The Arc of Institutionalization
The playbook - how alt investment platforms grow their AUM
We’ve talked about the explosion of interest in alternative assets. This trend does not seem to be going away. If anything, dollars flowing into the space are only increasing.
We are in the early innings of alt assets becoming mainstream.
How can investment platforms in the alts space build out their investor networks and distribution capabilities so they can lay the foundation for institutionalization of these new asset classes?
Investment platforms (or marketplaces) have three main components to their business:
(1) Assets, which relies on the investment platform to be good at origination.
(2) Investors, which relies on the investment platform to be good at distribution.
(3) Data, which relies on the investment platform to leverage tech to drive origination and / or distribution.
This post - and upcoming series of posts - will dive into a critical part of building an alt investment platform. Distribution.
Content may be king, but distribution is queen. And distribution will play a major role in defining how and when the alt space institutionalizes.
Retail demand is there … and growing
We’ve seen retail demand into alt assets such as startups and private equity funds - and, more recently, growing demand for alt alt assets like trading cards, collectibles, art, and even NFTs (non-fungible token) collectibles like crypto art and Dapper Labs’ NBA Top Shot.
Just this past weekend, NBA Top Shot sold 2,673 digital collectibles packs for $999 each in under 30 minutes. And there were another 19,000 people who tried to buy packs but couldn’t. An ultra rare CryptoPunk digital artwork was bought for $750,000 a few weeks ago. And a Michael Jordan PSA 10 Rookie Card sold in an auction for $738,000, only 13 months after selling for $32,000, marking a 23x return in a year. Not bad. Not bad at all.
The Arc of Institutionalization
These new alt alt assets will follow an arc of institutionalization. This arc starts with retail investors, whose passion, excitement, and early and unique insights about a new accessible opportunity will help grow and mature an asset class, lending it credibility and assets that institutions will begin to follow with larger capital allocations.
Why is retail access to alt alts so important? Individual investors and wealth managers are structurally underallocated to alternative investments as a category - and it means they could be missing out on meaningfully higher returns in their portfolio.
While institutional investors still enjoy substantially better access than the individual investor or wealth manager to alternative investments, alt investment platforms like iCapital, AngelList, Republic, Forge, and others have made it their mission to bring high-quality private market investment opportunities to these groups.
In the US alone, there is over $10 trillion of investable assets held at wealth management firms. That figure is orders of magnitude higher when you look at that opportunity on a global basis.
If a few percentage points of allocation were to shift into alts from the HNW and individual investor communities, the alts space would see a massive inflow of capital to the tune of hundreds of billions of dollars.
More AUM flowing into alternatives will further legitimize these investment platforms. Dollars flowing into these platforms means that issuers and product manufacturers (companies and funds and other assets) will be more likely to use these platforms to raise capital, which should increase both the quantity and quality of the assets available on these platforms.
These investment platforms also benefit both institutional investors and product manufacturers (funds and companies). They can streamline processes, pre- to post-investment, in ways that create structural cost efficiencies for the entire industry. These efficiencies will eventually benefit the entire community as reducing administrative costs should result in lower fees to the end investor.
As an example, iCapital’s end-to-end technology solution enabled private equity funds to bring in investors at lower minimums without increasing their administrative reporting burden. These funds can market to investors online via compliant video and virtual data rooms, rather than hire large investor relations teams. They can KYC and accredit potential investors online through iCapital’s platform. Instead of relying on paper processes and FedEx envelopes flying around the world, as usually happens with subscription documents for private funds, investors can subscribe to the fund and receive fund reporting electronically.
All of these services will help move the alts industry forward - and there are a number of investment platforms that are providing the tools to make this happen across all different types of alternative investments.
Zooming out, this is where the space is headed. But it’s easier said than done.
Distribution is the name of the game
Content, or in this case, assets and funds, may be king. But distribution is queen, and she wears the pants, as Jonathan Perelman said.
As iCapital co-founder, Nick Veronis, used to say all the time, “private equity funds are sold, not bought.”
Distribution is the lock and key to building investment platforms to size and scale in the alts space.
So, what’s the playbook for alt investment platforms to build out their distribution capabilities?
There are a number of questions that many of these investment platforms can ask as they prepare themselves for institutional adoption.
(1) Who are your investors? Investment platforms need to understand their target investor for the stage of their platform and asset class.
We saw the evolution of institutionalization happen at iCapital. Once we hit a certain threshold in AUM, we broke a psychological barrier for fiduciaries like wealth managers, who felt much more comfortable working with us and allocating client capital to funds on iCapital’s platform. Initially, we had to build up a track record with individuals, high net worth individuals, and family offices.
Investors have different AUM thresholds, so it’s important that investment platforms in the alts space think about what AUM they need to hurdle over to attract increasingly more institutional investors to their platform.
Individual Investors = Passion x Investing: These investors start the movement. They love culture and they can now vote with their wallet. They are the early adopters that help grease the wheels for institutionalization. The early belief from individual investors can create great stories that help investment platforms get press, build up a following, and create legitimacy for the asset class.
HNW Investors / Family Offices = Early Institutional Adopters: This is generally a unique, hard to access investor group. There’s a saying that goes “when you know one family office, you know one family office.” That certainly rings true. Each family office has their own unique goals and investment mandates. Unlike the wealth manager community, it can be hard to scale an investment offering for family offices given their penchant for privacy and unique needs. However, growing AUM from the family office and HNW channels can prove to institutional investors that there is investor demand for these assets. Furthermore, building a robust family office network will attract the attention of institutional investors and platforms who often find it difficult to build these networks themselves.
