Alternative Investments: Trends, Challenges, and Opportunities with Neil Bathon

Jack Sharry: Hello everyone and welcome. Thanks for joining us for this week’s edition of WealthTech on Deck. We’ve been having a series of conversations on our podcast around alternative investments. Clearly, alts are gaining in popularity and sales momentum. For me, that is a good sign, but also a sign of caution. Way back when, when we referred to these kinds of products that are enjoying such great popularity, they were often called hot dots. Experience has taught me that products considered hot dots should also have a reminder with them of buyer beware, not that they’re bad, just to be aware of what you’re getting into. So I thought it would be good to have someone who’s been around for a while and knows a thing or two about all this kind of stuff and weigh in on this latest, greatest phenomenon. Neil Bathon has been a friend in the business for decades. We both have lived through the ups and downs of the latest and greatest trends. Neil is the managing partner of Fuse Research Network. Fuse provides ongoing decision support to an exclusive group of asset managers to enhance the investment manager decision-making process around improving their competitive intelligence, product and sales trend analysis, and overall marketplace awareness. Today we will discuss the recently conducted research by Fuse on alts distribution. I also look forward to Neil’s unvarnished view as you will soon hear on many other topics. Neil and his team do a lot of research and have well-formed opinions, so I want to hear about those as well. So, Neil, welcome to WealthTech on Deck.

Neil Bathon: Thank you, Jack. It’s good to be here.

Jack Sharry: Yeah, good to have you. So, Neil, let’s start with you describing your background and what you’ve built with Fuse over the decades. I think, you and I were just chatting a moment ago, I think we’ve known each other 35 plus years. So fill our audience in on what you do and who you do it for.

Neil Bathon: Great. Thanks, Jack. In a nutshell, it’s a business intelligence service that helps asset managers, particularly those serving the retail markets, make better decisions about which products to bring to market and how to position them from a sales and marketing perspective. So it’s a tight group of predominantly mutual fund firms at our core, but all of them have grown into different facets of other products. And a lot of that of late has been in the alternative side.

Jack Sharry: Sure, sure. So the whole advisory world is run by asset managers, investment managers is what you all do. And I know also you kind of go deep with each of the firms. You have a smaller group of firms on purpose to go really deep with not only the research, but how they can apply that. Do I have that right?

Neil Bathon: Yeah, it’s much more tactical. It’s not about handing over research reports. It’s much more intertwined in helping to refine those tactics and improve productivity.

Jack Sharry: So let’s talk about the Fuse study you just did on alternatives. You do them from time to time. You may just describe that process because you’re not so much in the research publishing white paper business and you do that from time to time. But talk a little bit about that process at large and then also what you did with the alternatives distribution piece you just did.

Neil Bathon: So basically, we do a lot of benchmarking work. And when we applied it to the alternative side of the business, we looked into basically what sort of teams grow, different firms have built out, and how successful they are being at getting their products placed. So it’s a lot of feedback from advisors about who they think well of. So we survey individual advisors directly. We get a lot of feedback from the distribution platforms and both the general gatekeepers but also the due diligence groups. And then we get to see into the asset management firms directly in terms of how they’re deploying resources against the alternative side of their business.

Jack Sharry: Yeah, I should probably underscore… you said it, but I just want to underscore you’re looking not only just at the product side of things and all the trends that are happening around products, whether it’s called direct indexing or it’s called alts, or it’s called… all the different stuff you guys look at, but also how it’s distributed, marketed, packaged, positioned. You also I think do a fair amount around compliance, so why don’t you fill our audience in around all that.

Neil Bathon: Yeah, it’s basically we work with just about 50 firms and we get to see into how they all have the same core set of challenges, but each of them approaches it slightly differently. And we get to see into what makes for success and what doesn’t. And it’s a pretty fascinating position to be in because two firms can be approaching something in a very similar fashion, but they have different results because of the strength of their sales team or the marketing capabilities or just maybe some basic product features that they did or did not include. So it’s pretty interesting vantage point to evaluate what’s working and not and why.

Jack Sharry: Interesting. So talk a little bit about the alts distribution paper, what you found, what you learned.

Neil Bathon: It confirms some things and some surprising others. There’s a group of firms that are building out distribution for the more retail or intermediary distribution of alts at a remarkable pace. I think people know who they are and they’re always in the press, but a firm like Apollo in a few short years has really built out a sales force to cover traditional intermediary channels, which I think they hadn’t really covered maybe five years ago. And then the other side, so those traditional alternative shops, KKR, Ares, those types are coming down market. Blackstone probably had a large lead on most of them. They’d been doing intermediary business for many, many years. So it was good to kind of get reinforcement of just how much work they’re doing and it’s being well received, the educational programs, and then building out staffing. At the other end were the, I guess, traditional long-only shops that were going up market into the alternatives. Many of those have done so through acquisition. And firms like Franklin Templeton have made a number of acquisitions and they came out really well in the assessment in terms of how, and it really comes down for them in terms of using specialists to engage with a higher end advisor and helping educate them and bring them along to know how to allocate to their alternative products.

