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Assets in alternative investments hit a record $9.44 trillion in June 2018, and the market is set to keep growing to $14 trillion in 2023, according to researcher Preqin. Much of this investment has been through the institutional market. But the demand for alternatives creates an exciting opportunity for wealth managers who may previously have avoided the asset class due to its complexity.
The alternative sector includes a wide range of investments, from real estate to infrastructure, private equity, peer-to-peer lending, and aircraft leasing. This variety makes it harder to analyse, execute, clear transactions and report back to clients. But as better systems and processes emerge, wealth managers should find these tasks easier.
Reasons to invest
One major reason larger investors have flocked to alternatives is the low interest rate environment. With cash and high-quality bonds offering little return, institutions have increasingly looked outside traditional assets for yield. Also, says Preqin, alternatives have generally posted strong performance; and investors have a declining number of publicly traded companies to invest in.
Sophisticated investors use different alternative assets for distinct reasons. For example, in private equity, they seek predictable risk-adjusted return. With infrastructure and real estate, they want an inflation hedge and reliable income stream. With hedge funds and natural resources, the goals are diversification and low correlation with other assets.
But for some – particularly smaller – wealth managers, alternatives have been inaccessible.
Kel Nwanuforo, investment consultant at Asset Intelligence Research, says: “Alternative assets can be more challenging to maintain and monitor than conventional investments. It may be more difficult to keep abreast of the news flow about esoteric areas. For example, there are many more news articles about the FTSE 100 than about the fine wine or infrastructure markets. Alternatives may also have greater liquidity risks, which wealth managers need to assess.”
“Alternative assets can be more challenging to maintain and monitor than conventional investments.”
However, a good wealth manager should now be well placed to meet the rising appetite for alternatives, says Nwanuforo. With dedicated investment experts, they should have the time, tools and resources to conduct thorough due diligence on the broad range of options available.
They should also have the necessary specialist technological capabilities – including tools used to research, monitor risk and trade – that would be harder for small advisers or individual investors to access.
Anyone buying alternative assets without such tools could be exposing themselves to unintended or hidden risks, such as inadequate data and information relating to portfolio holdings, value at risk or liquidity, says Nwanuforo.
Amir Nabi, Chief Operating Officer at Dolfin, says the tools and processes needed to offer alternatives are becoming available, but challenges remain.
“Many more people are asking about alternatives,” he says. “They may assume wealth managers have all the tools and processes to offer alternatives. But there are many more nuances in this market. For example, in real estate, is the investment property residential or commercial; is it leasehold or freehold; and where is it – as there are different rules in different jurisdictions?”
Consequently, there is much less standardisation compared to traditional assets in terms of how to analyse, invest, monitor and report on alternatives. There is also more manual and bespoke work involved.
“For traditional assets, there is a set of common tools to do these things,” says Nabi. “In non-traditional assets, there are no off-the-shelf, readily available solutions. Some are trying to replicate the tools that others have designed to invest in alternatives. The result is lots of replication and no common standard. Consequently, many wealth managers are either staying away from alternatives or looking for a third-party manager.”
“In non-traditional assets, there are no off-the-shelf, readily available solutions.”
However, the market is changing in an exciting way, says Nabi.
“Some wealth managers are beginning to use a mix of tools built in-house and third-party solutions,” he says. “Often, they just need to tweak existing tools. Alternatives do require different calculations, but they also share similar fundamental characteristics with traditional assets – such as the need to track value, risk, initial outlay, return profile, profit and loss, and scope for future profit and loss.
“So, there are challenges, but it’s no longer as scary as some wealth managers may think. Having an open mind, and an agile and flexible approach to your technological infrastructure will be key. If you are ready, expanding your offering to non-traditional asset classes could be attractive given the demand. An early adopter could scale up in this market.”