Talk Your Book: Customizing Alternatives

0:00Today's Animal Spirits Talk Your Book is brought to you by GlassFunds. That's GLAS Funds. It's glassfunds.com. Go to glassfunds.com to learn more about how they can introduce an alternatives platform to your financial advisor wealth management platform. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:36Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:44Welcome to Animal Spirits with Michael and Ben. Michael, I've talked before how I grew up in the institutional investing side of the world. It was endowments and foundations and pensions, and they all puffed their chest out like they They were kings of the world, kings and queens of the world. And we're the only ones who have the ability to invest in alts because we have this money, we have scale, we have expertise. And it was kind of like anyone else who gets, who wants alternatives, they get seconds. They get our, you know, whatever's left, they get our leftovers. Yeah, I get the table scraps.

1:18And I think that's changed since I left that side of the world where I was managing money exclusively for a foundation in these billion dollar funds that now wealth managers are gaining access to these funds that aren't just like the also rands or the giant$50 billion fund that is just trying to bring in fee revenue. Did it start with the fund of funds? Was that how retail first access this? Yes. Like at scale? Which is rarely, if ever, a good deal if you're paying fees on top of fees. And so then came along some of the platforms where you can access these via a menu, for lack of a better word, and had the options to get some education information.

2:05And then along came companies like the one that we're about to talk with today, where they're tech enabled, and it's more than just access. It's actually working with the REAs and their advisors to facilitate a better experience. As someone who worked in the operational aspects of things like private equity and hedge funds and venture capital back in the day in a very small team, that was always my biggest problem with it is the operational headaches are such a big hurdle for anyone, whether they're institutions or wealth managers, that it's almost not worth it. But these new platforms are actually coming in and doing the operational stuff for you.

2:43So you can just kind of focus on the funds, which is kind of interesting. So we talked to Brett Hilliard today. Brett is the CIO of Glass Funds, and we're going to get into all of this stuff and more. So here's our conversation with Brett.

3:00We're joined again today by Brett Hilliard. Brett is the CIO at Glass Funds. Welcome back. Yeah, glad to be back. Quick reminder, you were on the show back in May, but for those that missed that, who is Glass Funds? What are you guys all about? Sure. We are an alternative aggregation platform, so we help wealth managers scale and allocate alternative allocations across our client base, including hedge and private capital strategies. So there's a bunch of these in the industry. One of the things that's unique about you is that, unlike some of the competitors, you guys are not a feeder fund. Can you explain what that is and how that separates you from some of the competition?

3:39Yeah, so we have two main buying entities, an onshore and offshore fund. And each underlying strategy is essentially a side pocket that's legally walled off from all the other side pockets. So that allows advisor firms to create fully bespoke portfolios across hedge and private capital. And there are a number of efficiencies due to our legal structure. One is they only need to subscribe an LP one time. That takes about five to eight minutes. And then we save all that data. And then if they six months later want to allocate to another private capital fund, that probably takes another two minutes.

4:21And then it also allows for lower frictions to allocate to underlying strategies. because we're not spinning up a new feeder fund, we can allocate to a manager for as little as a million dollars in the aggregate where spinning up a new legal entity may, you may want to get at least 30 million to spread out those startup costs. And then also time to market is much quicker as it's really just contingent on how fast we can get through our review period. There's really no lags due to the creation of a new legal entity. And then lastly, we also offer aggregated reporting, including aggregated tax reporting.

5:04So an investor can ultimately own 20 things. At the end of the year, they'll get a single aggregated K-1. And my background with investing in private funds was mainly from the institutional side of things. It was with I had a hard time wrapping my mind around alternatives because we had a small team at the endowment I worked for and it was just a lot of paperwork, a lot of due diligence. And frankly, if you weren't a huge Ivy League school or one of these really huge pensions, you were kind of at the lower end of things and you didn't get a lot of attention. But even then, it seemed like institutional investors were head and shoulders above everyone else in terms of their place in the hierarchy, right?

5:50It was easier to get allocations to these funds if you were an institution. This is 10 years ago or so. How have things changed? And at that time, it was mainly, I guess, maybe like Merrill Lynch and Morgan Stanley would have offered some, or Goldman Sachs would have offered some hedge fund allocation to their clients. But maybe you could talk to me about how things have changed in that time in terms of wealth management industry investing in private funds versus institutions and some of the pros and cons there. Yeah, there's been a lot of technology advancement and disruption in trying to democratize alternatives, and it's making it easier for wealth managers to allocate.

