New research has found that 78 percent of all advisors are using alternative investments within client portfolios, according to Cogent Research, mainly for diversification and with some variation related to channel differences and other factors. The main reasons for using alternatives are to further diversify portfolios (83 percent), manage risk (80 percent) and to achieve absolute returns (54 percent). Far fewer advisors report using alternatives in an effort to deliver returns above a benchmark (20 percent) or for tax-management purposes (19 percent).
These findings were included in “2011 Advisor Brandscape,” based on surveys of 1,643 retail investment advisors. This is the first time the report included a section on advisors’ usage and attitudes regarding alternatives, including alternative strategies that entail mutual funds, hedge funds and ETFs. Advisors now allocate an average of 11 percent of their book to alternatives, spread across a variety of products, Cogent says.
Independent advisors, the heaviest overall users of alternatives, show the strongest preference for venture capital, private equity and hedge funds. Bank advisors have a greater appetite for limited partnerships, and RIAs tend to use structured products/notes.
“It was somewhat surprising to us to see such broad and consistent use of alternatives, not only across channels, but also based on assets under management,” said John Meunier, Cogent principal and author of the report, in a press release. “Clearly, advisors of all stripes and tenure have embraced the notion that managing client portfolios in today’s environment requires the tools to provide greater asset-class diversification and better risk management strategies.”
Among the 22 percent of advisors not currently using alternatives, almost half (47 percent) admit that their own lack of knowledge is holding them back. Meanwhile, 52 percent of those now employing alternative-investment products say that a lack of client knowledge and sophistication is preventing them from embracing alternatives further.
Among eight types of investment vehicles, advisors say they are least likely to access alternative asset classes and strategies through mutual funds and ETFs. However, over the next year, more advisors expect to increase their use of alternatives and ETFs than any other product or vehicles.
The study found that 41 percent of advisors now using alternatives believe they will increase their use of ETFs and 28 percent will increase their use of mutual funds to access alternatives.
“These figures represent a huge opportunity for mutual fund and ETF providers to satisfy a growing demand among retail advisors for institutional-quality alternative investment strategies that are both scalable within their practices and palatable to skeptical investors,” said Meunier.
“However, as they roll out new products or broaden distribution of existing offerings, providers must not overlook the importance of providing the support and education that will be required to promote acceptance,” he explained.
Financial advisors should be speaking more with clients about alternative investments, according to a wealth-management expert at Baird. “In general, we think that alternatives are generally in the range of from zero to 20 percent of assets at any given time, with individual clients’ holdings in that range, too,” said Laura Thurow, CFA, co-director of Private Wealth Management Research for Baird, in an interview.
“Given the industry environment, when equity markets get tough, investors usually go to bond via reallocation and vice-versa,” Thurow explained. “When both markets are facing challenges, lots of advisors and their clients are asking, ‘Where do we look?’ ”
Alternatives can be a “nice destination” for some assets, she says, since clients may be looking to reallocate some funds into investments with low correlations to traditional equity and fixed-income markets. “This is an area with more complexity and less transparency that other investments [like equities and bonds],” Thurow said. “It is important, since this class of investments performs differently, that professional advice is given and received as much as needed for clients.
Baird, which now includes more than 700 financial advisors and about $65 billion in total assets under management, recently published a white paper entitled “Demystifying the Role of Alternative Investments in a Diversified Investment Portfolio” as a tool for advisors to help clients better grasp alternative assets and the role they can play in their portfolios. Some products mentioned in its research are private equity, fund of hedge funds, managed futures and structured products.
According to Baird, the Morningstar Alternatives Category has almost doubled in three years, the senior vice president says, and had some $70.7 billion in funds through June 30, excluding assets in precious metals, according to Baird. Recently, the value of the SPDR Gold ETF (GLD) surpassed that of the SPDR S&P 500 ETF (SPY) for the first time.
Overall, Thurow explains, Baird looks at gold, for instance, as a currency hedge against the dollar. “Alternatives can be used as alpha generators or diversifiers,” she noted. “As diversifiers, they work as a strategic allocation within a portfolio given their low correlations with other holdings.” In general, advisors aim to be sure clients “can sleep at night,” explains Thurow, and this approach lends itself towards the use of alternatives for diversification, the executive added.
According to Baird, educating clients in ways to successfully implement alternative strategies can be a competitive advantage for advisors.
“We are now talking to every client about alternative investing as a standard part of our practice,” said Tom Heidenrich, senior investment consultant in the firm’s Chicago wealth-management office, in a statement. “We’ve seen a 180-degree change in the availability of alternative products and solutions over the last 10 years. As a result, more than 75 percent of our clients today have some alternatives in their portfolios up from 10 percent to 15 percent just five years ago,” the advisor explained.