Animal Spirits Podcast - Talk Your Book: Streamlining Alternative Investments

Episode Date: May 22, 2023

On today's show, we are joined by Brett Hillard, CIO of GLASfunds to discuss advisor pain points when investing in alts, the fund manager due diligence process, how interest rates affect the alternatives market, and much more!   Find complete shownotes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation.   Check out the latest in financial blogger fashion at The Compound shop: https://www.idontshop.com   Investing involves the risk of loss. This podcast is for informational purposes only and should not be or regarded as personalized investment advice or relied upon for investment decisions. Michael Batnick and Ben Carlson are employees of Ritholtz Wealth Management and may maintain positions in the securities discussed in this video. All opinions expressed by them are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. For additional advertisement disclaimers see here https://ritholtzwealth.com/advertising-disclaimers. Investments in securities involve the risk of loss. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. The information provided on this website (including any information that may be accessed through this website) is not directed at any investor or category of investors and is provided solely as general information. Obviously nothing on this channel should be considered as personalized financial advice or a solicitation to buy or sell any securities. See our disclosures here: https://ritholtzwealth.com/podcast-youtube-disclosures/ Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is brought to you by Glass Funds. Go to GlassFunds.com, that's G-L-A-S, to learn more about how they work with advisors to bring alternative investments to their clients. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion, and do not reflect the opinion of Ridholt's wealth management. This podcast is for informational purposes only and should not be relevant.

relied upon for any investment decisions. Clients of Ridholt's wealth management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. Michael, one of the initial jobs I had early in my career was working for an investment office for a billion dollar fund, not to brag. And one of the, we were a small investment shop. There's only three of us, right? And one of my roles was as sort of operational manager of hedge funds and private equity. And I had to track capital calls and distributions from private equity accounts and paperwork. It was just a mess for such a small team. And it was a lot of like heavy lifting for these funds. And I came away from that experience thinking the

operational inefficiencies of running alternative platform are just not worth it if you have to do all of that heavy lifting because there's so much that goes into running it that you just don't have to deal with for more liquid public investments. How many funds were we talking? Do you remember, give or take? Hedge funds, probably a dozen private equity funds, probably 30 to 40. Jeez. So it was, I mean, it was a lot of, you know, new funds coming on and old funds maturing and money being moved around. And I learned a lot about how hard it is to get that to a more, to a very, and we were coming from, it was brand new money at the time. So we were like building it up. And so it wasn't like a mature book yet of investments.

It was... What year is this? Like 05 or... Like 07. 07 is when we kind of, when I started. So we were building it up. And so it was a lot. And I realized like you need to be, you need to have expert level knowledge, not just investing

wise in terms of like, you know, putting your money in the right funds or diversifying the right way and alternatives, but operational. You have to be a ninja to make that kind of stuff work. and so I thought it was interesting in this talk we ever talk your book with Brett at Glass Funds that that seems to be the main focus for them is the operational stuff and making it easier because you and I have looked at at plenty of different alternative strategies over the years and that is always the big pain point right is okay the strategy sounds great but how are we going to implement this operationally how can our advisors understand it and how can our

operation people actually make it work with cash flows moving in and out and working with the rest of the portfolio and performance printing, all this stuff, that's the difficult stuff for this, especially when it comes to advisors. Yep. So we get into all that, how Glass Funds works with advisors

to streamline the investment process. So without any further ado, here is our talk with Brett Hillard. On today's show, we're joined by Brett Hillard. Brett is the chief investment officer at Glass Funds. Brett, welcome to the show. Hi, thank you. A pleasure to me.

you, Michael, and Ben. All right. Let's start with the company. What is the origin story? What is the Infinity Stone deal with, man, I tried way too hard of that. I'm sorry, audience. What is the origin story for glass funds? Yeah, it's actually interesting origin story. Back in 2008, the founder, Michael Maroon, who's currently our CEO, he realized after working as a wholesaler for a traditional hedge fund of funds, he kept getting questions from his clients, hey, can I just allocate to this underlying manager, that underlying manager instead of the complete portfolio? So he realized that there was a growing demand for more bespoke, customized alternative portfolios. And he worked with a lawyer friend of his to draft up a novel legal concept that would allow certain actions.