6:28What's been around a long time is just digitizing the subscription process, so turning those 100 to 200 page subscription documents into a more easily digestible online questionnaire. Also, you know, aggregating small tickets to big tickets to make institutional level private funds or hedge funds more accessible. But then, you know, I think where Glass Funds is really iterated on is now that the subscription process has been digitized and minimums have been solved to a large extent. We're seeing advisor firms have challenges managing diversified portfolios of alternatives across a large client base.

7:10And that's where we think our platform can offer a lot of efficiencies and allow the advisor firm with more limited operational professionals on their side, being able to implement, cover, and manage existing and new allocations within diversified portfolios, as opposed to just viewing an allocation one by one by one. Can you talk about the existing part of it? I'm curious because often advisors will onboard a client from a wire house or wherever they're coming from, and they might have existing alternatives that the advisor did not recommend, the onboarding advisor did not recommend, but maybe they can't get out of for various reasons.

7:53How does Glass Funds help in a situation like that? Yeah. So we have the ability to transfer those positions onto our platform. You know, that's at the discretion of the end client and the advisor firm. We cast a wide net on what we'll accept. Now, the underlying strategy has to be operationally sound. Sometimes if the firm that currently holds it, if they view a competitive reason, they may block a transfer. But we don't really have those restrictions on our side. And then our efficiencies go up the more that the advisor firm and the client, the higher the number of positions they have in our platform, the greater number of the efficiencies.

8:36So if they're able to transfer the existing positions, then it all gets folded under the ability to do, you know, aggregated reporting, aggregated tax reporting. We have a single bank that we wire money to and distribute distributions from. So that creates efficiencies. So trying to, you know, fold as many of these positions onto our platform can offer the advisor firm a number of efficiencies. But again, the existing holder or custodian of that asset has to accept the transfer. Do those efficiencies translate at all into liquidity? Because that was always one of the other things I had that I found that was really challenging in this space is liquidity, where some hedge funds or real estate funds would have a certain window of time where you could get your money out.

9:27And maybe it was only a certain percentage of the fund. And it was sometimes it would have to be like a nine to 12 month lead. And so getting your money in was always way easier than getting it out. Have there been any changes there where things have improved at all there? And how do you all handle the liquidity, whether it's just for rebalancing or whether it's for someone who actually wants to take their money out of a certain fund? Our platform offers the ability for enhanced liquidity. So the advisor firm, let's say they allocate$10 million to a buyout fund. And, you know, despite all of the education that the advisor firm does to the end client, you know, this is a 10 year plus investment.

10:06You know, there's liquidity as they sell down underlying companies in the portfolio. You know, it's common where an investor will come in to the advisor firm saying, hey, look, I know what you told me, but I need liquidity now. So that advisor firm can come to us and they can either have other clients in their advisor firm saying, hey, look, client A wants out. He wants out of his$250 ,000 commitment. I have clients B, C and D that can assume that position. And at the glass funds level, we can just change the composition of the ownership. We do not have to go to the GP because at the all what the GP sees is glass funds in aggregate.

10:48They don't know, nor do they care how that aggregate is divided on our side. And in also glass funds, we don't dictate the terms. So the advisor firm and the transferor and the transferees, they dictate the terms on which the transfer takes place. We're just helping facilitate that. So there's no legal structure that's stopping you from changing that ownership halfway through the fund's life or something? No. It's really just the ability to source demand for that position. And as long as the advisor firm and or glass funds can source that demand, and as long as both parties agree to the terms, we can easily make that transfer.

11:33So you've created your own secondary liquidity in some ways. Yes. And we think the institutional secondary market has grown strongly over the last 10 plus years. We think the wealth management liquidity or secondary market is behind that. But we do think it's going to continue to grow and materialize where there's going to be more dedicated secondary investors targeting this area. because the early adopters, let's say, you know, in the wealth management channel, private capital started to become acceptable in the mid 2010s. You know, so now we're starting to see investors have more mature portfolios.

12:11They may have higher allocations to private capital, and then they may run into more liquidity needs. And that should spur higher turnover within secondary liquidity demand. Brett, isn't it hard enough for investors, certainly advisors, to analyze and contemplate whether or not allocating fresh capital into a strategy makes sense? How are they then supposed to determine, okay, this particular fund has all these underlying investments. It's been running for four and a half years or whatever the case may be. How are they getting the knowledge to determine whether or not they're paying a good price for the underlying investments?

12:48Is that something that Glass Funds is helping with? No, we'll help provide data, but we do not opine on valuation. Most of the transfers that take place on our platform are done at the most recent NAV provided by the underlying manager. And the reason is typically the advisor firm is sourcing that liquidity within their own client base. It can get complicated when we're talking about substantial either discounts or premiums compared to the most recent NAV, especially when you have clients under the same advisor umbrella. Got it. Do you think about Glass Funds as more of an investment firm, more of a technology firm somewhere in the middle?

