We Americans have witnessed an enormous amount of change in our economy since 2008. One result of our current low interest rate environment and the need for income for an ever-increasing boomer population is Alternative Investments.
The solutions to volatility and low yields have become more acceptable, particularly due the meteoric rise of liquid alternative mutual funds. A decade ago hedge fund and private equity strategies were rarely utilized by investment advisors, and other “subscription based” alternatives were rarer still. At that time, only the largest RIA firms were invested in alternatives, but now they have become accessible to even the smallest firms.
I am not surprised by the increased popularity of alternative investments, and I believe alternative strategies will continue to garner a larger portion of individual portfolios going forward. However, the increased attention brings complexity. There are many challenges facing investors and their advisors as it pertains to alternatives. Many investment advisors lack the appropriate training and experience with alternatives, making due diligence a difficult task. With traditional alternatives, such as hedge funds and private equity, managers offer varying levels of transparency, making it difficult for advisors to make educated decisions. Liquid alternatives bring greater transparency, but many of the products available for advisors to offer their clients have short track records. Moreover, strategists accustomed to managing traditional mutual funds are managing many of these strategies.
For those advisors willing to make alternative strategies an enduring part of their service offerings, I recommend that they focus on managing the overall risk of the alternative strategies being incorporated. Just because a strategy is labeled “alternative” does not automatically make it a high-risk, high reward option. It’s a mistake to consider alternative investments as an asset class. Just like the traditional market provides equity and debt instruments, so to does the alternative market.
The second major challenge is to fully understanding the risk-and-return opportunities of individual strategies and how portfolios change based on current trends in the global economy. It is one thing to provide education for financial advisors; educating investors is a whole different ball game. It is important that advisors who offer these services dedicate a significant amount of time educating themselves. A great way for advisors to increase their learning curve is partnering with alternative asset management companies who looking to develop long-term relationships, and can share key alternative portfolio management insights.
Finally, its important to remember that the risk to reward metrics used with traditional investments are not enough when evaluating alternative opportunities. For example, measuring the sharp ratio on an alternative investment may not be sufficient because the distribution of returns in many alternative strategies exhibit large values of skewness and kurtosis. In these scenarios, I strongly suggest that advisors turn to their alternative investment representatives with whom they’ve developed relationships. Alternative investments are here to stay; you must decide how you will utilize these instruments to benefit those you serve.