Alternative investments (such as hedge funds, real estate, commodities, currencies and managed futures) are becoming more and more mainstream. Even consumer finance/investing magazines detail the advantages of these formerly esoteric investments to potentially mitigate risk and boost portfolio returns. And based on our latest AdvisorBenchmarking research, you are increasingly turning to alternatives to provide your clients with better performance and a wider variety of investment options.
Advisors have turned to alternative investments for a variety of reasons–looking for different investment techniques (40%), seeking absolute returns (38%), filling portfolio allocations (29%), addressing portfolio correlations (28%) and seeking unique vehicle structures (25%). Advisors anticipate a moderate increase in their allocation to alternatives over the next five years. Fifty five percent of advisors estimate that they will increase their use of alternatives up to 25%, while 13% believe they will increase their use of alternatives by more than 75%.
Not only do advisors indicate that their use of alternatives will increase, they also believe that alternatives may become increasingly important in portfolio construction. Nearly one fourth of advisors (24%) believe that alternative investments will become even more important than traditional investments, about one half of advisors (49%) believe that alternatives will not become as important as traditional investments and 27% of advisors believe that alternatives will be just as important as traditional investments.
Alternative Investments Appear to Enhance Returns
Alternative investments are touted as risk mitigators and return boosters, and our research seems to support that positioning. We surveyed advisors to determine if there was a link between advisors who dramatically increased their allocations to alternatives and higher portfolio returns. We found that the largest group of advisors who increased their clients’ allocations to alternatives by more than 100% also had higher portfolio returns (11%-15%). (We surveyed advisors on the performance of their “moderate” risk clients for performance information.) The rise in usage indicates that financial advisors see alternative investments as smart financial choices for some of their clients.
Do Advisors Lag HNW Investors?
Advisors are not alone in their fondness for alternatives. You may be surprised that high net worth (HNW) investors are warming up to the idea of alternatives even faster than advisors. According to a recent Merrill Lynch report, allocation to alternatives represented 20% of HNW portfolios, and, based on this report, the trend will continue due to the growing population of HNW investors who will likely be attracted to these products. Compare that to advisor usage and HNW investor usage of alternatives is outpacing that of advisors. According to a recent joint survey by Morningstar and Research magazine, advisors state that most client portfolios typically have less than 10 percent of their assets allocated to alternative investments.
The Key is Education
The rising popularity of alternatives points to an opportunity for you–educate your clients on the opportunities available to them via alternative investments. After all, according to our survey results, you believe that lack of understanding (51%) is the number one roadblock to using alternatives with clients. But lack of liquidity (27%) and lack of clarity in how an alternative strategy works in the overall portfolio are also issues (27%). If you feel that alternatives may be a good fit for a portfolio, help your clients understand what the different investment options are, how they can be effectively used in a portfolio, as well as how they’ll benefit the portfolio in the long run. Your clients will appreciate the education.