And that’s because, yes, if you have a large institution, and these are often referred to as institutional asset managers, you trust them to have the risk controls that are in place. You trust them to have that brand to uphold in order to do things right. And a lot of these firms are publicly traded now.

So you believe that there are accounting practices…

Andy: That brings its own transparency just being publicly traded for sure.

Daniil: But then the question is, how does a variety of other asset managers compete in this space if they are maybe a little bit smaller than some of these largest firms?

Andy: Well, absolutely. And, I mean, you know, with AltsDb, we’re partnered with OpportunityDb. We’re sort of a sister brand. In the Opportunity Zones space, they had an incredible year in 2021 in terms of growth and assets under management, having a great year in 2022 in terms of inflows and a lot of independent, I don’t know if you call them boutique sponsors, are having, you know, very good success in the Opportunity Zones space.

So what do you think the keys are then for these smaller sponsors, smaller asset managers to go out and compete with the Blackstone, with the KKR? You know, what are the patterns that you’re seeing from the sponsors who are having success?

Daniil: I think there are a few strategies that managers can take to stand up to a much larger firm with one of these very, very trusted brands. And I think it comes down to maybe offering… well, you can offer a niche exposure. So something that is very unique and something that maybe has different properties from what is offered to some of these much larger diversified products.

So if you’re offering something and you have a story to tell about, well, our exposure is safer, our tenants constantly pay us, everything is under a lease. If you have a story to tell like that, I think that can be very attractive versus a product that can be perceived as riskier.

So I would argue there, you can offer a niche strategy, you can offer a strategy with better downside protection, you can offer something that meets a specific goal for an investor. I think there are a number of different strategies that a manager can take. You can offer exposure that complements one of the exposures from one of these very large managers and that’s probably a very…I would argue that’s an attractive way to gather assets.

Andy: Yes, swimming downstream rather than upstream. I think you make some good points. I totally agree on the importance of story. You know, we host events, investor events, that are matchmaker events between accredited investors and financial advisors on one end, and on the other hand, private placement offerings.

And, of course, investors do their diligence, they look at the decks, they look at the PPMs, they look at all the offering docs, but it really is the story that gets people excited, right? I mean, at the end of the day, if you have a diversified portfolio, you know, you want to maximize your returns, but a lot of funds in the end of the day are going to be pretty similar.

But if you invest alongside a sponsor that you’re excited about, that you see their passion or their interest or their philosophy and it resonates with you, I think that the power of story honestly cannot be overestimated.

And I also think there’s something to that niche, you know, having that niche segment. We were talking the other day that, you know, REITs, it’s like there’s a penalty for being a publicly traded REIT right now, right? And so, there’s a trend of more and more REITs are going private because why go public when you’re only going to trade at a discount, right?

And so I think it’s the last student housing REIT that is going to go private, and there’s no… I think I might be wrong about that segment but there was one particular segment that there won’t be any more publicly traded REITs. Do you think this is going to be a problem that, you know…? Do you think there are any, like systemic risks to having so much of these assets shift into the private equity world?

Daniil: Yeah. I think this comes down to some of those social issues that I mentioned earlier. When you have assets that are going private, there is probably a little bit less transparency for society as a whole into how those assets are operated, because these are private. These become private businesses.

And maybe there’s a little bit…there are fewer exposures and that’s going to be something that these firms have to address. I think that’s the bigger issue here. Long-term, we do see private markets continuing to grow significantly. So there’s going to be public capital and there’s going to be private capital that’s going to continue to grow significantly over time. And this is going to happen more and more often that as these types of firms are able to secure greater assets and as…

Frankly, a lot of publicly traded firms are finding that it’s more attractive to be privately owned, at least for certain periods of time. You see that investors maybe underprice certain companies in public markets. So that makes private capital more attractive.

Andy: Yeah, I had Michael Episcope, Co-CEO of Origin Investments on the show a while back, and I made the point that, you know, I thought a lot of publicly traded REITs historically had been overvalued but he had a wonderful rebuttal. And he kind of set me straight, like, “Hey, look, right now, publicly traded REITs are not overvalued.” And so, I mean, you have to look at incentives, right?

