Investing Strategies of the Future: From Alternatives to Personalization

Investors Losing the Taste for Plain Vanilla Assets Advisers to Steer Off the Beaten Path

Losing a taste for plain vanilla

There’s nothing quite like a bear market for stocks, coupled with spiking inflation, to steer financial advisers off the beaten path of plain vanilla stocks and bonds. That may well summarize 2022-23.

In the face of public market volatility, retail and institutional investors are actively seeking new avenues to generate returns. The uncertain landscape of the past 18 months, marked by rising interest rates, inflation, has reignited interest in alternative investments. Investors are drawn to the potential return premiums offered by longer-term investment strategies. Investing public’s interest in alternatives has been enhanced by the gradual “re-privatization” of capital markets, or the delisting of many heretofore public issuers from stock exchanges around the world. As a result, the traditional investment portfolio consisting of 60% stocks and 40% bonds is being re-evaluated, indicating a potential transformation in investment practices.

Alternative investments like private equity and hedge funds have long been the near-exclusive purview of ultra-high-net-worth people and large institutions. Asset managers, however, are expanding their investor base as institutional investors may be reaching their allocation limits. With retail investors are increasingly a key target audience, asset managers are coming up with innovative solutions to deliver illiquid (or partly illiquid) alternative strategies to the retail world by reducing or bypassing traditional barriers, such as long-term capital commitment or high investment minimums. For fund managers, these innovative alternative strategies represent an opportunity to deliver alpha and justify fees while aligning with unique client requirements.

Potential retail opportunity looming for advisors

Among alternatives fund managers polled by Preqin for Future of Alternatives 2025, 35% expect retail investors to account for a larger proportion of their assets under management over the next five years.¹ As per McKinsey, retail investment in alternatives is currently estimated to be only 2 percent of overall investment portfolios, leaving the room for growth in alternatives is immense. McKinsey projects the retail allocation to alternatives has the potential to more than double to 5% in the next three years. An increase McKinsey estimates could add between $500bn and $1.3tn in new capital to alternatives.²

So, what’s holding advisors back?

Advisors have historically allocated lower to alternatives. Cited reasons ranged from lack of access due to the higher investment minimums of private alternatives, diverse investment objectives and investment holding periods of their clients they serve, the dearth of bespoke training related to the potential complexity of some alternative strategies, challenges in price discovery, to the generally relatively more cumbersome process for placing trades.

Post Global Market Volatility in 2022, Investors Are Seeking Value From Alternatives

2022 witnessed a paradigm shift, ushering in an age of heightened macroeconomic uncertainty and rollercoaster market volatility. The US Federal Reserve’s response to persistent inflation created a challenging environment for both equity and bond investors. Inflation uncertainty has the potential to continue to impact the economy in 2023 and beyond.

According to a Bank of America Private Bank study, 75% of high-net-worth investors between the ages of 21 and 42, compared to 32% of investors over 43-years-old, don’t expect “above-average returns” solely from traditional stocks and bonds. The firm polled 1,052 high-net-worth investors with at least $3 million in investable assets from May to June 2022.³

The effectiveness of the traditional 60/40 portfolio and the ability of bonds to act as a buffer during equity sell-offs has been lessened, if not erased. The difficulty of forecasting multiple economic headwinds and its effect on the stock-bond correlation means that now may be a good time to diversify your diversifiers. To confront the prevailing economic uncertainty head-on, investors should seize the opportunity to incorporate commodities and alternative assets into their portfolios.

Where are global and Canadian investors pouring money into alternatives?

As per Preqin, global alternative assets under management will be worth $23 trillion by the end of 2027 – up from $13 trillion at the end of 2021.

