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Also available as podcast (Episode #129)
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Can I Use Alternative Investments As An RIA?
TL;DR – It has long been preached that access to alternative investments (“alts”) in the RIA model is inferior to what is available via the large broker/dealer model (ex: wirehouse.) While that might have been true at one point, it is categorically false today. In fact, the scope of alternative investments available to use is now generally much more expansive in the RIA model vs traditional broker/dealer model. It is important though to consider variables such as expense, how to logistically access the investments, etc.
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Full Transcript:
Can I use alternative investments as an RIA? That is today’s question on the Transition To RIA question and answer series. It is episode #129.
Hi, I’m Brad Wales with Transition To RIA where I help you understand everything there is to know about why and how to transition your practice to the RIA model.
If you’re not already there, hear to TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers. All kinds of things to help you better understand the RIA model.
Again, TransitionToRIA.com.
On today’s episode we’re talking about if you were to transition into the RIA model, perhaps by starting your own RIA or joining an RIA, could you use alternative investments in that model with your clients?
Alternative investments, other people call them “alts”, particularly the last couple years there’s been increasing popularity of using alts in investment portfolios.
So the question is, if you’re using alts now, will you be able to continue to do that? Or if you’re not currently using them, and you aspire to, what would that look like? Is that going to be available to you?
Part of the reason I want to make this episode is because there is at times a misconception out there by some advisors that the RIA space is lacking in access to alternative investment products.
That was fair to say 10 years ago or farther back, but as with a lot of things in the RIA model, the ecosystem supporting the RIA model has grown to the point that is no longer accurate to make that statement that… “if you were to leave our big broker-dealer firm, our big wirehouse, you are going to lose access to using alternative investments with your clients, or at least the depth and scope of alternative investments that we make available to you here at our wirehouse.”
Nowadays, if you hear someone trying to say that to you or message it to you, it’s more than likely either one, they simply don’t know what the RIA model has evolved to and the ecosystem to support it nowadays. And/or two, they are trying to convince you not to go in a different direction because that would involve leaving their firm.
They are trying to either scare you or give you wrong information to get you to stop considering what a different path for your practice might look like. And again, as we’ll be talking about on today’s episode, that’s entirely incorrect.
If anything, it is arguably now better in the RIA model.
For example, and we won’t name any particular firms, but if you’re at a large broker-dealer firm and they make alternative investments available for you to use with your clients – and there are some nuances with that which I’ll get into – but they have procured a list of alternative investments that you have to choose from.
That is not the entire universe of alternative investments in the marketplace. Whatever their motivations are, whether it’s economics, suitability concerns, maybe just to have a variety, whatever the case is, they have narrowed that field to a subset of solutions for you to choose from.
And of course, they would position this as… “We’ve done the due diligence for you, we went out to the universe of choices, and we found the 60 best options, and that’s what we make available to you.”
There’s some degree of truth to that as they certainly have done due diligence, because they want to reduce their liability with potential concerns with clients. Understandably, they maybe don’t want some crazy super exotic alts fund in that option set. But make no mistake, there’s also some other reasons they might have narrowed it down to that amount.
But regardless, for you as the advisor, that’s the playground you must play in. That’s what you must choose from. And out of fairness, they probably have chosen good investment options to be part of what you must choose from. But that’s not to say there are not additional options out there.
When you are in the RIA space – and we’re going to get into how you access them – you likely have access to significantly more alternative investment options than you do if you’re at that sort of large captive firm now.
Now, that doesn’t necessarily mean you’re going to want to use all those other options. That’s for your due diligence to figure that out. But rest assured, the number and type of investment solutions is likely much larger for you in the RIA space than if you’re at a captive large firm now.
I am going to go through a couple things about how this all works. And there are several similarities between this and a recent episode I made about if you are currently using SMA managers now, or investment models that are procured or made by a third party, can you continue to use them in the RIA space? It’s pretty similar here with respect to alternative investments.
One of the main keys to answer is, what alts are you using now and what do you aspire to use going forward?
The name of the game is how are you going to access those investment solutions? Again, either ones you’re currently already using and you want to keep everything as-is, or you maybe want to expand your universe and take advantage of the bigger selection of choices.
