As the S&P 500 continues to hit new highs, an increasingly large sum of retail and so-called “smart money” flows are focused on ferreting out any and all sources of non-correlated return streams. This includes relatively new investment classes such as cryptos and special purpose acquisition companies (SPACs) as well as traditional diversifiers such as gold, real estate, hedge funds and private equity.
While recent media headlines have focused on newer asset classes, here we explore the growth and opportunities associated with the somewhat less exotic world of hedge funds, private equity and interval funds. We believe assets in these strategies will increase and that they represent a somewhat more reliable manner for high net worth investors to multiply their wealth. Of course, this is not to say that investments such as crypto or SPACs do not have a place; in fact, they will likely end up as underlying investments in many hedge funds and private equity vehicles. Rather, we believe that in the end, most investors are best served by professional investment management utilizing proven investment vehicles, operated in well-known jurisdictions, and overseen by competent regulatory regimes.
In the United States, long-run trends to make alternative investments more available to a wider number of investors are likely to continue. For example, in August 2020 the SEC adopted rule changes that became effective in December 2020 to modernize and add flexibility to the definition of an “accredited investor—a test that had been, for the most part, unchanged for 35 years.
In parallel, regulators have also indicated a greater willingness to allow Defined Contribution (DC) plans to access private equity. In June 2020, the U.S. Department of Labor (DOL) issued Information Letter 2020-06-03 in response to an inquiry for the views of the Department of Labor on the use of private equity investments in designated investment alternatives made available to participants and beneficiaries in individual account plans, such as 401(k) plans, subject to the Employee Retirement Income Security Act of 1974 (ERISA). In response, the DOL provided that it believes a plan fiduciary of an individual account plan may offer an asset allocation fund with a private equity component in a manner consistent with the requirements of Title I of ERISA. However, the DOL also touched on many of the factors that a responsible plan fiduciary must take into account when choosing to add such an option in order to meet its fiduciary obligation under Title I of ERISA.
It should be noted that this guidance was issued during the Trump administration and that there was significant Democratic resistance. On June 12, 2020, shortly after the guidance was issued, Sen. Sherrod Brown, D-Ohio, the top Democrat on the Senate Banking Committee, and six other senators, including Elizabeth Warren, D-Mass., and Bernie Sanders, I-Vt., sent a letter asking the DOL to reconsider its position that plan fiduciaries would not violate their duties by allowing private equity investments in defined contribution plans. Given recent moves by the Biden Administration to reverse many Trump-era policies, it is possible the DOL guidance could be changed. Nevertheless, we continue to be of the view that, ultimately, private equity will find its place in target-date funds. There are simply too many possibilities for long-term risk/reward enhancement similar to that experienced by Defined Benefit (DB) plans and endowments.
There are a number of different vehicles open to accredited investors but interval funds are an area of growing industry interest. In the spring of 2020, and despite the fact the industry was in the midst of the COVID-19 crisis, approximately one-half of a survey of 28 leading investment managers indicated they were looking to expand alternative investment offerings. Interestingly, distributors are now much more willing to consider utilizing these structures than they were in the past. In a survey conducted by SS&C Research, Analytics, and Consulting at the end of 2020, which surveyed a variety of distributors including wirehouses, regional and independent broker-dealers, private banks and TAMPs, approximately 63% indicated a willingness to use interval funds, up from approximately 44% in the survey conducted in the spring of 2019. This number will likely rise as home offices, financial advisors and their clients become more accustomed to the benefits of these vehicles as well as some of their limitations. It’s important to note that the industry continues to work diligently to address some of the operational challenges associated with interval funds, an area in which SS&C is itself quite active.
Willingness to Utilize Interval Fund Structures
2019 n: 23 respondents
2020 n: 24 respondents
Source: SS&C Research, Analytics, and Consulting Productivity Insights BD/ GK RES/DD Team Survey 2020
We asked: Are you open to utilizing an interval fund structure for investment strategies constrained by increasingly strict liquidity considerations?
We discovered: A much higher industry willingness to utilize interval funds to provide access to less liquid alternative offerings is revealed.
Due to SS&C’s large role as a participant in the alternatives investment market, we have been observing long-term trends for many years. After peaking in 2014, we observed an overall decline in sales across a broad universe of interval funds, non-traded REITs and non-traded BDCs which began to reverse in 2019. Moving into Q1 2020, sales were on track to exceed $15 billion but were derailed by the COVID-19 crisis, which capped sales and drove an increase in redemptions that, to the industry’s credit, it was able to successfully manage. Fortunately, as we move through 2021, it appears that sales are strongly rebounding, particularly in the wirehouse channel, which is increasingly adopting these structures. We expect sales across interval funds, non-traded REITs and non-traded BDCs to steadily increase throughout the course of 2021. In fact, we would not be surprised if total sales for 2021 across these structures rival the last high seen in 2014.
Clearly, the term alternative investing can be, at times, an overly broad and simplified description of a very diverse range of investment choices. The challenge for investment professionals making decisions and recommendations on behalf of their clients is the degree of complexity associated with these investments. The choice is about not only what investment is best from a fiduciary or suitability perspective, but what vehicle is the most appropriate and also available to the client given their particular financial situation. The investment management industry is responding to these needs with a variety of structures and fee configurations. We are confident investors will have access to an increasing array of choices in the coming years.
To discuss how SS&C can help you to evaluate your firm’s needs and opportunities in distributing alternative investments, please read more about our Distribution services.
Written by Michael Andrews, CFA
Head of Investment Products Research & Consulting