Feb 08. 00:12
Interview: Two Managing Directors From Alternative Investment Platform CAIS
Welcome to IntervalFunds.org. Today (12/21/2021) we have the pleasure of speaking with Brad Walker, Senior Managing Director of Alternative Investments, and Nic Millikan, Managing Director and Head of Investment Strategy, both at leading alternative investment platform CAIS.
CAIS, founded in 2009, solves for a longstanding infrastructure problem that limits access to alternative investment strategies – namely, having a unified place to efficiently explore alternative products, conduct diligence, and execute transactions.
Any advisor who has stared down a foot-thick stack of sub docs on behalf of clients seeking alternative income will immediately see the value in CAIS’s work. Not only does CAIS list products spanning hedge funds, private equity, private real estate, private credit, and structured notes, they make third-party diligence available via Mercer, offer technology-assisted subscriptions, and even provide their own advisor learning module, CAIS IQ.
We can’t think of a better team to interview for our theme of RIAs under-allocating to interval funds and alternatives than a firm that is at the forefront of closing that gap. Gents thanks for joining us today.
IF: Starting with a bit of a level set – it’s December 2021, inflation is at a 40-year peak and real yield on TIPS is negative. Equities are still on a historic bull run, but were likely propped up by quantitative easing and P/E ratios are significant. This really feels like an inflection point for alternatives and the interval fund wrapper given the difficulty in finding yield, but both of you have been involved in alternatives in some capacity for at least a decade, with Brad joining CAIS in 2012, and Nic joining boutique real assets firm Salient the same year. So – what were you seeing ten years ago that motivated a full court press on alternatives?
Brad: My career started in wealth management, so I was at CitiBank circa 2004 – 2010 at which point I left and led wealth management and distribution at High Bridge Capital Management for a few years before joining CAIS in early 2012. I’ve been leaning into alternative investments for the better part of two decades now, one part on the allocator side and one part on the asset management/tech platform side.
Historically, alternatives have largely only been accessible to the wealthy – and when you think about allocating in financial markets, if you’re not “wealthy” you’re allocating to stocks, bonds, and mutual funds. As we’ve seen, volatility is real, and traditional 60/40 allocation is being challenged. It’s important for folks to understand the use of alternatives, and that they’re an asset class that can do three things – diversify risks from stocks and bonds, enhance returns via access to new types of opportunities that aren’t accessible to stocks, bonds, and mutual funds, and also provide yield in this low interest rate environment.
Knowing there’s something out there beyond stocks and bonds put me head-on into wanting to understand alternatives better. I’ve been working to bring this asset class to wealth management for 14 years.
Nic: I started my career at BlackRock and was working in Australian quantitative equities, working with institutional clients in the Asia-Pacific region, before moving to NYC to work on our global bond products. I worked across the globe working with clients ranging from retail to sovereign wealth funds, all types of traditional actively managed strategies. Seeing the plethora of solutions out there, everything started to look very similar. Having the ability to see how a pension was allocating money, as opposed to independent wealth managers, or even retail clients, exposed me to the valuable roles that alternatives play within a portfolio.
Flash forward to my time at Salient where we were constructing alternatives to asset allocation, we looked at the 60/40 portfolio and saw secular trends with interest rates declining since the early 80s. Of course, as rates decline, bond prices go up. During that period you’d be hard pressed to find a better-returning asset class on a risk-adjusted basis than a bond. Bonds provide income and capital preservation – not appreciation – and that confluence of bond yields declining and equities appreciating is great for 60/40. The problem we have is that it ends when rates hit zero and valuations in equities are at the levels we’re seeing right now. We have an arguably overvalued stock market, interest rates can’t go anywhere but up, and we have drag inflation which is deleterious to the overall portfolio – you have negative interest rates in most of the developed world. I liken it to carbon monoxide, where you initially don’t notice it, but over time it’ll kill you. You need to outpace that pressure, and to do that, alternatives offer attractive non-correlated sources of return, or additional drivers of alpha in an overall portfolio.
