The Alternative Investments Opportunity: Traditional Asset Managers at a Strategic Crossroads

In my discussions with traditional asset managers, alternative investments are the hottest topic, bar none. Nothing else is even close. The landscape of asset management is rapidly evolving, with alternative investments emerging as a critical frontier. This shift is reshaping strategies for both traditional asset managers and private market firms, as they vie for the lucrative high-net-worth (HNW) investor segment. This article explores the current state of play, the strategies being employed, and the challenges faced in this dynamic market.

For this discussion, I define alternative investments as non-traditional asset classes and strategies delivered in product structures that are not open-end mutual funds, ETFs, or other daily-liquid or exchange-traded vehicles. This encompasses a spectrum from interval funds to institutional-style drawdown funds, and everything in between. The target market for this discussion is HNW investors who, heretofore, have not had many compelling alternative investments choices.

This product space is shaping up to be a competition between two factions. One side includes traditional asset managers seasoned in serving the mass market and HNW investors with conventional offerings. The other side includes private markets firms, experts in serving institutions and family offices that make multi-million-dollar commitments to a single fund. Both are now maneuvering to capture the under-served and lucrative middle ground of the HNW market.

Discussions with traditional asset managers are wide-ranging, but they always touch on the key points of whether, when, and how to launch and grow an alternative investments business line. Despite broad consensus on the topic's importance and the need to define a strategy, agreement stops there as there is a wide disparity of opinions and strategies. The approaches traditional asset managers are taking with alternative investments business space can be segmented into three distinct camps.

Camp 1: Aggressive Entrants. The first camp’s strategy is primarily inorganic. These players are moving aggressively forward with the view that the traditional markets are in long-term revenue decline, and a transformational move into alternative investments is necessary and prudent. These players accelerate their entry via acquisitions and lift-outs, although this strategy may be supplemented with internal product development, which is a long-term play. These firms use their balance sheets and cash flow to invest and reinvest in their burgeoning alternative investments business line. A challenge of this strategy is the return on capital. Alternative asset managers enjoy valuations that are twice that of traditional asset managers (approximately 15.0x vs. 7.5x EBITDA based on publicly-listed comparables). Thus, a traditional asset manager that acquires an alternative asset manager needs a re-rating of their firm post-transaction, or else they suffer capital destruction, at least in the short term.

Camp 2: Steady Entrants. The second camp’s strategy is primarily organic. These players are focused on building an alternative investments business line in a methodical and capital-efficient manner, often with product vehicles that are hybrid in nature (think interval funds or evergreen LP funds). These businesses are approaching the alternative investments business line much the same way that a traditional manager would expand into a new asset class: recruit new investment talent, incubate a record, and prepare to apply distribution and marketing resources when ready. Most traditional asset managers (for whom the alternatives investments space is reachable) appear to be in this second camp or preparing to enter this camp to one degree or another. A twist on the second camp’s approach is market entry via a strategic partnership or joint venture. Capital Group’s recently announced partnership with KKR is a prominent example of this strategy, and it will be interesting to see how this partnership develops.

Camp 3: On the Sidelines. The third and final camp is on the sidelines, at least for now. These firms cite a few different reasons for their abstention. Some express skepticism that synergies can be realized between their current business and an alternatives business. Others see an unattractive opportunity cost: they are confident in their current growth plans and believe that they will derive superior returns by investing in their existing strengths than by trying to develop a new business altogether, one which also has greater uncertainty of outcome. These firms don’t dispute the attractiveness of the opportunity; they just don’t believe they are the best positioned to exploit it.

A key implementation point for market entry is the interval fund structure, commonly seen as a solution for delivering scalable alternative investment products to HNW investors. While theoretically promising, the interval fund has yet to fulfill its potential as a vehicle for HNW alternative investments. Despite increased launches and media attention, total AUM remains a modest $80 billion. Moreover, fewer than 20 funds have more than $1 billion of AUM and only one fund has more than $10 billion. The crux of the challenge lies in the classic 'chicken-and-egg' problem of seed capital. I have personal experience launching two interval funds that were not commercially successful primarily because of insufficient seed capital. Most financial advisors and home offices were unwilling to invest in an interval fund unless it had at least $50-75 million of AUM. The early adopters of our mutual funds and ETFs did not invest in our interval funds. We experienced a wall of resistance due to the AUM. Seeding a single fund with $50+ million of capital (especially when that capital is locked up for a long time) is prohibitive for all but the largest asset managers. Perhaps new entrants, many of whom are seeding funds with larger amounts, will have more success in 2025.

As we stand in the early innings of this market transformation, traditional asset managers face a critical strategic juncture. The allure of higher fees and locked-up capital is clear, but the path to success in alternatives is fraught with challenges and temptations. Firms must candidly assess their core competencies, potential synergies, and long-term vision. The easy answer for management, initially, is to launch a strategic initiative to enter the alternative investments space. In the short run, this may appease the Board and shareholders, promising extension into an attractive adjacent business. However, the hard part is delivering: in the long run, the execution must match the audacity of the vision. Even if the answer to entering the alternatives space is ‘no’, it must not be a default decision achieved through inaction. It must be a deliberate decision that weighs all key considerations. In the end, the decision not to do something may be the best one.

In this evolving landscape, companies’ decisions today on this important opportunity may well determine the winners and losers of tomorrow's asset management industry. The stakes are high, and the path forward requires careful strategy, honest self-assessment, and unwavering commitment to execution.

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“Beware the investment activity that produces applause; the great moves are usually greeted by yawns.”

- Warren Buffet