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Alternatives' Appeal in Retirement Grows: PracticeEdge, February 2009

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With the Dow Jones Industrial Average up or down a few hundred points a day, it’s no doubt a difficult time to manage portfolios. But by understanding client expectations, educating clients on alternative investments and highlighting their expertise in alternatives, advisors can still uncover opportunity during these challenging markets.

AdvisorBenchmarking’s Advisor Confidence Index improved moderately in January as investment advisors became cautiously optimistic about the economy and stock market, in large part due to President Obama’s plan to use government money to stimulate the economy.

Even if that optimism is premature, there’s no doubt that the current economic situation has had a significant impact on investors, shrinking their net worth. According to a recent report by the research firm Spectrem, titled Attitudes of Affluent Investors on Surviving the Economic Crisis, most millionaire households feel they have lost 20% to 30% of their overall net worth, with some respondents believing they have lost more than 40%.

With investors realizing that they may have a difficult time maintaining their existing standard of living during retirement due to the significant losses to their portfolios, most are moving to cash-based investments. According to our data, 40% of investor portfolios are parked in cash. At the same time, recent research by the Investment Company Institute found that despite an overall 40% drop in the U.S. stock markets last year, the vast majority of U.S. workers who invest for retirement via 401(k) plans are staying the course and want to preserve the 401(k) as a retirement savings vehicle.

Increased Interest in Alternatives

While looking for different ways to reduce volatility, a growing number of advisors are looking toward nontraditional asset classes. Because these investment vehicles–such as alternative investments and absolute return strategies–have a low correlation to a traditional portfolio of stocks and bonds, they can help mitigate risk and enhance returns through diversification. According to the most recent AdvisorBenchmarking survey, 20% of advisors’ clients (most are high-net-worth individuals) are expressing an interest in directing their retirement investments to alternative strategies.

By adding alternative investments to their clients’ portfolios, financial professionals can demonstrate to their clients that they can navigate unstable markets and that they’re looking beyond the investment vehicles that closely correlate with the broader market. According to our data, 38% of advisors surveyed recommend 5% to 10% of their clients’ investments now be allocated to alternative assets, while 22% of advisors surveyed recommend an 11% to 20% allocation. More than half of advisors surveyed (57%) rated the importance of being able to use alternative investment products within retirement solutions such as IRAs and 401(k)s as 3.5 on a scale from 1 to 5, with 5 being the most important and 1 being the least important.

As we mentioned in the December issue of PracticeEdge, advisors who are savvy can find opportunities through closer relationships with clients. Here are some other ways advisors can find opportunity during challenging markets:

= Understand client expectations. About half (48%) of advisors say that at least 40% of their clients had unrealistic stock market expectations prior to the market turmoil. Helping clients reset their expectations is a way to add value and can be an important step in helping them find investments that are appropriate for their portfolios. Cannon, for instance, says that a normal expectation could be that a market would go up or down 11% annually. In today’s market, however, advisors will need to factor in an expansion of that range when helping clients with their portfolio allocations.

= Educate your clients on alternative investments. Take the time to understand your clients’ knowledge level of alternative investments. As you gain a clearer understanding of what these are, you’ll be able to better explain how alternative strategies could play a role in meeting them.

For instance, many clients may not know that while alternative investments generally have low correlation to traditional investments, the correlation of some alternative investment classes changes during down markets. “While alternatives can’t subtract all volatility away from a portfolio, they can help mitigate risk and add to a diversification of a portfolio,” says Cannon. The challenge, he adds, is finding investments–like short funds–that hold their correlation value during down markets.

= Use several factors when considering how to use alternatives in client portfolios. When deciding how alternative investments fit in a portfolio, correlation with traditional asset classes is one factor to consider. Others included average expected returns, historical volatility, and correlation with other alternative investments.

= Highlight your expertise in alternatives. Positioning yourself as an expert in alternatives will enhance your credibility with your clients and within the industry. Use your firm’s Web site to highlight your use of alternatives, or focus an article in your firm’s newsletter on alternative investments. Better yet, pitch your expertise to the media to increase your chances of being mentioned in an article about alternatives. You could even write an article and pitch it to a local or industry publication.

Your efforts to educate existing and potential clients on the benefits of alternatives will not go unrewarded. In the end you’ll have smarter, more satisfied clients. Can your business afford not to put the word out?

What Are Alternatives?

In its 2008 report, Alternative Investments, Cerulli defines alternative investments as products that pursue an alternative strategy or invest largely in alternative asset classes. “You start using alternative investments when traditional investment vehicles are not working,” says Robbie Cannon of Horizon Investments, LLC. “While alternatives can’t subtract all volatility away from a portfolio, they can help mitigate risk and add to the diversification of a portfolio,” he adds.

Maya Ivanova is a market research manager with Rydex She can be reached at [email protected].

About Rydex AdvisorBenchmarking, Inc., an affiliate of Rydex Investments

AdvisorBenchmarking is a free practice management program designed to help RIAs better manage and grow their firms. The analysis on Rydex is based on the number of completed surveys and reflects only information from those surveys. This information is intended to be general, and these overviews are no substitute for professional, legal or consulting advice. This information should not be construed as advice from Rydex Investments or any of its affiliates.


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