That led me to alternatives, which led me to CAIS. We’re revolutionizing an industry that hasn’t seen the disruption faced by other industries, and we’re certainly leading by disrupting the traditional model of financial services and product distribution.
IF: This misnomer of alternatives being risky and hard to value – it’s interesting how often that continues to show up. People don’t think you can earn the yield of a junk bond with the risk profile of a quality municipal bond, and don’t know how to evaluate risk on unrated securities.
Talk to me about how you’ve seen demand on your platform evolve since 2009, both in terms of asset managers looking to list products as well as from advisors.
Brad: In 12 years there’s been a giant shift – I’ll give you a couple examples. When we first started in the business we knew there was an opportunity in independent wealth management (RIAs, RIA aggregators, and broker-dealers). In the early days we would speak with asset managers, and 3-4 out of 10 would say “that’s a really interesting business opportunity.” 6-7 would say, “we’re out. We can go to Morgan Stanley, Merrill Lynch, and UBS and then pick an institutional endowment or foundation, and be just fine.” Wanting to be in the independent wealth channel was like, “no thank you,” but we kept our heads down because we knew everyone would want to be here.
It’s a fantastic wealth management channel, the advisor channel we work with is amazing, they just didn’t have access – so they weren’t calling on asset managers, and so asset managers didn’t know the space. What’s happened over the last decade is asset managers are realizing that independent wealth management is a large and growing channel. They’re strong, sophisticated wealth advisors, and they’re under-allocated to alternatives in a big way. It’s not because they don’t believe in them – the reasons are, how should an advisor access them? If they can, how do they know what’s performing?
That’s one of the biggest questions we hear from the market all the time. If there are just a few options, and they sound too good to be true, can someone smarter than me do due diligence on these products and put an institutional stamp on them? Conversely, with a lot of options, how does an advisor weigh the good, vs the bad, vs the middle? Again, it would be great to have a due diligence provider smarter than “me” putting an institutional stamp on them.
What’s happened over the decade is:
The wealth advisor is becoming more confident talking about alternative investments, which means the client conversations are now starting to include alternatives. They’re feeling more confident and empowered to have that conversation.
The asset manager is now seeing the opportunity beyond institutional and wirehouse capital to bring unique solutions to independent wealth, and it’s an under-allocated part of the industry. Together, with a platform like CAIS and an asset manager leading in with education (the “what,” “why,” and “how” of alternatives) is really changing over the last decade.
What we’ve seen over ten years is a change in investment structures. After the financial crisis, hedge funds protected capital quite well. Everyone wanted a hedge fund allocation, but we’re running into a bull market on equities, and hedge funds by nature focus on risk-adjusted return, not just absolute returns – so how do advisors maintain performance while moderating risk? Hedge funds have generally done relatively well risk-wise, but over the past five to six years people have been pushing money into private equity, private real estate, private credit, and investments that show a yield component. We had to move from hedge funds to private markets, and this year our flows are an even balance. You also saw a lot of structural innovation. The 3c7 structure – general partnerships and limited partnerships – used to be it.
Now we’ve seen the rise of some tender offer structures, the rise of some BDCs, some REITs, and suddenly you’re in a world where asset managers want wealth management capital but their structure isn’t perfect. So asset managers are asking, what types of structures can give you those return streams but are more wealth management friendly – open-ended, scalable, fully-funded types of products. It’s not for every single wealth advisor, but I would say the vast majority are looking for the easily scalable, “asset allocation” type of access point that alternatives can give them.
IF: The 1940 Act has been amazingly resilient against regulatory uncertainty this year relative to ESG, ETFs, SPACs, IPOs, etc but funds that have been able to innovate within the ‘40 Act structure have been relatively free from regulatory scrutiny in 2021. Even though it provides, for innovation it also mitigates innovation risk, which has been interesting.
Nic: If I were an allocator or asset manager out there, I’m working off the fact that no new pension funds are really coming to market. You might have an asset manager that has one or two big pension funds or endowments, and they’re really at the whim of the CIOs of those orgs to continue to want to invest with them. The opportunity that we have for asset managers is the diversification of their business.
