Redefining the Horizon: Shedding Light on Independent Advisor Access to Hedge Funds

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1 Redefining the Horizon: Shedding Light on Independent Advisor Access to Hedge Funds by Matthias Paul Kuhlmey, Managing Director and Colin Healy, CIMA, Executive Director

2 About HighTower HighTower is the first nationally operating, advisor-owned financial services firm. HighTower advisors are experienced investment professionals with established practices serving high net worth individuals and institutional clients. As a dually-registered, multi-custodial and multi-clearing firm, HighTower provides sophisticated open-source investment solutions as well as an independent and unobstructed view of the markets. The company is headquartered in Chicago and maintains corporate centers in New York and San Francisco, and offices around the country. See *Disclaimer and Methodology The statements included herein are the opinions of the authors and are not intended to be statements of fact. Such opinions are derived from the research of the author and from third party sources that are believed to be reliable but cannot be verified or guaranteed. All of the opinions and views herein are as of the date of this publication and no obligation to update is undertaken or should be inferred. Securities offered through HighTower Securities, LLC, Member FINRA/SIPC/MSRB, HighTower Advisors, LLC is a SEC registered investment adviser HighTower Holding, LLC 2

3 REDEFINING THE HORIZON: Shedding Light on Independent Advisor Access to Hedge Funds The Economic Crisis of exposed fundamental weaknesses of the financial system, ultimately prompting wealth advisors to question their way of doing business and long-established industry traditions. With economic indicators improving, but market volatility still elevated, an increasing number of advisors continue to reassess their role in the larger context of providing investment advice. Because credibility issues of traditional firms continue to exist, more advisors have developed new objectives that include forging deeper client relationships, improving practice management and increasing assets under management. All considered, the independent space for providing investment advice appears to be a natural fit for many. According to a study conducted by Cerulli Associates 1, a research firm specializing in the financial services industry, a small group of intensely specialized independent registered investment advisors (RIAs), serving as fee-only fiduciaries, will dominate the retirement investment market for years to come. 2 The study concludes that these RIAs are positioned for significant growth, particularly as new Department of Labor rules restrict conflicts of interest in the management of retirement plan assets. 3 At the same time, the popularity of alternative investments, such as hedge funds and fund of funds, has grown dramatically over the past few years. According to Cerulli s Retail Alternative Products and Strategies 2011 report, mutual funds using alternative strategies such as long-short equities and commodities experienced an increase of their respective assets by 60% last year. 4 In comparison, all other long-term investments in mutual funds increased assets by 16%. In addition, the report indicates that 65 alternative mutual funds were launched in 2010, up from 45 in Despite this positive development, a significant number of established wirehouse advisors question the independent space with respect to its accessibility to alternative investment solutions. FOLLOW THE MONEY: The Growth of Independent Advisors While wirehouse assets represent 60% of all assets of managed solutions nationwide, the number is down from 64% of all assets in In the second quarter of 2009, nonwirehouse firms grew their managed solutions assets to $711 billion from about $500 billion, giving the independent space a 40% market share vs. the previous year s 36%. It is questionable, however, if this perception can be supported by real numbers or if breakaway advisors truly have less of an opportunity to choose from top hedge fund managers when compared to their wirehouse counterparts. ABOUT THE SURVEY In the summer of 2008, HighTower initiated an informal research project to address concerns and answer questions as stated above. The firm began to collect data with the purpose of exploring and demystifying the complex world of alternative investments for advisors from inside major brokerage firms and across the independent space. HighTower identified two emerging trends: 1. The increase in numbers of advisor teams exploring independence 2. The rise of third-party alternative investment platform providers The second trend was subsequently confirmed by a Cerulli study that showed a 46% increase in availability of alternative investments in the independent space from 2008 to HighTower began exploring both trends with the goal of initiating an industry dialogue about optimal solutions for clients, and also to dispel the ambiguity surrounding the availability of hedge funds. HighTower asked questions related to pricing, account minimums, as well as research resources in order to create data that would allow advisors and their clients to assess alternative investment solutions more comprehensively. Data was collected from advisory practices, custodians and individual hedge funds, and stored in database format for each wirehouse and as a whole for the independent space. The survey s overarching conclusion correlated with a majority of Cerulli findings, with an additional -- and unanticipated -- discovery that independent firms had access to at least four times as many hedge funds as wirehouses.* 3