for investors to more easily access blue chip hedge funds, as well as create fully bespoke customized portfolios based on the needs and risk tolerances of their underlying clients. So Glass Fund started out as a customized hedge fund platform for about the first four or five years. And then with growing demand from wealth management for private capital funds, started onboarding private funds like buyout, venture, growth, private credit, starting in about 2012, 2013. And we've made a number of iterations to make the process as seamless and frictionless as possible for advisors to allocate to alternatives across their client base.

And today, we cover the full spectrum of hedge and private capital. It's a fully digital process online. and, you know, advisors can come on the glass platforms and create fully customized alternative portfolios across hedge and private capital across their client base. Brett, but I should mention that is, I am jealous, that is a baritone voice right there. Credit to you, sir.

Yes, I've heard many of times that I should be on the radio. My dream job is to do voiceover work for, like, movie previews and commercials. Well, yeah, I mean, you've got it, man. You've got it. All right. So before we, we're going to dive deep into glass funds and how it works. But what problem are you solving for? So we were an RIA.

We want to do some private investing. What sort of pain in the butt things do we have? What sort of hoops do we have to jump through to get our clients to access to these funds? Sure. So first and foremost, there are qualifications thresholds. Our platform, we only work with qualified purchasers or QPs. So that's. What does that mean?

So a qualified purchaser, based on definitions by the SEC, they have to have a certain amount of assets and a certain amount of net worth to be qualified as a QP. And then once they're qualified, they can access QP eligible strategies, which most institutional hedge funds and private capital funds do have the QP threshold. So I assume you're doing all the due diligence up front, picking the managers, and then the advisors come to you and say we're looking for this certain type or we're looking for you guys to help us and you can get us placed and that's how the investment process works. Yes. There's some additional capabilities. So going back to, you know, what are the issues that wealth managers have when trying to allocate two alternatives. There are a lot of pain points. One is the. there's high minimums. So some minimums go up to 20 million plus. And when individuals are looking to build a diversified alternative's portfolio, that becomes very owners very quickly.

So we're able to aggregate positions to allow individual investors to essentially allocate to funds for as little as $25,000. Secondly, there's a lot of paperwork in terms of subscription documents. And for a larger institution making one subscription, that's not that big of a deal, but when you're trying to scale an alternative program across dozens, if not hundreds of individuals, it's very challenging for advisor firms to consistently fill out 100, 200 page subscription documents. So we've digitized the full process, takes six to eight minutes to fully on board a new

client and submit the necessary information for AML KYC. And then also the subscription is fully electronic, fully electronic signature. So, you know, we don't have to send out paper docs to the end client or the advisor firm. And then... I'm sorry. My previous life, I worked for a small investment office, and there's three of us in endowment fund. And like you said, we worked with dozens of private equity and hedge funds and alternatives.

And you're right, the 200-page documents they had to sign, and they're all legalese and lawyer speech, speak. And it's very operationally inefficient and difficult to just, allocate to these funds or get your money in or get your money out. So operationally, you guys have figured out that paypoint, I guess, is your point. Yes. First and foremost, by using technology to make the processes much more efficient and time efficient and when scaling across a large client base. So what is it about the blockchain that makes us so much? I'm only kidding. So I'm looking at your site and you list like our partners just in terms of the complexity.

and all the moving parts that are involved here. So you've got PWC, which is a third-party auditor that you work with. There's Northern Trust, a Custodial Bank. There's a compliance consultant. There's a registered office and independent director. There's an independent legal counsel. There's a secondary administrator, a third-party administrator. There are a lot of moving parts when you're investing in just one of these funds,

let alone sometimes up to half a dozen or even beyond that. Correct. So operational soundness is very important in alternative investing. And we need to have robust third-party controls across the complete process. So that includes our custodial bank, Northern Trust, our third-party administrator, NAV consulting. So cash does not move from investor to Glass Funds to the underlying alternative manager without the dual sign-off between Northern Trust and NAV consulting. Glass Funds itself does not touch cash. Secondly, we also need to have strong audit controls and tax reporting, and that's where PWC provides high-level services for us and our clients. So Glass Funds has been in the business. I don't know, you said a decade or something.

