Show V/O:
This is Alternative Allocations by Franklin Templeton, a monthly podcast where we share practical relatable advice and discuss new investment ideas with leaders in the field. Please subscribe on Apple, Spotify, or wherever you get your podcast to make sure you don't miss an episode. Here is your host, Tony Davidow.
Tony:
Welcome to the latest episode of the Alternative Allocation podcast series. I'm thrilled today to be joined by Daniel Shapiro of Cerulli Associates. So Daniel, welcome.
Daniil:
Tony, thank you so much for having me on your podcast. Excited to be here.
Tony:
And Cerulli Associates has really been doing a lot of industry research for a really long time. But maybe for our audience, can you describe Cerulli Associates and your specific role?
Daniil:
Of course. We're a research and consulting firm that is focused exclusively on the asset and wealth management industries. My role is within the product development practice, and my focus has increasingly shifted to alternative investments in recent years because there has been so much focus on these exposures in particular.
Tony:
Yeah, and it's exciting. I think as you and I were talking about in our prep call, it seemed like that's all anyone wants to talk about today, even though Cerulli's looking at the industry overall, it seemed like asset managers are very focused on alternatives. It seemed like the wealth management community is focused on it. Advisors are focusing on it. And increasingly, individual investors are asking a lot more about alternatives. Why do we think alternatives will be different this time and we're actually going to see broader adoption?
Daniil:
At this particular point in time, one of the key changes we've seen with alternative investments is the greater focus by asset managers on rolling these types of exposures out to a wider variety of investors.
So increasingly, retail investors in the U. S. through their financial advisors have access to institutional-quality alternative investments. And the key difference there really comes down to the structures that are being used. It's a greater focus on interval funds, tender offer funds, non-traded REITs, non-traded BDCs. These are exposures with enhanced liquidity that give advisors some, not full, liquidity.
Tony:
I think as we've talked about on this podcast series in the past, we'd argue interval and tender offer funds, in particular, have helped democratize alternatives because they are available to a broader group of investors, more flexible features. But one of those features is illiquidity. You're dealing with underlying illiquid investments, and I'd argue that's something advisors should lean into because we want to teach investors to be long-term investors.
But it's interesting. You folks have done an awful lot of research on the topic, and I know that's an area that came up. Maybe we'll talk a little bit about advisor adoption, and I know you're coming out with a new report recently. Talk about what you're hearing from advisors. What are the challenges? What are the opportunities? Are they changing their behavior?
Daniil:
Alternative investments are very difficult for financial advisors, and this happens for a few good reasons. You brought up the concept of liquidity. Advisors cite the lack of liquidity as a key reason for not using alternative investment products.
And there are a couple of schools of thought around liquidity, and you're perfectly right to the extent that some illiquidity can be beneficial to an investor's portfolio. But even at the outset, advisors don't want to get themselves in trouble with their clients. They never want to put a client into a product, have that client have a negative experience, and then come back to the financial advisor, and potentially even fire the advisor, if they're upset over that one particular thing.
So the lack of liquidity, and I would completely agree with you to the extent that end investors whose portfolios are otherwise very much liquid, they have very low alternative investment allocations currently, they should be able to handle that illiquidity. But at the same time, it may bode poorly for their experience.
They're still at the beginning of that journey, so advisors are finding it difficult to get investors to increase their use of these types of exposures. So I think the liquidity is certainly one, but we also have to talk about the subscription, redemption challenges that are associated with these types of products, the paperwork, and this has to be taken within the context of the daily life of an advisor.
What an advisor should be doing from day-to-day is looking for new clients in order to improve their business and in order to improve assets under management, the assets that they manage for clients. So advisors should be either finding new clients, they should be working with their existing clients in order to meet their outcomes, in order to provide some of the behavioral support, in order to provide them with a wealth of needs.
Financial advisors have a lot of things to do that don't include alternative investments. So, we absolutely believe that advisors have the opportunity to increase their use of alternative investments. They can use alternative investments in order to differentiate their practices. They can target that higher end investor. They can use this to retain clients. You don't want to lose a client because the advisor next door offers alternative investments that you don't offer.