13:32Or how would you think about your business through that lens? We view it more as a technology firm and as an enterprise solution. No matter any type of client we have, they interact with our technology and the efficiencies that they gain from our technology and structure. Research is just an additional course in the buffet of things that they can decide to utilize. And some advisor firms, they source pretty much all of their own ideas, and they're just using the Glass Funds architecture to scale that across their client base. Where we have other advisor firms that they more heavily rely on Glass Funds research team, of which I lead, and getting our ideas across various alternative categories.

14:21So advisors can bring their own deals as long as it has the operational infrastructure to be supported by you guys. Correct. We call those advisor source funds. We will do an operational overview to make sure there's institutional plumbing on the administrator and auditor side. And as long as that passes, we will onboard it onto our platform. We do not opine on the investment merits of advisor source funds. I'm curious if the efficiencies of scale in your business have led to any changes in the fees. I know a lot of people assume across alternatives, whether it's private equity or venture capital or hedge funds, that it's all 2 and 20.

15:00And I'm sure for a lot of the biggest funds, it still is maybe that same fee structure, but not everyone in the alternative space charges that. I don't know if you can tell me the averages if it's now, I don't know, 15 and one and a half or whatever it is. how does the fee landscape look these days for alternatives? The fees are drifting lower, and I think it will continue to do so as the space gets more competitive. And that's where I also think where we can help wealth managers use their scale to get institutional-like fee breaks. One common opportunity that we see consistently in the market are seed deals for private credit platforms.

15:46So GPs that are trying to scale up in private credit, they can typically offer a combination of discounted fees or some form of GP economics. And those can be pretty lucrative for the end investors. But for them to offer that, They're going to want commitments anywhere from$10 million,$25 million and up. And they also want to target the wealth management channel, but they don't want to take a bunch of$250 ,000 checks. So using an aggregation platform like Glass Funds, advisors can scale up and deliver a large check to these private credit managers and also take advantage of some of the seed economics that they're offering to help scale their platform.

16:32We see more of these opportunities as the alternatives ecosystem continues to grow. And I think that's where wealth managers should take a close look at to enhance their fee efficiency and net-a-fee returns to their end investors. Glass Funds has been operating for a while. You must have a pretty good look through to the industry. I don't know if you disclosed. What is the metric that you guys use? Is it assets under advisement? What is like how much money is on the platform? Yeah, we look at a couple of metrics. We measure AUM and committed. So we're a little over 2 billion in AUM and committed capital.

17:15The majority of our aggregated capital is in private drawdown funds compared to open end hedge funds. And then we also look at how many advisor firms we work with, how many positions we have on the platform. So that's sort of how we gauge our size. Got it. And you work only with RIAs or is that not the case? We mostly work with fiduciaries, so RIAs and private banks. Okay. Yeah. All right. So do you have any sort of insights as to where the money is going these days? What's popular? So alternatives is a very wide bucket. There are, as Ben mentioned, there's hedge funds, there's private equity, whether it's buyouts or venture, there's private credit, there's private real estate, there's infrastructure.

18:03I mean, there's a lot going on there. Is any one or two of those areas seeing particular client interest above the rest? There's different pockets of demand. I would say over the last several years, in looking at the broader market trends, as well as the flows across our platform, firm, private capital is still dominant over hedge funds. Hedge funds garner some strong feelings, either on the positive side or negative side. Certain firms are large allocators to hedge funds, but there's a number of firms that they've decided that hedge is not the right solution for them. There's much less firms that have decided that private capital is not the right solution for them.

18:50So the majority of our flows are still being driven by private capital. Sorry, Ted, when you say private capital, is that the same thing as private credit? Yeah. So under private capital, we include buyout, venture growth, credit. And also with under the real assets category, that will include private real estate, infrastructure, natural resources, et cetera. I'm curious how the current interest rate environment affects alternatives, because I can see it going both ways. With 5 % T-bill yields, on the one hand, I can see that being a much higher hurdle rate. And people would say, why would I invest in alts?

19:29Because those credit funds would have to have much higher returns. On the other hand, things like hedge funds, I would imagine higher rates have to be a good thing. Because if you're shorting or doing something like that and you're holding cash, you're actually earning something on the cash these days. For private equity, obviously, there's a higher borrow rate. but obviously not all that money is being invested at once. So how do you see the rate landscape impacting alternatives? And you can take it any way you want with the types of alternatives and how it impacts them. There are a number of cross-currents.

