Diving into the Wealth Channel

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When I started my journey into becoming a financial advisor in 2023, I came across a financial advisory firm specialized in providing clients with access to private investment opportunities in the sustainability sector. Their offering, to the most part, was not surprising, ranging from solar to wind to agriculture. However, one opportunity piqued my interest - a private placement of a bond for a mobility start-up offering investors a 6% interest rate. 

That seemed way too low for me: Interest rates had been going up, providing investors with EUR fixed income yields in that range at comparably lower range. Furthermore, 6% just seemed very low for the risk at hand, as the company was unprofitable, and actually raising equity as well. Why would any retail investor chose to take the risk for just 6%? Wasn’t this more like venture debt, which should at least have a double-digit yield?

I had a few theories, but I did not expect the final answer: “You’re absolutely right - but if the company asked for 12% interest, then retail investors would think it’s too risky.”

Over the years, I had more and more of such conversations, and they make me sad. We can argue about whether alternative investments make sense for the non-super-rich, and it goes without a doubt that selling to many small investors warrants a higher fee than selling to few large investors. But without a break, almost all private investment opportunities that I’ve seen benefit everyone but the retail investor. And it shouldn’t be that way.

Which is I am cautiously excited about the prospects of the so-called Wealth Channel. What exactly is it? What does it entail for private investors - and the financial advisors that try to sell to them? Let’s dive in.

What is the Wealth Channel (and why does it matter)?

In the past, alternative investment firms such as KKR or Blackstone did not raise money from retail investors. Instead, the capital for their funds came from institutional investors such as pension funds, insurance companies, or other asset managers. Over the recent years, this exclusive group was complemented by family offices.

A group that they did not actively pursue was wealthy individuals. There’s a number of valid reasons for them to not do so, ranging from sophistication (a wealthy dentist is perhaps not the best investor for a complex private debt strategy), to minimum ticket size (large funds typically look to raise 5-10M€ or more from an investor per fund), to access (it’s easier for them to find one large investor than to find many small ones).

And in the past, they didn’t need to. There were fewer competitors, and many of their large investors were only starting to see benefit in increasing their allocation to alternative assets. Today, things look differently:

• The market for alternative investments has matured. Private equity and private credit aren’t new anymore - there’s more competitors, competing for pockets of money that are at target allocation or even overallocated to alternatives.

• The market environment has gotten more challenging. Between tariffs, looming recessions, and higher interest rates, alternative asset managers are having a hard time to exit their investments at attractive prices - which locks up the capital of existing investors.

• Many alternative investment firms have gone public - and are looking for reliable new pockets of growth. For publicly traded GPs such as Blackstone or Apollo, performance and exits are important - but less so than showing growth in fee-related earnings from more predictable sources such as management fees. (For more on that development, check out The Rise of Permanent Capital).

Or to say differently: They need to tap other sources of capital. And for that, affluent investors seem like a natural fit. But those aforementioned challenges, especially the relatively smaller net worth per wealthy investor, as well as reaching them in the first place, remain. Which is why they try to convince wealth advisors and private banks to become their salesperson to reach those investors at scale. And that’s what we call the Wealth Channel.

It’s worth noting that the Wealth Channel is nothing new. In public markets, institutional asset managers have long complemented their direct distribution through partnerships with private banks, asset managers, and brokers. In their cases, the perhaps less sexy way to describe this was ‘Third Party Distribution.’ But it is new for alternative investments - which come with a less-established infrastructure and higher complexity than distributing an equity fund or ETF.

What (affluent) investors can expect

Let’s tackle that question by first asking another fiercly debated question: Why should affluent individuals care about alternative investments in the first place?

Our answer at Cape May would be simple: You don’t need to. In most cases, an affluent individuals’ Investment Objectives can be more easily achieved through liquid investments like stocks, bonds and commodities. And especially for entrepreneurs, there is merit to keeping your investment portfolio simple and to rather focus on entrepreneurial activities that offer a much better return on time and high-risk capital. But of course we wouldn’t be offering our clients access to alternative asset classes if we didn’t believe in them - and there are indeed some benefits to such alternative assets that we see:

• They offer investors a chance at a higher return. Asset classes such as private equity have historically offered investors an outperformance over public comparables ranging somewhere between 2-4%. Of course, this does not come without higher risk. But for investors looking to boost their returns, some alternative investments might offer prospects over riskier attempts do so in public markets (like picking individual stocks).

• They offer access to differentiated sources of returns. Whether it’s private companies, niche lending solutions or Listerine royalties: Alternative assets offer almost unlimited sources of less-correlated returns than one can find in publicly traded assets.

• They have some structural benefits over their public peers. Public investors are often limited in how active they can be as an investor. Private markets, in the ideal case, are unconstrained - offering opportunities that range from minority to majority stakes to ‘loan-to-own’ transactions that wouldn’t be possible for a typical UCITS fund.

(Of course, the same case can be made for the benefits of some public investments over private ones (i.e. wonderful products such as index funds that don’t exist for private markets yet). It’s important that investors don’t let themselves be fooled by sales-y claims in regards to risk-return and/or structure, and analyze each investment, public or private, critically.)

Attentive readers might already wonder: Jan, you said yourself that most retail-oriented investments you saw were not worth their money. Why should that be different for this new wave of products?