If there’s no incentive to be a publicly traded company, if it’s from the sponsor’s point of view, if it’s adding cost, if it’s adding complexity, if it’s adding headaches, and then it punishes you financially, why would you do it? You wouldn’t do it, right? So let’s talk about advisor goals with alts. And now I’m on page 4 of this white paper and so the advisor reported goals of alternative investment allocations.

And so this is a table and it shows that the number one…that 69% of advisors agreed with was to reduce exposure to public markets. I mean, I guess that’s kind of obvious. The second goal, though, 66% of advisors agreed that they wanted volatility dampening or downside risk protection.

Okay, now, this is a thorny one. So Daniil, I’m going to put you on the spot here. Are advisors…are they actually achieving this goal when they’re shifting client funds into alternatives? Are they actually reducing volatility?

Are they improving downside risk protection, or are financial advisors achieving the goal of masking volatility, or achieving perceived downside risk protection?

Daniil: Yeah, that’s a really…it’s a tremendous question. It’s something that’s very difficult even for us to get our heads around. If you have these types of exposures and you try to mark them down to how public markets are performing, then suddenly they appear a little bit overvalued.

So maybe you start thinking, “Well, our advisors may be using these products to tell a different story from…”

Andy: Well, yeah. And, sorry, just going back to the REIT thing, talking about taking a publicly traded REIT private, you take it private, what’s changed? Well, now you no longer have the stock market re-evaluating every day and saying, “Oh, that should be at a 15% discount,” or whatever discount it’s trading at.

Of course, once it’s private, the sponsor is not going to say, “Well, actually, it should trade at a 15% discount,” right? But nothing has actually changed about the underlying asset at all, nothing has changed at all.

Daniil: Yeah, that’s a really interesting thing because we’re conditioned to believe that the daily market price on an investment is the right price. I mean, that’s the Efficient Markets Hypothesis in action. But suddenly, you have prices that dropped significantly, you have tremendous markets volatility, markets in turmoil.

So you have prices that maybe don’t align to the underlying values of the investments but there’s a separate question here. If you can buy the same asset for a smaller price in public markets, you should just go and do that. So that’s just another consideration here. For advisors in terms of using these products to mask volatility, and I think, Andy, you also made this point when we spoke in our pre-call, it may be helping them keep their clients calm to the extent that they can point to these types of exposures and say, “Look, at least you have one thing in your portfolio that isn’t doing that bad and that means that these products are doing their jobs.”

And there’s…

Andy: Yeah, absolutely because everyone expresses risk as volatility but there’s other types of risk. From an advisor standpoint, one of my main risks is the behavioral risk of my client panicking and saying, “The S&P is 2008. The S&P is down 40%, 50%. Let’s go all cash. I don’t care, let’s go all cash.”

I mean, that’s probably your single biggest risk, right?

Daniil: Yeah. It’s a very significant behavioral factor that these products may to some extent be helping to remediate.

Andy: Interesting. Yeah, you know, I had Meb Faber on the show a while back of Cambria Funds and I told…jokingly, I made the suggestion that we should launch a mutual fund and all it does is it buys the S&P but it has a 10-year lockup period and that’s it.

There’s no other value add but just you’re not allowed to sell, that’s the value add. And it would outperform, you know, the median investor, right? So that is so interesting that on the one hand, you know, the volatility dampening may be overstated but on the other hand, it still may be achieving a favorable outcome for the investor because you’re absolutely right.

If I’m a panicked investor, I call my advisor, and the advisor, she says, “Well, look, your overall portfolio, you still have this 35% allocation to alternatives, and those haven’t budged at all, even though the public markets are down 25%.” And that probably would put my mind at ease.

Daniil: Yes, but there’s also something to worry about here. And you wonder if at some point, an advisor may decide to time the market and to remove assets from one of these less liquid products after they see the public market comparables significantly drop in price, leading to a significant outflow event.

