Amid a range of topics at the Morningstar Investor Conference held this week in Chicago, including the future of the business of financial advice, outlooks for equities and bonds, and advisor technology, there was a strong undercurrent of advisors and asset managers grappling with whether and how to deploy private investment strategies in the wealth space.
In a session on the evolution of asset and wealth management over the last 40 years, and predictions on the next 40, Hightower CEO and Chairman Bob Oros pointed to private market investment opportunities as one area in which RIAs can differentiate their businesses, along with increasing client services such as estate planning.
“Many areas of investment management have been commoditized, but private markets is an area you can create some differentiation,” Oros said. “Managers have started to discover the RIA space.”
Oros and others at the conference pointed to the proliferation of limited liquidity '40 Act fund wrappers, including tender offer funds, interval funds and business development companies, as the entry point for asset managers like Blackstone, Apollo and the recently announced partnership between KKR and Capital Group, to access the wealth space. These types of investments typically have lower minimums than traditional drawdown funds (typically in the thousands of dollars, not millions), come with easier tax reporting (generally on 1099s rather than K1s) and do not require capital calls.
“Retail is what they call it, but there’s a ton of interest from managers to reach investors through RIAs,” Oros said. “I don’t think these have ever been more accessible than they are now.”
Hightower tends to serve high-net-worth and ultra-high-net-worth clients who have more capacity to invest in private markets and are more interested in esoteric themes. “They are not looking for the next liquid investment in a '40 Act fund,” Oros said. That demand prompted Hightower to launch a cybersecurity fund with a third-party manager, which Oros said was well-received by clients.
In the same panel, Katie Koch, CEO and president of asset manager TCW Group, said her firm is also looking at how to bring capabilities to the wealth market.
“The hardest thing is figuring out the vehicle that will be acceptable to the whole market and that does not put a lot of restrictions on investors,” Koch said. Some of the newer structures “have not been tested in environments when liquidity has not been available.”
“It’s the asset managers responsibility to figure out what they want to invest in and how to structure it,” Koch added. “If you launch the wrong product at the wrong time [in the wealth market] you will never get back into the market again.”
Drilling Down on Interval Funds
For its part, Morningstar this week published a report focused solely on the interval funds. According to its database, there are now exactly 100 interval funds across various strategies with more than $80 billion in AUM collectively. Interval fund AUM has grown roughly 35% annually for the past decade, and accelerating. At the current pace, total AUM is doubling every two years.
That is driven almost entirely by RIAs. (The main difference between interval funds and tender offer funds is that interval funds are required to provide a fixed amount of liquidity—typically 5% per quarter—while tender offer fund managers have discretion as to when they open up the fund for redemptions.)
Asset managers have experimented with the types of asset they are packaging in the interval fund wrapper, but private credit has emerged as the most popular because they can provide some income and the underlying assets are easier to sell than other private asset classes, making it easier for the manager to maintain the necessary liquidity for redemptions. Overall, about 60% of existing interval funds are in fixed income. One private credit fund—the Cliffwater Corporate Lending Fund with $19.6 billion in AUM—accounts for nearly 25% of the AUM of all interval funds combined.
The performance of traditional fixed-income markets in recent years as interest rates shot upward spurred many RIAs and investors to seek private credit interval funds as an alternative. In comments with reporters, Alec Lucas, director of manager research at Morningstar, pointed out that the Morningstar 10-year+ Treasury Index lost 47.6% from March 9, 2020 to Oct 19, 2023. If not for a rally at the end of 2023, traditional bond markets would have produced losses for an unprecedented three consecutive years.
But for their part, Morningstar analysts said they are not yet convinced interval funds are the solution.
“For end investors and the advisor that they serve, we wanted to ask, ‘What are these things?’ and go into some detail as to whether they are good for investors,” Lucas said. “The answer to that question is that you don’t want to be definitively negative, but are the complexities worth it? Do they add value to a well-diversified portfolio? That’s not clear.”
Brian Moriarty, associate director, fixed income strategies at Morningstar, is the primary author on the study and focused on the interval fund sector.
“What I would like to see happen is the rationalization of the appropriate assets with the right wrappers,” Moriarty said. “There are some interval funs that do private equity, but if they get outflows for a few quarters in row and they can’t sell assets, they end up in liquidation. That’s an obvious mismatch with the interval fund wrapper.”
He pointed to the case of the Wildermuth Fund, a private equity-centric interval fund that has been forced to liquidate, as a cautionary tale.
“Some of these funds may be taking advantage of investor interest. The sweet spot for a portfolio are assets that can generate cash, or assets that can mature, or assets that can be sold in weeks or months,” Moriarity said. “That narrows things down.”
Phil Huber, head of portfolio solutions of Cliffwater, sponsor of the single largest interval fund, also spoke on the growth of the space. Huber himself served as a chief investment officer on the wealth side before moving into asset management and joining Cliffwater.
“There’s been a lot more interest post-2022,” Huber said. “It was easy to say ‘no’ before that. But then people started to say, ‘Maybe I do need a third leg of the stool or new exposures to create a more diversified portfolio.' But, you are introducing more complexity to the equation.”
The goal for Cliffwater (and other asset managers) is to package private strategies so that advisors don’t have to make granular decisions on how to invest in private credit, private equity, real estate, real assets or other strategies.
He said the reason Cliffwater’s core fund has gained so much traction is that its particular lane in the private credit space is conservative lending to established private corporations with strong fundamentals. It’s not a fund that’s built on providing finance to highly-levered companies or about funding growth strategies. (Cliffwater has a second, smaller interval fund with more of a growth tilt.)
“We don’t originate loans,” Huber said. “We work with 20 lenders. We think they are top tier. It’s an asset class you want to be diversified into. It’s not for alpha. There is not as much dispersion in manager returns as venture capital or private equity. The loans use modest leverage and we do not have any one single position that is able to blow us up.”
Other Non-Traditional Options
In recent years Morningstar has forged partnerships with a few different entities as part of a strategy to give advisors more non-traditional investment options. Those partners include iCapital, a marketplace and fintech that provides access to alternative asset managers as well as tools aimed at easing subscription processes and managing investments. In addition, Luma Financial Technologies is a multi-issuer platform for structured products and annuities. And, Sora Finance is a fintech that focuses on liability management—assessing clients’ debts and looking for opportunities for clients to refinance or otherwise optimize whatever loans they may have. Morningstar has integrated all three platforms in varying degrees to its Advisor Workstation product.
“One of the things we’re seeing in the market is the complexity of the products continues to increase,” said Jay Charles, head of retirement solutions for Luma. “Everyone is looking to outdo each other. That makes the job of advisors more difficult. How do you compare products? This where I see technology coming in to assist.”
Charles added there is a lot of talk of education when it comes to alternatives, but getting up to speed requires more than sitting through a few videos or primers. “Advisors need to understand how these can be analyzed, what outcomes are going to be driven and how to compare them against each other. What is going to have an outsized impact on client portfolios? And, you need to understand how to manage and track them over time.”
Mike Doniger, senior vice president of platform partnerships at iCapital, said the use of alts has grown to the point that iCapital alone now has $200 billion in platform assets and an additional $70 billion in transactions annually in structured investment and annuities.
“There are now funds that cater to a broader spectrum of investors,” Doinger said. “UHNW used to be the focus, but now it goes all the way down to mass affluent and accredited investors and registered funds. That, coupled with greater demand for personalization and customization from clients, is driving advisors to look more at the asset class and how they can use it and get clients invested.”