Jack Sharry: So I assume with the study, just to help our audience understand what you guys found, I would think a lot is around education and wholesaler proficiency. Why don’t you talk a little more about what that means?

Neil Bathon: Yeah, the amount of education up and down the line. Distributors are making it clear that despite many, many educational initiatives for years, some of these traditional firms have big institutes or universities specifically to help bring advisors along, but there’s still an enormous need for additional education. And until that ramps up, the guardrails that I think are around most advisors in terms of what the alternative products they’re allowed to use for their clients will stay in place and maybe they always will. But education definitely without a question number one in that firms realize that they need to do that upfront investment without an immediate return in terms of placing product because education is a multi-year. And then I think what you were alluding to, in-house, some of these alternatives can get very complicated. So a large cap core equity mutual fund is pretty straightforward. Any retail salesperson can cover that in their sleep these days. But some of these private credit offerings and private equity offerings are really complicated. And while you need to educate, you need to make a significant investment in educating your sales team and your marketing team, you really have to back them up with specialists who can go this third, fourth, fifth level deep.

Jack Sharry: And what have you found in terms of, it’s still early days, it seems to me, in terms of alternative distribution, alternatives products in general. What advice would you offer up to those that are wanting to get in the game? Clearly the market is driving this. I’m not sure whether it’s the press that’s driving it or the consumers, but certainly firms are driving it in terms of seeing that as a great sort of differentiating or margin kind of product.

Neil Bathon: So like any of these things, it gets tight pretty quickly. The tier one firms just have such an aura and brand and image and identity and reputation that there’s no question they get the lion’s share of the business. I also think one of the unique things about this end of the investment products is anyone can buy Apple, but not everyone can get into every one of these deals. And so on the private side, the top tier firms get the best access to the best deals. And so I think we’re going to, ultimately that’s going to play out in a way that the second and third tier teams just are put in little bit of a different spot. But I think if you’re not, if you’re a traditional long-only firm and you’re not yet in the alternative side of the business, the prices to buy something are probably going to be a little bit too much for most firms. Evaluations are wicked high. So it’s probably a partnership, some advisory, Calamos did something with Aksia, I think through a joint venture and that’s raised a lot of money. And even though you’re splitting the fees, they’re still better than most traditional mutual fund offerings. So I think partnership of some form is the way to go for most firms if they’re already firmly in the alternative business.

Jack Sharry: So one of the things I’m hearing, reading, finding out in conversation is what you just described, is a lot more partnerships, firms getting together, whether they’re long only and alts or they’re working with distributors, large national distributors, advisory firms. What’s your take on that? Where is it now? Where is that going? I would assume for a lot of folks that they want to get in, they’re going to have to partner with somebody who’s already there or someone who has the wherewithal to be a presence, a strong presence.

Neil Bathon: I do see these traditional alternative shops that never had cause to build out intermediary distribution realizing at this point in time, they don’t want to build out their own sales force. So they’re trying to scour the marketplace for firms that have good distribution but don’t have alternatives and that want to partner to move up market. So that’s pretty active and that oftentimes turns into sub-advisor relationships. I think that, and as I mentioned, there’s a handful of alternative shops that are aggressively hiring away from asset managers to kind of staff their own efforts. And it’s interesting to see what it’s doing to compensation because it’s driving it up dramatically. We’re taking somebody, a senior internal off of someone’s desk and changing them into an alternative specialist. They’re probably doubling their comp almost. And that’s rippling through the system. But yeah, there’s this desperate need for distribution and distribution’s getting harder and harder to achieve because access to advisors or access to the platforms is harder. So there’s all these forces at play so something has to give ultimately because they don’t all work together too well.

Jack Sharry: Interesting. What’s your, how do you see that playing out? What do see happening there?

Neil Bathon: I see the big getting bigger and specialty shops probably being just fine and anything the middle that doesn’t have all the boxes checked in terms of distribution and unique product and proper marketing support I think because they don’t have the scale probably to pull it off I think they end up getting squeezed out.

Jack Sharry: And how do you see the whole… alts is a product and clearly across the industry and for some time, the industry has been about multi-account, multi-product, multi-category. So we keep adding to it. And so more and more, it’s really at a portfolio level of a variety of products or try to show how you fit into an existing portfolio. How do you see that playing out? Because alts are sort of a new kind of category that ostensibly brings greater return and greater risk and potentially greater reward, of course. So how do see all that being incorporated? Because it seems to me that in line with the whole sub-advisory direction and partnerships, that working together is going to be an important way forward. So fill me in what you think on that.

