Words like "arbitrage" and "derivatives" spook retail investors.

Invesco research finds that the majority of investors want to include alternative investments in their portfolios. However, they are unaware of exactly how mutual funds and other tools can fit the bill due to a misunderstanding of the terms involved with such investments, a recent study by Invesco and Maslansky + Partners on Tuesday shows.

The firm also created a list of “toxic phrases” advisors should avoid when talking about alternative investments.

Nearly eight in ten investors (77%) would rather invest in “alternative mutual funds that are bought and sold like any other fund” than in “liquid alternatives” (23%).  In other words, they seem to want growth that comes from diversification along with more liquidity than hedge funds provide.

“Our research found that nearly 8 in 10 investors would rather invest in alternative mutual funds bought and sold like any other fund than liquid alternatives, yet they are the same thing,” said Scott West, head of Invesco Consulting, in a statement. “This demonstrates that investors do not have a good understanding of liquid alternatives.”

The majority (65%) of the 800 investors surveyed say they are comfortable investing in mutual funds. At the same time, though, less than one-quarter are comfortable investing in global-macro funds (24%), unconstrained equity funds (23%), hedge funds (20%), arbitrage strategies (19%) and derivatives (17%).

“Investors are very open to hearing about how alternatives can help them meet their goals, but this value proposition is quickly clouded by words like derivatives and arbitrage,” West explained. “By avoiding jargon, advisors can eliminate misconceptions, improve conversations and help their clients understand how these strategies may enhance their portfolios.”

When asked what type of new investments they prefer, 73% of investors select those that complement investments already in their portfolios. Just 27% prefer those designed to replace some of the investments in their portfolios.

“While institutions have used alternative investment strategies to achieve their goals for decades, more work needs to be done to ensure all investors understand their role in a portfolio,” said Walter Davis, an alternative investment strategist at Invesco, in a press release. 

“To shorten this learning curve, advisors should focus on how alternatives can help clients achieve their personal goals, how mutual funds and ETFs offer efficient access to these strategies and the role alternatives can have in complementing core portfolio holdings rather than being used as satellite investments,” Davis said. 

When asked which phrase best describes an investment that does not rise and fall with the markets, less than one-fifth, 18%, selected “noncorrelated.” Most (59%) preferred “behaves independently.”

Close to two-thirds (64%) of investors would rather invest in “funds that focus on more consistent returns,” while 25% prefer “equity funds that give up a little on the upside to get more protection on the downside.” Roughly one-tenth (11%) express a preference for “long-short equity funds.” A large number of investors (71%) would rather invest in alternative funds managed by a team “with a long track record in alternatives” over one that is “well-known” (16%) or “that has over $900 million under management” (13%).

What Not to Say

The following is a list of “toxic phrases” that the Invesco and Maslansky + Partners suggest advisors should avoid when talking with clients about alternative investments:

1. Derivatives

2. Future-proof your portfolio

3. Smooth equity returns

4. Immediately allocate 20% of your portfolio to alternatives

5. Nontraditional investments

6. Strategies usually associated with hedge funds

7. We can predict that rates will rise in the future

8. These are portfolio managers that I have carefully selected

9. Arbitrage  

10. Satellite

— Check out Best Words, Images for Advisors to Hook Clients: Frank Luntz on ThinkAdvisor.