There are a couple ways to potentially access alternative investment solutions in the RIA space.
First, some custodians, not necessarily all, have procured, similar to your large firm, a platform of options of alts. They’ve gone out to the marketplace and procured them
However, unlike if you’re a large broker-dealer firm who has potential liability and needs to “supervise” your activities, when a custodian procures this type of platform, they do not have a responsibility to oversee or supervise your RIA activities when they procure a platform.
It’s more to provide a value add to the RIAs that use them as a custodian. They say… “If you want to use alternatives in your investment portfolios, we’ve helped you out and we’ve provided a logistical way to access this subset of them. It’s all piped together.”
Again, they can’t necessarily have every option out there, but they have tried to make an attractive offering and a way for you to access alts through their platform.
So number one would be looking at what your custodian – and I’ve talked about in other episodes how one day you might be multi-custodial; but as a starting point when you transition to the RIA model it’s almost inevitable you have a sole custodian – is to look at what sort of alts platform that custodian might make available.
The next option, this is similar to that SMA episode I did, is regardless of whether your chosen custodian has a platform available to you, you can instead utilize 3rd party platforms.
These platforms didn’t exist really 10, 15, 20 years ago. But they have gone out to the universe of options, as they’re not trying to narrow the field down to 60 options.
They do some degree of due diligence to make sure these are not completely fraudulent providers. Afterall, they have a reputation to maintain. But at the end of the day it is the RIA that decides which products to use. You can’t put that onus on the platform. They are just giving you access to them.
But they are saying… “As opposed to you, the RIA, having to go out to individual product manufacturers, whether it’s a PE firm with a hedge fund or whatever the case is, we’ve gone out to all of those, and we continue to go out to all those, and think of what we’ve built as a supermarket. You, the RIA, only must show up to the supermarket and you can see all these in one place on the shelf. And then to the degree you want to utilize one, we’ve put all the logistics together and all the technology to make that happen.”
So using a third party platform is another way to access alts. Those platforms are generally always going to have more availability for you to choose from than if you’re at a large firm that has narrowed the options for you.
The third potential access point relates to how there are multiple pathways into the RIA model.
As I speak of frequently, some of you might end up starting an RIA. Others might join an RIA. This is a flavor in the middle. I help advisors figure all that out. Pros/cons, which would be the better path for your practice, etc.
If you end up joining an RIA, there are several different flavors of RIAs you can choose from. So don’t come into it with preconceptions of what that means. You need to understand them to understand the options.
But part of their value add is to say… “Advisor, as opposed to you having to start your own RIA, we’ve built out all this infrastructure for you. It’s easier for you to use our platform than building the individual pieces yourself. We’d love to talk to you about it.”
With the ongoing popularity of using alts, these firms have generally procured some sort of access point to alts for you to use. They have either made their own platform, or more likely nowadays, they are relying on one of these big third party alts platforms.
They might say… “We’ve partnered with this third party provider. If you join our firm, look at all the options you have available to choose from.”
If you are considering joining an RIA, and plan to use alts, you will want to understand how they make that available to you.
From there I want to discuss a few more variables to keep in mind.
First, keep in mind there are three main levels to considering the RIA model. I help you with all three.
The first level is how does the RIA model work? Is it even a fit for your practice? Will it accomplish whatever your vision and goals are for your practice going forward? Does it make sense to be continuing exploring the path?
If it does, the next level is, there are multiple ways into the path. Start an RIA, join an RIA, the flavor in the middle.
And then the final step is, depending on what path you chose, how do I put all these pieces together?
One of those pieces is, if applicable to your practice, how do I access alternative investment solutions with my clients?
Do not be overwhelmed by this. This is what I help advisors with. Understanding what the steps are, the order to work through them, and how to get through the process. So don’t be intimidated by it.
But part of your due diligence is to figure out how to continue, or if desired, start, using alts with your clients after transitioning to the RIA model.
Part of that process is often referred to as an asset mapping exercise.
Custodians will help you with that process, or if you’re using a third party platform, they will. You’ll take a snapshot of your current alts you use with clients, and determine if you can carry those over as is? Can you replicate them? How can you access them? Part of your due diligence is to do that exercise.