But simultaneously, we recognize that using alternative investments, increasing that use, is difficult for their business because of these operational hurdles that come up, because of the risk of potentially upsetting a client, because these products happen to be more expensive. These are all commonly cited by financial advisors.
Tony:
I get the challenges. I'll push back a little bit because I'd argue that the reason you really want to consider alternatives is it increases the likelihood of achieving your client's long-term goals and objective. And in today's market environment, I'd argue it's not a nice to have, it's a need to have. Alternatives provide the opportunity to provide enhanced return, growth in income, some defense when we get volatility in the market. And I'd argue that those tools are sought after today. And I think we're starting to hear more and more advisors understand clearly some challenges, but they know that they need to increase their allocation to alternatives. I wanted to go to your survey because I know you've been doing a survey for a couple of years now. In a couple of years you'll start to see some trends and I know you and I have had this discussion probably a dozen times over the years, but it seems like we've stubbornly been at that five to six percent allocation across the wealth channel, but I think in your survey, the results are suggesting advisors are looking to increase those allocations over time. What are your current findings and where do we think those opportunities are going to take us?
Daniil:
We currently see approximately a six percent allocation to alternative investments for the average advisor for the moderate risk investor. So the actual numbers are going to differ. You're going to have the higher tier advisors that are allocating much more to alternatives. But in general, that six percent number, and that's also liquid alternatives, illiquid alternatives, about 50%, half of it is going to be liquid alts, that's GLD as an ETF or some kind of hedge fund-like liquid alts product.
That six percent number has just been stagnant. So it's been very difficult to get advisors to increase that allocation across the industry. You have that very heavy portion of alternative investments on users. And you're perfectly right, they are looking to grow that number. We do believe that number goes higher year over year. It's going to happen slowly, but there is room to, let's say in five years, push that number for maybe 6 percent to 10 percent for the average advisor. That wouldn't be shocking at all.
It makes sense within the concept of private markets, just growing. Increasingly private markets are taking over from banks, they're becoming much, much larger. It's something that financial advisors, I completely agree with you need to have access to at this particular point in time. They just have to do this carefully. But it comes down to the enhanced liquidity products that are being increasingly made available to them. It's using platforms like iCapital and CAIS in order to streamline the access to alternative investment exposures.
Tony:
And I would argue again that if advisors have a good experience with a 5 percent allocation, they're then going to be that much more comfortable to increase their exposure to 10 percent, to 15 percent over time. I'll share just an interesting sort of factoid. I have the great opportunity to travel around the country and meet with a lot of advisors. And we happen to be doing a series of due diligence meetings over the last couple of weeks. And it's interesting, one cohort of advisors had 20 to 30 percent allocations to alternatives – exactly to your point. And the other cohort had zero to 5 percent allocation. And we just need to take everyone on that journey wherever they start, realizing it is a journey and it's going to take them a period of time to get there. Those advisors who are zero to five, it's more in the “why to” and they're trying to get comfortable with some of the impediments and the structural challenges and all of that. Those with the 20 to 30, they've recognized that's how they differentiate their practice. That's how they provide better outcomes for their clients and all that. So everyone is on a different path of getting there, but I'd argue you need to be on that train. The train is leaving the station. We've given more products, better products than ever available before, and I think more and more people are starting to get on that journey along the way with us.
Daniil:
That's exactly right. You have different types of education that are necessary for different types of financial advisors. The one thing that I think is really important for the industry, I think what you will find amongst some of those advisors that don't use alternative investments at all, you have some advisors that were burned by a prior generation of product.
This is some kind of real estate investment trust that maybe either took the money and ran or just had unscrupulous accounting, etc. We went through these things as an industry. I think it's very important today for asset managers that are looking to increase alternatives adoption from advisors to use a consultative sales approach. So it's work with a financial advisor to find the one exposure that they are interested in and get them using that product, but let them pick what it is as opposed to pushing that one particular hot exposure.