20:01I would say on a same-store-sales basis type view, allocations from our vantage point are down modestly. And I think that's partly just there was a large decline in the 60-40 portfolio. That's probably the major funding source. So even despite the rebound in 2023, a traditional portfolio is most likely still under its high watermark. And then also cash is a viable asset now. Now that you can get 5%, 5.5 % on cash, that becomes a little more attractive. It's more competitive. I would say we have still experienced strong growth because there's so much secular white space within wealth management allocating to alternatives.

20:51So a large percentage of our growth this year has been onboarding new advisor firms and helping them scale up their alternatives across their platform versus longstanding clients increasing their pacing to private capital and hedge. I'm curious, what's the range and size of the type of advisors you're working with? Yeah, there's quite a wide range. Some of our advisors are more specialists and alternatives. So they focus on ultra high net worth families that typically have founded or run a business. And they're just managing their alternatives portion. They can, given their specialty, they could be on the smaller size of a billion, two billion.

21:33upwards to some of our clients, larger private banks, 50, 60 billion of AUM and everything in between. So you said that advisors have the ability to customize portfolios as opposed to say to a client who asks, hey, do you guys do alternatives? And then them giving like sort of the laundry, I don't know why I said laundry, the, oh, I was saying laundry list, the list of things that they can invest in. Oh, we have this, we have this, we have this. Are advisors creating custom portfolios that like, this is how we do alternatives and it's a portfolio of however they chop it up. And then it's just one cohesive message.

22:09Is that something that you're seeing advisors do? Yes. They're building now a program and they need, they lever our technology and platform to deliver that program. So they'll start out with some different iterations of, let's say a vintage 2023 private capital series that will include perhaps some buyout, growth, private credit. And that will sort of serve as a base to iterate on. But then given certain client suitability or preferences, they may tweak that around the edges. And in that way, they have greater efficiency in scaling the allocations across their client base as opposed to doing fully bespoke portfolios on a client-by-client basis.

22:54So just following up on that, does the fact that a lot of these funds have vintages, meaning that they'll open up a new one once every year, once every other year, whatever it is, does that further complicate the idea that I just mentioned? Does it make it harder for advisors to implement the strategy like that? It can at first, but the more experienced advisors, they learn the cadence of a stable of managers that they're familiar with. So they'll know that manager A, they'll raise every three to four years and they're going to come on board in 2024. And that offsets with manager B that's live in 2023.

23:33And so they start out with a core stable of managers, but then they may drop one, add another one and modify it year by year. That's where we've seen some of the more longer tenured teams do it on our side. One of my roles early on in my career was tracking the performance of our alternative investment part of the portfolio. And that's pretty easy, relatively easy for hedge funds. But for holdings in private real estate and especially private equity or venture capital, it can be kind of tricky because you're dealing with IRRs, which is not the same thing as the compound greater return. So how do you handle the performance reporting aspect for advisors?

24:14We take all of the underlying accounting data that we get from our funds, and then we provide that data through an API to a number of front end reporting systems that the wealth management shops use. Then they can take that digital raw material and customize client reporting reports and deliver certain metrics such as multiple invested capital, net IRR, percent called, percent uncalled. So there are some efficiencies with that, especially us digitizing it and feeding it to them electronically and then their ability to customize. wise. Certainly, there's still challenging aspects. Private capital reporting is typically lagged by a quarter.

25:03Some strategies are lagged by two quarters. So an end client, obviously, they'll have all full up-to-date public market performance, let's say as of the end of second quarter, where they look at their private book, a portion of it could be marked as a first quarter and another portion could be marked as a fourth quarter 2022. One of the challenges with alternatives, traditionally has been some of the opacity around the fee structure, especially if there's just more than one party involved. And the SEC has some proposals out there that I want to get your take on. But before we get there, how does Glass Funds, what are the economics of your business?

25:46We charge a flat management fee to the end investor. And then that management fee is struck at the advisor firm level. And that fee scales down as the advisor firm scales their usage up with Glass Funds. And what is that? What is the fee for a new user? It can range anywhere from 25 to 50 basis points. And it's really dependent on the size of the firm, how much they think they're going to initially allocate, what the outlook is for the next 12, 24 months. And then we set breaks over time to revisit it. Got it. So the SEC is taking a closer look at some of the business practices in private markets.

26:33And there's a bunch of proposals out there. And I'm sure this is going to be litigated and lobbied. And who knows where this will eventually land. But could you just talk at a very high level about some of the things that they're going to be going after that you think, rightly or wrongly, do need to be revised? Yeah, we've been keeping up to date on it, mostly through media reports and also some sources that we rely on. In general, anything that enhances the transparency to end investors and creates perhaps better negotiating power to the LPs compared to the GPs, we're in favor on. I think where it can get a little tricky is if the right balance isn't struck, do some of these provisions create onerous burdens on the GPs for them to more efficiently deliver their strategy?