It's been in the business for a while. Correct. Starting in 2008, for the first four to five years, we primarily made hedge funds accessible, blue chip hedge funds. And then starting in 2012, 2013, we incorporated private capital, including buyout, credit, real estate. Today, private capital is the majority of the assets. And the marginal flows to the platform are dominated by private capital strategies as well.

When you say private capital, is that private credit or Is that something different? Under private capital, we include a whole host of strategies, including leverage buyout, growth, venture capital, real estate, natural resources, infrastructure. It's the umbrella. Yes, the overall equity. How do you, operationally, how do you handle the capital call thing? If you said that you could do it for a minimum as low as maybe 25,000, and if you have an advisor who has hundreds or maybe thousands of clients, and obviously all of them are not going to be qualified purchasers, but let's say an advisor has 100 clients who, want to invest in privates. How do you handle something like capital calls? How does that work?

Because, I mean, are you going off for every deal or is it just a one-time thing? Sure. So we can open up a position with the manager for as little as a million dollars. So in the aggregate, we require one million. But that one million and above can be chopped up in any number of ways across the end glass funds investor. So advisors who've identified a strategy and a manager that they want to allocate to, if they want to allocate across 100 or 200 of their clients, they can unload their clients to our platform. We offer bulk upload so, you know,

they can download certain census data per client. We can upload that to our platform to get them started. And then for each client, they'll have to go and submit the final information. It takes about, for the first time, six to eight minutes per client. but once they're registered on the platform, they don't have to register again. It's an evergreen subscription.

And then when they allocate, they select the allocations they want per client. And then when it comes to capital calls, a manager, let's say, will make a capital call for 50% of the commitments. We will send the advisor firm the aggregate capital call in terms of the total amount. Plus, we will break down the total capital calls per client. and they will then, in turn, wire the money to our Northern Trust account for those capital calls. Where there's a number of efficiencies is when a portfolio is built up. So now the underlying investors may hold four to six positions. Let's say they're holding a private credit fund that kicks out quarterly income distributions.

They can anticipate, okay, well, I'm getting quarterly distributions from this strategy. strategy or that strategy. And now I know a capital call for strategy B is coming. So instead of taking cash out of the Northern Trust account and wiring it back to the clients, let's just keep it there and then we'll satisfy the cash in the account for the future capital calls. And then with the capital calls and distributions all going to the same Northern Trust account, as the portfolio builds, there can be greater, there can be greater efficiencies by crossing calls and distributions and less administrative work. What have you learned working with RAs and what are some of the unique challenges that are

different from, say, like a family office or something like that? So from my experience in working at previously a private bank and then now with glass funds, reporting is very important and being able to provide detailed reporting. on scale is something that probably many family offices don't have to deal with because either family offices are managing a single pool of money or they're managing it for a smaller group of end clients where RAs and private banks and other fiduciaries they have to implement these strategies not just across one client but maybe hundreds if not thousands and they have to administer it and report it so they need technology.

platforms like Glass Funds and other providers to help them do that in scale. Do you integrate with the likes of Orion and Adipar and those performance reporting software? Yes, we do. So an advisor over time, on average, their clients will own about 10 to 12 things on the Glass Funds platform, and we can take all of the underlying position data and pipe it to their front-end reporting systems through an API. And in that way, the advisor firm can take the raw digital data and format it that suits their business and their clients however they want. So how does this onboarding process work?