And that’s a very valid question. Many articles and papers claim that alternative investments are not worth their fees even for institutional investors - so it’s easy to imagine that it won’t be different for retail products that are at best just more expensive, and at worst also worse-performing. But there’s a few points that make me cautiously optimistic this time around:

• The regulatory framework. When I got started as a financial advisor, many advisors told me to be careful around alternative investments given their higher regulatory requirements. At least here in the EU, I actually don’t expect regulation in financial products to get less complex - which I would see as a win for retail investors: Even as Wealth Channel-oriented products become more widespread, financial advisors will be cautious to ‘sell’ products that they and/or their clients don’t fully understand.
  

• The product structure. Many of the prior retail-oriented products were launched specifically for retail investors with a risk-reward-ratio that no skilled institutional investor would’ve ever touch. The new wave of Wealth Channel-oriented products either allocate capital into investments alongside (pari passu) institutional investors, or are even the same product with different share classes. In some cases, the GPs themselves are also heavily aligned interest-wise (like Apollo investing ten billion dollars into its Aligned Alternative Fund).
  

• The liquidity profile. Most existing retail products were extremely illiquid with long-term lock-ups (5-10 years) with no (functioning) secondary market, and no option for the retail investor to redeem their capital vis-a-vis the GP. Wealth Channel-oriented products, on the other hand, are typically semi-liquid, meaning that investors can sell their shares back to the GP at regular intervals.
  

• Transparency. Semi-liquid products have an ongoing, auditable track record than prospective investors can look at before they invest - other than retail-oriented products such as dubious mezzanine bonds that sold them on expected (but never realized) returns.

Of course that view is simplified, with easy ways to critize each of my point. To name a few:

• The regulatory framework has not protected investors in the past.

• It doesn’t matter that there’s alignment between retail and institutional investors if the product is also a bad deal for institutional investors (as many claimed about semi-liquid secondary funds after a recent WSJ article). Alignment of interest with capital does also matter less if there are other components benefitting the GP, like their fee earnings from management fee or carry.

• A theoretical liquidity option is worth nothing if it doesn’t take place at a valid price (because of NAV shenanigans) and/or if the GP limits redemptions (gating, as we saw with BREIT). Liquidity also didn’t keep dubious advisors from selling underperforming public equity funds with a 5% one-time fee to their clients

But nevertheless, if done right, they seem like a much better option than many of the existing products. One can only dream of a day where retail investors actually get an equal (or better…?) product than institutional investors at perhaps just a slightly higher price.

What financial advisors can expect

With that in mind, let’s move onto the other side - financial advisors. What should they keep in mind as they consider offering such products to their clients? What are the chances, what are the opportunities?

To start with a key learning of mine as we build our offering in this area at Cape May: While everyone wants to start selling their fund(s) through the Wealth Channel now (or is even building a Wealth Channel-specific fund for that matter), offering this products is still far from easy to do, at least here in Germany. Challenges include but aren’t limited to operational questions (do we have the internal workflow to onboard, recommend and book such products?), regulatory questions (are external financial advisors even allowed to formally recommend a specific GP’s product and to charge a fee for it, i.e. Anlagevermittlung?), and of course investment-related matters (do I have the expertise as financial advisor to source, screen, select and monitor adequate products?). There’s a number of platforms that take on all or some of these challenges, and some GPs and advisors that I spoke to are convinced that in 12-18 months from now, access to semi-liquid alternatives will be a commoditized service. But at least for now, that is not yet the case.

But beyond that, an advisor might also wonder if they want to actually recommend such products to their clients. Or said differently - is it worth it?

First, whether those products are worth it for the client. There’s many products where I see this not being the case, and/or where liquid, passive products offer a higher chance of achieving similar results. But there’s also areas where I see clear benefits that cannot be found in public products - such as private credit (trading some level of illiquidity for higher ongoing distributions and structural benefits), or despite the recent negative press, secondaries (achieving long-term equity-like or slightly better returns, boosted through discounts as an undiversified return driver). As with any investment, advisors should be clear to their clients on what they can realistically expect (not 35% IRRs since the 1970s).

Secondly, if it’s worth it for the advisor. Clearly the less publicly debated question (likely on purpose), but equally worth asking. There’s a number of things to consider here. First, the operational side - as we mentioned, at least for now, semi-liquid alternatives are still more complex in terms of tasks such as custody or the advisory workflow, although this is getting better. Second, the complexity - do I want to go through the effort of sourcing and screening such active products if at worst they add little to no value to client portfolios? And third and last, the fee model - which revenue streams do alternatives drive for me; is it one-off ‘placement’ fees, an ongoing monitoring fee, and/or a retrocession from the asset manager?

Depending on your setup and general business model, your answer might look very different. A self-employed “one-man shop” financial advisor might be unwilling to add complexity through high-touch alternative products, even though they might boost their share of wallet and thus their earnings’. A small ‘investment office’ might have the employees to tackle screening, sourcing and operational complexities, but might have to ask if alternatives is aligned with their vision and asset allocation framework. A multi-family office might already be working on alternative investments with their larger clients, and can now also offer them to smaller ones.

Despite all the challenges that I’ve mentioned on client and advisor side, I think that the chances outweigh the complexities. Frequent readers (hopefully!) know that I advise any investor, regardless of size, to really think through their investment decisions. Alternatives, while clearly more exciting than public investments, are in most cases not needed to reach a client’s return goals, which is why clients should be careful about adding them. But their higher complexity does in some cases also add benefits: Financial advisors in the US, which are a few years ahead of us in regards to the Wealth Channel, tell me success stories of how liquid portfolios with 10-20% allocations to semi-liquid alternatives have seen higher returns/distributions and/or lower risks. I could see this happening here as well.

I’m curious to see how we’ll revisit this trend a few years down the line, or maybe even next year. You can be certain that I’ll keep you up to date on what we are thinking. 

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