Alts platforms and private equity managers have been laying the groundwork for a wider slate of low-cost feeder fund vehicles for advisors, aiming to avoid the 100 basis point bite of the market’s priciest structures.

Feeder funds have become more common as private equity managers target the high-net-worth market and advisors seek to diversify client portfolios into alts, spreading from early usage primarily in the wirehouses and large private banks to a broader array today of product platforms, managers, and advisory firms. Feeders typically pass along the 2% management and 20% performance fees from the underlying private equity funds and then tack on administrative fees of up to 100 bps a year.

Cost is one of the impediments to greater high-net-worth client adoption of illiquid private equity funds, market watchers say, and that’s one reason many managers in the past year jumped aggressively into product development of non-listed registered alts funds for the advisor market. Some managers have cited a potential ceiling in sales of illiquid private equity funds to high-net-worth clients as motivation for their non-listed product efforts, and some of those new vehicles have come online with cheaper cost as a main feature.

But platforms developing low-fee feeders could determine whether the ceiling for illiquid funds may be higher than today’s market indicates. For now, most lower-cost options are available to independent registered investment advisors (RIAs) through platforms such as PPB Capital Partners and the iFunds arm of Mercury Capital Advisors.

Developing lower-fee models can be a smart play for alts managers in a market where many products carry high price tags, says Kimberly Flynn, managing director at XA Investments, which recently built a closed-end fund subadvised by Octagon Credit Investors.

“It makes sense that both hedge fund and private equity managers would try to find ways to reduce the cost to the end investor,” she says. “In alternatives, fees are not noise. You should really be thinking about the net-of-fees, net-of-expenses cost to clients.”

Net fees are especially important for advisors to outline for private equity vehicles that typically have a 10-year or longer life, and where a 100 bps feeder fee charged annually can add up to significant performance drag at the end of a fund’s life, Flynn says.

“Advisors need to account for the full impact of these fees,” she says. “They can radically change the investment proposition for an investor.”

That scenario played out in stark terms recently, says Brendan Lake, CEO at PPB, describing the reaction from a high-net-worth client of an RIA who was being pitched a new private equity fund by a manager that touted its prior fund as having 30% returns. The investor was surprised at the figure, given that he had been in that same prior fund through an account at one of the wirehouses, but had only earned 21% – a 900 bps difference that traced back to annual feeder fees charged over the life of the fund.

“That’s what has given us a reason to exist,” Lake says, citing interest from RIAs that want to deliver private equity to clients at the same cost that institutional investors pay or for as low a fee as possible, from the single digits to 25 bps.

PPB’s model entails a combination of automation, volume pricing discounts from managers, strategic partner relationships, and policies that avoid added costs to investors, such as not stockpiling client cash as much as 18 months in advance of expected capital calls, Lake says.

Mercury’s platform also offers lower-fee feeders to wealthier clients, with 57 bps options for clients with $1 million or more to invest, and no-fee options for investors that can meet the private equity manager’s stated minimum investment level, says Donal Mastrangelo, head of U.S. iFunds distribution. Mercury, which is a placement agent, only collects its sales fees directly from the manager and doesn’t participate in non-institutional share classes that try to pass on those charges, he adds.

Fees are “always front and center” for advisors on any strategy, but especially on alternatives, Mastrangelo says. “The second layer is how much of those fees are disclosed,” he says. “That becomes the enigma for advisors to solve for. Some firms are reticent, others are more transparent, but it can take a little bit of forensic accounting to understand what the total cost of ownership is over the life of the fund.”

But lower cost isn’t the only concern on advisor checklists. Access to well-regarded managers and top-performing funds is also a big priority, says George Lucaci, partner and senior advisor at Mercury. “There’s no doubt about it – that’s what the bigger producers want,” he says.

Access to top private equity brands drives investment decisions for many advisors in part because they associate those names with quality, Flynn says. That also means advisors are willing to have clients pay more for those funds, she says.

And it’s no accident that access to top brands often is reserved for advisors at the wirehouses or private banks – the firms where feeders typically carry the highest fees.

“The larger [advisory] firms follow the path of least resistance – investing their clients with the largest private equity sponsors in the world,” Mastrangelo says. “It’s like buying IBM.”

However, at least one mega-size private equity manager is exploring options with PPB to develop its own low-cost feeder structures, Lake says. “Some of these firms want a bigger piece of this market,” he adds.