RIAs / Wealth Managers = Cracking the Code on Institutionalization: Wealth managers are fiduciaries. They are responsible for managing other people’s money - and with that comes big responsibility. They are regulated, licensed, and must find the best investment products at the best fee structures for their clients. They are also in the business of wealth preservation over wealth creation. This means that they need to see audited track records, some level of institutional adoption, and professionalism from those offering investment products. Generally, they will be later to adopt alternative investment offerings from funds or alt platforms because they need to have confidence that the offerings are of institutional quality. Alt platforms will need to build up enough AUM to be able to attract wealth managers, and should focus on finding the right wealth managers who are willing to be earlier adopters.
Pensions / Endowments / Sovereigns = The Big Leagues: Institutional investors will likely be the last to move into one of these new alt alt asset classes. And for good reason. They too are fiduciaries. They are responsible for managing billions of dollars - and have to see audited track records, benchmarking, professional investors, and meaningful AUM to be able to convince their investment committees that they should allocate to these assets or funds. They also have to see a path to allocating hundreds of millions, if not billions, of dollars to these assets. A pension plan like CalPERS, with $444 billion in assets, can’t invest $1 million into a new fund. Even a 100x return for them on a $1 million investment just wouldn’t move the needle. They need to allocate tens of millions, or more, into a fund or an asset class to justify the time and energy spent on diligence.
(2) How does this fit into investors’ portfolio construction? Alt investment platforms will have to figure out how to position their product so that investors understand why they should invest in the product and where it fits in the context of their overall investment portfolio. This is important in order to generate retail investor adoption. It’s even more critical when convincing fiduciaries like wealth managers how and why to include alts in portfolio construction.
We did a lot of work on this at both Mosaic and iCapital. When we started building our investor network at both firms, we spent a lot of time with investors trying to understand how they would think about the products we were creating the context of their broader investment mandates.
At Mosaic, we were structuring a solar loan product that didn’t have much of an institutional track record at the time. We had to determine if a solar loan product would be classified as a fixed income investment or an alternative investment. Same with iCapital, we had to convince HNW investors and their wealth managers why they should carve out a piece of their equities or fixed income exposure for investments in more illiquid, but potentially higher returning private equity funds.
We don’t talk about product-market fit in the investment world as much as we do in the technology world, but there are many similarities. With each investor type, investment platforms have to figure out how they fit into an investor’s portfolio and why their investment offering adds value to their portfolio.
(3) How do you educate investors? Helping investors to understand the merits of these alt alt assets - and why it deserves a place in investors’ portfolios - is key. Investor education will be one of the major reasons why institutionalization occurs.
Alt investment platforms that invest time and resources in investor education will reap the rewards. Education helps build earned media on the space, which also serves to usher in institutionalization over time. This is particularly important for the wealth manager community, as they look to understand how to offer alts to their clients, in a constructive and informed manner.
A lot of work goes into educating family offices and HNWs about the asset classes on these platforms - and it’s work that doesn’t go to waste. Figuring out how to tell the story of your platform and asset class will help you work with wealth managers as you scale the platform.
At iCapital, we invested a lot of time and effort into educating wealth managers about alternative investment funds. We shared the pros and cons of alts in an investment portfolio. We provided them with access to industry experts and top fund managers so they could begin to understand the space. And we even partnered with the Chartered Alternative Investment Analyst (CAIA) Association to offer a 20 hour course on alternative investments to help wealth managers become sufficiently expert in the asset class so they felt confident discussing them with their clients. More recently, iCapital acquired AI Insight, which provides alternative investment research, training, and compliance support to thousands of advisors and financial firms who use this educational content to grow their understanding of alternative investments.
(4) Can you build an institutional backstop? Find some early institutional adopters - family offices, HNW individuals, even institutions - who believe in the asset class and are willing to put meaningful dollars to work on the platform to help build up AUM and attract more assets to the platform.
Many of these investment platforms are marketplaces. Marketplaces need to balance out supply and demand. And marketplaces succeed when they get the flywheel going. More AUM attracts more assets. More assets and AUM attract more investors. All of which leads to institutionalization.
A company like Opendoor has been very successful in part because they used capital to buy assets to seed the marketplace (and seed their data flywheel). That becomes critical in starting the marketplace flywheel.
Many alt investment platforms can do the same. They can work with family offices or HNW investors who want exposure to an asset class and give them the opportunity to put meaningful capital to work on their platform.
(5) Who are the key influencers in the industry? A few early customers who are industry leaders can go a long way. Particularly in the wealth management world, followers will take their cue from leaders.
Investment platforms that can forge relationships with market leaders in the wealth management space early on will end up bringing other wealth managers to their platform as a result.
We saw this happen first-hand at iCapital. We were lucky enough to build relationships early on with Fidelity and Dynasty Financial Partners, a wealth management and technology platform with $30 billion in AUM and over 50 independent advisor teams. They helped us shape our business, better understand the wealth advisor space, and gave us instant credibility with the broader advisor community.
(6) How can you build community? FinTech companies that crack the code on building community will emerge as winners.
Communities educate. Communities forge connections. Communities create engaged users. FinTech companies have a huge opportunity to create community in ways that traditional financial institutions have not. Investing is inherently social - and FinTechs that embrace the social nature of investing will reap the benefits. And community can help scale a company in organic ways that traditional marketing and advertising can’t.
Investment platforms that create ways for investors to build relationships, expand their networks, and come together to learn from each other will emerge as winners.
And alt alt investment platforms - that live at the intersection of culture, community, and investing - have the opportunity to engage community in ways that many others cannot.
That’s why the collision of Community x Capital will be critical as investment platforms build their businesses.
In subsequent posts in this series, we’ll dive deeper into each of the investor types who will play a role in growing the alts space - and what they need to see in order to be able to put their money where the movement is.
Investors will be a big part of what makes Alt Go Mainstream - and investment platforms that figure out distribution will have a major role to play in making that happen.
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