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In Alts Investing, Managing Expectations Is Top Priority

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Headlines about the relative success or failure of alternative assets like hedge funds can affect clients’ — and advisors’ — attitudes about those strategies.

Advisors need to educate their clients on what alternatives can do and what they should reasonably expect, according to Jeremy Frank, managing director and head of quantitative research at 361 Capital, a firm that provides liquid alternative mutual funds to advisors and their clients. (Disclosure: 361 Capital’s chief investment officer, Cliff Stanton, writes for Investment Advisor magazine.)

Alternative assets increased $648 billion in 2014 to almost $7 trillion, according to Preqin’s “Investor Outlook: Alternative Assets H1 2015.” However, different alternative asset classes fared better than others. For example, hedge funds, where 48% of alternatives investors have more than 10% of their AUM invested, struggled in 2014, when they had their worst year since 2011 and 22% of investors said they lost confidence in the funds.

By comparison, investment activity in private real estate remained stable, and investor confidence actually increased; a third of investors said their real estate investments exceeded expectations, and almost 80% said they plan to increase their investment in 2015.

Frank said in an interview Monday that 361 Capital takes a consultative approach to education, “working with our advisors and really helping them understand what it is we do, what it is our strategies are trying to take advantage of, [and that for our flagship strategy,] a comparison to the S&P 500 index return really has no meaning.”

That way, when advisors’ clients “say inevitably, ‘Well, the S&P was up 30% last year and this fund was only up 5% or 10%. Why is it underperforming so much?’” the advisors can explain that “our strategy in particular has no correlation, or sometimes negative correlation, to equity markets.”

Frank said that’s a “general theme across the industry — many shops, not just us are working to educate advisors, kind of move them away from the headlines [to] focus on understanding the strategy and what drives the strategy’s returns.”

Frank made a distinction between alternative asset classes and alternative strategies. “We focus on alternative strategies, and I think historically, people’s first foray into the term ‘alternative’ was in MLPs and REITs, and things such as that — commodities. Part of the education process for us has been discussing alternative strategies that can either be done [with] traditional asset classes such as equities and bonds.”

He said the biggest growth in alternative assets is in mutual funds, largely due to advisors’ interest. “Liquid alternatives have seen about double the growth as traditional alternatives over the last year,” Frank said, as advisors are “looking for the ability to diversify that many institutions have had for years. With the proliferation of liquid alternatives, they now have that tool in their toolbox.”

There’s a “general fear” among investors that equity markets have run their course and “the traditional diversifier, fixed income,” isn’t as attractive with current interest rates.

Frank stressed the most important thing for advisors who use alternatives in their clients’ portfolios to remember is “setting expectations and [knowing that alternatives] will act differently from other markets.”

“It’s a continual process,” he said, but “investors will eventually get that as well, just as the advisors have. When we have a prolonged bull market, everyone’s going to wonder why they weren’t more in equities and then as soon as we have a strong bear market, everyone’s going to wonder why they didn’t have more alternatives. The key to that is understanding the role of alternatives in the portfolio.”

— Check out Why Can’t Advisors Tell the Difference Between Alternative Assets and Strategies? on ThinkAdvisor.