Diversification strategy looks strong as 2018 approaches

By Kevin Gale

Alternative investments often have suffered in comparison to plain vanilla strategies, such as investing in the S&P 500 index amid a bull market for equities. However, the outlook for hedge funds, private equity and other alternative investments looks strong as the end of 2017 approaches.

The topic was highlighted at the Florida Alternative Investment Association’s meeting of the Americas, which was held Oct. 19 at the Akerman law firm’s office in Brickell City Centre. The meeting demonstrated how South Florida can be a crossroads for investing in Latin America and the Caribbean, just as it is for international trade. South Florida economic development officials have been urging hedge funds and other wealth companies to relocate to the region.

Sustainable investing and using new technology to pick investments were among the hot topics at the FLAIA event.

Leopold Peavy, head of investor products at Preqin, presented a chart that showed hedge funds had a 10.9 percent return over 12 months ending in June, compared with 15.46 percent for the S&P 500 index.

Hedge funds, with $3.25 trillion in assets, and private equity, with $2.58 trillion in assets, represented the vast majority of the alternative assets under management. One of Peavy’s slides showed private equity has roughly doubled the total return of the S&P 500 since 2000. First-time private equity funds have outperformed established funds, but the gap has narrowed.

North American real estate continues to be popular with investors, although Peavy thinks some investors may be pulling back after strong returns in recent years. Closed-end private real estate funds raised $20 billion in the third quarter, and 65 percent of that was secured by North American-focused funds, Preqin’s data found. The biggest amount raised was $4 billion by Carlyle Real Estate Partners.

A panel gave insights into the perspective of family offices and other asset managers.

Brett Hickey, founder and CEO of Star Mountain Capital, says debt with high single-digit yields and lower-risk profiles are attractive.

Demand for capital in the debt markets has increased so much that leverage is at an all-time high, he says. Covenants to protect capital have dropped.

One opportunity for PE firms and their investors are deals of less than $150 million because companies such as Goldman Sachs aren’t pursuing that space, he said. Underwriters can get 15 percent returns with low risk.

One attractive investment in private equity are rollups, often driven by owners who want to retire, he says. Demographics indicate that trend should run for another decade.

David W. McCombie III, founder and CEO of McCombie Group, a Miami company that works with families on investing, is finding businesses in the $2.5 million to $10 million range to be attractive opportunities for investors. They tend to have fewer banking relationships, but that also means they may not be used to having their financial scrutinized.

Michael Corcelli, founder and chairman of Alexander Alternative Capital, wants to buy 100 car dealerships over the next four years. The exit strategy is to sell to a major investor or issue an IPO.

Craig Edelstein, a venture capital investor and turnaround specialist with the Frost Group, says his company has a huge funnel on health care. “Our ability to assess it is world-class,” he says.

That’s not surprising given the company’s namesake is billionaire Phillip Frost, South Florida’s most successful serial entrepreneur in the health care and pharmaceutical space.

Lunchtime speaker George Lucaci, a partner and senior adviser at Mercury Capital Advisors, showed how his company provides online offerings, independent research, product tutorials, roadshow videos and institutional due diligence that can be accessed on mobile devices. Mercury’s offering menu has 19 verticals. It includes the usual alternative investments, such as private equity, real estate and hedge funds, but also offers more-focused fare, such as infrastructure, distressed, pre-IPO and special situations.

Mercury, which recently opened an office in Palm Beach, is a 2008 spinoff of Merrill Lynch and was ranked first in 2015 private equity placements at $160 billion by Thomson Reuters. It has 15 specialists handling originations and due diligence, which helps registered investment advisers in vetting investments. Lucaci says Mercury meets with more than 400 investment managers a year.

Mercury says it has relationships with 2,500 institutional clients, such as sovereign wealth funds, corporate and public pension plans, insurance companies, endowments, family offices, foundations, funds of funds, and consultants.

Lucaci demonstrated the portal for Mercury iFunds, which is designed to provide the type of opportunities for RIAs as it does for the big institutional investors, including better pricing. The system that makes it easier for RIAs to get vetted information on investments and choose investments with a few keystrokes.

Another panel looked at impact investing—investments in companies, organizations and funds that generate both financial returns and social and environmental impact.

Tim Albright, Summit Partners’ long- and short-fund portfolio manager, said he’s in the returns business and the markets are favoring more sustainable and fewer resource-intensive solutions.

“The core to our strategy is this is sort of a disruption fund. We see sustainability as the driver of disruption,” he says. For example, investments can involve companies that are updating the electrical grid, making HVAC more efficient or making a factory floor more efficient.