We can deliver 100-odd CIOs that are all doing independent work with low correlation to the overall market, and they appreciate the diversified capital base and new source of capital that is under-allocated. The opportunity isn’t just diversifying the capital base, but also growing it, because the independent wealth management channel is allocated from 1-to-2-to-3%, and family offices and wires are closer to 10-to-15%, so there’s an opportunity to diversify the capital base, but also grow it as an asset manager.
IF: Let’s look at the closed-end interval fund wrapper. We’re wrapping the #2 year for new interval fund registrations currently. We are obviously biased toward interval funds than other both ’40 Act and private ways to gain exposure to alternatives, and one thing we appreciate is it can bridge the gap between retail investors and private markets. Have you seen an uptick in interval fund adoption on your platform to mirror the growth in the broader space?
Brad: Yes. We’ve seen a large uptick in the use of interval funds. It’s been a larger uptick on interval funds and lower-accreditation products. Our platform has 15-or-so products that are for lower-than-Qualified Purchaser-accreditation clients. That uptick is there because it used to be the case where advisors were bringing solutions to their clients, and now clients are starting the conversation with advisors.
IF: Can’t wait until interval funds are “bought, not sold.”
Brad: That’ll be a good time for everyone. Look at more end clients going to RIAs and saying “look, we had a phenomenal run in equity markets in 2021,” and so clients are asking what the next ten years looks like. They’re provoking that conversation with their RIAs outside of conversations about stocks and bonds. I think that’s why we’re seeing an uptick in interval funds, tender offer funds, and lower-accreditation-type products. A lot of folks are getting into alternative investments, and these are products they can use.
IF: We also have a generational shift happening. A lot more people will be living off fixed-income from target-date funds and the like, and you look at fixed-income yields, and think “wow, I can allocate the same amount of capital to a different product and triple my income? I’m motivated to go learn about these things.”
Brad: Exactly. You look at 2021 and how your bond portfolio did for you this year. How many folks in a traditional 60/40 have a down or flat “40?” We don’t know what inflation will do. You have access to products that weren’t there before, like private credit and direct lending. If you can get an 8-10% yield, but even 6-8%, that’s a lot better than down or flat in your “40.” The access to these types of strategies in interval or lower-accreditation-type structures is leading to increased volume numbers. Our volume is well up over 100% year-over-year just across the platform. Advisor usage is up well over 100% year-over-year. I say that because our focus is on adoption and usage –and we’re seeing both happen.
Nic: If we look at the interval fund platform, year-to-date we’re getting a fourth of dollars going into the interval fund structure, which is quite remarkable given how small interval funds are as a percentage of our overall platform. We’re also seeing a realization that liquidity isn’t necessarily the panacea for all allocation decisions. You don’t necessarily need that liquidity, and liquidity can hurt you – it allows you to do the wrong thing at the wrong time, an investor behavioral trait we see sometimes.
IF: You’re knocking off 200 bps of yield to pay for daily redemptions that you’re not using in a long-term investing strategy, and that seems incredibly expensive.
Nic: Especially if you look at pools of capital that are looking for yield, that’s exactly right. Most people are retiring at 65 and living to 80-85, so looking over that 15-20-year window, so “do I need to have daily liquidity for my fixed-income allocation, or can I afford to put that money to work in an interval fund structure, where I do have liquidity if I absolutely need it?” Or, do they want to move further into private markets, and access private equity through a tender offer-type structure where they’re getting the growth component that should outpace inflation over the long term? The product set may align with the overall investment goal of the retirement phase for some.
IF: As far as technology being a barrier to bringing interval funds onto your platform, we can see tech-enabled operations being an advantage for interval funds, but also recognize challenges integrating with legacy FinTech. Has it been a challenge to bring interval funds, which often have subscriptions handled via paper docs, onto your platform?
Brad: From our perspective it’s quite simple. Many of the interval funds transact with a ticker symbol. The subscription process is unique. Some of our clients prefer to use the ticker symbol, that they trade through their custodian, but some request we create subscription documents for the product. You often see that in the broker-dealer world, where broker-dealers say, “we understand the product is available for below-accredited clients, but we still want a check-and-balance,” which requires a signature on a subscription document.
