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Financial Advisors Are Bullish on Alternative Investments: iCapital

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Thirty-four percent of financial advisors in a survey released Thursday by iCapital Network, a financial technology platform, currently have at least 5% of client assets in private equity funds and 27% have at least 5% of client assets in hedge funds.

Over the coming year, the majority of respondents said they planned to maintain or increase exposures to alternatives, motivated mainly by potential investment returns and diversification goals: 87% to private equity funds, 61% to hedge funds and 93% to private direct deals.

“This research shows that advisors recognize the potential benefits of investing in alternative asset classes,” iCapital Network’s CEO, Lawrence Calcano, said in a statement. “However, the ability to access high-quality alternative investments has historically varied widely based on the business model of an advisor, a finding evidenced in this research.”

The research involved some 450 respondents, 55% of which were RIAs, 29% independent broker-dealers and 16% wirehouses. Virtually all advisors had been in business for at least 10 years, and more than 60% for 20 years or longer.

Fifty-five percent had built practices with $500 million to $750 million in assets under management, while 34% were managing upward of $750 million, the latter group concentrated among the wirehouse representatives.

Private Equity

According to the survey, 77% of advisors allocated to private equity funds in client portfolios.

Two-thirds of advisors had less than 5% of client assets in private equity funds, but this was primarily driven by RIAs and IBDs, with more than 70% of each cohort allocating at this relatively low level compared with just 38% of wirehouse advisors.

Forty-eight percent of wirehouse advisors allocated between 5% and 10% to private equity funds, and 11% allocated between 10% and 15%.

Nine out of 10 advisors surveyed cited attractive returns as the most compelling reason to invest in private equity funds.

An outsize number of RIAs, compared with their wirehouse and IBD counterparts, also pointed to diversification and the unique nature of the investment opportunities as reasons to invest. The report said this may be related to the historically limited access to private equity funds within the independent channel.

As for obstacles to greater investment in private equity funds, 86% of advisors cited finding more appropriate clients, 61% high minimums and 53% illiquidity. Fifty-four percent of IBD firms and 49% of RIAs also cited ease of access.

Over the coming 12 months, 54% of advisors planned to invest the same in private equity, 32% more and 13% less.

“The majority of advisors we surveyed have incorporated private equity into client portfolios due to its performance in relation to public markets over longer-term periods,” Nick Veronis, co-founder and managing partner at iCapital, said in a statement.

“The characteristics of the asset class increasingly appeal to advisors who recognize the potential to promote a buy-and-hold discipline and to seek enhanced client returns amidst challenging market dynamics.”

Hedge Funds

Average allocations to hedge funds were lower than to private equity funds among surveyed advisors, according to survey data.

This echoed the latest report from the Tiger 21 peer-to-peer learning network, which showed that its wealthy members allocated 21% of their portfolios to private equity in the first quarter and just 5% to hedge funds.

Seventy-three percent of advisors in iCapital Network’s study allocated less than 5% of their assets to hedge funds, and 22% allocated between 5% and 10%. Wirehouses were more bullish on hedge funds than their independent peers, with 67% planning to maintain or increase investments; 54% of advisors planned to at least maintain their hedge fund exposure.

As with private equity, investment returns were the main reason for advisors seeking out hedge fund investments, followed by diversification.

Wirehouse advisors were less likely than their counterparts to cite ease of access and illiquidity as issues affecting their ability to invest in hedge funds, which pointed to differences in business model characteristics such as net worth and infrastructure among advisor models, according to the report.

Eighty-three percent of RIA respondents said they gained access to hedge funds directly from general partners, with 14% also using feeder funds. RIAs steered clear of hedge funds of funds — consistent with an overall industry trend in recent few years, the report said.

In contrast, advisors at wirehouses and IBDs continued to use both feeders and funds of funds, perhaps because of legacy programs in place at their home offices, iCapital suggested.

“Hedge funds can employ a wide array of trades and strategies to take advantage of changes in the economic and geopolitical landscapes,” Eileen Duff, managing partner and head of independent wealth solutions at iCapital, said in the statement.

“It’s critical that advisors have access to comprehensive education and due diligence when determining how hedge funds may fit into client portfolios.”

Direct Investments

Eighty-eight percent of advisors said they were interested in private direct investments for the returns they offered, and 57% said these were “unique opportunities.” Only 33% cited their diversification benefits, wirehouses being likeliest to do so.

For purposes of the study, iCapital used the term “direct deals” to cover investments in small and midsize privately held companies, startups and other private assets such as intellectual property rights and royalties; it excluded private real estate investments.

The survey found that the average check size into private direct investments ranged from less than $1 million at RIAs to between $1 million and $5 million at wirehouse and IBD advisors.

Across all advisors, 45% said they allocated less than $1 million per deal, 42% between $1 million and $5 million, and 4% more than $10 million. However, 18% of wirehouse advisors said they typically invested upward of $10 million per deal.

To source deal flow, 58% of advisors said they relied primarily on their networks, 42% on family and friends and 21% on angel groups. Respondents reported that finding more appropriate clients and limited deal flow were the major issues affecting their ability to invest in direct deals.

Forty-eight percent of advisors said they planned to increase their allocations to direct investments over the next 12 months, and 45% said they would invest the same amount.

RIAs evidenced the strongest interest in increasing exposure, which could present an opportunity for aggregation platforms offering high-quality deals and due diligence to these advisors, iCapital said.

“Despite the shortage of high-quality deals that are available to them, advisors have expressed more enthusiasm about private direct deals than other alternative asset types,” Hannah Shaw Grove, managing director and chief marketing officer at iCapital, said in the statement.

“Advisors and their clients will continue to look to their personal and professional networks to source unique investment opportunities.”

Several obstacles continue to impede advisors seeking to invest in alternatives: finding more appropriate clients, illiquidity and high minimums. The report said this suggests that advisors need wealthier clients with the risk tolerance and diversification goals appropriate for these investments.

“Technology, new product structures and education are removing many of the barriers associated with investing in alternatives, but certain characteristics inherent to alternative investments that drive performance, like longer investing timeframes, will remain,” Tom Fortin, managing partner and chief operating officer at iCapital, said in the statement.

“This places a greater emphasis on portfolio construction expertise for advisors seeking to reap the return and diversification benefits of alternatives.”

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