Drew Saito, senior vice president for First Green Bank, says his bank puts an emphasis on environmental sustainability, which has led to lending for solar. Its shareholders also believe not in just bottom-line profit but paying a fair wage.

First Green is one of the fastest-growing banks in Florida and still just as profitable as other banks despite its sustainability mission, Saito says…

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Today we sit down with George Lucaci of Mercury Capital Advisers.

George Lucaci is a member of the Mercury iFunds Distribution team.

Before this, he was the head of Capital Alternatives Group, an independent hedge fund capital raising enterprise. He was also Senior Managing Director of HedgeFund.net, one of Wall Street’s first electronic alternative asset distribution platforms and spearheaded its capital raising business and broker-dealer. Previously he served variously as head of Proprietary FX Futures Arbitrage Trading at Citibank, was National Product and Sales Manager for Nomura Securities and Head of U.S. Fixed Income, and also served as Managing Director of Merrill Lynch’s Mortgage–Backed Securities business.

Our focus today is on the Mercury iFunds digital platform, which provides wealth intermediaries exclusive access to leading-edge alternative investments. Also, as part of the firm’s mission to educate advisors and investors, the platform delivers third-party research and videos.

It is part of a growing trend of companies investing in resources provided to members to further expand their knowledge base about alternative investments. The concept of ROE (return on education) helps investors and advisors better understand the benefits of alternative investments, key differentiators between asset classes, portfolio differentiation strategies and today’s current market environment.

FIN: How fast is this digital transformation taking hold in the industry, and what are the pros and cons?

George Lucaci (GL): By accelerating the extinction of outdated information the digital revolution is constantly transforming our world. Automation, artificial intelligence, and robotics have become part of our daily lives.

Companies that understand this are now called “exponential organizations,” and will invariably create a larger footprint in their industry. Supporting innovation has a lasting effect on productivity, but keeping the client’s needs in mind during this evolution must be part of the process.

What considerations do institutions, wealth advisors and other intermediaries need to be aware of when adopting digital?

GL: Efficiency, education, ease of use along with a secure infrastructure are key consideration needed to promote confidence. Digital should be a route to strengthen and expand your business. This means working with an experienced partner, who has a deep knowledge base and a history of offering curated alternative investment opportunities.

What are the benefits of shifting to digital?

GL: Focusing on client service is crucial for growing any business. This means reducing administrative burdens through state-of-the-art technology. Embracing digitalization saves time for value-added and customer-centric pursuits such as working with clients and investment research.

Reducing administrative burdens provides the most valuable of resources to an advisor, time to focus on growing their business, rather than completing paperwork. Digital Darwinism means “disrupt or be disrupted.” Our digital platform includes 19 different alternatives investment categories, enabling investors to look across multiple asset classes, choose from leading managers in each category and perform due diligence to build confidence in the specific choice.

While multiple managers are available on the site, they are all subject to the same firm-wide diligence to ensure that investors know they are selecting from world class managers gathered together with sophisticated investors.

You’ve re-coined ROI to ROE – what does this mean and why?

GL: “Return on Education” is our mantra, yet the challenges are daunting.

The need for lifetime learning and a willingness to constantly change and reevaluate goals must be established by those organizations hoping to remain relevant – and profitable. An organization must embrace digital Darwinism, or become the victim of it. We believe that providing more third-party information to advisors ultimately contributes to better investment decisions and results.

With the above in mind, where do you see the placement agent model in 10 years?

GL: We believe that investors working with trusted counterparties that understand their investment goals – given the range of available opportunities – will be increasingly important. Placement agents who truly partner with and understand the manager’s mission – as well as their investors’ objectives – will be standing strong in 10 years.

Many aspects of investment research/asset allocation are already affected by digital technology. This includes broad screening to focus on high-quality managers, as well as the diligence effort to know a specific fund. Placement agents identify leading managers, and then investors choose the best fund for their unique investment need. Digital tools will enable investors to make solid choices among leading providers.

About Mercury iFunds™

The Mercury iFunds platform, delivers leading-edge alternatives managers to the Private Wealth community through a comprehensive, highly efficient, and low-cost, digital platform. Being an elite global firm our principals have raised over $160B across various alternatives asset classes/managers in both the institutional and Private Wealth investor channels.

The Mercury iFunds™ digital platform provides access to world-class managers that typically are available only to large institutional investors [$25MM+ LPs]. The platform offers a menu of asset classes, leading to a curated list of distinguished managers. The next step drills down to a series of virtual data rooms, so investors conduct institutional due diligence and then review/execute subscription documents in a far more time-efficient process than is generally the case.

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