(AlphaWeek) - The adoption of alternative investment products and strategies by wealth managers in the United States has been slower than their institutional counterparts. Reasons abound; cost, complexity, performance when compared to a traditional 60/40 portfolio to name a few.
Another is the sheer amount of paperwork involved. Chicago-based Third Wire Asset Management seeks to accelerate the adoption of some of the more liquid alternative investment products like hedge funds and managed futures strategies by smoothing the process.
“The process issue is two-fold” said Daniel Harms, CEO of Third Wire. “First, when an RIA makes the recommendation to a client that they should allocate to an alternatives product, their client is inundated with 100 pages of subscription documents, accredited investor questionnaires, fund formation documents, private placement memorandums, etc. The physical paperwork can be intimidating and regularly it just sends RIA clients running in the other direction. The other is that RIAs using alternatives will have had to manually input the NAV statement values into their performance reporting software. Which if you are utilizing alternatives across your book of business, is a job in itself, i.e., increased operating expenses and staff.”
Third Wire has solved for this issue, naturally, with technology. A partnership with IOI Capital and Markets, a technology company that has built a platform for issuance, management, and trading of private securities, manages the onboarding process. It’s twenty minutes from login to execution; at the reporting end, an API directly pipes the relevant data into whatever software system that the RIA uses.
“Streamlining the investment process and getting rid of the paperwork by way of digital documents, providing a solution to having your investment data be piped directly into a performance report platform - basically anything that can be done to make an RIA client’s investment process as painless & secure as possible will make RIA usage of alternative investments more & more commonplace in the independent investment advisory universe,” said Harms.
Another issue is the complexity and sheer choice available to investors looking to allocate to alternatives. There are thousands of hedge funds from which to choose, making the selection process as time consuming as the aforementioned paperwork. Additionally, individual investors have been exposed to a different risk due to the size of allocations they make.
“Constructing a properly diversified alternatives portfolio using individual managers traditionally also means a lot of minimum investment thresholds to clear, usually $1mm a pop. So, they’re restricted from adding actual diversification via multiple strategies to the traditional stock/bond mix, because if they’ve only got enough cash via the prescribed asset allocation to access one manager, they’re exposed to manager risk. That’s a lot riding on a single manager’s ability to operate independently and counteract the movement of a portfolio’s entire equity allocation,” said Harms.
Third Wire’s solution takes a multi-manager approach; Harms and his team have created five portfolios, each with different risk tolerances tied to industry standard buckets (i.e. conservative to aggressive), which reduces the paperwork and provides diversification.
“Third Wire’s model portfolios use a mix of 5-8 equity, fixed income and managed futures-based hedge strategies. That way, you get the diversifying effects alternatives are supposed to provide - uncorrelated return streams, lowered volatility, and increased risk-adjusted returns,” he said. “And we design based on statistics, research, and assessment of a manager to continue its strategy into the foreseeable future. Our choices are made based on TWAM’s in-house quantitative & qualitative analysis, along with how the strategies/managers have worked together & will work together to achieve the goals of our RIA clients.”
A large part of the day to day for Harms is an ‘education offensive’ – attempting to undo some of the pre-set views some of the RIAs that he speaks with have about alternatives, which include the view that alternatives and private equity go hand in hand, something that he feels strongly about.
“Generally, a knee-jerk reaction RIAs have to hearing the term ‘alternatives’ is to think private equity, multi-year illiquidity, heavy fees,” he said. “We try to explain that the alternative investment world is made up of so many more additional strategies to private equity - Relative Value, Long/Short, Systematic Trend-Following, Left-Tail/Risk Mitigating, Global Macro, Fixed Income Arbitrage, Currencies/FX, etc. Putting the correct strategies together can bolster an RIA’s client portfolios, and offset against future shocks to the public markets. You buy a basket of stocks to prevent any individual company from bringing down your performance, you should do the same with alternative investment strategies.”
Despite the challenges Harms alludes to here, he is seeing increased interest in alternative investment products from RIAs in the U.S. due to the current state of their client’s existing portfolios.
“RIAs are exploring their alternative investment options, and I think a lot of that is driven by their respective clients asking questions about what to do now. Fear is a great motivator and wanting to preserve the accumulation of wealth that has been created in the stock market's parabolic run-up the last few years is a high priority for their clients,” he said.
Harms has built Third Wire to help RIA clients achieve that goal.
“Most RIAs haven’t had access to the ‘alts’ space like the investing elite, institutional investors, and Wall Street shops have had for decades but we believe we have solved the barriers to entry for RIAs and their accredited investor clients. We’re trying to make alternative investments an ‘access class’, not just an asset class, for HNW accredited investors.”
Greg Winterton
November 8, 2021
