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Why Institutional Investors Dominate the Liquid Alt Market

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There are a lot of good statistics collected to show investing trends among institutional investors, according to David Katz of Larch Lane Advisors, but putting a finger on where retail investors put their money can be more difficult.

“It’s very hard to get a very good idea of what retail investors invest in and what their allocations are. Institutions report them in different ways so you can get a good sense of what university endowments are doing; that information is fairly readily available to the public, as are public pension funds,” he told ThinkAdvisor on Monday.

A December 2013 report from Goldman Sachs put the percentage of U.S. retail assets under management in alternatives at 4%, compared with 20% of institutional assets. While demand is clearly largely coming from institutions, Goldman Sachs predicted retail liquid alts represent an opportunity of approximately $2 trillion, with the potential to grow between 15% and 20% over the next five to 10 years.

PwC reported Monday that the global alternative market was on track to reach $15.3 trillion by 2020.

A survey conducted by Altegris at its Strategic Investment Conference in May found that almost 60% of respondents believe that alternatives should represent between 10% and 25% of a diversified portfolio and 15% believe the allocation should be as high as half of the portfolio.

Katz is president and chief operating officer at Larch Lane. Last year, the firm joined forces with Rothschild Asset Management to launch the Rothschild Larch Lane Alternatives Fund (RLLIX), a multimanager, multistrategy mutual fund.

“It’s the kind of fund that investors will invest in to achieve diversification, reduce volatility in their portfolios and allow them to invest in strategies that have lower correlation to the stock market and the bond market,” Katz said, and is appropriate for any retail investor, whether they have an advisor or are investing on their own.

“Really, that’s sort of the premise of liquid alternatives in general,” he added. “It sort of levels the playing field for investors. […] Up until several years ago, hedge funds were really only accessible to institutions and super-affluent investors. This is sort of a way to allow with a small minimum retail investors to get access to the same kind of hedge fund strategies that institutions and very wealthy families have been able to access for decades.”

The challenge for advisors in finding appropriate investments for their clients is how to differentiate between the many funds available, Katz said.  

“One way you can do that is look at performance, which is not, as you know, a guarantee of anything,” he said. “Simply looking at past performance isn’t the right metric; it can help you, but that’s not really what you want to look at. You have to really do research on each of the funds and try to understand what differentiates one from another, like you would do with any mutual fund. The difference here is these are hedge fund strategy, so it’s incumbent on the advisor and investor to understand what’s going on.”

Another challenge is that clients aren’t that interested in alts when equities are doing so well.

“We’re in the sixth year of this bull run,” Katz said, “and with traditional asset classes like the S&P doing so well over the past six years, advisors have a challenge in terms of convincing clients that alternatives make sense in a portfolio because relative to equity markets, hedge funds have not done that well. They’ve done OK, but relative to a market that is in the sixth year of a bull run, it hasn’t done quite as well.”

— Check out 10 Phrases to Avoid When Talking About Alt Investments on ThinkAdvisor.