Neil Bathon: Well, the alts that are delivered in, say, an interval fund, I think most of the systems will learn how to incorporate them into their asset allocation reviews and timing and withdrawals and tax optimization. I suspect interval funds will end up with monthly liquidity, which probably waters them down a bit to make the whole illiquid portion of it not all that powerful anymore. But the high end of the marketplace, I think if you’re an ultra high net worth client that doesn’t already have alternatives and doesn’t have a comprehensive overview, I’d be surprised. It just seems like that’s got to be the core of the relationship. Access to some special managers, but also a really sophisticated tax optimizer, as well as asset allocation that reaches across all your holdings.

Jack Sharry: So, Neil, tell me your thoughts on this. You and I were chatting a week or two ago about all this. When you came out with a study. And one of the issues, concerns is that these may blow up at some point, or not all of them, of course, but here or there, there will be some blow ups. We’ve seen it before. And you and I have been around the beginning days of mutual funds and their popularity and SMA and UMA and all the rest of it. What are some of the concerns you have as you look out in terms of how they’re being distributed, how they’re being sold, positioned, and frankly, the education that has not fully played out?

Neil Bathon: I’m encouraged by how cautious I think distribution platforms are being in who gets in. I think they’re decidedly weighing the experience and assets and expertise. And so I think it’s the tier one firms that are getting preferred access because they have demonstrated expertise and they feel safer. Having said that, there are firms like Blackstone where when they had to gate their re-product in terms of redemptions, it was fully disclosed and known that if certain market conditions presented themselves that 5% quarterly liquidity, you might exceed that, you’ll get out on a prorated basis. I think it was pretty well described, certainly in all the documentation, but also in how clients when they got into the products and yet that didn’t save them from having this massive run on the fund. So I think they probably did as good a job as anyone could have in helping to explain what was going to happen in certain situations. And it still didn’t impact that their reputation took a bit of a hit there for a period of time. And that’s not even a real blow up in my opinion. I think that was just natural market cycle stuff. I think there will be a blow up of a second or third tier product where they’ve reached too far or they’ve taken too much risk and the expectations, as you get down market, the expectations of mass affluent type of investors is just not going to be something you’re going to be able to corral and keep in sync. And they’re going to be very upset when they don’t get what they on their own came up with what they should. And that will ripple through. If it’s a third tier firm and it’s a hundred million dollar product, probably not so much. If it’s five of those in six months, the press will jump on it and carry it up to something more. Like you’re saying, Jack, we’ve seen, there’s always something that doesn’t deliver, whether it’s North American government income funds, 130-30s, those principal protected products. I don’t know that we’ve tested these buffer products fully yet either that are all the rage. So there’s always something that feels right and the models look good, but they don’t properly anticipate what the market reaction of individual investors is actually going to be.

Jack Sharry: And I can hear those phone calls now. I don’t care, get me out.

Neil Bathon: What do you mean I can’t get out?

Jack Sharry: Remember I told you we couldn’t get out? No, I don’t care, get me out. I’m sure there will be a few of those. And actually, Neil and I were chatting about this recently. He said, well, I may not have the most glowing picture to paint and I said, well, let’s paint it. You and I have been through, you just cited a bunch of them. We could have gone on for five minutes of all the things that have blown up over time, all around expectations that were, frankly, shouldn’t have been there in the first place, but that didn’t matter. Get me out. That was really what the advisors were having to deal with.

Neil Bathon: I think there’s also lessons to be learned a little bit. Again, this is much more for mass affluent investors, 500,000 to a million maybe. In 2009 and 10, it probably was the best market for liquid alternative funds ever. And they may have gotten up to a 4% allocation. And then there were, liquid alts, there’s so many different variations. But despite the best efforts of advisors, they were relatively expensive and since the markets didn’t break, they looked like they were a drain on the portfolio. So the protection and the insurance policy that essentially were putting in place, if it didn’t deliver a return in a short time period, investors got anxious with them and got out. So I think we can expect something like that. Although I think advisors will be more careful placing true alternatives than they will be with those liquid alt funds.

Jack Sharry: So where do you see things headed for the alts business? What’s some advice you’d give to the powers that be in the alts world? What would you caution them or at least recommend to them?