1

Global Alternatives Factoid

^{Sources: Private Equity sources – Preqin 2023 report and CVCA; Venture Capital sources – Preqin 2023 report, Businesswire and Tracxn; Hedge Fund sources – Wealth professional and Mordor intelligence; Liquid alternatives sources – CAASA and Calamos investments; Private debt – Preqin 2023 report}

2a

Canadian Institutional Investors Were Expected to Increase Allocation to Alternatives

2b

Average Current and Expected Allocations to Alternative Investment Types (Inclusive of Funds and Direct Investments)

^{Source – CIBC Mellon – The race for assets survey of 2019}

While there’s no breakdown showing where Canadian advisors lie on the global spectrum of alternatives’ adoption, at a recent Alternative Investment Management Association (AIMA) Wealth Advisor Summit, panelists cited that despite disappointment with the traditional balanced portfolio, fewer than 20% of Canadian wealth advisors have an allocation to alternative investments, with the average allocation being 4%.

Are Asset Managers Focusing on Retail?

Compounding this economic uncertainty and the appetite for alternatives, asset managers are expanding their investor base as institutional investors may be reaching their limits. Retail investors are, therefore, increasingly becoming a key target.

Institutional investors have sought exposure to non-traditional asset classes for decades, acknowledging that alternative investments, including hedge fund strategies, private equity, private credit, and real assets, may help enhance returns, manage risk, or improve diversification. Currently, alternative investments account for more than one-third of institutional portfolios and market volatility pushes that figure even higher.

In 2020, the largest Canadian pension funds demonstrated significant allocation to alternative assets, with research from Manulife Investment Management revealing percentages ranging from 34.7% to 54.3%. This is approximately 10% higher compared with 2015, when the allocation to alternatives ranged between 24.6% and 44.1%.

3

Canadian Pension Funds Growing Allocation to Alternatives

Percentage allocation to alternatives ranged between 25% and 44%

^{Source – Manulife Investment management}

As alternatives reach portfolio limits for institutional investors and the ultra-high-net-worth, asset managers are looking to broaden their client base and target affluent high-net-worth clientele, and even mid-market investors with alternative strategies.

Until recently, just a handful of institutional products have been available to retail investors, such as Blackstone’s flagship Real Estate Investment Trust, an unlisted fund, and its private credit fund. But offerings designed for retail investors are set to multiply.

Sun Life Financial Inc. through its institutional fixed income and alternatives asset manager, SLC Management acquired Advisors Asset Management Inc., a Colorado-based retail distribution company that works with investment managers. The takeover was the final piece of an almost decade-long effort by Sun Life to bring its alternative products to retail clients. Other firms like Mackenzie, Bank of Montreal and Wealthsimple have followed pursuit and launched dedicated private funds for accredited retail investors.

Retailisation of Alternatives Has Huge Potential for Advisors

The motivations of retail investors are understandable. Traditional equity opportunities are being squeezed, public companies have been delisting, while high-growth companies are staying private for longer. Among alternatives fund managers polled by Preqin for Future of Alternatives 2025, 35% expect retail investors to account for a larger proportion of their AUM over the next five years.

According to McKinsey, retail investment in alternatives currently represents just 2 percent of overall investment portfolios. As per their estimate, the retail allocation to alternatives has the potential to more than double to 5% in the next three years, or add between $500bn and $1.3tn in new capital to alternatives globally.

According to research conducted by Bain & Co, the opportunity can be encapsulated in two significant figures: 50% and 16%. Individual investors hold roughly 50% of the estimated $275 trillion to $295 trillion of global assets under management (AUM), yet those same investors represent just 16% of AUM held by alternative investment funds.⁴

If you are an oenophile, maybe investing in wine through platform is a good option

The range of available investment alternatives is also expanding in intriguing ways.

For ages, savvy oenophiles have made significant profits off smart investments in collector bottles. The $5 billion resale market is unfriendly to those without deep wine knowledge and monetary resources. But now new platforms like Vinovest and Cult Wines are breaking down those obstacles for a broader consumer and creating accessible models of wine investing.

Cult Wines, now available in Canada, is an innovative wine investment platform which can be described as a separately managed account for fine wine investing. Clients who come on to the platform are walked through KYC reviews to determine their objectives and investment time horizons. From there, they’re given an actual allocation of cases of wine that’s suitable for their investment profile.

Having a digital platform has also disrupted the traditional realities of wine investing. What used to be largely available to wealthy 55- to 60-year-olds in Europe is now within reach for people in their mid-30s up to mid-40s in North America. The Cult Wines client base is also shaping up to be more balanced between genders, with more female clients than what’s been expected in traditional markets.

