Finding the Right Fit: How to Leverage Alternative Portfolio Structures

Author: NICSA

Over the last few years, market trends have shown investors increasing their allocations to non-correlated asset classes, Chris Shaw, Head of Alternatives, DST Systems, Inc., explained to NICSA members on the October 25 #WebinarWednesday.

Citing DST research, Shaw said that allocations to alternatives could rise from 10% to 14% of client portfolios over the next three years, largely in an attempt to protect against downside risks or yield incomes above current rates.

“That shift would obviously result in a significant amount of money moving into [alternatives],” Shaw said. “You see various dollar figures thrown out, but all of them indicate a significant amount of growth over the next few years into these products.”

Shaw moderated the discussion, in which experts from SEI Investment Manager Services and FS Investments shared their recent experiences implementing and servicing new alternative investment products. (NICSA members can replay an archived version of the webinar here.)

Zach Klehr, Executive Vice President of Fund Management, FS Investments, said there are two main reasons why investors and financial advisors look at alternatives: The first is performance, and the second is diversification (to mitigate risk).

“If you look at where we are in the market cycle and expectations going forward, what has worked in the past is not going to work in the future,” Klehr said. “There needs to be an alternative approach to generating return, and that’s the key reason why advisors and investors are incorporating alternatives into their portfolios and why more and more will continue to do so in years ahead.”

Klehr stressed the importance of marrying the right structure to the right asset class. For example, he said, “Highly liquid asset classes like equities make a ton of sense for a mutual fund structure. The mutual fund allows daily liquidity—you can sell those assets—that works out quite well.”

When bringing alternatives to mainstream or retail investors, Klehr said challenges can arise around scale. “While the processes between the qualified purchaser (QP), accredited and retail markets are similar, volumes are dramatically different,” he said. “A lot of the challenges traditional alternative managers have when they come to the retail marketplace revolve around a lack of understanding on how to reach, educate and service retail investors.”

Klehr also noted that challenges occur with regulation, which is at the core of financial services and is increasingly important for asset managers. For illiquid alternatives, regulations vary by state and product and require manual controls, he said.

John Alshefski, Senior Vice President and Managing Director, Head of Traditional Business, SEI, compared the standard limited partnership hedge fund (LP) with the 40 Act Interval Fund and 40 Act Alternative Mutual Fund, starting with fees.

“Performance fees can occur in any of the vehicles,” Alshefski said. However, “for the most part they really are only common in the Hedge Fund (LP) vehicles. Most of the 40 Act liquid alternative vehicles we’ve seen do not have performance fees.”

When it comes to multiple classes of shares, Alshefski said, “in the 40 Act space you cannot have different advisory fees—the advisory fees must remain consistent by class; you have a little bit more in flexibility in the true alternative LPs.”

Alshefski said that alternatives managers can also struggle with a few of the regulatory and diversification requirements as they enter the 40 Act space.

“A lot of the flexibility that the alternatives managers have enjoyed in the private placement environment, particularly around the flexibility they have with the end investors and investments, are off the table,” he said. “In the 40 Act space, all investors are treated equally, and that’s the beauty of the product.”

In addition, before entering the 40 Act space, investment managers need to have a distribution plan. “Distribution needs to be considered and well thought-out,” Alshefski said. Experience also is a factor. “If you are looking to launch liquid alt vehicles and you’re coming from alternative-class-only organization, you want to make sure you have that expertise on-hand to handle the uniqueness of running this portfolio day-to-day,” he said.

NICSA thanks DST for sponsoring this webinar. To view the archived webinar for additional insight, visit, and be sure to share your thoughts with us.

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