If top managers have trouble recognizing the difference between alternative assets and alternative strategies, what hope do the rest of us have?
“I was at a conference recently and asked a keynote speaker about the future of alternative strategies,” Curian Capital’s Gabriel Burstein, Ph. D. (left), told ThinkAdvisor during a discussion with colleagues on Thursday. “He answered by describing assets like commodities and real estate, and not a word about strategies, so even legendary managers get confused, and that confusion is spreading.”
It’s an ongoing and widely observed problem. Although Dorothy Weaver, CEO of Collins Capital, recently said advisors are on “the cusp of really understanding the difference between alternative strategies and assets,” they’re not quite there, and it remains a frustration for all involved.
“An advisor in Texas with whom I was recently speaking said whenever he talks to his clients about alternative strategies, they don’t want to hear it because they might have lost so much recently on commodities or real estate,” added Burstein, head of investment strategy in asset management at the Denver-based firm. “They don’t realize that the assets might have a volatility of 20%, say, annualized over a 10-year period, but the strategies might have 5% to 8% volatility.”
Disentangling strategies from assets with advisors and clients is the challenge the industry faces, he said.
Jim Gilmore, a VP and portfolio manager at Curian, noted the number of people with institutional experience at the firm that are “getting used to common terms on the retail side,” but are seeing abuse in how they’re used and implemented.
“Institutional plan sponsors use no more than 10% in their portfolios to combat inflation, and in periods of low inflation those allocations may be dead weight,” Gilmore (left) said. “Look at gold; everyone on the retail side has been told it’s where they have to be. Well, if they started the year with $1 they ended with $0.75. We’re trying to recognize the risk/return characteristics of each strategy and weight them appropriately.”
He added that the retail side is looking for one strategy that is a “panacea” for managing volatility, and it’s usually something that “isn’t a very substantive return driver.
“What is needed is a wide range of strategies that have a wide range of volatilities and return drivers,” he argued. “If you add in 10, 12 or 15 of these strategies, individually they might have 8% to 12% volatility, but acting in concert they might have 5% volatility.”
One of the biggest challenges to effective portfolio construction on the '40 Act retail side is manager selection, and that's where Brian Hargreaves comes in. The firm’s VP of alternative investments and manager research uses a top-down approach that looks at strategy and allocation, combined with a bottom-up approach of manager selection.
“When evaluating a manager, its critical to ensure returns are alpha driven and not deviating from stated objectives,” Hargreaves noted. “Particularly, look to ensure managers avoid style drift by employing a repeatable and sustainable process. Managers should also avoid chasing the flavor of the month or the hot, new thing.”
As for the sources of alpha, it must be “pure or real alpha,” says Hargreaves (left), not a passive strategy that might happen to be doing well during a given period of time.
“We then look at performance and the idiosyncrasies of the manager’s firm,” Hargreaves added. “The standard due diligence process is also performed to review the investment thesis as well as legal, compliance and operations.” He pointed to multi-strategy funds as growing in popularity, as are long/short credit strategies, among others.
Gilmore moved to a description of what Curian means by its conservative, moderate and growth allocations. “'Conservative' has 5% target volatility, plus or minus one. With one-third the volatility of the S&P 500, it can really have an impact on the portfolio. And it can be used as a replacement for fixed-income allocations.”
Moderate, he continued, adds in a bit of equity beta through some private equity, real estate and infrastructure and has volatility on the order of a 7% target. “The growth portfolio increases equity beta to maintain a target of 9%.”
The key, Gilmore concluded, is to start with the investor’s purpose in mind. “Too often, I see the allocation as the last item for consideration, and it doesn’t get the attention it deserves. How do advisors get it matched right for the investors’ needs? Advisors are thirsty for that kind of knowledge.”