A brief timeline of how Canadian alternative retail story has evolved

Regulators Eased Investment Criteria for Retail Investors

The 2019 amendment to National Instruments (NI) 81-102 has effectively democratized alternatives by bringing accredited and retail investors under one common investment horizon with access to diverse strategies. As per the new rules:

The new category of funds known as “alternative mutual funds“ allows for investments in asset classes and the implementation of strategies that are typically restricted in other types of mutual funds.

Due to lower investment minimums, these indigenous strategies, which were otherwise accessible only to accredited investors (who form a small subset of wealthy Canada) are now open to investment for retail investors.

Liquid alternative funds under this amendment are a significant step towards inclusivity for retail investors, granting them access to sophisticated products and enabling portfolio diversification to navigate market turbulence. These new alternatives have traits of regular mutual funds and privately offered hedge funds, i.e., a combination of lower investment minimums, investment flexibility, along with diverse investment tools and strategies. In this way, the amendment has somewhat democratized alternatives by bringing private and retail investors under one common investment horizon with access to diverse strategies.

Canada’s alternative mutual fund (“liquid alternative”) market has seen rapid growth since the new NI 81-102 rule hit the tape in January 2019. Hedge funds and asset managers are increasingly launching liquid alternatives as they offer asset managers more flexibility in deploying capital than traditional mutual funds. Liquid alternatives also allow for strategies to enhance portfolio diversification and potentially better optimize risk and return for investors.

… But are the Advisors Adopting?

A recent survey by the ISS Market Intelligence in the US has revealed growing interest from financial advisors in alternatives although noted that “it’s not the field of dreams4”. Survey findings show advisors have increased allocations of client dollars across all types of alternative investment solutions, leading with non-traded REITs and followed by private credit and private equity. Amongst advisors currently using alternatives, private credit and private equity are the areas expected to see the highest increase in dollars invested over the next 12 months.

Historically, among reasons for lower allocations to alternatives, advisors cited:

Education of retail investors, as well as their advisors, is thus key to building a presence in the retail market for alternatives specialist managers. Preeminent alternatives firms such as Brookfield, KKR, and Blackstone are launching branded education centers to bridge the knowledge gap and enhance the value proposition of well-formulated alternative investing for retail investors and their advisors.

Besides the players, Canadian Securities Institute also produced a short course on “Know Your product” regulations. From both a regulatory and commercial perspective, firms, individual advisors and portfolio managers must be able to show that they have sufficient knowledge and understanding of a particular product. The more complex the product, the more important it is that advisors can demonstrate their knowledge of it.

The Know Your Product rules impose requirements at both the firm and individual advisor level. The firm is required to establish a product due diligence process to ensure that investments made available to clients are assessed, approved, and monitored on

an ongoing basis for significant changes. Rather than relying on third-party reports of investment products, firms should do their own analysis of the report to determine that it is reliable, fair, and balanced.

Advisors may have to conduct a more detailed review of investment products that are more complex or risky (or both). An understanding of all products that registrants purchase, sell, or recommend to clients is an essential component of the regulatory requirement to determine suitability. Furthermore, advisors must consider a reasonable range of alternative products as part of a suitability determination for each client.

On the alternatives offering, another course which mutual fund representatives must complete to sell alternative investments to their clients is what CSI offers “Hedge Funds and Liquid Alternatives”. This course perhaps can then be a segway into the regulatory requirement for dealers to provide training to their advisors (and other registrants) on Client Focused Reforms of which KYP is one aspect.

Emergence of independent alternative platforms is also making it easier for financial advisers, wealth managers and asset managers to access private market alternatives for their clients. In simple terms, democratizing alternative assets products enables an expanded range of investors to access alternative strategies with potentially lower minimums and simpler tax reporting requirements.

In recent years, Fintech platforms such as Moonfare and Institutional Capital Network Inc. have moved to open up private markets. Like most retail-focused alternative investment products, Moonfare is only available to accredited investors, usually people with enough sophistication and money to stomach big losses or who work in finance. Investment minimums on these platforms are still about US$75,000.