4 SECTION I RESEARCH RESULTS AND METHODOLOGY RESEARCH RESULTS: WIREHOUSES According to HighTower survey results, the three wirehouse platforms offer: A narrow selection of hedge fund managers within each wirehouse; Limited access to the broader hedge fund universe; Very limited access to top-performing hedge funds; Little access to the largest hedge funds. Of the wirehouse-approved funds covered by the HighTower survey, 74% were available at HighTower (as a proxy for the entire independent space) through a thirdparty provider, a custodian or directly by the respective fund in comparison to wirehouses, where direct access is not allowed. This also included 80% of the largest funds in the hedge fund universe. Overall, the research suggests that custodians, such as Charles Schwab, avoid hedge fund platforms. Consequently, investors seeking access to funds that are not available on a bank/brokerage platform are on their own. This market gap, however, has been filled by a number of specialized alternative investment providers. Firms, such as Altegris, CAISfunds and Central Park Group, have emerged to provide a channel for independent advisors to select from a wide variety of high-quality hedge funds. RESEARCH RESULTS: INDEPENDENTS According to HighTower survey results, independent platforms: Increase the number of third-party independent providers; Provide access to most funds available through wirehouse platforms; Increase access to funds not available through wirehouse platforms. METHODOLOGY HighTower researchers interviewed 500+ high net worth advisory teams over a three-year period. 1 In the process, HighTower built an approximate inventory of managers from the wirehouse platforms of Merrill Lynch, Morgan Stanley and UBS. Survey questions included: What does the wirehouse platform offer? How are managers selected for those platforms? Can investments port over to the independent space? What platforms are accessible to the independent advisor GLOSSARY OF TERMS HEDGE FUND Private investment vehicle available in a limited partnership structure. WIREHOUSE One of the last remaining brokerage houses on Wall Street: Bank of America/Merrill Lynch, Morgan Stanley/Citi/Smith Barney, and UBS. INDEPENDENT ADVISOR Registered investment advisor who has access to investments via a custodian, third party vendors or directly from the fund itself. PLATFORM A grouping of funds that exists with a predetermined contract, including fee, minimum, terms and liquidity. A platform must also vet the funds with an acceptable form of due diligence. 1 Ultimately, HighTower transitioned approximately 25 teams from wirehouse legacy platforms, including their hedge funds, and expects to transition several more large teams by the end of 2011 with significant hedge fund investments. 4

5 SECTION II RESEARCH RESULTS: A CLOSER LOOK WIREHOUSE ACCESS TO ALTERNATIVE FUNDS CHART A This data reflects the number of hedge fund offerings managers, not strategies --- available at three major wirehouses, broken down by single strategy and fund of funds. It demonstrates that the largest of the wirehouses offers access to about 30 hedge fund managers, with about 14 or 15 managers also available at the other two wirehouses. Conclusion: Only about 15% of the offerings overlap amongst the three, which means that very few hedge fund managers are available on at least two wirehouse platforms. 5

6 CHART B This data, which was collected primarily from HighTower advisors, reflects the number of hedge fund managers available across each wirehouse platform. Only about 10 are available at two wirehouses and, in general, little overlap exists among managers at the wirehouses. 6

7 CHART C According to HighTower data, the wirehouses only have access to about five of these high-performing, well-known asset managers. 7

8 INDEPENDENT ACCESS TO ALTERNATIVE FUNDS In addition to interviewing advisory teams, the HighTower researchers surveyed third-party alternatives platforms, custodians and individual hedge funds to measure availability to wirehouses and independents. Respondents included advisory practices, custodians, platforms and individual hedge funds. 2 More asset managers are focusing their efforts on RIAs as their primary strategy for distribution of alternative investments, with 73% in CHART D This data shows that from managers of alternative products and strategies increased their distribution to RIAs at a high pace, while distribution focus on wirehouses decreased. 2 HighTower researchers collected and stored data in database format for each wirehouse and, as a whole, for the independent space. HighTower researchers did not have direct access to the manager rosters at the wirehouses. Data collected about independents ended with dozens of additional platforms and providers still available. Due to time constraints, not every independent provider in the space, let alone thousands of individual funds, were surveyed. 8

9 CHART E* This data demonstrates that the number of independent platforms offering alternative funds is growing. Some of these specialized firms were formed recently, indicating that alternative platforms are multiplying and gaining in popularity. This presents a number of opportunities for independents to access alternative products. CHART F This data, which is based on responses from custodians, demonstrates that of the roughly 66 investment managers available, independents have access to 73%, or 48, of them through third-party providers, custodians or direct contractors. 9

10 CHART G CHART C showed that wirehouses only have access to about five of the largest hedge funds. The data in Chart G demonstrates that independent firms have access to 80% of the largest hedge funds. SECTION III FINAL ANALYSIS Based on its research, HighTower was able to confirm what had previously been only theory: (a) that independent advisors have significant access to the same hedge fund managers available at the wirehouses, and to many more as well; (b) that, on average, wirehouses offer access to roughly 12 hedge fund managers, while independent advisors can choose from potentially 50 hedge fund managers; and (c) that asset managers are ramping up their efforts to work with RIAs, noting that 73% of asset managers focused their efforts on RIAs as their strategy for distributing alternatives in As more advisors strike out on their own in search of flexibility, freedom and greater capabilities to better serve their clients, our research shows that they can do so with the knowledge that, while wirehouses offer quality products, the independent space allows greater choice through customized inventory, mixing and matching access points from third-party providers, custodians and direct access. 1 Shidler, Lisa; Cerulli Report: Specialized RIAs likely to win middle-market 401(k) plan battle; RIABiz; April 14, 2011; accessed June 27, Shidler, Lisa; April 14, Shidler, Lisa; April 14, Benjamin, Jeff; Alternative investments on the rise in retail world; Investment News; April 15, 2011; investmentnews.com/article/ /free/ ; accessed June 27, Benjamin, Jeff; April 15, Levaux, Janet; Wirehouse Assets: Still on Top, But Losing Market Share; AdvisorOne; August 31, 2010; advisorone.com/article/wirehouse-assets-still-top-losingmarket-share; accessed June 27, Cerulli Associates; Cerulli Quantitative Update: Cerulli Retail AlternativeProducts and Strategies

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