An advisor comes to you and says, listen, we've tried this on our own. It's cumbersome. It's operational and inefficient. We want someone to help us. They come to you and say, you know, we want to get on your platform. Where do you begin with new advisors? Sure. So an advisor, you know, they're looking for a tool.

to help them access alternatives, you know, were one of several in the marketplace. You know, obviously, we think we offer some unique next level benefits. And there's typically a due diligence process that the advisor firm conducts on glass funds. And if it resonates with some of the problems that they're trying to solve, then we will sign a side letter with that advisor firm that will lay out, you know, fees at the advisor level in terms and conditions. And then as soon as that side letter is executed and signed off by each party, they can start loading clients onto the glass platform through our online portal. And once they load in the clients, they can start selecting allocations to managers that either Glass Funds has sourced in due diligence or the advisor form has sourced in due diligence and is utilizing Glass Fund's architecture to more efficiently implemented across our client base.

So an advisor can bring their own manager if it's not on your platform. Correct. So we have two classifications of strategies. One is an advisor source fund, which many of our advisors have built up robust sourcing and due diligence capabilities and alternatives, but they need our capabilities to scale it. And so they can bring the strategy to us. We'll do an operational review on the strategy to make sure that there's institutional plans. plumbing and institutional controls to protect the platform. And if it passes that process, we'll open up the position on our platform for that advisor

firm's clients only. And we can do that for as little as a million dollars. And there's no startup costs and there's no fees to do that because we're not spinning up new dedicated legal structures for that specific allocation. How many managers are on the platform and what does the process look like for getting on? Do you just, do you let anybody on? What does the diligence look like? Is there some sort of revenue share?

Like, what does, talk to us about what that looks like? Sure. So we have about over 200 positions on the platform. The vast majority of those have been sourced by our advisor clients where about 25 to 30 are currently or either were sourced by Glass Fund's research team or being currently monitored by our team. So when you say we source, what does that mean exactly? start to cart you off. No, no, no problem. Great question. So we have a dedicated research team where we're out in the marketplace sourcing best ideas across hedge fund strategies and private capital. We do not take any economics from underlying managers. So we do not take any fee sharing

agreements or distribution agreements. So that model really resonates well with fiduciaries, mainly RAs and private banks. And we are looking for true best in class strategies. across the spectrum and hedge and private capital. And it's a institutional due diligence process takes three to four months. There's a number of either Zoom meetings or on-site meetings with the underlying manager. We get access to their data rooms. We do quantitative analysis, qualitative analysis. We summarize our findings in a 15, 20-page report.

And it has to get approved internally by glass funds, including compliance. and then we also use a third-party alternatives consultant to conduct operational due diligence. If a strategy passes all of those steps, then we onboard it onto our platform, and then it's available to all of our advisor clients. What is your selling point to these funds, maybe not the ones that the advisors bring to you, but other funds that you've partnered with, what is the selling point for working with, from like you that's going to work with advisors as opposed to working with large institutions like pensions or endowments for that, thing. Yeah, we resonate very well with managers. A source of growth for them has been wealth management, but the economics are not the same for them as in the institutional space. For example, a relationship manager, a sales professional, and an asset manager could spend the same amount

of time on a pension fund, you know, one to three months, multiple meetings, you know, multiple hours spent, you know, educating that pension client or pension prospect on a strategy. Let's say it gets approved by committee, then the pension may turn around and write them a $200 million check. Now, the same manager could spend the same amount of time for an RAA. And depending on the demand and size of the RIA, the RAA could say, well, great, I love your strategy. I just approved it. I expect total demand to be $6 million. and I want to give you checks at $250,000 a piece.

And for the manager, that's just not the same, those aren't the same economics. So by working with a platform like us, they can tap into the wealth management channel, go through a single point of contact on due diligence. We aggregate the small tickets into a bigger ticket, and it's much easier for that manager to administer an account for and report on. And in terms of portfolio updates, there's also a single point of contact to the Glass Fund's research team, which we in turn issue quarterly updates on all of the Glass Fund platform managers. So the fees for the asset management on the platform is what it is.

What are the economics of Glass Funds? Do the advisors pay you per household, per account? Is it an annual fee? What does that look like? Sure. So our fee is struck at the advisor firm level. and it scales down the more that the advisor firm uses us as an enterprise solution. And that fee is applied to all of their clients.