Tony:
I agree with you a hundred percent. I think that's so important. It's one of the things I always emphasize. Advisors spend so much time developing a really robust process for their traditional investments and then sometimes treat alternatives as a separate product. It should be integrated in the exact same consultative process, understand client needs, understand how the strategy and structure fits within those confines.
I wanted to go back on something you were talking about in the beginning because I think again, truly has such a unique vantage point. So many asset managers bringing products to the market. I think that's a really good thing and not just products, but good products. And you and I have been looking at this for a long time and the ability to have access to truly institutional quality products makes a difference.
If you have a good product and a good experience, people are going to come back for more. If you produce a watered-down product, which past generations, I think we're guilty of. You have a bad experience. You don't come back for more. Talk to us about what you're hearing from the asset management community.
Daniil:
Yeah. Tony, let's start with stating the obvious here, then we can work from there. The reason that asset managers are focused on alternative investments is the ability to generate above average fee revenues. So it starts with that. But then the next part is that alternative asset managers are finding that the retail markets are growing quicker than institutional markets. In general, retail wealth is growing at the same time that institutional markets are retrenching somewhat. So the market is changing and both traditional and alternative investment managers are waking up to this and they see this tremendous opportunity to serve what has otherwise been a very much underserved segment of U.S. wealth with this type of alternative investment product. So they are very focused on managers are acquiring other managers, they're acquiring these capabilities. Some firms want to be a one stop shop. Other firms want to be niche in terms of what they're offering. But they're all increasingly focused on this advisor segment and they're rolling out Interval Funds, Tender Offer Funds, non-traded REITs, non-traded BDC’s, all these exposures. They have evergreen exposures and increasingly they are able to gather advisor wealth into completely illiquid product through some of these platforms also.
So it's very promising. We expect these segments to grow quickly. We're seeing announcements from firms and just a very quick rollout of product. You're seeing OCIOs get in the business and also offer their own interval fund product. And it's just really exciting. And we do see some of this as being very sustainable growth.
These are again, channels that have been missing out on what has been a growing segment of the product landscape.
Tony:
I did want to pick up on the comment that you made with these products that are available to a broader group of investors as well. So again, we primarily have focused on interval and tender offer funds as being that democratizing sort of vehicle because they're available to accredited investors below, more flexible features. We talked about liquidity. There is a quarterly liquidity valve. Is that the impetus you think for a lot of this growth, those vehicles that are appealing across the wealth spectrum?
Daniil:
That's a very strong part of it. So I think when you had Blackstone come in and revitalize that REIT structure in order to offer additional liquidity, that really changed the industry. And you have other asset managers now taking off and doing the same thing with their products.
So I think the enhanced liquidity, that's what advisors tell us that we're looking for from these products. So 56 percent of advisors told us they would use more alts if they had enhanced liquidity, and here you go. So, that's a start to the enhanced liquidity, but it's also the more pure play private capital exposures.
This is advisors being able to get the products that they want from the managers they want in the structures they want, which is really exciting. And if you look at performance of, I hate to pick on private credit here, but private credit interval funds last year, they've done absolutely terrific.
And investors have been able to access that through the interval fund structure and you have the same thing happening in terms of private equity, tender offer funds. You had positive performance being posted by a large segment of this intermittent liquidity ecosystem. It's all, very promising.
It's investors getting what they're looking for in the structures they want.
Tony:
Maybe we'll talk a little bit about the sort of strategies and I'm curious where you're seeing maybe opportunities that perhaps we're not. Clearly will pick up on private credit. We think private credit looks really attractive here. We think in light of what happened with Silicon Valley Bank and a lot of the traditional lenders backing away, we think this is a great opportunity for private credit managers who can now dictate the terms and conditions.
We like secondaries. Secondaries obviously very attractive. A lot of money raised in the secondary space. And I think largely due to the fact there was so much money in private equity and a lot of institutions found themselves over-allocated and they were looking maybe to unwind some of the positions and secondary managers provide liquidity there.
I mean, the third pillar of where we see opportunities real estate and as much as offices get kind of a negative rap, we think there are ample opportunities and industrials, multifamily, life sciences, or even real estate debt.
