Amid a range of topics at this week's Morningstar Investor Conference in Chicago, including the future of the financial advice business, the outlook for stocks and bonds and advisor technology, there was a strong undercurrent of advisors and asset managers grappling with whether and how to deploy private investment strategies in the wealth space.
In a session on the evolution of asset and wealth management over the past 40 years, and predictions for the next 40 years, Hightower CEO and Chairman Bob Oros pointed to private market investment opportunities as an area in which RIAs can differentiate their businesses, along with increasing client services such as estate planning.
“Many areas of investment management have been commoditized, but private markets is one area where you can create a differentiation,” Oros said. “Managers are beginning to discover the RIA space.”
Oros and others at the conference pointed to the proliferation of illiquid '40 Act fund wrappers, including tender offer funds, interval funds and business development companies, as entry points for asset managers such as Blackstone, Apollo and recently announced the partnership between KKR and Capital Group, to enter the property space. These types of investments typically have lower minimums than traditional drawdown funds (usually in the thousands of dollars, not millions), come with easier tax reporting (generally on 1099s rather than K1s) and don't require capital calls.
“Retail is what they call it, but there's a ton of interest from managers to reach investors through RIAs,” Oros said. “I don't think these have ever been more accessible than they are now.”
Hightower tends to serve high net worth and very high net worth clients who have more capacity to invest in the private markets and are more interested in esoteric topics. “They're not looking for the next liquid investment in an Act '40 fund,” Oros said. That demand prompted Hightower to launch a cybersecurity fund with a third-party manager, which Oros said was well received by clients.
On the same panel, Katie Koch, CEO and president of asset manager TCW Group, said her firm is also looking at how to bring capabilities to the wealth market.
“The most difficult thing is to find the vehicle that will be acceptable to the entire market and that does not impose too many restrictions on investors,” said Koch. Some of the newer structures “have not been tested in environments where liquidity has not been available.”
“It is the responsibility of asset managers to understand what they want to invest in and how to structure it,” Koch added. “If you release the wrong product at the wrong time (in the property market), you'll never get back into the market.”
Drilling for interval funds
For its part, Morningstar this week published a focused report only in interval funds. According to its database, there are now exactly 100 range funds in various strategies with more than $80 billion in AUM collectively. Interval fund AUM has grown approximately 35% annually for the past decade and accelerating. At the current rate, total AUM is doubling every two years.
This is almost entirely run by VNR. (The main difference between interval funds and tender offer funds is that interval funds are required to provide a fixed amount of liquidity—typically 5% per quarter—while tender offer fund managers have discretion over when to open the fund for redemption. )
Asset managers have been experimenting with the types of assets they package into mutual fund envelopes, but private credit has emerged as the most popular because they can provide some income and the underlying assets are easier to sell than classes. other private assets, making it easier. for the manager to maintain the necessary liquidity for repurchases. Overall, about 60% of existing range funds are fixed income. One private credit fund—Cliffwater Corporate Lending Fund with $19.6 billion in AUM—accounts for nearly 25% of the AUM of all mutual funds combined.
The performance of traditional fixed income markets in recent years as interest rates rose prompted many RIAs and investors to look to private credit bridge funds as an alternative. In comments to reporters, Alec Lucas, director of manager research at Morningstar, noted that the Morningstar 10-Year Treasury Index + lost 47.6% from March 9, 2020 to October 19, 2023. If not for a rally in late 2023 , traditional bond markets would have produced an unprecedented three consecutive years of losses.
But for their part, Morningstar analysts said they are still not convinced that interval funds are the answer.
“For the end investors and the advisor they serve, we wanted to ask, 'What are these things?' and go into some detail about whether they're good for investors,” Lucas said. “The answer to that question is you don't want to be ultimately negative, but are the complexities worth it? Do they add value to a well-diversified portfolio? That's not It is clear.”
Brian Moriarty, associate director, fixed income strategies at Morningstar, is the lead author of the study and focused on the interval fund sector.
“What I would like to see happen is the rationalization of the right assets with the right wrappers,” Moriarty said. “There are some interval entertainments that do private equity, but if they take exits for several quarters in a row and can't sell assets, they end up in liquidation. This is an obvious mismatch with the envelope of the interval fund.”
He noted the case of The Wildermuth Funda hedge fund focused on private equity that has been forced to liquidate, as a cautionary tale.
“Some of these funds may benefit from investor interest. The sweet spot for a portfolio is assets that can generate cash, or assets that can mature, or assets that can be sold in weeks or months,” Moriarity said. “That narrows things down.”
Phil Huber, head of portfolio solutions at Rock water, sponsor of the single largest fund of the interval, also talked about increasing the space. Huber himself served as chief investment officer on the wealth side before moving into asset management and joining Cliffwater.
“There's been a lot more interest after 2022,” Huber said. “It was easy to say 'no' before that. But then people started saying, 'Maybe I need a third leg of the stool or new exposures to create a more diverse portfolio.' But you're introducing more complexity into the equation.”
The goal for Cliffwater (and other asset managers) is to package private strategies so that advisors don't have to make detailed decisions about how to invest in private credit, private equity, real estate, real assets or investment strategies. others.
He said the reason Cliffwater's flagship fund has gained so much traction is that its particular lane in the private credit space is conservative lending to established private corporations with strong fundamentals. It is not a fund that is built on providing finance to highly leveraged companies or to finance growth strategies. (Cliffwater has a second, smaller range fund with more of a growth bias.)
“We don't take credit,” Huber said. “We work with 20 lenders. We think they are top notch. It's an asset class you want to diversify into. It's not for alphas. There is not as much dispersion in managers' returns as venture capital or private equity. Loans use modest leverage and we don't have a single position that could blow us up.”
Other non-traditional options
In recent years Morningstar has partnered with several different entities as part of a strategy to give advisors more non-traditional investment options. These partners include iCapital, a marketplace and fintech that provides access to alternative asset managers, as well as tools aimed at facilitating subscription processes and investment management. Except this, Financial River is a multi-issuer platform for structured products and annuities. And, Sora Finance is a fintech that focuses on liability management—assessing customers' debts and looking for opportunities for customers to refinance or otherwise optimize whatever credit they may have. Morningstar has integrated all three platforms to varying degrees with its Advisor Workstation product.
“One of the things we're seeing in the market is that product complexity continues to increase,” said Jay Charles, head of retirement solutions for Luma. “Everyone is looking to outdo each other. This makes the work of counselors more difficult. How do you compare products? This is where I see technology coming in to help.”
Charles added that there is a lot of talk about education when it comes to alternatives, but getting up to speed takes more than sitting through a few videos or primers. “Advisors need to understand how these can be analysed, what results will be drawn and how to compare them to each other. What will have a major impact on customer portfolios? And, you need to figure out how to manage and track them over time.”
Mike Doniger, senior vice president of platform partnerships at iCapital, said the use of alts has grown to the point that iCapital alone now has $200 billion in platform assets and an additional $70 billion in transactions annually in structured investments and annuities. .
“There are now funds that cater to a wider spectrum of investors,” Doinger said. “UHNW used to be the focus, but now it goes down to massively wealthy and accredited investors and registered funds. This, coupled with greater demand for personalization and customization from clients, is driving advisers to look more at the asset class and how they can leverage it and get clients to invest.”