Asset managers have aggressively targeted the wealth channel with new products and investment strategies anticipating rapid growth in the next decade.
However, potential obstacles exist on the regulatory front. Rules restricting the definition of an accredited investor and making it more difficult for advisors to recommend limited liquidity products are discussed at the state and federal levels.
The Institute for Portfolio Alternatives represents members who are active in lifecycle REITs, net asset value REITs, business development companies, interval funds, closed-end funds and direct participation programs. The association is engaged with regulatory agencies to shape how new rules are implemented.
Wealthmanagement.com spoke with Anya Coverman, president and CEO of the IPA, about the expanding use of alternatives and the potential regulations the association is monitoring.
This interview has been edited for style, length and clarity.
Wealthmanagement.com: Are you seeing any particular trends in expanding certain types of private vehicles? There seems to be a marked increase in asset managers looking to build products for the wealth channel and retail investors.
Anya Coverman: You are right. We represent all types of alternative investment products geared toward the retail channel and less correlated or non-correlated. The products span strategies and asset types. I always say that alternative investments are not “nice to have” but a “must have.”
From a high-level perspective, the endowment model has 50% allocated to alts. For pension plans, it’s 20% to 25%. Retail investors, meanwhile, are at 1% to 2%. The last study I saw from McKinsey projected that to more than double to 5% in the next three years. These channels represent a huge part of global AUM, a significant factor driving interest in our association and this space.
I will give you two other perspectives. The traditional model with a bond/equity division hasn’t behaved as it was traditionally designed. The goal for many is how to give the retail channel the same endowment model.
The other factor is that demographics are changing amid the largest generational wealth transfer in the history of humanity. Trillions in assets will pass from baby boomers to Gen Xers and millennials over the next 15 years. So, having opportunities for investments is a big factor. That’s why, despite market and economic headwinds, we are still having this robust discussion.
WM: If you think in longer terms, individuals used to have more exposure to alternatives back when more Americans were on pensions. The shift to defined contribution has changed what individuals are invested in. Is that right?
AC: Yes. And in fact, the defined contribution space has been a huge focus for us for a number of years. Individual investors largely have DC plans. Many are invested in target date funds that are responsible for making investment choices. If you compare the DC performance to defined benefit plans, even today, defined benefit plans have a larger allocation to alts and have significantly outperformed the 401(k) market.
Ensuring investors with 401(k) plans and IRAs get the same access and performance has been very important to IPA and a key initiative for us, as well as looking at the allocations that defined benefit plans have made toward private real estate and private credit and real assets.
WM: On this front, there seems to be a real push on limited liquidity structures like interval funds, business development companies, tender offer funds and non-traded REITs. There is a steady drumbeat of product launches, and a number of asset managers seem to be eyeing the wealth channel and rolling these out.
AC: A number of products in our space are geared towards sophisticated, high-net-worth investors. Other products in our space, specifically the non-traded REITs and the non-traded BDCs, allow any investor to invest in these strategies. That, to me, is a unique product in the sense that it gives investors the opportunity to invest in private real estate or private credit when they would otherwise not have that ability.
I talked last year about the NASAA REIT proposal, which includes concentration limits on investors’ ability to invest in these products. But from a federal level, there are no restrictions. They are publicly registered like any other publicly traded company.
WM: Speaking of that, what are you watching on the regulatory front right now?
AC: We expected to see a proposal on the definition of accredited investors last year. It was on the SEC’s Reg Flex agenda. However, it is now on the Reg Flex agenda for April. We have not seen a proposal.
In December, the SEC issued a staff report on its accredited investor position. It was part of a four-year review that Dodd/Frank requires. At that point, the SEC did not make recommendations on changing the definition, but they did reference quite frequently the expansion of the definition and concerns about more investors being qualified as accredited. They also questioned the utility of financial thresholds to measure investor sophistication, and they expressed concerns about including retirement savings when calculating household net worth.
So, reading the tea leaves, it looks like the SEC will put out a proposal that would restrict the number of investors that qualify by making it more difficult to qualify as accredited. From an IPA standpoint, we don’t believe that’s the right approach. The definition is meant to qualify someone who has the appropriate sophistication and the ability to withstand investment loss, and that can be done in qualitative and quantitative ways, but severely limiting the number of investors that can access investment opportunities to support their retirements is looking at it through the long lens, we believe.
Outside of that, we are monitoring the SEC’s ESG proposal, which they say might come out in April. We are also closely monitoring NASAA’s REIT statement of policy that would put pretty severe restrictions on investors’ ability to purchase non-traded REITs and non-traded BDCs. Provisions about a concentration limit have many worried. NASAA has pulled that back and has been fairly quiet. We don’t know what will happen next but are closely monitoring it.
