Insights on capturing the retail alternatives market: PwC

The democratization of the private markets is emerging as a game changer for both retail investors and asset managers. For years, private market products were largely available only to large institutions and ultra-high-net-worth (HNW) individuals. However, in recent years the alternative investor landscape has been undergoing an evolution.

Demographic shifts and changing investor preferences have been driving the demand for alternatives by retail investors, while regulatory changes, new product types with greater liquidity and technological advancements have made them more accessible. As the door into alternative investing cracks wider and more assets flood in, this shift will not only transform the investor landscape but also redefine the rules of the game for all asset and wealth managers.

Success in retail alternatives market requires commitment, preparation and adjustments

Despite the rising demand, overcoming the complexities of offering alternative investments to retail investors — including the resulting regulatory requirements — will require asset managers to reinvent their business models through continued innovation, commitment, preparation and adjustment. We are already seeing this reinvention occur through shifts in the value chain. On one hand, traditional asset managers are expanding into private markets to meet shifting investor trends, while on the other hand, alternative managers are chasing private wealth through dedicated investment vehicles and distribution teams catered to financial advisors. In some cases, asset managers from both sides are partnering and bringing their complementary capabilities — private market products, wealth-oriented distribution and brand — to tackle this opportunity. As these shifts occur, disintermediation of distribution is happening throughout the ecosystem as tech platforms find white space in the distribution chain, enabling connectivity between alternative asset managers and distributors.

Managers will therefore have to overcome a number of hurdles to enter or scale into the retail alternatives market, and success is not guaranteed. They’ll need to acquire new capabilities, adjust their ways of operating, enhance their technology and, considering the dearth of specialized talent in the area, leverage third parties.

In this vein we recommend three key actions to help alternative and traditional managers identify and steer clear of several of the hurdles for success that will be in their path as they look to onboard the mass affluent:

Develop a disciplined retail-focused product strategy
Enhance distribution capabilities
Develop an operating model that is fit for purpose

Develop a disciplined retail-focused product strategy ensuring a fit-for-purpose value proposition

The following steps can help you develop a disciplined retail-focused product strategy that positions your firm for success in the alternative investments market while meeting the needs of retail clients. To create an effective retail-focused product strategy that aligns with the managers’ business goals and caters to the needs of retail clients, managers should:

Identify suitably scalable alternative investment products

Focus on a sequenced product development approach, starting with larger scale, core strategies that have the potential to become successful after multiple rounds of fundraising. With scale come competitive advantages such as the ability to build a dedicated supporting platform with the right talent and technology. In the last few years, we have seen the rise of mega private credit and private equity vehicles. These types of vehicles can enable managers to acquire talent, innovate and compete aggressively by creating joint ventures with banks and other financial institutions to increase deal flow. Alternatively, poorly designed or limited product suites may not meet client needs but, more importantly, may result in fee leakage. Some of the more liquid open-ended publicly traded funds, for example, come with lower fee structures than traditional closed-end alternative funds. Without the scale or operating model to support these products they may not prove to be a profitable option for some managers.

Determine appropriate product structures

Develop a product suite that addresses a wide range of needs across different client segments, considering variations in return, risk, liquidity requirements and alternative exposure interests. For example, clients will have varying needs for liquidity and those with higher liquidity constraints will gravitate toward more liquid structures, such as the non-traded BDC which is offered through a broker-dealer network. But before a manager who has never managed a regulated product can begin, they should consider the following example for launching a BDC focused on middle market loans:

In this example, the manager launching their first alternative, regulated product will be contending with a host of new and unfamiliar issues such as compliance and reporting requirements with the Securities and Exchange Commission (SEC). They will also be dealing with unfamiliar tax issues, such as regulated investment company (RIC) qualification and reporting. And these issues will not simply rest with the finance function.

Investor relations will have to develop a strategy to communicate with shareholders on issues outside their normal purview or understanding.

Legal and compliance will have to ensure that there is a robust internal compliance and risk management program that will not only satisfy the board of directors and audit committee overseeing the operations of the BDC but also the regulators.

To ensure that they fully understand all the relevant implications of regulated products, managers focusing on retail clients will need to work with knowledgeable professional advisors to understand each type of product and its implications – whether they are considering US products like BDCs, real estate investment trusts (REITs), operating companies, interval funds, or European products like long-term asset funds (LTAFs) and European long-term investment funds (ELTIFs), if they are operating globally.

Launch of BDCs, REITs and interval funds grows exponentially in recent years

As interest in private markets products grows among high-net-worth, sovereign wealth and mass affluent clients, so too do the product offerings in the space. That’s because asset managers have innovated to bring new products to these clients, including private, non-traded REITs and BDCs, as well as other private markets ‘40 Act vehicles, including interval funds and tender offer funds. Some of these funds will also provide diversified exposure across alternatives — more appealing to a client just getting started in retail alternatives.

