Mix It Up

In these volatile fiscal times, advisors say alternative investments can be a key ingredient in a client’s retirement portfolio.

As much as their emergence in the mainstream is a relatively recent phenomenon, so-called “alternative” investments are hardly new to the advisors at Partners Wealth Management. “We’ve been using them for 20 years,” says John Freiburger, CLU, ChFC, AEP, managing partner at the Naperville, Ill.-based firm, which serves primarily high-net-worth clients.

Now, it appears mass-market investors and their advisors are catching on, too, as they look beyond traditional portfolio models in search of protected growth and an antidote to equity market volatility leading into and during retirement. Indeed, to meet the challenges presented by the new, highly volatile realities of today’s market landscape, more advisors and investors favor a strategy that incorporates alternative investments over the traditional stocks-and-bonds asset allocation model (see sidebar on page 56).

“Our research confirms that financial advisors are questioning the merits of time-honored portfolio construction strategies and looking for new solutions,” says John T. Hailer, president and CEO at Natixis Global Asset Management in Boston. “We think that by putting risk [mitigation] first, managing volatility and incorporating alternative investment strategies, investors can both reduce risk and produce the growth that will help allow them to meet their long-term savings goals.”

For the senior client

Once reserved for a narrow slice of the investing public, alternative investments—a broad category of vehicles that includes non-traded REITs, managed futures, private equity/venture capital and many more—are finding greater traction with mainstream advisors and investors, including seniors. A new generation of products built around alternative investments, from annuity contracts to mutual funds to ETFs, come with minimums that make them accessible to the mass affluent market, not just accredited or institutional investors.

The appeal of alternatives lies mainly in their ability to not only diversify and grow a portfolio but also to protect a retirement nest egg from volatility. Their lack of correlation to stocks and bonds is what attracts wealth managers such as Richard Grund, AIF, and Irwin Gross, RFC, CFS, AIF, of Family Wealth Partners in Weston, Fla. “Non-correlated assets can help control volatility, and at the same time they can provide growth and income,” explains Gross.

“Really what we’re doing is using risk- controlled types of instruments as a way to keep clients on track with a balanced portfolio,” adds Grund.

The heavier reliance on alternative asset classes in portfolio construction results largely from the current prolonged period of high equity market volatility, along with sagging yields from traditional fixed income instruments, plus the apparent erosion of the non-correlative relationship between stocks and bonds, say Freiburger and Jason Mirabella, his colleague at Partners Wealth Management. As a result, “advisors have to be more innovative in managing risk and minimizing volatility,” asserts Mirabella.

Such market conditions are “forcing advisors to look at new ways to capture yields,” observes Freiburger. “That’s one of the most challenging things we as advisors face today.”

To meet those challenges, Partners Wealth is steering some of its older clients toward a portfolio model that includes anywhere between 10 percent to 30 percent non-correlated assets (depending on individual risk profile and liquidity needs). They’re allocating money to alternatives that they otherwise might have put in diversified global equity instruments and traditional fixed income vehicles, for example.

For clients of Gross and Grund, meanwhile, these days the portfolio mix typically includes roughly 5 percent to 15 percent alternatives. However much a portfolio is weighted with alternatives, the overarching goal, says Grund, is “to capture positive equity returns when markets are doing well but to have something in the portfolio that moves them toward their goals and keeps pace with inflation when equities aren’t performing.”

Retirement income planning is a key determinant in configuring a portfolio with alternative investments, say wealth managers. Gross says in many cases he looks for alternative investments with higher yield potential, such as a preferred stock ETF, “because at some point with the senior age group, they’re going to need income from their portfolio.”

Putting such a model into practice is predicated on the client being comfortable devoting a significant chunk of their portfolio to investments with which unfamiliarity might breed hesitance. “It can take a significant amount of education time with the client,” says Freiburger. “A client has to understand that while there may be more volatility associated with that individual [alternative] investment, in the big picture we are trying to reduce the volatility of the portfolio. If they’re not comfortable with that, we’re not going to go there.”

That enthusiasm is doused somewhat by results of the fourth annual U.S. alternative investments survey by Morningstar and Barron’s. Overall, financial institutions reported a retreat in interest and investment in alternatives in 2011 after three consecutive years of growth. According to Morningstar and Barron’s, the $23.2 billion in alternative mutual funds inflows in 2011 represented a drop of $1.8 billion from 2010. What’s more, 26 percent of the institutions surveyed indicated they plan to allocate more than a quarter of their portfolios to alternative investments, down from 37 percent in the previous survey.

Still, a majority of advisors (64 percent) indicated in the Natixis survey that they are apt to employ alternative investment strategies for mass-market clients with $200,000 to $300,000 in investable assets.

What kinds of alternative investments are they most likely to use? According to Morningstar and Barron’s, institutions identified long/short equity (or debt) and private equity/venture capital as the top two strategies for increased allocation, followed by managed futures. For the second consecutive year, advisors cited managed futures as the asset to which they were most likely to increase their exposure.

Do your due diligence

Putting an alternatives-infused model to work is also predicated on extensive due diligence. The uneven recent performance of some alternative classes puts a premium on wise—and suitable—product selection. “There are a ton of these strategies out there that haven’t worked,” notes Grund.

With senior clients, Grund and Mirabella say they tend to prefer alternatives that mitigate the possibility of irreversible loss of principal. “You really have to try to identify the true risk associated with individual [alternative] investments, because you can lose 100 percent of your principal,” asserts Mirabella. “We tend to avoid those types of products.”

Before investing in an alternative, it’s also important from a liquidity standpoint to recognize that some instruments will tie up a client’s money for five, seven, even 10 or 15 years. “You really have to watch your exposure,” advises Grund.