WM: What are the main concerns with the NASAA standard of conduct proposal?
AC: It could conflict with Regulation Best Interest in significant ways. It would require B/Ds to consider reasonably available alternatives with lower costs and lower risk. That will drive brokers to the cheapest or whatever they view as the least risky securities. However, risk is not defined by securities laws. It is a subjective determination. There’s no consideration of a retail customer’s needs, risk profile or portfolio diversification needs.
A large coalition of groups is very concerned about this proposal and the extent to which it goes far beyond Reg BI. It calls out certain products that seem to be disfavored by NASAA.
NASAA messaged it as an attempt to update and codify Reg BI, but it ultimately goes well beyond Reg BI and would be built into state-by-state law. States are sovereign autonomous entities, so there’s a large risk of this being adopted non-uniformly.
WM: So, the concern here is we already have Reg BI and don’t need another layer on top of that?
AC: It’s significantly beyond Reg BI. I mentioned one piece of it, which is the reasonably available alternative test that Reg BI already defines. It goes beyond that test, and frankly, it becomes a product-specific focus, whereas Reg BI is product agnostic. It also effectively prohibits traditional forms of broker compensation that are permissible under Reg Bi. If the goal was to codify Reg BI, that’s a simple sentence. That’s not what this is.
We are also monitoring the DOL fiduciary proposal. The IPA wrote a comment letter and testified.
To take a step back from all of this, we spend a lot of time thinking about how investors have a secure retirement and gain access to private and public market products that will meet their needs. With such a significant escalation of private wealth with this large wealth transfer, it’s an important consideration.
We’re also in a presidential election year, and Congress is more dysfunctional than in the past. Many members have left. That leaves regulators quite busy. What we saw last year and will continue in 2024 is a lot more activity on the regulatory front.
WM: Another theme I often hear when it comes to alts is the importance of education. Where are IPA’s efforts focused on that front?
AC: Our membership includes financial professionals. We are unique in that we represent not only the sell side with asset managers but also the financial professionals looking to provide these investments to clients. We work on education in a variety of manners. These are more complex products. There are important disclosures for investors. There are important benefits of the products for advisors and clients to understand. We have a lot of educational sessions at our events.
Because there was a high level of interest in private real estate and NAV REITs, there was a recent research report by academic professors that looked at how adding private real estate and using a mix of NAV REITs would affect a typical portfolio that included public REITs, bonds and equities. It showed statistically significant alpha relative to public market indexes. It’s substantial to have independent research by well-respected academics. We’re happy that’s it out there now. We’re always looking to do more. We’re always looking to ensure we have educational pieces, research and discussion around the products in our space. This is something IPA will be increasingly doing over the next several years.
WM: Real estate is a big component in some of these products—interval funds and non-traded REITs. But real estate is also getting hammered because of difficulties, specifically in the office sector. What’s your take on real estate investment right now?
AC: Commercial real estate investing is about taking a long-term view. Most real estate investors take that view. We see more funds launching. They are not looking to time the markets based on a cycle. We are in a period of transition and waiting for interest rates to restabilize. As we go into 2025, that will have a positive impact.
We have also seen a large influx of credit funds. They are very hot. They are hot when there is uncertainty in the economy and commercial bank lending is more constrained. Companies look to private credit for financing if they can’t get it from traditional lenders. We’ve seen a lot of growth in private credit and more deals that have come to the market that look to absorb some capital that’s been redeemed.
There’s also a lot more interest in private placements. I mean private placements in asset strategies, but in private structure wrappers. There are a lot of new entrants, from Blue Owl to KKR to Goldman, and about $30 billion of capital from 2023 is being redeemed by new funds. We also see a lot of innovation in funds focused on renewable infrastructure and emerging markets. I have had a lot of conversations about decarbonization and digitization.
I also still hear a lot about large RIAs and wirehouses that are standing up their own interval funds. They have captive audiences. They are raising proprietary businesses.
It has not been a slow period.
I was also just on a call on interval funds and bringing in different fund of fund structures. If we tie it back to where we started—why is there still significant growth and interest from financial advisors and RIAs—it’s to address the opportunities, the need for diversification, new investment models, and the changing demographics.
WM: What about, for lack of a better word, the technological plumbing that makes investing in alternatives easier for advisors and their clients?
AC: IPA spends a lot of time on that. We have a technology, innovation and operations committee. There is room for improvement. From a plumbing standpoint, there are benefits from the 1940 Act fund structure, where you can have a ticker and liquidity options. There’s also a lot of new technology being advanced, including the influx of new and more sophisticated platforms and solutions. There is more opportunity for growth, and it will continue to improve to become more efficient and streamlined.