Find the right talent and compensation strategy

Recognize that talent is crucial in the alternative investments business, extending beyond investment professionals to roles like investor relations, legal and finance. To attract the right talent, managers will need to develop a competitive compensation strategy that includes salary, discretionary bonuses and profit-sharing (carry or incentive fees) to attract and retain top talent. Operationally, managers will need to be able to leverage knowledgeable product specialists to allow investment teams to focus on their core expertise.

Create a governance framework to manage the process

To ensure that there is a disciplined approach to product development, managers should establish an effective governance framework. This may involve establishing a product strategy team and a project management function to coordinate the end-to-end process of launching new products.

This governance process should ensure that:

The organization remains focused on product innovation and addresses the risk of product proliferation.
All the right stakeholders across the organization, including legal, finance, tax, compliance and investor relations are properly consulted and brought into the development process.
There is strong adherence to the framework and decisions and an extremely limited set of exceptions. Senior leadership modeling the right behavior is crucial for success.

Product innovation (i.e developing new products or modifying existing ones) may result in managers creating regulated products, leveraging digital distribution platform providers or developing tokenized feeders. Special attention needs to be paid to the risk of product proliferation because it will inevitably lead to higher organization costs, increased marketing expenses and potential client confusion on which product to choose. A robust governance process is crucial to ensure new products and vehicle opportunities are thoroughly vetted and the outcomes validated.

Enhance distribution capabilities

To successfully launch retail alternative strategies, asset managers must focus on enhancing their distribution capabilities. This involves several key distribution imperatives.

Fostering investor education and trust to attract new clients

To successfully distribute alternative products, educating retail clients is a critical component of engaging with the retail channel. Many retail clients and their intermediaries, such as the registered investment advisors (RIAs) and wealth managers, are not as familiar with the benefits and the risks of alternative products. In addition, not all RIAs require the same level of education, with smaller independent advisors needing more support than larger ones. As a result, asset managers should plan to publish and provide more tailored educational resources and tools for retail clients and their advisors.

For example, if the manager has historically published only private equity or credit content for closed-end funds, launching regulated funds will mean creating new types of content for a new retail client base that may not have an intimate understanding of the risks and opportunities associated with private equity or credit. It will be crucial to provide clear, easily accessible information about the investment, focusing on details like liquidity, risk, tax reporting, redemption limitations and cash flows. This will help build initial trust while ongoing investor support and transparent performance reporting will help maintain that trust.

Reorganizing the distribution function to improve effectiveness

Targeting retail clients requires a fundamentally different distribution function and strategy than targeting institutional clients, so managers will need to assess the alignment and gaps in their existing capabilities. When it comes to organizing the distribution function, asset managers should consider factors such as channels, regions and products to determine the best approach. This diversity in practice reflects the fact that no one model will suit all. Rather, the function should be aligned based on your investor profile and ultimate strategy. In new global markets, for example, this may include establishing a physical presence (i.e a “voice of the region”), and with intermediaries it will mean a team that maintains ongoing engagement with a focus on building relationships, which can include intermediaries of RIAs, rather than relying solely on fundraising cycles.

Additionally, it is important to ensure seamless information sharing between product specialists and investment teams, regardless of where they are positioned within the distribution function. This promotes effective collaboration and enhances the overall distribution process. Finally, as managers think about the organization of the distribution function they should also consider how technology (e.g., customer relationship management [CRM] platforms) can be leveraged for efficient distribution and investor engagement and how functional teams can support increased work volumes during capital fundraising.

Enhancing the investor experience to retain clients

Building a systematic approach to enhancing the investor experience will become increasingly important as firms move into retail. Workload volumes will inevitably increase with the rise in the number of clients. This increasing complexity will require commonality and consistency. Managers seeking to enhance the investor experience will need to address the unique needs and increasing demands of individuals, such as life events, liquidity and personalization. Establishing dedicated private wealth fundraising and operational teams, launching multichannel educational programs, developing retail CRM systems, and developing investor onboarding and servicing capabilities integrated with key intermediaries will be key focus areas.

Technology alone will not be enough, however, as managers will have to consider how they can provide a “white glove” experience for clients. One option is to build a sizable internal team to support this experience. Alternatively, managers can opt for a lower-touch investor experience model and rely on third-party service providers to provide that experience. In recent years, there has been significant progress as fintechs have sought to improve operational processing efficiency in the alternatives space by acting as intermediaries to clients.

While these third-party solutions do not address all pain points and do not achieve the ultimate goal of straight-through processing that we are used to in more traditional asset classes, they do provide significant improvements that can improve the experience for asset and wealth managers, their employees and clients, and, as a result, enable alternative platforms to be more scalable.

“Effectively overcoming the complexities of offering alternative investments to retail investors — including the resulting regulatory requirements — will require asset managers to rethink their models from product and wrapper design through fundraising, investor relations, operations and reporting.”

