Ramped up alts right-sizing follows key regulatory moves

In the nine months since the U.S. Labor Department announced that private equity would be an option within 401(k) plans, platform providers, communicators and investors are still mulling how to move forward. Alternatives Watch recently reviewed the challenges communications professionals face in the private equity world, but platform providers are also making strides to widen access to private capital strategies. This coming week, the SEC’s proposal to lower the income threshold for those deemed to be an ‘accredited investor,’ takes effect. To date much of what has been available to investors is under the branding of liquid alternatives and has offered sub-par performance relative to the original strategies they are based on. Those individuals meeting the accredited investor thresholds of at least $200,000 in annual income or a net worth of $1 million or more is currently estimated to be over 13 million American households. The competition between private and public financing for high-tech companies has meant more investors are locked out of the return potential of rapidly growing businesses that are less likely to issue an IPO and remain private longer. And so both the market appetite and the marketplace are seeking to grow in tandem. Eric Knauss at platform firm Proteus is the first to admit that the goal that he shares with many in the industry is to bring the same high-quality managers that over the years have populated the endowment models to investors that may only have $1 million or so to put to work across alternatives. For Knauss it is around the definition of what makes an alternative investment – is it leverage or an exotic ETF? “It’s a question that Wall St. has been trying to solve since the 90s,” he said in a recent interview. “So you have SPACS, interval funds and non-traded REITs. I’ve been involved in those and have invested in them for families. They are all partial solutions that don’t quite get you there.” Part of the hiccup is that those types of vehicles still fall under 40 Act registration, so there are disclosure guidelines, liquidity constraints and the products don’t have the same investment thresholds. In essence it is a poor imitation of the top-tier managers and funds the likes of Yale University and Harvard University endowments have access to that may carry investment minimums of $50 million and up. He uses the example of a single family office. They may have $100 million in assets, but there are three generations. Most of the capital remains with the older generation and is $50 million and if they have done any estate planning that too is split up in many accounts. So in the end they may have $20 million of which only 20% is in alternatives, which leaves an investor with only $4 million and only potentially four bites of the apple, Knauss quipped. For him it is a question of how a wealth advisor can build up a well-diversified ready-made portfolio to provide top-tier investment access. Proteus has relied on its research partner Callan LLC to select and vet institutional managers and strategies for each model and asset class pool. Three model portfolios include exposure on a conservative, moderate and aggressive basis to private equity, private credit, real assets and hedge funds. There are also distinct sub-asset class pools that are available. These are grouped as core and non-core private credit, private equity and real asset strategies and a second pool of directional and absolute return hedge funds. This is all offered in addition to the individual funds on the platform. The investment minimum for the newly developed portfolios is at $250,000. The aim is to offer RIAs, multi-family offices, independent broker-dealers and private banks access to these niche strategies. For wealth managers, they are able to create their own diversified alternative investment portfolios for clients. Knauss predicts that 2021 will be a year of substantial growth for the firm, which also operates as an RIA and has fiduciary responsibility to clients rather than choosing to be a distribution platform only. Currently, there are 40 investment offerings on the Proteus platform. One of the largest platform providers in the space, iCapital Network recently partnered with the CAIA Association to offer RIAs greater education regarding alternative investment strategies. In January, iCapital acquired AI Insight, an alternative investment education and compliance platform offering financial advisors investment research, training, qualification, and compliance support for a broad range of alternative investments, including private capital, hedge funds, non-traded REITs and BDCs, and alternative mutual funds. A recent deal with private equity giant KKR further aids iCapital in forming its own RIA subsidiary to help expand access to individual investors. Experts at both iCapital and Proteus point to the improved investment outcomes offered by private markets. The World Economic Forum estimates that the retirement savings gap is rising by a whopping $3 trillion annually and will reach $137 trillion by 2050. Proponents of private market access say that the potential for better portfolio outcomes alongside improved investor education can have an outsized impact long-term impact. Last June, the U.S. Department of Labor’s information letter was meant to clarify how defined contribution pension plan fiduciaries can incorporate certain private equity strategies in their offerings. Large private equity firms celebrated the guidance, which offered insight on whether private market options can fit safely into diversified investment options such as target-date funds. Creating those funds is still very much a work in progress. The $455 billion private equity firm Apollo recently announced an all-stock merger with retirement services firm Athene. The deal was seen by many as yet another signal that large scale investment firms are looking to gain access to the retirement plan community in short order. Now that the largest players in the alternative investment management space are willing to shrink down their offerings, other considerations besides fund structuring are coming to the light. The Defined Contribution Alternatives Association (DCALTA) late last month also published its practical framework in a bid to offer some ways how plan sponsors can implement daily valuation of private assets in individual retirement plans. “Including private assets and other alternative assets in 401(k) plans is relatively new in the United States,” said Jonathan Epstein, DCALTA Founder and President. “The full breadth of DCALTA members have looked deeply enough at the operational issues to form a meaningful industry consensus.” In a white paper on the subject, officials suggest a robust, scalable approach based on current accounting practices. "The framework encompasses 11 positions grounded in principles of fair valuation, ISO quality management, and effective governance," said Sheridan Porter, DCALTA member and co-founder of valuation technology firm FEV Analytics. "These elements are important for retirement savers and plan sponsors to have confidence that the procedure used to value these private assets is fair and robust." DCALTA’s 12-page paper on the topic of valuation goes into detail on policies and procedures that can help investors assess on an ongoing basis the actual value of the underlying private assets within a retirement plan. Alternative assets included in the research are investments in private companies, infrastructure, and real estate that have been broadly adopted by defined benefit pensions, and institutions like university endowments, for their beneficial contribution to portfolio performance. Officials said that numerous studies have shown that the retirement outcomes of 401(k) savers could also benefit from access to alternative assets. DCALTA advocates for a professionally managed and diversified portfolio of such assets as a modest component of a multi-asset class fund, such as a target date fund. DCALTA relies on its members -- a uniquely broad group of industry stakeholders, including plan sponsors, fiduciaries, consultants, accountants, asset managers, record-keepers, and others -- to research and reach general agreement on critical operational procedures, like daily valuation. "Operational considerations of private asset investing are often nuanced and relatively resource intensive," added Epstein. "To the extent that operational issues impede progress, we apply the collective wisdom of our members to analyze the issues and show the industry a path forward. Daily valuation is the first operational topic addressed by DCALTA, with other important topics, such as liquidity management, to follow."

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Ramped up alts right-sizing follows key regulatory moves

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