So there's clearly opportunities, but I'm curious from your seat, are you seeing different opportunities? I know there's been some acquisitions in the infrastructure space. Are there things that you're seeing that maybe we're not hearing about?
Daniil:
This is a really interesting concept that's taking place in these markets right now. So alternative investments are supposed to be diversifiers, but we do get the sense that what investors find interesting at any particular point in time, it ends up being, very cyclical. So it does seem that real estate is a little bit less interesting this year. Infrastructure is maybe, we think that the long-term trends for infrastructure are incredibly positive. That's an absolutely under penetrated asset segment in the U. S.
Right now, there's tremendous demand for private credit. There is a lot of demand. This is investors turning to these types of exposures as the yields are higher. We think private credit is really interesting because you're perfectly right. The banks have stepped away and some of the investors who are participating in this market and they're taking some of the companies that are borrowing from private credit firms. These are top-tier household names that have been pushed out of the banking system, and they're now looking to private credit firms for funding, and the loans are being made at attractive rates. If SOFR is at about 5%, then now you have loans coming in at 10, 11, 12%, which is wonderful for the investor. Of course, the big asterisk there is how long can this continue? Can these companies support the debt loads? A lot of them can. They're top-tier household names, but then you're going to have the potential for the rise in defaults, and investors need to be aware of all this
Tony:
I think it's a perfect comment. I think one of the things we've certainly been thinking about and talking about is the fact that you'll likely start to see a greater dispersion of return between the seasoned managers who have the ability to negotiate favorable terms and conditions and those who maybe lack the experience who are just chasing where all the flows are.
So I think our view is disruption creates opportunities and really seasoned managers across the alternative ecosystem, I think are well positioned to take advantage of a challenging environment and other managers may struggle a bit more. I did want to go back on this whole notion. We started our discussion talking about advisor adoption and you did a great job, I think, outlining some of the challenges and what it's like to sit in an advisor seat.
I do think, though, as an industry, we've come a long way, and I think one of the things that I'm kind of proud of is I think Franklin Templeton, I think a lot of other firms, have committed a lot of resources into white papers and blogs and podcasts like this, which are really designed to help advisors make those better informed decisions. And it seemed like more as an industry, we're aligning around “we know to be successful, we need to educate advisors”. From your seat, you're seeing a lot of firms out there. What are successful firms doing? And how is an industry are we making this easy? So you've outlined the challenges, how are we overcoming the challenges? And how are we helping with education along the way?
Daniil:
I think you said it perfectly. A lot of it comes out to education. It's meeting the advisor where they are with the information they need. I think we have to recognize that these exposures happen to be complex. You can have an annual report, which is 800 pages. And if you missed a disclosure about interest rate hedging, then you don't understand the product.
It's not about blaming the financial advisor for knowing or not knowing something. It's about meeting them where they are. It's about offering education on the asset classes, the exposures through the various mediums that you mentioned, and then seeking ways of just making these products more understandable to the advisor, giving the advisor the exposure.
That they tell you that they are looking for for their clients. So I think that firms are absolutely on the right track here. They're all offering education portals. They're writing white papers. They are creating media around their funds. And I certainly see the industry becoming more and more transparent as we go along.
So firms recognize they need to work very closely with advisors. It's very important for firms to make sure there's somebody available to work with financial advisors in order to explain their product. So it's about having that distribution staff on hand. So it's congratulations, you've been approved on the platform, you've won the support of the Home Office, but now you have to make sure that you're actually there in order to get the advisors to increase use of your product. And that means maybe paying for lunches for financial advisors. Maybe it's meeting them and going over your exposures, but it's really providing that next level of support that really large private capital managers just haven't done as of a few years ago.
Tony:
It's interesting you say that I was having a discussion with one of our sales team and that's exactly what they were talking about. It's not just the sale. It's the support and it's the ability to answer the questions when the advisor has a question, or the investor has a question. So, it really is a commitment.
