I recently had the opportunity to sit down with Robyn Holloway to discuss retail alternatives. Robyn is the sales lead for DST’s Alternative Fund Solutions offering. Based in New York City, she focuses her sales efforts on the leading alternative investment managers, broker/dealer and bank custody platforms and the traditional fund companies that are looking to enter the retail alternatives market.
Here are the highlights of my conversation with Robyn…
Robyn, can you define Retail or Liquid Alternatives and describe how they differ from other products?
Retail alternatives is a broad term that can cover many types of funds. In general, the term “retail” refers to registered funds as opposed to private funds. Open-end funds, or mutual funds, are generally referred to as daily liquid alternative funds as they trade (purchase and redemption) and price daily on exchanges and are therefore highly liquid investments. Closed-end funds can be classified as retail alternatives, but because some structures are not required to redeem daily, they do not fall into the definition of daily or liquid alternatives.
What is considered “alternative” is harder to define. In some cases, people classify “alternatives” as an asset class like equity and fixed income. As well, there are “alternative” trading / investment strategies such as short-selling or use of derivatives. To make it even more confusing, traditional private alternative funds are sometimes characterized by their use performance fees, high water marks, and other aspects. Retail alternatives don’t usually use those latter components, as they are prohibited or limited under ’40 Act regulations.
So where does that leave us? The most fitting “alternatives” definition is probably a fund that generates absolute return and has a low correlation to other investments such as equities and fixed income.
What makes Liquid Alternatives such a hot topic today?
Alternatives have long been viewed as being investments only for the wealthy. There are also stories of huge returns and significant wealth generated from investing in these products. Some of this is misplaced. Alternatives offer portfolio diversification as they generally have less volatility and correlation to other investment products. And they provide absolute return. So the retail investor might not get rich overnight, but the right funds should help protect that investor’s portfolio while generating some return.
Why is developing an alternative investment for a 40 Act fund more complex than doing the same for a private fund?
For a traditional hedge fund manager who is accustomed to private funds, entering the retail market presents a new set of considerations and challenges. The number of shareholders is far larger, which requires advanced, scalable transfer agency capabilities.
There are also specific compliance and oversight obligations due to the registered nature of the products. Distribution is a new consideration as fund managers must have a robust model for selling their funds and reaching and servicing advisors. Lastly, the actual fund management is different. With daily liquidity and limitations on investments, some traditional Hedge Fund manages find it more challenging to generate returns.
The mainstream ’40 Act manager who is launching alternative product is more familiar with these requirements. The challenge for this manager type is entering the closed-end or interval fund space, where the requirements are different from those with open-end funds.
DST has customized a shareholder servicing model for the complexities of BDCs and closed-end funds —across exchange-traded / listed and unlisted products. Other providers do not have the same platform capabilities. DST is well-suited to capture the growing retail alternatives flow into closed-end funds.
What does the future look like for these investments?
Strong! Provided these funds meet the objectives of generating absolute return with less volatility, they will continue to be good additions to an investment portfolio. With the continued growth of the advisory channel, and the fact that more and more people are saving for retirement outside a traditional DB plan, the need will increase. Some managers might not succeed, but those with the infrastructure and operational capabilities to scale in this market are well poised for success.
If I was working for a 40 Act fund company developing their first liquid alternative product, what would you recommend for me?
It is important to do comprehensive due diligence on your servicing partners. Don’t assume that your service providers today are knowledgeable and proficient in the retail alternatives space. Also, for overall education on the market, there are several conferences and webinars that provide good overviews of the market.
This week, Robyn will be joining a panel on industry experts to speak on this topic at our Client Forum. I would like to thank Robyn for her time and for sharing her knowledge on this topic.