And it's a flat management fee that's charged quarterly. We do not take any economics from underlying managers and we do not charge any performance fees. So we say it's a flat fee. You mean, for example, I'm making up a number. It's $10,000 per household and you charge $2,500 a quarter or is it an AUM fee? It's an AUM fee that's quoted on an AUM fee. annualized rate. So our fees range from 25 basis points, maybe up to 45 basis points. Got it. Okay. Obviously, there's a range of results in the advisors that you work with, but what are you

looking at the general allocation that these advisors are giving, that are cutting out for their, their clients? Are we talking 5%, 10%? What does the allocation to privates or hedge funds or else look like for, for certain advisors? It really depends on where the advisor firm, is in their life cycle of alternative investing. Typically, what we see for an advisor firms that are earlier on in their process, it starts out around 5 to 10 percent. And we've seen it skew more towards private capital than hedge. There's more firms that do private capital only than there are that do hedge fund only.

And then it, so it starts there. And then as they get through their process, they may bump up the total allocation to 15 to 25 percent as they get comfortable with the space. And really that makes sense because the way that it takes to build a private capital portfolio, you can't deploy 10% of your portfolio within six or 12 months anyway based on the timing of capital calls and the life cycle of a private equity fund. So most advisors are not experts in alternatives. What does the educational process look like between glass funds and the advisors? Sure.

So we've issued several white papers on alternatives to help, you know, get advisors up to speed. And then also we work on a one, on one basis with advisor firms to discuss various aspects of alternative investing. And we've also worked with advisor firms to help them create a customized education program for their financial advisors and other client-facing professionals. So it's really a bespoke, customized platform for our clients because our goal is to have them adopt us as an enterprise solution across our client base. Are you willing to go out and make recommendations to advisors, or is it strictly, you know, here's the information, here's the due diligence, you're kind of on your own.

How does that relationship work? Yes, we can offer guidance on portfolio construction and how to place it in a portfolio. and the risk return profile, and given those parameters, which types of clients this may or may not be suitable for. But at the end of the day, the advisor firm retains 100% discretion over the allocations and portfolio construction. So what if, for example, there is, obviously with like things like venture, there's a vintage year and there's the life cycle of the fund is what it is. There's not, there's no liquidity. But what about if an advisor or a client wants to fire a hedge fund? What does that process look like? Sure. So an advisor firm that has sourced their own

strategy and brought it to the platform, they make that call. So we're just facilitating redemptions. They tell us, we're redeeming from XYZ fund, please process the redemption. And then we facilitate that forum. We remind them of the redemption terms of the fund and the underlying liquidity. For funds that the Glass Funds research team covers, we are re-underwriting our Evergreen or hedge fund strategies on a daily basis. There are hundreds of hedge funds to choose from. We want to make sure that we have very high confidence and conviction in the hedge funds that are currently on the platform. Unfortunately, there have been times where we had to downgrade a hedge fund strategy. and then we send out communications to the advisor firms that are currently invested in that position

and recommend that they redeem from that fund. Now, at the end of the day, they have 100% discretion. They can take our recommendation or not. Now, we will cover a downgraded fund for 12 months after we downgraded it. And then after 12 months for that fund to remain on our platform, the underlying advisors that are still invested in it, will have to source that idea themselves. As an investor in alternatives, what are your feelings about people piling into private investments? Because my sense of coming up in this industry is that after the 2008 crisis, everyone, everyone, in quotes,

you know, all the institutional and family offices piled into hedge funds because they were fighting the last war. Do you think that there's something similar going on in private markets, or do you think private markets have just expanded enough where there's a bigger pool now, it's more institutionalized and more people can and will invest in that space? I think it's more of the latter, but I do think with the changing monetary and economic conditions, people need to incorporate that when they're looking to allocate to private capital. You know, there are differences in what returns are going to be when interest rates are at close to 0% and there's QE going on in the market versus when interest rates are 5 plus and there's quantitative tightening.

