Growth, however, was primarily driven by institutional investors such as pension funds and endowments, as well as some advisers serving ultra-high-net-worth clients. Now, new types of products are opening market segments that were traditionally closed to individual clients, and technology is making it easier than ever for advisers to access them.
The money is definitely getting behind this technology because private equity firms are seeing that although pension funds and other corporate investment structures are all but maxed out in the asset class, the private market of accredited investors is ripe for the picking, said Eric Roberge, founder of Beyond Your Hammock, a fee-only financial planning firm in Boston. Now platforms like CAIS are trying to connect with the adviser crowd to gain access to these accredited investors and the pitch isnt all that bad. Instead of the typical highly illiquid, high-minimum funds, they are pitching $50K minimums with quarterly liquidity options.
The assets are following. In 2018, alternative assets accounted for 12% of the global market, double what it was 15 years earlier, according to CAIS. Preqin expects assets in alternatives to reach $17.2 trillion in 2025, up from $11.8 trillion in 2021.
Alternatives are looking especially attractive in 2022 as the Federal Reserve combats historic inflation. Between a volatile stock market and low-risk bonds dropping in price, advisers are looking for a safe haven as the traditional 60/40 portfolio underperforms from both ends.
EP Wealth Advisors, an RIA out of Torrance, California, has long offered liquid alternatives to clients but is starting to add strategies like private credit and private real estate, said Adam Phillips, partner and managing director of portfolio strategy at the firm. This was done as an acknowledgment that what worked in the past wont necessarily work in the future, and todays unique market requires advisers to be creative in how they allocate money, he said.
We are trying to take a more proactive approach as allocators, Phillips said. We see weakness in the market driven by a number of factors. Were not abandoning traditional investments, but we see long-term value in these types of investments that have been available to us in the past. If they are additive to portfolios, lets take a look.
Reducing exposure to public markets is the top reason advisers allocate to alternatives, with 69% of those surveyed by Cerulli and Blue Vault citing this as a goal. Two-thirds of advisers named dampening volatility or offering downside protection as a goal, while 59% cited income generation.
Less than a third said they use alternatives to hedge against inflation, and only 19% said the allocation was in response to a client request.
The fit of alts will vary exposure by exposure and client by client, hence wouldnt paint this with one brush, Cerullis Shapiro said in an email. A key takeaway here is that the demand (and likely brand sale) is coming from the advisors, not their clients.
A survey by F2 Strategy, however, found that some wealth managers are pulling back on their use of alternatives because client demand just wasnt there. Many advisers arent experienced in offering alternative investments, and the knowledge gap is even larger between advisers and clients.
The products themselves also remain cumbersome for many wealth managers. Support and administration of the assets are difficult because of the quality, format and usefulness of data, according to a survey by F2 Strategy. There are also liquidity constraints and additional fees involved.
Once you start experiencing the challenges there, you realize that there are additional costs and additional considerations. You need to invest in additional resources, said Joe Price, F2s senior manager of consulting services. I didnt get the read that the advisers are pulling away or wouldnt use alternative investments, but [rather] decelerating and being more thoughtful with how they approach it.
The juice isnt worth the squeeze, Fritz said, adding that his survey found 47% of advisers currently using alternatives expect to decrease allocations in the coming years.
Henrickson Nauta Wealth Advisors is one such firm. Though it has allocated 20% to 40% to alternatives for most clients over more than 20 years, the firm is rebalancing this year to sell well-performing alternatives to purchase equities, Nauta said.
Another significant downside is the lack of consistency in how alternative products report pricing. A significant allocation to alternatives can mean an incomplete picture of a clients assets, which in turn can impact how a firm collects fees.
Because they arent pricing daily, they tend to understate volatility, Phillips said. Its important to educate advisers because we dont want them pitching something because its the easy answer.
This opaqueness is enough for advisers like Bruer to steer clear of alternatives entirely. The accounting standards on products like private equity are haphazard at best, he said, and he knows other advisers whose clients got burned when a product failed to deliver.
Pulling from his background in the military, Bruer tells clients that the road to a good financial outcome is a narrow path with minefields of bad investments on both sides.
The minute you get off [the path], youre going to get blown away because there are so many products out there being pushed, he said.
Bruer is also skeptical of claims about downside protection, citing a lack of long-term data on the viability of some types of alternatives compared to more traditional portfolio models. Without that, advisers are just reverting to market timing, a behavior most encourage their own clients to avoid.
Clearly a lot of money is being made by marketing and selling these products whose outcomes we dont know, Bruer said. If youre not doing financial planning and a firm is strictly pitching products, then youve got to have that next, sexier thing to talk about.
Nauta, a self-proclaimed proponent of alternatives, agrees that much of the increased adoption of alternatives reflects the return-chasing nature of financial services. While many of the products being advertised are traditional hedge funds and private equity funds from big-name sponsors with long track records, they wont create new opportunities for investors or provide the desired diversification, he said.
Either because youre receiving watered-down products, asset classes highly correlated with equities, or a combination of both, Nauta said. I think there will be a number of clients and advisers that will be surprised and frustrated by the actual realities of owning alternatives.
After guiding his firm through introducing alternatives to clients, Phillips recommends advisers new to the space to take a serious and methodical approach to due diligence. It can take months to understand a strategy well enough to have the conviction necessary to put an alternative product into a client portfolio, he said.
A lot of them sound really interesting but what advisers need to understand is you need to look beyond the marketing materials, Phillips said. Even though we have approved them, theyre not right for all clients.
When Nirvana and some of its contemporaries were wildly successful, major music labels quickly invested in hundreds of bands hoping to find the next big alternative hit. The once revolutionary sound quickly became commodified and oversaturated on the airwaves as more traditional pop music made a return alongside the swelling popularity of hip-hop.
While investing trends arent nearly as ephemeral as music tastes, advisers need to be wary of untested strategies from managers new to the space, Phillips said. Even if theyve successfully gathered assets in a short time, alternatives cant be a crutch to lean on or a distraction for clients when traditional markets are bad.
I think you need to be careful, he said. Alternatives are so personal and unique to clients circumstances and their willingness and ability to take on risk, not just with the investment but also liquidity. There is some danger to making these available to clients.
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