Roland Kastoun,Asset and Wealth Management Consulting Solutions Leader, PwC US

Develop an operating model that is fit for purpose

Evaluate whether you build, buy or borrow the new capabilities you need

Addressing the unique needs and increasing demands of individual retail clients will require managers to enhance their operating model. These enhancements will go beyond simply improving the investor experience as mentioned previously. Retail clients will create additional demands for liquidity, transparency and reporting. Managers will have a choice to make. Do they attempt to hire and build out their internal operating model or do they rely on various managed services platforms that can support every aspect of the fund life cycle from launch through to liquidation? For example, vehicles like BDCs, interval funds and REITs create additional demands for many alternative managers, such as more frequent net asset value (NAVs), accelerated or new valuation protocols, additional regulatory reporting such as 1099-Qs and 1099-Ks and accelerated tax reporting.

Alternative managers launching these products will likely find that a transfer agent function and a third-party administrator can be a viable alternative to building these functions internally. Even with a third-party service provider in place not all responsibilities may be pushed outside the organization. For example, in addition to hiring a third-party transfer agent function, some alternative managers have also created dedicated teams and processes just to address tax inquiries related to 1099s or simplified K-1s. The key is finding the appropriate balance while keeping the process efficient and cost-effective.

On the other end of the spectrum, traditional managers launching alternative investment products who are familiar with many of the requirements for running regulated funds will find they will now have to value assets they may lack experience or expertise to value. They in turn will need to establish robust valuation policies, procedures and controls to ensure accurate and fair valuation of the investments while adhering to SEC guidelines. As a result, they will have to determine whether supporting these valuation requirements is best done by hiring externally or utilizing third-party managed services.

	Investor base: Institutional	Investor base: Private Wealth
Investor experience	White glove	Optionality (i.e., white glove, outsourced, etc.)
Annual onboarding volumes	Low (e.g., hundreds)	High (e.g., tens of thousands)*
Valuation frequency	Quarterly	Daily / Monthly
Liquidity management	Simple, single asset type	Complex, multi-asset type
Financial reporting requirements	Annual financial statements	10-Qs, 10-Ks, prospectus, shareholder reports, etc.
Regulatory requirements	N/A	8-Ks, change in beneficial ownership, leverage restrictions, diversified portfolios, distribution requirements, PTP restrictions, etc.

^{*Largest democratized funds can have up to hundreds or thousands of investors}

"To attract the mass affluent, managers have stepped up their product development, with some choosing to launch traditional BDCs and interval funds, and others opting for more cutting-edge products such as tokenized funds. Fintechs are also stepping in and disintermediating the market by creating new distribution channels, which will be important to helping retail investors access alternatives.”

Andrew Thorne,Partner, US Asset Management, PwC US

Evaluate your data and technology requirements

Managers will also have to make critical decisions in regards to technology and data management. For example, they must decide to what extent they will invest in data and analytics to create a competitive edge. For some, this may include building out a data hub as the central repository for all major data domains and using that data to automate reporting and perform analytics. Leaders may have to decide what functions can be done in-house, what can be outsourced or even what can be offshored. Part of that decision will be the evaluation of the trade-offs between investor experience/service-level cost and operational effort. Managers will have to decide whether they want to provide a “white glove” experience for clients, which requires a sizable internal team to support, or a lower-touch investor experience model, which relies significantly on service providers.

From a technology perspective, specialized software tools, built for the asset category, can be a facilitator of investment performance and fundraising. Technology should spur more automated portfolio outputs and reporting, facilitate what-if projections and cost and performance analysis of Illiquid assets, and enhance risk management to create a better user experience for clients and streamline/de-risk operations. Such tools can make an alternative program more efficient and effective.

Conclusion

The democratization of private markets is clearly a growing trend in the asset wealth management industry. More and more, private markets are becoming accessible to retail clients through regulated and tokenized funds. Some industry experts believe that we may even see indexes and ETFs for private markets in the future. However, these changes present challenges, especially for smaller players.

Overcoming the complexities of offering alternative investments to retail investors and the resulting regulatory requirements will require continued innovation and likely result in further consolidation, with larger players having the advantage. We should also expect to see more strategic partnerships where traditional mutual fund managers partner with private market managers to leverage each other's distribution capabilities and infrastructure.

Fintech will also play a role in the democratization of alternatives — whether through technological advancements, education or the creation of distribution marketplaces. Many fintech companies are already stepping in to bridge the operational gap between managers and advisors by acting as intermediaries, allowing fund managers to scale their business, create their own branded marketplace and reach a broader retail client base.

We may someday see alternative investments included in defined contribution plans. While this may still be years away, the doors are being opened for private market investments to reach not only the mass affluent but also, eventually, everyday investors.