now one of the more obvious examples are buyouts their leverage buyouts so when that cost of leverage goes up 500 to 600 basis points after incorporating spread widening investors going into the buyout strategy needs need to calibrate that in their decision making they need to make sure that their allocations are geared towards managers that aren't holistically dependent on cheap leverage and can drive attractive operational improvement and growth in the underlying companies. Now, on the flip side, higher interest rates can be attractive for private credit investors. Now, the risk-free base rate is 5% plus, before it was less than 1%. For high-quality underwriters that have shown an ability to underwrite attractive loans in many different

market conditions and cycles, those returns on private credit strategies probably have gone up. And then another example is venture capital. Did the venture manager, did they ride the wave of cheap money and high venture flows? Or did they? I would say, yes, there are a decent amount of managers where that's the case. There are other managers that will continue to gain access to the attractive deal flow and constructively work with entrepreneurs to create value at the company level. So I think with anything, I say it depends, but certainly allocators need to incorporate the monetary and economic backdrop today versus what it was four or five years ago.

Brett, last question for me. You mentioned that there is competition in the space. You're not the only platform that works with advisors or brokers. what is it about glass funds that's different? Like, I assume that advises aren't coming to you because they can get, you know, a blackstone, for example. Like, what is that a correct assumption or how do you differentiate yourself from the competition? Yeah, several ways.

On the operational front, our differences really stand out as the underlying investor holds more and more positions. So what has become table stakes in the alternative? access platform ecosystem has been fully digitized experience, being aggregate smaller tickets to larger tickets, those are all table stakes now. Where we think we differentiate is we're offering next level efficiencies as individuals move from just give me access to more efficiently manage my alternatives and private's portfolio going forward.

So some of those next level features are an aggregated K-1. So as investors hold more and more private funds, they get a K-1 for every fund they hold. Some private funds will also kick out 40 to 45 state K-1s. We work with our tax partner, PWC, to allow underlying individuals to file on composite, which could collapse the administrative burden for state tax filing materially. Secondly, given our legal construct, advisors can more efficiently source their own ideas, as well as select off the Glass Funds platform. And then lastly, the secondary market for institutional private capital has grown tremendously

over the last 10 years and is becoming more and more mature. The secondary market for wealth management, private capital positions, is still in its infancy. And we think our construct is, provides a lot of benefits for the potential for secondary liquidity for underlying investors that need it but can't get it from the underlying manager. To be clear, I didn't want to, I didn't intend for Blackstone to catch any shrapnel there. My point was, my point was that you could, you can get Blackstone anywhere. So, Brad, I'm sorry. Finish your thought. Yeah. So in terms of sourcing, yes, we believe we can find the smaller, more focus niche

strategies that can serve more of a satellite position to more of the core positions that could include a black zone or from the larger GPs so that advisors can build a more holistic portfolio of alternatives for their clients. But to be clear, we do both. We think there are some well-known middle of the fairway large strategies that have a competitive advantage, and we recommend a portion of those. And we also think investors need to explore smaller, more focused strategies that could either provide exposure to either an asset class or underlying assets that are truly differentiated, and they beat to a different drum compared to other asset classes or have higher return potential. So we take a barbell approach in how we source managers and the types of

managers that we put on our platform. Brett, where can we send advisors for one more? Sure. They can go to our website at glassfonds.com, and they can also ping me on LinkedIn. And that's one S. Where did the name come from? Great question. It stands for Great Lakes alternative strategies.

Ben, you must like that. Yes, fly over states. I'm a big proponent. You just wait, Michael. When climate change is taking the coasts down and the oceans are rising, everyone's going to want to come to the Great Lakes. You just watch it. They're going to, right?

Ben, I was just going to say, Ben, I've told managers that Cleveland is strategically undervalued because of our freshwater access. Exactly, right? I'm all right. All right. Thanks for coming on, Brett. Thank you. Thanks again to Brett. Thanks to Glass Fund.

Remember, go to Glass Funds.com. To learn more, it's G-L-A-S. What is it, Great Lakes, asset? What did he say? Solutions. Okay. It does it. I like it.

I know you're a. coastal lead us, but us flyover state guys got to stick together. And send us an email Animal Spiritspot at gmail.com.