Ask any two firms how they go about investing in and reporting on their alternative investments, and you're certain to hear two wildly divergent and complex responses.
The initial complication is simply gaining access to such investments. Writing for WealthForge, Ryan Gunn said that 35% of advisers surveyed “claimed they have difficulty sourcing investments. Even though RIAs technically have access to the entire market of alternatives, they lack a centralized location to source and diligence investments.”
Once a suitable investment is sourced, RIAs must then overcome challenging investment minimums, which are typically in the range of $5 million to $20 million per investor. To surmount these relatively high hurdles, Deborah Dana of Bel Air Investment Advisors explains that many firms aggregate an RIA's clients into one vehicle, a feeder fund, which acts as one client on the books of the fund but could equate to several hundred investors who in aggregate meet the high investment minimums of the fund company.
Many RIAs use alternative investments as a differentiator in the crowded marketplace. Dana tells us that the “traditional 60/40 equity/fixed income portfolio isn’t sufficient for our client base — we have to provide them with a broader diversified portfolio with unique investment vehicles.” This not only makes sense as sound investment practice, especially in today’s inflationary environment, but also as a way of generating interest and excitement among a firm’s clients.
Eric Stephenson of Align Impact explains that clients need exposure to a wide range of asset classes and that alternative investments can “provide diversification and a defensive nature to their portfolios.”
“By investing in private companies before they go public, we are hoping to gain exposure to the most highly profitable years of a company’s life cycle,” Stephenson added.
Once the fund is properly sourced and diligenced, the RIA must then figure out how to subscribe to the alternative investment. In his article, Gunn said that “the number one complaint regarding alternative investments is that the subscription process is too time-consuming and laborious.” This results from a lack of uniformity across fund administrators. Each fund will likely ask different questions, in different ways, for each investment in their funds. Unfortunately, the lack of consistency means RIAs will need to throw more bodies at the problem than would typically be necessary with traditional investments.
Then we get to the biggest headache of all: performance reporting. As many RIAs know, many alternative investment positions simply will not appear on the custodian’s books and therefore aren't included in the nightly feed into the RIA’s performance reporting software. Even when these positions are included in the feed, the custodians only post values without transaction data, so RIAs are forced to remove positions from the automatic feed and reenter the adjusted values manually.
Access to this important data becomes an issue, as each fund administrator uses a different portal, likely with multifactor authentication, to pull statements for each individual investor. Add to this a lack of standardized data, timing issues, and a slew of other challenges — all of which we discuss in our latest white paper, The Complexities of Alternative Investment Performance Reporting — and you can see why some RIAs shy away from the administrative burdens associated with alternative investments.
Several solution providers such as Arch, Canoe and Mirador have emerged to partner with RIAs in the alternative investment reporting space.
As is probably evident by now, it takes a village to invest in alternatives. Dean Horwitz of IEQ Capital says, “Our clients expect these types of investment opportunities in their portfolio — you simply have to figure out the reporting.” Easier said than done, but we like the can-do attitude!
Matt Sonnen is founder and CEO of PFI Advisors, a consulting firm that helps financial advisers build more impactful and profitable enterprises. Follow him on Twitter.
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