This article examines the behavior of RIAs and how they use and interact with the alternative investments space.

The following article on the RIA channel comes from an occasional contributor to these pages, Richard Hillson, a consultant on the sector. He delves into the details of the industry and how it goes about the job of allocating to areas such as private equity, hedge funds and other alternatives. He argues that there are still problems and barriers.

This news service is pleased to share these views and invite readers to respond. The usual editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com, jackie.bennion@clearviewpublishing.com

The sub-$500 million assets under management independent Registered Investment Advisor (RIA) market is one of the most untapped sources of capital in the alternatives space, if not the single most untapped. Meanwhile, the independent broker dealer community is thriving in the alts space. I am asked weekly why that is.

Firstly, let’s look at why the IBD channel is the most targeted by alternative product sponsors.

BD reps can typically earn 3 to 5 per cent commission selling alts products. This makes it well worth reps learning the nuances of the product and then educating their clients. If a rep can recommend a Delaware Statutory Trust for a 1031 transaction, they are essentially earning a commission on a whole pot of money which they would never have had access to. Additionally, the BD firm can usually request a 1 per cent marketing and due diligence allowance which covers their costs and can often turn into a nice profit center.

BD reps are also not always a fiduciary and therefore the transactional nature of their business is very suited to the alts space with high commissions, often paid by the sponsor. Some BD reps make their living exclusively in the alts space, not advising on any of the “core” funds.

Now let’s analyze why the RIA channel is oft neglected and why advisors are less inclined to allocate to the alts market. I heard some research at a recent conference suggesting that 2/3 advisors do not allocate to alts!

Advisors can charge the same wrap fee, whether the allocation is to Amazon stock or to an alternative product.

This provides very little financial incentive to allocate to something deemed to be more complex; requiring more client handholding; and with a perceived higher regulatory risk. This makes it very difficult for an advisor to get out of their comfort zone.

As a fee-only fiduciary, the wealth advisor is not incentivized by short-term transactional commissions and must take a long-term perspective of what is best throughout the client’s investing life cycle. 

Decreased financial incentive coupled with increased regulatory, investment and diligence risk that come with alternative investments, so it’s easy to understand why smaller RIAs are likely to maintain the financial planning status quo. Darrell Habben Jr, wealth advisor, Mariner Wealth Advisors, [believes that] alts products require a lot of education and therefore time and effort to get comfortable with. It is not just about the specific product or even the specific vertical within the space, education and support are vital across the alts spectrum, to understand the risk and diversification through lesser correlation approach. Their clients need to know  that resources and not just an internal wholesaler’s job are a product specific way.

Reporting, billing, and custody are often an issue in the alts space. I regularly have conversations with advisors who will not touch anything which cannot be held at TD or Fidelity. The emergence of alts-friendly custodians has definitely helped this. 

“In recent years we’ve seen an increase in asset resignations from traditional custodians who have merged and are not built to custody alternative assets long-term which can create a disruption for the investment sponsor and their investors. This has also influenced alt-friendly custodians to invest in data integration to provide a more cohesive experience for the advisors," Lisa Rodriguez, director of institutional sales, NuView Trust Company, has said.

However, the question /arises as to how the advisor can pull feeds from multiple custodians for reporting and billing. This is simply not an issue that the one-time commission BD rep has to deal with.
 

Why we need to change this
Most experts agree that the equity market is overheated and long overdue a sustained period of correction. The traditional advisor model of 60/40 has become more like 70/30 in some cases due to the underperformance of the bond market and advisors having no choice between cash and equities for that part of the allocation. This is exacerbating the overheating of the equity market.

It is essential for clients to have a diversified portfolio. Diversified does not just mean stocks and bonds anymore. There must be allocations to real estate, private credit, energy sponsors etc. or clients are due a rude awakening in the very near future.

The last few years have been monumental in the development of the alts space. Quality alternatives are no longer the playground of family offices and the ultra-high net worth but are now accessible to the mass affluent market and in manageable minimums. Clients are becoming aware of this and are now actively asking advisors for products that they would never even have heard of a couple of years ago.

What we can do about it
We need to remove as many roadblocks as possible and take away every reason to say NO. This requires investment from product sponsors and others offering support and platform services in the space.

Custodians and reporting and billing platforms need to recognize this trend and become more alts-friendly. We have seen product providers digitize paperwork to some extent, but this needs to improve. Existing alts custodians and support platforms need to continue their crusade to make this marketplace more mainstream and accessible.

The most limited, yet most important resource in this space is education. Let me say one more time – education, education, education! Wholesalers do a good job of educating around their product or their vertical but that does not help a 60/40 advisor who knows that they need to evolve or die but needs to understand the alts market as a whole. And to help their clients understand, to really crack this underserviced and untapped channel, sponsors need to invest in more holistic alts education. We are talking portfolio construction; dispelling the myths around alts; and best practice to facilitate custody, billing, and paperwork more easily.

The number one reason why wholesale reps' prospects/clients hang the phone up on them is not their approach. It is because the advisor is not comfortable with alts in general and may or may not know they need to invest time and effort into this space. The number two reason is that they believe that billing, custody and reporting will be too cumbersome.

Add that to client paperwork and collecting signatures, and this is daunting.

It is also imperative for product sponsors to approach this market very differently from the IBD channel. Advisors need to be provided with quality content as part of the marketing approach, not just the typical exec summary, PPM, and intro call. Advisors will absolutely read content about how they can use the alts space to differentiate themselves from competitors, grow their AUM and achieve superior returns for clients, as well as insulating them from equity over-exposure.

I will never forget a due diligence event I attended a few years ago where I met an RIA who had not allocated to the host sponsor. During our cocktail hour conversation, it became very clear he knew that he needed to grow his offering to clients but did not know where to start. He also did not feel it appropriate to ask the product wholesalers for help with his alts offering in general. I ended up spending a week in his office educating his team and clients individually. And guess what – they ended up being a significant allocator to that sponsor and other products in the space. And, how many wholesalers had he hung up on in the preceding weeks ….

About the author

Hillson Consulting is a boutique investment consultancy founded by financial services entrepreneur Richard Hillson. The company helps independent advisors enhance and improve their offerings and drive revenue through alternative investments. HC also works with product sponsors to help them with education and access within the independent RIA channel.