So I think our findings from the research paper was that this absolutely is not that type of environment. Advisors aren’t really focused on doing that. They have better things to do than time markets.

Andy: So you’re referring to like the intermittent liquidity type products, where if there were a scenario where there are major market drawdown, then the NAV rates or interval funds, or any of these intermittent liquidity products could see like major outflows? Is that the specific risk that you’re concerned about?

Daniil: I think it’s a possible risk in certain situations, should there be a severe enough of a dislocation, and should investors potentially become very concerned about their intermittent liquidity holdings not being marked down?

Andy: Interesting. Yeah, and I guess you’d have to go through those offering docs with a fine tooth comb. I mean, are there contingencies in some sort of a severe drawdown where there was just a rush for the exit? Are there contingency plans? What happens?

Daniil: I would imagine that in that type of adverse scenario, you would just see some of those gates kick in and you’d have managers simply offer less redemptions. So I think this big story that we’re telling with this white paper is that these products are an incredible improvement over a prior generation of products. They very likely have an important role in your client’s portfolio. But please be aware that there is no free lunch.

There’s still leverage that’s associated with these offerings, with a lot of these types of products. There’s still high costs that are associated with them and it’s important to be aware that you can have an adverse scenario where you actually bear some of the costs that are associated with that lower volatility.

Andy: Interesting. So as an insider, but also an outside observer, right, you don’t work for a sponsor, so I think you could be a little bit neutral about this. You know, you mentioned there’s higher fees, higher revenue, higher costs associated with alternative investments, but at the same time, I would say that, you know, slowly but surely, the amount of transparency in the alternatives industry is growing and, you know, the amount of liquidity with alternatives is slowly growing.

Do you see that sort of competitive market environment…is that, you know, helping investors, is that making these sponsors more competitive with their fee structures and delivering a better experience for investors?

Daniil: One hundred percent. The products that we’ve seen launched in the last few years are a tremendous improvement over a prior wave of offerings. We certainly have managers considering the types of fees that they’re charging when they’re offering these types of products. I think there’s more education and as you have more and more sponsors enter the field, I think they’re going to be offering better and better terms to investors over time.

I think it’s just…I would argue that we’re still in the early stages of the development of this particular segment of the industry and I think over time, investors are just going to continue to get a better and better deal.

Andy: Yep, I think I’d have to agree with that. We might be in the third or fourth inning, I guess, of the baseball game. Well, do you think there’s an argument, though, as liquidity increases, at some point, do these products just stop being an alternative, or do they really need to be a publicly traded REIT, and then we can say, “Okay, they’re no longer an alt?”

Daniil: Andy, you’re getting into this very, very long discussion about what an alternative investment is, right? Kind of, if you’re a REIT that’s owned by the S&P 500 index, then nobody considers you to be an alternative. But if you own that REIT separately outside the index, then suddenly it is an alternative. And what percentage of our assets as individuals are alternative assets?

It’s probably a pretty high portion.

Andy: Yeah. Yeah, that’s a good point. When we launched “The Alternative Investment Podcast,” we launched AltsDb, it was like this existential question. What do we cover? Because really anything besides stocks, bonds, and cash, you know, technically, you could call an alternative investment. But something like GLD, you know, the ETF, it’s interesting product but I think there’s a lot of coverage of products like that in the traditional TradFi investment media space.

And so we’ve chosen to focus more on private placement offerings and they’re relatively illiquid alternatives. So, you know, I think they’re just a little bit more interesting. There’s more opportunity for active management and active investment. So, you know, just that perennial drive for outperformance and I think is going to, you know, continue to put interest in that side of alternatives.

Daniil: And that’s another exceptionally important point that you bring up. In public equity markets, you have this greater interest in indexing. I think there’s been, over the last few decades, this greater understanding of, well, how much can an active manager really outperform in public markets when you consider the amount of analysts that are covering individual companies?

