A 60/40 investment portfolio, in which 60% is invested in stocks and 40% in bonds, was long considered classic. But that’s no longer the case, as many investors are now diversifying beyond publicly traded assets.
Alternative investments, or alts, are a direct corollary to diversified portfolios. And they are not just for institutional funds: Individual investors too are showing increasing interest in this asset class, which encompasses all sorts of supports, from wine and watches to gold … and startups.
Startups can be on the receiving end of investments into alts, but some of them have also facilitated this trend. California-based fintech VC firm Broadhaven Ventures invests in companies on the tech side of enabling alts, with a portfolio including Allocate, Alongside, Alt, Capital (known until recently as Party Round), Caplight, Carta, Latitud, Pipe, Republic, Syndicate and others.
Talking to TechCrunch, Broadhaven co-founder and partner Michael Sidgmore said that when investing in the sector, the early-stage fund has “focused on helping to build out the alts ecosystem by investing in many of the enabling technologies across various areas of alternative investments.”
Sidgmore himself has spent a large part of his career in alts and launched a podcast and content platform called Alt Goes Mainstream in January 2021. We spoke with him about alts beyond crypto and what’s next for a space that’s seeing some of its tailwinds fade. His answers below were edited for length and clarity.
Has crypto volatility erased some of the rising interest in alternative asset investing?
Not really. I put alts into two distinct buckets — traditional alts and “alt alts.” Traditional alts include private equity and venture capital funds, direct investments into private companies, hedge funds, real estate and private credit. “Alt alts” include passion and community-driven assets such as art and sports cards; collectibles like watches, wine, sports memorabilia and vintage cars; as well as other culture assets like shoes, crypto and NFTs.
Crypto is an exciting part of the alts universe, but it’s far from the largest piece of the pie. Private equity, private credit and venture capital should see significant inflows as both individuals and intermediaries (wealth managers) look to boost their allocations to private markets and generate returns over the coming vintages.
What’s a common misconception about alts?
That they are “alternative.” I say that tongue-in-cheek — but only a bit.
Certainly, alternative investments are called “alternatives” because they differ in a number of respects from listed stocks and bonds, but these investments will become a staple in all investors’ portfolios due to the downstreaming (providing access to individual investors) and mainstreaming (alts encapsulating a larger portion of investors’ portfolios). We no longer live in the era of the 60/40 portfolio (60% stocks/40% bonds).
We have already seen this play out with pension funds, endowments and family offices, many of whom have generated superior returns over time with large allocations (more than 20%) to investments like private equity, venture capital, hedge funds and private credit.
Continued innovation in alts is now providing the appropriate infrastructure for both individuals and wealth managers to include high-quality alternative investments in their portfolios.
What makes you say that alts went mainstream in 2021?
Alts have gone mainstream over the past two years due to several trends in private markets that have made it more palatable for investors to put money into alts. I expect inflows to slow on an absolute basis over the next year or two in a rising interest rate environment, but we should still see meaningful inflows into alternative investments on a relative basis as the industry continues to grow and investors continue to increase their allocations thanks to the mainstreaming of alts and a more favorable regulatory environment.
1. Technology innovation: Alts have undergone a market structure evolution that has made them investable and tradeable. Just as we’ve witnessed with market structure evolutions in other asset classes, such as equities and fixed income, technology innovation has improved the experience across the lifecycle of an investment. Just as we’ve become accustomed to shopping online with one-click purchases, retail brokerages made one-click investing in stocks seem normal. Now, alts platforms such as Republic, AngelList, iCapital, Allocate, Alt, Rally Rd. and others provide very efficient access to invest into private companies, funds and assets online.
2. Favorable regulatory environment: Private investments into startups and funds were previously the domain of institutional investors. That is no longer the case thanks to a much more favorable regulatory regime for private companies, funds and investors. Crowdfunding regulations have enabled investors — both non-accredited and accredited — to access private markets. Regulation CF of the JOBS Act has enabled private companies to complete security offerings that allow them to raise up to $5 million from accredited and non-accredited investors online.
3. Once-low rates: We are currently witnessing a rising interest rate environment; however, the past decade-plus was generally defined by historically low interest rates. In response, investors went searching for yield, which generally meant seeking out investments higher up the risk curve. Alts fit the bill. It’s worth noting that certain areas of private markets may not be as attractive in a higher interest rate environment, so we expect some level of diminished demand in certain corners of the alts world.
4. Value capture having shifted to private markets: Private companies staying private longer shifted the value creation event for investors into private markets. Investors who were able to invest in companies and funds in private markets captured the value. Technology innovation has made it possible for investors to access private markets.
5. Largest asset managers wanting to distribute alts products: The world’s largest asset managers have sought ways to distribute products beyond ETFs and mutual funds to investors. Adding alternatives is a way to boost revenues when fees on other products are compressing and mutual fund inflows have been negative for the past several years. We’ve seen many large asset managers partner with or buy alts businesses, such as BlackRock taking a meaningful stake in iCapital and Franklin Templeton buying secondaries firm Lexington Partners to push their assets under management (AUM) in alts to over $200 billion. Asset managers seeking to distribute alts products to the wealth management channel have been a boon for alts platforms who partner with these large firms.
Do you expect private wealth to catch up with institutional wealth in terms of the percentage invested in alts?
Yes, I expect to see the retailization of alternative assets that will help private wealth get closer to institutional wealth’s allocation to alts. Technology innovation and regulatory changes have made this possible.
Both sides of the market — product manufacturers and investors — are ready for alts.
The supply side (asset managers and investment products) are ready to provide alts to individuals and wealth managers and now have the tools to reach this new group of investors in a systematic, efficient way that enables them to bundle up smaller investors. The prize? An $80 trillion AUM market of individual investor dollars.