And if you’re not currently using alts, but want to start, you want to understand what options you’ll have available to you on your new path.
I’ve talked to plenty of RIAs where it was only after they transitioned to the RIA model, they came to realize how much more was available for them to use with their clients. They maybe only ever knew the large captive broker-dealer world that they were in prior. They transition and then have hundreds if not thousands of options to choose from.
Next, if you’re currently using alts, you want to be careful about using proprietary products.
Thankfully, over the years there’s less use of proprietary products where a firm has advisors but also has proprietary products. That could be mutual funds, investment models, an SMA manager that’s in-house, or alts.
Most of the time, such products are not easily portable, if at all. That’s because they are proprietary to that firm. You might not be able to access them elsewhere.
My suggestion typically is if you’re not already using proprietary investment products to your firm, I suggest not doing so. It will limit your options. You often must sell out (if you can) as they are not portable.
Or if you are already using such products, and albeit it needs to be in the best interest of the client, but consider trying to transition out of those investments before making a transition.
This is part of the asset mapping exercise, to see what will or will not be able to transfer.
Next, you also want to factor in costs.
I mentioned this with the SMA episode here recently as well, if you’re using alts currently you’ll want to understand what those costs are now, and what they would be in the RIA model.
Now you might think… “But it’s the same investment product.”
But these things get very blurred because your current firm might either have negotiated some sort of different price than is available over on this option over here, or your current firm might have added bps.
Usually the cost of these products are expressed in basis points. There is the cost of the product, but also potentially your firm might have added some bps, either transparently or not transparently as essentially a profit center for the firm.
Those costs might not be applicable on your new path. It depends on how you access such products. There could be a separate cost (for the platform), but it’s generally much more transparent than a lot of captive environments have.
So not only do you want to confirm product availability on your new path, you also want to understand how the costs differ.
And be careful, don’t just assume that because an alt product costs one thing on your current platform, that it will be the same on your new path.
Because your existing firm takes the lion share of your payout, they may in turn be subsidizing some of the cost of the alts product, or platform.
You must look at the full economics involved to really understand how it all compares.
Also keep in mind how this expanded set of investment options will be part of your value proposition going forward.
You’ll be able to say to your clients… “One of the benefits of why I’ve made this change is because I didn’t want to be limited by just a subset of the investment solutions in the marketplace. Even if those were good solutions to choose from, I want to be able to access the entire universe of options. As the industry continues to evolve, those options continue to expand, and so I need to evolve my practice to make sure I have them available to you.”
I did an episode on some of these talking points of how to explain a transition to clients if you want to look at that episode as well.
But part of your value proposition will become that you are not captive to a narrowed set of alts solutions.
For example, if you’re an RIA and you look at what your custodian has for an alts platform, and if you like what they’ve built out, have at it, use that. But you are not required to use that. You can look at third party options.
That’s part of your value add to say to your clients… “I do this work on your behalf. I find the best investment solutions that we can use. And I need and want the most options to be able to potentially present to you.”
Now there’s additional work with that. For better or worse, if your current captive firm has narrowed it down to 60 product options, and they’ve given you a one page data sheet on each, and maybe came up with their top five, they’ve done some of that work for you.
In the RIA space, it’s not the wild west, these platforms help you figure out how to do due diligence yourself, but with more choice comes more work on your part. But that is again, part of your value added.
With that, like I said at top, my name is Brad Wales with Transition To RIA. This is the type of conversation I have with advisors all the time of what does your practice look like now? Per today’s topic, are you using alternative investments?
And then helping you understand how does that work in the RIA model. What are the options available to you. Is it going to be to your advantage to make that change and how would that impact you both from a flexibility standpoint, from an economic standpoint?
That’s the type of thing I help advisors think through all the time. I’m happy to have that conversation with you as well.
First things first though, head to TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers.
And at the top of every page is a Contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me, whether you want to talk about today’s topic or anything else RIA related. I’m happy to have that conversation with you.
Again, TransitionToRIA.com.
With that, I hope you found value on today’s episode and I’ll see you on the next one.
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