Democratizing Alternatives: Building Distribution and Proprietary Strategies

Deep Dive

Michael Kelly's journey into the investment business began in the mid-90s, driven by a desire to enter the "pure meritocracy" of hedge funds, a segment then considered arcane. He recounts cold-calling prominent hedge fund managers from a paper directory, eventually connecting with Lee Cooperman, who offered him a position despite his MBA rather than a PhD, recognizing his "poor, hungry, and driven" qualities. This led to his early career at Tiger, followed by co-founding FrontPoint Partners with the aim of bringing specialized alternative hedge funds to institutional investors. This initiative, he explains, was part of what was then termed the "institutionalization of hedge funds," a trend that involved demystifying these strategies for institutions, providing greater transparency, and integrating the best facets of traditional asset management.

A key lesson from his early experiences with Lee Cooperman and Julian Robertson was the importance of intellectual flexibility -- being open to changing one's mind when presented with disconfirming evidence. He also learned about "variant perception" from Michael Steinhardt, emphasizing the need to identify an investment thesis that differs from what is already priced into the market. Kelly describes the investment landscape of the late 90s and early 2000s, where information was less ubiquitous, allowing for greater comparative advantage through diligent legwork, understanding supply chains, and identifying macro trends. This contrasted with later periods where passive indexation and ETFs rendered some of those advantages obsolete.

Kelly then discusses his pivot from company research to building asset management businesses, viewing this as a less crowded and more inefficient market compared to aspiring to be the next great macro investor. This perspective informed the building of FrontPoint, not merely as a platform for managing money, but for growing and managing the business itself. He highlights that while many aspire to be star investors, fewer aim to build and manage the firms that house them.

When FrontPoint began partnering with institutions, Kelly identified a crucial need for transparency and understanding of risks and positions, which was often lacking in the more family-office-like operations of many hedge funds at the time. He explains that FrontPoint aimed to be a key partner, helping institutions embrace alternative strategies by offering a level of reporting and diligence akin to traditional asset management. He notes that the trajectory of that decade saw hedge funds adopted by institutions, but also periods of difficulty, underscoring the importance of managing expectations and incentives appropriately.

Following the sale of FrontPoint to Morgan Stanley, Kelly sought another entrepreneurial opportunity, focusing on where the world of asset management was heading. He identified the democratization of alternatives for the mass affluent and individual investors as the next significant trend, questioning why these strategies were not accessible to a broader group of investors if they were beneficial for the most sophisticated allocators. This mission-based opportunity led him to Future Standard.

Kelly recounts his time at ORIX USA, where he led the acquisition of Robeco, a large global asset manager. He then joined Franklin Square, drawing an analogy to Netflix packaging and distributing content. Franklin Square, he explains, had built a strong distribution engine through independent broker-dealers for other people's content, specifically GSO's middle-market lending for Business Development Companies (BDCs). Kelly's vision was to build their own "studio" and put their "quality content" through their existing pipes, transforming Franklin Square from a distribution company into a world-class asset management firm.

Upon arriving at Franklin Square, the product suite initially consisted of non-traded BDCs and a closed-end fund, exclusively partnered with GSO. The strategy then evolved to include external partnerships with managers like GoldenTree, EIG, and Rialto for private credit and real estate income strategies, catering to a market "starving for yield." Subsequently, they began internalizing capabilities, hiring teams for private credit and later expanding into growth strategies by merging with Portfolio Advisors, a private equity solutions business. This integration created Future Standard, now managing $90 billion across private credit, private equity, real estate, infrastructure, and multi-asset investing, with plans to add digital infrastructure.

In selecting external partners, Kelly's team prioritized areas with appropriate risk-reward profiles for the private wealth channel, such as varying forms of private credit and commercial real estate lending. They sought "best of breed" managers with strong risk orientation and workout capabilities, often based on existing personal relationships. He notes that the post-Great Financial Crisis era, with collapsing yields, drove demand for alternatives in fixed income that offered less liquidity and higher credit or shorter duration.

Addressing the alignment of incentives, Kelly explains that to avoid "fees on fees" for individual investors, Future Standard pursued strategic partnerships where they shared revenues and offered a single layer of fees. This mission to level the playing field for private wealth investors, providing them with the same access, fees, and structures as institutional investors, has been central to Future Standard's identity. He highlights that their fully built national wholesale distribution capability, serving independent broker-dealers and registered investment advisors, was a significant resource investment that differentiated them from many other firms attempting to serve the private wealth channel.

Regarding the buy versus build decision for new strategies, Kelly points to the acquisition of Portfolio Advisors as an example where the target company had a 30-year operating history, a strong presence in the middle-market private equity space, and hundreds of relationships with sponsors. He explains that replicating such a network would take many years, and this strategic partnership model allows them to offer comprehensive solutions to private equity sponsors, viewing Future Standard as a strategic partner rather than just a capital provider.

Kelly contrasts BDCs, originally created to bring capital to private businesses, with interval funds. He notes that BDCs are well-suited for income generation through leverage but have limitations on qualified assets, while interval funds offer greater flexibility but less leverage. He explains that certain strategies align better with specific wrappers: private equity in tender offer or evergreen funds, credit in interval funds, and real estate in REITs. He discusses the trade-offs in evergreen private equity structures, such as immediate capital deployment and J-curve mitigation, versus potentially lower returns compared to traditional drawdown structures.

On the private equity side, Kelly observes that the days of achieving higher returns through financial engineering are over, with outperformance now driven by faster revenue growth, lower entry multiples, fragmented ecosystems, and operational value-add, trends he believes are more prevalent in the middle market. He emphasizes the importance of educating advisors and end clients on the fundamental drivers of returns, including revenue growth, leverage, and the qualitative impact of private equity firms with specific expertise.

Looking ahead, Kelly anticipates the integration of private market alternatives into the 401(k) market through structures like collective investment trusts, arguing that a multi-decade investment horizon justifies including less liquid instruments for diversification and potential return enhancement. He trusts advisors to determine the suitability of these investments, recognizing that alternatives are different, not necessarily better, than traditional investments and involve trade-offs in liquidity, fees, and complexity.

Competing in the market alongside large public alternative asset managers, Kelly emphasizes Future Standard's distinct focus on private middle-market companies, differentiating them from larger players who often provide capital to companies that might have previously been publicly traded. He admires their competitors but believes Future Standard offers a unique value proposition. He also discusses the importance