February 28, 2014 | View original article

Boutique broker-dealers often grow out of teams leaving larger wirehouses, just as David King’s did at UBS on the way to co-founding Houston-based US Capital Advisors (USCA). But like proprietary trading desks spinning off, these firms often discover new technology needs that aren’t easily met. Enter platforms like CAIS.

King knew CAIS co-founder Rafay Farooqui from his time at UBS, and as USCA—which now has about $2.5 billion under management and about $3 billion under advisory and administration—sought to rapidly grow out its wealth management and capital markets offerings simultaneously, it quickly became clear that a partner would be required.

“When we started the firm in 2010, we found that much of what was provided by our clearing firm was good, but that there were holes to fill. A scalable alternative investments capability was one of those,” King tells Sell-Side Technology. He says it’s a broader feature of the “breakaway broker phenomenon” that is a shared focus of both vendor and end-user.

The Texan firm would have spent significant time and expense up front to source and review a large sample of funds, structure feeder vehicles, create a private placement memorandum (PPM), and get audit and reporting functions established prior to making an investment. “And after taking those steps, we might not even know what kind of demand we’ll have for the fund,” King says.

“Where, for example, maybe a small group of financial advisors form their own shop with $800 million in assets under management, it would be extremely challenging for them to build any real alternatives capability that has any scalability to it,” King continues. “Our firm is focused on capturing breakaway brokers as they look to leave the wirehouses. We aim for a more entrepreneurial environment, but one where they can still have all of the necessary infrastructure, product, and solutions that they would not have if they decide to hang out their own registered investment advisor (RIA) shingle. Those that do are starved for product, and they typically underestimate how much they got from their former big firms. They get out on their own, assume they can get everything they need from their clearing firm, but it’s just not the case.”

‘Stepping In-Between’

Increased demand for liquid alternatives from USCA’s high-net-worth (HNW) clients was one driver behind the choice to use CAIS, and that demand comes from the need for balance. Many HNW investors want to avoid being too invested long-only in equities after 2008, but more recently, the largest traditional investment asset class—fixed income—has offered historically low yields as well.

With the potential for interest rates to rise over time, King says USCA questions the risk-return offered today across a number of fixed income sub-sectors. “We find ourselves in an environment where equities have appreciated significantly, and we have concerns regarding fixed income, so alternatives allow us to try and fill in that risk-return profile between higher volatility in equities and low-return fixed income, trying to find a kind of middle ground between those two.”

Handling that internally, the Texan firm would have spent significant time and expense up front to source and review a large sample of funds, structure feeder vehicles, create a private placement memorandum (PPM), and get audit and reporting functions established prior to making an investment. “And after taking those steps, we might not even know what kind of demand we’ll have for the fund,” King says.

Instead, CAIS gives USCA the ability to quickly gain access to premier hedge fund managers at attractive minimum levels, for example $100,000 or $250,000 for funds that may have $5 million to $10 million minimums. The firm has quickly gone north of $50 million invested via the web-based platform helping to meet some of the alternative investment needs of those clients, which is made easier by CAIS’ “thoughtful” approach to the platform—partnering with Mercer for due diligence information, JPMorgan for custody, and State Street for administration.

“Essentially, CAIS is stepping in between a growing population of sophisticated advisors and clients, who need to get high-end products somewhere, and the issuers who need distribution, whether that is a large hedge fund that has institutional clients and wants to more access to the HNW segment, or an investment bank that want to increase retail distribution on syndicate offerings. There are a number of interesting high-growth niches for them.”

Sweetened Syndication

Indeed, while most hedge fund distribution platforms such as Altegris are happy to stick to that market, King points out that CAIS has gone the opposite route, expanding its offering into structured products, private equity funds, and—increasingly relevant to USCA’s capital markets arm—equity syndication. Four years in, USCA has participated in close to 50 syndicate transactions. In the bulk of those, it acted as a selling group member, although more recently it has begun acting in a co-manager role, as well.

“We participate in equity syndicate in two primary ways,” King explains. “First, as a co-manager or selling group member because we are invited to do so, based on our relationship with the issuer, and the majority of direct participation is with issuers in the energy and utilities sectors. Second, we access syndicate offerings through firms with whom we have developed partnerships, and although we are able to participate in a relatively significant number of energy deals directly, those broaden the number of deals that we are able to show to clients. Our wealth management clients have appetite to participate in transactions in other sectors, too. So CAIS, along with a handful of other partners that we work with—primarily investment banks—allows us to expand the scope of our syndicate offering.”

Likewise, a larger sell-side firm that doesn’t have a significant wealth management business may hesitate to partner with a competing investment bank or large regional firm with significant retail syndicate distribution capabilities, because they would be sharing deal economics with a competitor. That, too, makes CAIS attractive, according to King.

“In that situation, you’re not allocating to a competitor and you’re hitting a niche within the industry that is hungry for product, and difficult to sync up with directly. CAIS has done a great job building those relationships. They’ve become very active in the syndicate calendar now, and from a client perspective, we see those deals and the more transaction flow we can look at for our clients, the better.”

The Bottom Line

• Boutique sell sides are looking to third-party platforms like CAIS for access to hedge fund distribution and other opportunities like equity syndication. This is driven by new demand from high-net-worth clients, as well as by the high cost of building the necessary technology internally, and the favorable minimum investments external platforms can offer.
• CAIS and similar venues are also beginning to attract tier-one sell-side attention to bolster the economics of distribution, instead of working with potential competitors to raise HNW or retail capital in the market for hedge funds and other buy-side clients.