The demand side (individuals and wealth managers) is looking to find ways to move away from the 60/40 portfolio and access alternative investments. A recent McKinsey study projects that retail allocation into alts has the potential to double from around 2% to 5% in the next three years.
KKR, a leading alternatives platform with $459 billion AUM, has said that they are earmarking 30% to 50% of newly raised capital to come from the retail channel. Blackstone, with $880 billion in AUM, now has roughly 25% of its AUM come from the retail channel.
Access platforms like iCapital, Allocate, Moonfare, CAIS and others are enabling individuals and wealth managers to invest into alts. And it’s a business-critical feature for wealth managers to offer alts to their clients, so I expect to see wealth managers meaningfully increase their allocations to alts.
Which asset class would you say is the most promising? Which one might be overhyped?
Private credit and venture capital are compelling asset classes to many allocators right now. In the current market environment, private credit and direct lending funds will have attractive opportunities to provide capital to many companies where they will be able to dictate terms and covenants. Venture capital funds, particularly seed-stage managers, should have attractive opportunities as valuations have come down over the past six months.
It would not surprise me to see funds (as opposed to direct investments) become more interesting to allocators over the next few years. Professional investors should have the best position to generate outsized returns, so I think access to platforms like iCapital, Allocate and Moonfare, which provide access to private equity, venture capital and hedge funds, should benefit from investors, particularly wealth managers, looking to increase their exposure to funds run by professional investors sourcing the best investment opportunities.
I believe that late-stage venture capital will face stronger headwinds in the current environment than early-stage venture capital. Access platforms and institutional/wealth management allocators will have to balance the desire to allocate to brand-name large funds with the willingness to take a bit more risk by allocating to smaller, early-stage and emerging managers. Those who are willing to take the risk will be rewarded.
What are some interesting value propositions you have seen startups make in this space?
Platforms where distribution outweighs technology have defined the first wave of alts innovation. Asset management is a scale game where adding AUM drives revenues. A differentiated product experience can certainly matter, but many of the largest businesses in the first wave of alts platforms have won by focusing on distribution.
iCapital, the infrastructure and access platform that enables the wealth community and private banks to access high-quality alternatives funds in a feeder fund structure, is case in point. iCapital focused on locking down distribution partnerships with the world’s largest asset managers (BlackRock, Invesco, Blackstone, Carlyle, Apollo, KKR, etc.) and with private banks. Trillions of dollars in AUM remain tied up in private bank and wealth management complexes. They need access to product and iCapital has partnered with these firms to bring the pipes to enable that AUM to flow into alts funds. This strategy has enabled iCapital to scale to over $150 billion in AUM and a unicorn valuation. [Editor’s note: Michael Sidgmore was an early employee at iCapital.]
Product matters, but distribution matters even more. Historically, alts have been sold, not bought, so investing in education is key to helping investors and intermediaries (wealth managers) understand the merits of alts in portfolios.
The next wave of innovation is going to centralize around the horizontal expansion of alts platforms that start in a specific wedge to build a business that far outstrips their initial market size.
For Carta, that’s meant moving beyond cap table management and 409A valuations to providing a secondary marketplace for investors and equity owners and fund administration services to VC funds.
For AngelList, that’s meant moving beyond SPV infrastructure [special purpose vehicle] for investors to offering startup banking services and rollup vehicles to companies who want to streamline capital raising and investor management and traditional fund administration services to large funds.
For Capital (formerly known as Party Round), that’s meant moving beyond SPV infrastructure to enable companies to raise rounds from smaller, value-added investors to offer a next-generation suite of banking and financial services products for startups built on both fiat and crypto rails.
Much bigger businesses are hiding in plain sight in the alts space, so I’m excited to see how horizontal expansion will create alts behemoths.
What’s left to be done to increase access to alts?
The average retail investor remains woefully underallocated to alts, with on average less than 2% directed to these investments. Increased access will be critical for the space to continue to grow. Platforms are enabling this access, but regulation could also be a helpful driver. It’s possible that we could see the ability for 401(k)s to have allocations to alts, which would be a big opportunity for the alts space and also match the illiquidity timeline.
I believe that the next frontier for alts is innovation with data. Data will create more transparency and the investing experience into alts. It’s interesting that many of the global exchanges are spending meaningful time investing into the alts space, such as London Stock Exchange Group investing into Floww, Nasdaq creating a private markets capability to trade private company stock and Deutsche Börse investing into private company stock exchange Forge.
With IPOs on hold, do you expect more M&As? Who would be the likeliest buyers: Banks? Tech giants? Others?
I do expect to see more M&A activity in the alts space. Banks and asset managers have made it clear that they want to build out their alts capabilities, so we’ll see further consolidation in the space, with large asset managers buying alts platforms to serve the wealth community.
We will also see larger alts companies with strong balance sheets acquire startups to strengthen their distribution, product offerings, data and infrastructure. Some examples of this include Public acquiring collectibles investment platform Otis, iCapital acquiring SIMON and Republic acquiring Seedrs.
What is your favorite unconventional quality in an entrepreneur?
I find that when founders have done something truly extraordinary in their past, it can be a strong indicator that they will be successful entrepreneurs. That spectacular thing generally isn’t related to the company they’re currently building, but the traits of what it takes to be great are related. Excellence shines, and it often tells us so much about the person, because to be excellent they have to be focused, have the right mental mindset, figure out how to get things done and put in the work.
Are you open to cold emails? If so, would you like to share an email address that founders can use to send you a pitch?
Absolutely. Great ideas can come from anywhere and we are seeing innovation in alts and fintech more broadly happen in all corners of the world. We invest into early-stage fintech companies globally and founders should contact us at investments@broadhaven.com.