Everyone has some kind of viewpoint on them and every single day, they come together on a conversion of a particular price. But here you have private markets, which are far more inefficient. And you have private equity firms that do bring insights and a lot of them are very, very specialized. You have thousands of private equity firms and some of them are exceptionally large and very diversified. Others will focus on specific niche area and bring some kind of unique expertise, and using leverage, they can add value.

There’s this very strong argument for greater use of private markets.

Andy: Absolutely. I mean, at the end of the day, you need active management at some level. At some level, you need management, right? The S&P own stocks, the stocks are part of corporations, corporations need managed. Businesses need managers.

So I’m a huge believer in indexing. I’m a huge believer in ETFs. But I don’t discount the value of active management at all. I know we’re getting close to the stop on time here, but I wanted to ask one more. Was there anything in your research report that really surprised you beyond what we’ve discussed already? You know, anything that you put a pin in and you said to yourself, “I’d like to come back and research that in my next report?”

Daniil: Yeah. I think the most important themes are greater advisor use of intermittent liquidity products. This is a flowering ecosystem and it’s incredible. We have very high expectations for it, huge opportunity for asset managers. But the one thing that I really enjoyed learning about, something that I think asset managers are going to be really focused on in the coming years is actually integrating all their newfound alternative investment capabilities, and figuring out getting into the nitty gritty of how do you distribute these products to advisors that maybe aren’t as familiar with them?

How do you structure your distribution function? How do you incentivize a wholesaler to position these products when your wholesaler was previously only familiar with mutual funds and ETFs? So there’s a lot of training to be done both of advisors, but also on that wholesaler front, making sure that these firms are integrating their technology. This is entirely new wave of product offerings that, for traditional managers especially, they need to learn how to work with.

So there’s going to be a lot of effort that’s put into place both culture integration, technology integration. There’s so much work to be done from traditional managers while when you take a look at the alternative managers that are going down market, they’re dealing with clients they just haven’t dealt with before. They’re answering questions they haven’t had to answer before, and they’re hiring hundreds of people in order to do so.

So they’re kind of…this is a very broad story that’s touching many, many elements of the asset manager ecosystem. We haven’t even gotten into iCapital, in CAIS, and all these different platforms. They’re trying to make it simpler for advisors to purchase these products. There’s a lot going on there from that distribution lens that we’re really excited to continue to focus on.

Andy: Yeah, and the companies that solve for that equation, the distribution equation, I think they’re poised to add a lot of value and make a lot of profit. You know, in my time in the alternatives industry, I’ve seen sponsors that create their own distribution channels and have done quite well.

So speaking as an entrepreneur, you know, I love to see that. I love to see creative people attacking a complex problem like that and figuring out the riddle, figuring out the solution there. Do you have any more research, Daniil? Do you have any more research coming down the pipeline that you can share? Is it all kind of top secret until it gets published?

Daniil: No, a lot of our research does end up in the mainstream financial press because we have tremendous working relationships with some of those organizations. So I would say keep a lookout for our alternative investments report, maybe findings from our ETF research, our broader product development research. Cerulli.com, we have tons of white papers that I think will be very interesting to advisors who are very focused on practices.

We have a lot of projects where we look to see how advisors should be structuring their practices and this is all available on our website. So would certainly encourage advisors to go there.

Andy: Yeah and Cerulli has a lot of stuff available for free. I mean, I was amazed that this white paper, just available for free download. So we’ll make sure to link to that specific white paper in our show notes, as well as link to Cerulli Associates’ official website. So just make sure to go to altsdb.com/podcast for our listeners and our viewers. You can see those show notes.

And don’t forget to subscribe to the show on YouTube and on your favorite podcast listening platform so you can be sure to receive our new episodes as we release them. Daniil, thanks again for coming on the show today.

Daniil: Thank you very much for having me on here.

Andy Hagans
Andy Hagans

Andy Hagans is co-founder and CEO at AltsDb, and host of The Alternative Investment Podcast. He resides in Michigan.