The Cambrian Explosion in Alternative Investment Options

The proliferation of alternative investment options for wealth managers offers new avenues for diversification and enhancing risk-adjusted returns. It also introduces some risks that must be considered.

The broadening of options beyond the traditional 60/40 portfolio is long overdue. Considering the secular decline in the number of public companies and the related rise in major indices for a dwindling number of mega-cap stocks, this broadening is more necessary than ever to enable true factor diversification.

For all the attention this trend receives, it remains in its infancy.

According to a study by Bain, high net worth investors in aggregate have less than a 5% allocation to alternatives. This is in contrast with around 20% for ultra-high net worth and family offices, which are more in line with the allocations of public pensions and sovereign wealth funds. Further down market, the mass affluent market is largely untapped, with a de minimis allocation.

Alternative asset managers are eager to tap into these pools of capital and have been investing heavily in multi-pronged strategies to penetrate the wealth market. Broadly, these strategies take two forms: first, the evolutionary development of structures tailored to the needs of the wealth market, which are seeing enviable growth, and second, the (potentially) revolutionary use of tokenization, which could enable wider individual investor participation with vastly lower investment minima, but which remains in the proof-of-concept stage.

Blackstone (BX) is among the leaders in perpetual vehicles and illustrates the growth potential; as of March 31, Blackstone oversaw $241 billion in private wealth AUM across vehicles dedicated to real estate, private credit, and private equity.

KKR (KKR) and Hamilton Lane (HLNE) have been among the leaders in tokenization. KKR, for example, partnered with Securitize to create a tokenized feeder fund for its Health Care Growth II Private Equity Fund. The minimum investment of $100,000 is a relative pittance, and the Securitize platform offers the potential for vastly improved liquidity following a one-year lockup. There remain key regulatory and other dependencies that must be resolved before tokenization could become mainstream, but it holds the potential to enable another step-function increase in the breadth of alternative options in the wealth market.

Yet, none of this is without risks.

Perhaps most glaringly, torrid growth in the private credit market in recent years makes a shakeout inevitable when credit sours.

As a more general proposition, “democratization of investment opportunities” is the first-person component of a Russell conjugation, the third-person component of which is “finding the last pool of exit liquidity.” Caveat emptor.

Moreover, increased allocations to markets with limited price discovery means increased difficulty in understanding what individual investors really own, identifying the factors to which their portfolios are exposed, and in performance attribution (i.e., how much is alpha really versus leveraged beta).

None of these risks are insurmountable, nor should they dissuade most wealth managers from embracing the new tools being placed at their disposal. Neither risk, however, should be ignored.

Even so, with a clear-eyed appreciation and responsible management of the risks, this Cambrian explosion of alternative investment options has the potential to give wealth managers an unprecedented ability to tailor portfolios to individual client needs and risk tolerances. It can also enhance the risk-adjusted returns and overall economic security of individual investors.

For additional perspective and solutions, listen to the segment of our alternative asset ETFs (28:06 - 32:20). You could also explore the wealth management solutions FactSet also offers to help you drive engagement, grow your book of business, and meet your clients' investment goals.

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