Daniil, you're kind of in an interesting vantage point. You're really studying what the industry is doing. You've watched it evolve over the last couple of years. I'm going to ask you to put on your crystal ball and think about where is the industry going to be in 10 years from an allocation perspective and just how it's going to evolve in the next 10 years.
Daniil:
I did prepare some numbers that I'd love to discuss with you. I think the baseline is that alternative investment allocations 10 years out are going to be higher. Advisors are going to be allocating more to alternative investments. They're going to be allocating more to these high-quality alternative investment products.
If we put on a 10-year hat, there are going to be trillions of dollars up for grabs here from U. S. retail financial advisors. So that's the headline number. There are going to be, I would say, five years out, a trillion. Ten years out, far more than that. But it's not going to be even across that broad landscape of alternative investments. What I would say is going to grow the most are going to be those semi liquid exposures that are easily accessible to advisors. These are going to be the interval funds, the non-traded BDCs. I think that's an ecosystem that's going to get traction. It's just easy for an advisor to adopt. These are streamlined exposures. A lot of managers are focused on them.
I think what also grows is the true private capital exposures. This is the financial advisor who's able to access through a platform, a secondaries fund, or they're able to access a true private capital exposure. So that segment grows rapidly, probably doubles or triples in terms of how much advisors are allocating to it now, versus five, 10 years from now.
What doesn't grow is maybe those more expensive hedge fund type exposures. So, hedge funds have been in outflows for many years. That's going to be a segment that kind of holds that total alternative investments allocation maybe a little bit more level, so that, let's say, stays where it is.
Liquid alternatives, if you are going to have exposures from true private capital managers available, yeah, you don't need to put money into a more expensive liquid alternative fund. That maybe does what a hedge fund is supposed to do, but not exactly. So that segment doesn't grow as quickly, if at all.
So, I would say, yeah, trillions of dollars up for grabs. You're going to have best in class managers take a lot of that. The largest firms are going to fare, very well. You're going to see the niche providers – these are managers that maybe do something the larger managers can't – those do great as well. And then similar to traditional markets, it's the middle that gets squeezed. So, you either get acquired or yeah, you have to compete another way.
Tony:
Clearly winners and losers like in everything. Daniil, thank you so much. I think we covered a lot of ground. I really appreciate your insights, and I look forward to 10 years from now and seeing how this industry has grown and matured and how that's ultimately beneficial for advisors and investors and for asset managers. So we've got a long ways to go, but I think we're on the right path here.
Daniil Shapiro. Thank you so much for your time today.
Daniil:
Tony, thank you very much for having me on the podcast. It's a pleasure.
Show V/O:
Thanks for listening to Alternative Allocations by Franklin Templeton. For more information, please go to alternativeallocationspodcast.com. That's alternativeallocationspodcast.com. And don't forget to subscribe wherever you get your podcasts.
Disclaimers V/O:
This material reflects. the analysis and opinions of the speakers as of the date of this podcast and may differ from the opinion of portfolio managers, investment teams, or platforms at Franklin Templeton.
It is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell, or hold any security or to adopt any investment strategy. It does not constitute legal. or tax advice. The views expressed are those of the speakers and the comments, opinions, and analyses are rendered as of the date of this podcast and may change without notice.
The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, security, or strategy. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy.
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Please see episode specific disclosures for important risk information regarding content covered in the specific episode. Data from third party sources may have been used in the preparation of this material, and Franklin Templeton, FT, has not independently verified, validated, or audited such data.
FT accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions, and analyses in the material is at the sole discretion of the user. Products, services, and information may not be available in all jurisdictions and are offered outside the U. S.
by other FT affiliates and or their distributors as local laws and regulation permits. Please consult your own financial professional for further information on availability of products and services in your jurisdiction. Issued in the U. S. by Franklin Distributors LLC, member FINRA, SIPC, the principal distributor of Franklin Templeton's U.S. registered products, which are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation. Issued by Franklin Templeton outside of the U. S. Please visit www. franklinresources. com to be directed to your local Franklin Templeton website.
Copyright Franklin Templeton. All rights reserved.