Part of our platform’s value proposition is that we have a customizable platform to meet the needs of the RIA or broker-dealer. We can facilitate the ticker symbol transaction, and if someone needs to transact via a subscription document, we can digitize it and electronically execute it via DocuSign. So, the interval fund onboarding process is simple, and then on the private funds side, our technology platform offers a monster advantage through the complete digitization and automation of the transaction workflow.
IF: As far as advisors go, there are a bucket of surveys and studies show clients increasingly asking about private markets – particularly private real estate – but RIAIntel found that the average advisor allocates less than 5% of assets to alternatives in any fund wrapper. Compare that to north of 40% for large family offices. Clearly there is a disconnect here.
Normally we’d ask more broadly why RIAs aren’t taking more advantage of interval funds, but the answer comes down to some of your core offerings – ease of research and due diligence, advisor education (especially B2B2C), using tech to maximize ease of use in transactions. So given that the entire CAIS business model is built on solving these problems, maybe you can get into some more granular detail about why more RIAs aren’t adopting alternatives today.
Nic: It is a level of comfort. This industry is heterogeneous in nature, hedge funds are different from one another, and the performance dispersion between the best and the worst is large. You’re coming to the conversation at a disadvantage due to that asymmetry of information and difficult accessing it. CAIS is trying to break down that barrier – that’s why we work with Mercer on independent investment operational due diligence to vet the managers and try to identify those that are of investment quality and rating. That’s part of our core business offering and a key differentiator of us in the market.
Then you look at services like CAIS IQ, where we meet the advisor where they are in their journey of understanding alternative investments. We use artificial intelligence and machine learning to understand where the advisor is in that journey and provide them with education that’s appropriate to bring them up that knowledge curve until they’re comfortable having those conversations.
We want to put advisors in the best situation, with the access to the best products, and if we can’t get them comfortable with these solutions that they would implement in their clients’ portfolios, they won’t have that conversation to begin with. Think about a wire where you have teams of people thinking about this daily – the independent wealth management doesn’t have that, and so that’s the gap we’re looking to fill.
IF: This has been phenomenal. Is there anything else I should have covered today?
Nic: From an investment perspective, diversification has been costly over the last ten years and we’re in an environment where active management becomes important to navigate the types of dislocation we’re going to see, especially if we’re moving toward a more normalized monetary and fiscal policy outlook. Forward capital market assumptions are low-single-digits for 60/40 and most riskier asset classes, so it’s time to start thinking about diversifying portfolios. It’s like insurance – it’s costly until you need it.
As you said, we feel we’re in a market inflection point where diversification, non-correlated returns, and access to diversified drivers of alpha and true return are going to become increasingly valuable.
What’s in store for Brad, Nic, and CAIS going forward? What should we look forward to down the pipe?
Brad: We’re in hyper-growth mode as a business. We’re around 150 people today, going to 250-300 in short order. Our tech team is now 70 and growing. We’ve laid a lot of strong groundwork in the industry, both on the advisor side and the asset manager side, and now there’s a lot of energy being pushed into having technology enable all parts of the business. We have so much data. Structuring that data and having the industry be able to leverage that is big. Tech-enabled distribution – we are learning how to help advisors make decisions faster and not spend all their time analyzing. Get them the information faster so they can make more informed decisions faster.
Nic: I would add we’re at a point of maturity in our industry and our business where people want more access to more information, more thought leadership, more ways to consider and conceptualize the opportunity set in front of them, so for me, 2022 is going to be focused on evangelizing the case for the alternative investments the market is looking for. There’s no single source of truth or single entity that owns that, and CAIS wants to do that on behalf of advisors, the independent wealth management channel, and ultimately investors.
Brad: At the heart of all of it, it’s the client experience. If you aren’t hyper-focused on the client experience, you’re missing it. That’s the heart of our organization, making sure the experience of both sides of our market is perfect, seamless, easy, and quick.
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