As market volatility continues to raise client concerns, alternative investments are gaining traction as a way to smooth out the highs and lows for investors. That means financial advisors are bringing investments like long-short funds, real estate, tax liens, precious metals and non-traded REITs into their portfolios.
Slightly more than 81% of financial advisors and other investment specialists are now using alternative investments for their clients, up from 74% a year ago, and nearly 69% plan to increase their use of these investments during the coming year.
The growing popularity of these vehicles was reflected in a recent survey conducted by Financial Advisor and Private Wealth magazines and SkyBridge Capital, an alternative asset manager with $6.3 billion in assets under advisement or management. The survey included 925 registered investment advisors, registered representatives and other wealth managers.
Although it seems everyone's definition of an alternative investment is slightly different, most advisors who are enthusiastic about them say they come to this space because of its non-correlation to the rest of the market.
"Stocks, bonds, cash and alternatives are becoming the four-legged stool for ultra-high-net-worth investors," says Gerald Dubey, the co-founder, along with Richard Cyphers, of the Cyphers Dubey Group in Hartford, Conn. The group is affiliated with UBS, and most of its clients have between $25 million and $75 million in assets.
"Alternatives and managed funds of hedge funds take the volatility out of the market," says Dubey. "You have to get over the three layers of fees, and we put that on the table for the client in the very beginning."
Dubey will use alternatives for as much as 20% of his clients' portfolios, and even go higher if short-term liquidity is not an issue, which is often the case.
Most of the survey respondents were RIAs or reps for broker-dealers. Nearly 38% of the respondents handle accounts of less than $500,000, but others deal with high-net-worth and ultra-high-net-worth clients. Most respondents (60%) have been in the financial business for more than 15 years.
A majority of the respondents (65%) said the market's volatility has them looking for ways to diversify their clients' portfolios, while 25% of them said the diversification depends on the needs of each client.
A minority, slightly more than 18%, do not use alternative investments; 55% of those respondents say they have achieved good returns on investments without these vehicles.
Forty percent of those not using alternatives feel they are too complex to get a good sense of possible performance. Nearly 42% do not like them because of their lack of transparency, and 31.5% do not like them because of the liquidity problem.
Those who have decreased their use of alternatives in the past year have very specific reasons for avoiding them.
Russell Drabold of Legacy Wealth Management Group LLC in Moorestown, N.J., says his broker-dealer has made it more difficult to use alternatives and that one of his options, real estate, is not doing well now.
Likewise, Mason Dinehart of Silber Bennett Financial in Los Angeles says he had clients in real estate, but the poor market made him question its value as an investment for now.
Most advisors are more enthusiastic about the use of alternatives. Seventy-five percent of the respondents said that in the past year they have increased their use of these products in general and 14.5% said they have increased their use of hedge funds or funds of hedge funds.
"The survey shows that because of market volatility, solutions are clearly needed for investors," says Ray Nolte, Skybridge CIO. "The adoption rate for alternatives [as one of those solutions] is quite strong. The survey reinforces the fact that RIAs and financial advisors are looking for solutions for their clients.
"Some 75% increased their use of alternatives in the last year and more than two-thirds plan to increase their use in the future. The standout [statistic] is that [nearly] 88% say they are using alternatives for diversification or low correlation to the market, which circles back to the market volatility that is causing this high adoption rate for alternatives," he says.
But alternatives are not bought worry-free. Many of the respondents were concerned about the liquidity and transparency, fees, complexity and clarity of the strategies.
Nolte points out that it is industry veterans with years of experience who are embracing these investments: 31% of those using alternatives have used them for two to five years, and 24.63% have been using them for five to 10 years. Nearly one-quarter have included alternatives in their clients' portfolios for 10 years or longer.
Most use a combination of different types of alternative products, but nearly 44% use managed futures and 35% use private equity. More than 30% like funds of hedge funds; nearly one-quarter use hedge funds; and 21% use hedge fund replicators. Most alternative investors (87.94%) say they like hedge funds or funds of hedge funds because of the risk management benefits, such as their low correlation to other asset classes and their diversification. About 40% use them for alpha generation.
"Clients' appetites are increasing for alternative, uncorrelated investments," says Thomas H. Mahoney, the senior managing director of Tangent Capital Partners in New York City, which handles institutions, family offices and high-net-worth individuals, as well as pension funds and endowments. "Hedge funds, private equity and real assets, like real estate infrastructure, are less correlated to the market."
Belinda Savage, an RIA and consultant for Red Bridge Development Partners, a private equity firm in Granada Hills, Calif., agrees.
"People are asking what they should do, and I see a great opportunity that is presenting itself to financial advisors in alternatives," Savage says. "Every day I see this message resonating with different classes of investors."
"You can take an IRA or 401(k) plan and direct those funds to any type of investment. Some people are afraid of the illiquidity, but not after they see there is little volatility," she says.
Savage says she has one client who has three apartment buildings in Beijing making a substantial return on investment, and another is investing in ranches. She says she's seen returns of 9% to 12%.
"There is an enormous foundation starting to build in alternatives with creativity and control, and the returns are coming in."
To review the complete survey results, click here.