Neil Bathon: I’d like to make sure that the benefit to the client, this notion that alternatives, I don’t think people challenge the underlying premise that much that a retail client needs an alternative allocation. I think it’s not universal the way I think it kind of is being presented. Like everyone can benefit from these and now you have access to investments that only the rich and famous had access to in the past. I just, I’d like to see a little bit more verification, certification, validation of someone who has $500,000 and is 65, going to retire next year. Is that alternative private credit thing that they’re locked up in, is that really going to serve them well?

Jack Sharry: Yeah, I’m with you. And sadly, there’s a small percentage generally, maybe not so small sometimes, but I would hope for this, since we’re already talking about a smaller percentage to begin with, hopefully. But given that small percentage is what’s appropriate, it’s not going to have as much of an impact, at least we would hope. But it’s just like you said, certain people, this is appropriate for certain people for a small portion, but it’s maybe not so appropriate for everybody. And that is our tendency, particularly when someone goes to the, I guess today, I was gonna say the golf club, today it’s the pickleball court and they start talking about investments, as they do. What’s your alts allocation? I remember a story that way back when you and I were first getting rolling here in the 80s and 90s. I remember getting some advice from a cabbie in New York about mutual funds. He was telling me what he liked, what he was buying, and I’m like this is trouble. This is trouble when the cabbie starts giving me advice on what I should buy.

Neil Bathon: Did he mention Phoenix Investment Partner Funds or is that…?

Jack Sharry: I’ve been waiting for that. That’s slight, that smack, that rapier wit of Neil Bathon.

Neil Bathon: I think another concern, and this is a really small one, but I don’t know that asset managers, the traditional long-only shops, let’s say a mutual fund shop, I don’t think they appreciate just how different the advisors are at the high end of the marketplace and that their generalist wholesalers are not going to be able to position their alts for them there. That they really need a different specialist type of model in order to engage with that level.

Jack Sharry: Sage wisdom, Mr. Bathon. So what haven’t I asked you that we should make sure we cover before we head out?

Neil Bathon: I don’t know if I’ve mentioned this, but it just feels a little more comforted about how cautious distributors are being. I get the hype and I get that distributors will make nice fees on these products and advisors, it’ll be a part of their advisory ultimately, but, it’ll help them grow their book. It’ll help them attract higher end clients. Asset managers, I think the benefits to them are quite clear in terms of higher fees, higher margins. I just, that said, I know I just hit on it, but it’s really that client benefit and making sure that’s truly there. Cause the other three parties, I think it’s clear, but the fourth one, if it’s going to stick and have legs to it, I think that’s where we have to prove it.

Jack Sharry: Any takeaways beyond what we’ve shared for our audience?

Neil Bathon: I don’t know that you can anticipate the unexpected or the known unexpected, I think I just heard someone refer to it as, but I know we touched on it, but something’s going to blow up. And I don’t know that you can protect yourself because at the mass affluent level, it’s all one thing to people. So your… or your private credit or your infrastructure, you should anticipate something getting caught up in something else blowing up. I wish I had a more positive upbeat thing.

Jack Sharry: Well, I think that’s frankly, we’ve lived it. It tends to be a small part of what happens, just, it’s life, you know? But I think caution is, that was my hope out of this conversation. I think we’ve succeeded. It’s not that it’s down, it’s not a bad thing. It’s just that we’re just being prudent. We’re being smart. At least that’s how I view it. I don’t know if you agree.

Neil Bathon:, we find our right level where it, how far down market does it come? Does a $10 million dollar client need these products? I don’t question that at all. $2 million probably still. $750,000, I think now we’re getting close to being on the edge.

Jack Sharry: Yep, I’m with you. Neil, this is great, fun to catch up on the air. Appreciate your perspective, very useful all around. Last question, my favorite, what do you do outside of work that you are excited or passionate about that people might find interesting or surprising?

Neil Bathon: I don’t know that people would find it interesting… I mean, I’m 60 now, so I play pickleball. You mentioned that. But I think rail trails in New England are phenomenal. And a lot of them have micro breweries on them so I can get my kids to go with me. So that must be it. Yes.

Jack Sharry: That’s great. Neil and I actually, as it turns out, don’t live far from one another in suburbs of Boston. Occasionally, I see him heading home and we have a chat by my mailbox. We often talk about our kids who are now adults. So…

Neil Bathon: Well they’re older. I’m not sure if they’re adults yet or not.

Jack Sharry: That’s great. So Neil, thanks a lot. It’s been a great conversation as always. For our audience, if you’ve enjoyed our podcast, please rate, review, subscribe, and share what we’re doing here at WealthTech on Deck. We’re available wherever you get your podcasts. You should also check us out at our dedicated website, wealthtechondeck.com. All of our episodes are there along with blogs and curated content from many of the folks around the industry. Thanks again, Neil. It’s been a great pleasure.

Neil Bathon: Thank you, Jack, I appreciate it.