Sometimes the solution is staring you right in the face. The world of alternative assets could be the solution to returns, fees and client satisfaction, while raising productivity across investment management.
However, its adoption requires a radical rethink. Alternative investing requires the same dedicated in-house resourcing as other mainstream asset classes. But first we need to understand how we got to this point.
Where are we?
In a world in constant flux, some changes still stand out. The first ETF launched in 1993 and now ETFs constitute nearly one-third of daily value traded in the US. The iPhone didn’t exist until 2007 and yet by 2016 there was more than one smartphone per person aged over 16 in the UK.
Finance and investment hasn’t moved on in quite the same way. At its core, Thomas Phillipon has shown the unit cost of financial intermediation hasn’t changed in 130 years. Put another way, financial assets go up in tandem with financial services sector income as a percentage of GDP.
He estimates an annual cost of 1.5% to 2% of intermediated assets. Elsewhere, the UK’s Office for National Statistics highlighted banking as one of the principal sectors showing a decline in productivity growth since the crisis. Finance didn’t get the SMS about productivity, that is, perhaps until now.
Financial technology, ETFs, DIY platforms and, sotto voce, enormous regulatory and governmental pressure are changing this rapidly. MiFID II is possibly as much about the investor as China/US relations are about trade.
In mainstream investing there is now a relentless bear trap as price of services falls, costs rise. Regulators and governments finally seem to have parts of finance exactly where they want it.
Assume that that annual cost is firmly in the crosshairs, if you are a mid-sized asset or wealth manager, what do you do? Merge and hope that you will sidestep this trend?
That would be a brave long-term strategy if you were relying on the same products, delivered the same way, as the past. At the large asset manager end of the scale ask Standard Life Aberdeen or Janus Henderson shareholders whether they think M&A is the answer or the only thing they can now do.
Which brings me to alternative investments. If you don’t have a massive legacy business or are a modest-sized asset manager, wouldn’t a braver long-term strategy be to look at where success and growth is occurring in your industry, and try and emulate it?
One current approach to increasing alternatives exposure is to simply grow allocations - frequently by investing in blind pools of capital – perhaps a through limited partnerships or listed alternative vehicles.
These purport to have higher fees and stickier capital, which is good for the investment manager providing this service, and better, or at least uncorrelated, returns, which is good for the end investor. It’s the investment industry’s way of pushing back on those pesky productivity changes. It goes something like this – find a product, have it wrapped in a structure and allocate. Job done.
Whilst I am a strong proponent of both alternatives and permanent capital vehicles, this generic, stuck-in-the-middle approach is doomed to fail. You wouldn’t build your asset allocation or listed equity capability this way, so why do capable investment houses take this approach to alternatives?
Leaving aside whether many of these vehicles and their investments have appropriate skin in the game from either sponsors or investment managers, I hate to be the bearer of bad news but so much of the good stuff, meaning differentiated investments, are either dominated by significant permanent capital vehicles or by vehicles such as Blackstone Tactical Opportunities.
Take a look at the Specialist Fund segment as an example. There may be some gems, but how do you know whether a vehicle is home to investments which got rejected by these investors if you are not constantly reviewing opportunities in this space with your own team?
Are you prepared to make the bet that the better transactions and counterparties simply end up on the major stock exchanges? For a private investor, these access products are all you’ve got.
However, for a €10 billion or greater asset manager, there simply is no excuse not to offer your clients more while stopping the hurtling productivity meteor.
There is no suggestion that you become a specialist originator in every possible type of alternatives but with a dedicated team of originators and building partnerships outside of conventional markets, such as a different internal approach will lead you to treasures troves of actual assets/structures out there.
This can be equity release, student loan privatisations, and multifamily programmes in the US. Life at this end is tough but rewarding. It requires that kind of resilience that we are told to now teach our kids.
Asset and wealth managers who fail to equip themselves for this journey will fail. The number of listed stocks is declining and buying shares in the next alternatives investment trust won’t necessarily help you stop the steamroller. Building your own alternatives origination team in the same way as you built your European equity team will.
Julian Sinclair was most recently the chief investment officer of Talisman, a UK-based single family office, and a Wealth Manager coverstar.
He was previously a Partner at award-winning Altima Partners and is an Ira Sohn conference speaker alumnus and a founder member of Adjuvo, the private investor network. firstname.lastname@example.org