Advisors Face Knowledge Gap

(Dow Jones) Financial advisors are shifting to more conservative investing approaches and making greater use of alternative investments, a move that requires an education in new types of risk, among other issues.

Research firm Cerulli Associates interviewed some 1,800 advisors online over the past year for its annual survey and found that "there is a hunger for education on newer strategies, such as alternatives or tactical asset allocation, designed to reduce risk in client portfolios."

Unless an advisor fully understands the issues involved, clients won't buy what they're offering, either in terms of strategy or specific products, says Katharine Wolf, a senior analyst at Cerulli.

"Given what happened this year, clients are less willing to take the advisor at their word and want more detail, more information, and demand increased levels of transparency," she says.

Ron Rough, director of portfolio management at Financial Services Advisory, an investment advisory firm in Rockville, Md., says the interest in alternatives clearly stems from stocks' poor performance in the last 10 years. Less clear is exactly which investment vehicles that entails.

"One of the issues with alternatives is what are we talking about-hedge funds, commodity or currency funds?" said Rough. "It can be pretty broad or more narrow, and they carry their own risks."

Chuck Roberson, a wealth manager at Modera Wealth Management in Westwood, N.J., notes a growing interest in investments like managed futures, for example, because they "had strong positive returns when everything else was such a big negative," he said.

His firm limits private placements, which aren't as liquid as some other investments, to typically no more than 25% of a client's portfolio. "All of those risks are something that an advisor needs to become more comfortable with and understand before they make recommendations for those kind of vehicles," Roberson said.

Many alternatives did poorly themselves in the downturn, but most still outperformed broad market benchmarks and offer diversification beyond the traditional mix of stocks and bonds, Cerulli says. Still, many advisors haven't used them in clients' portfolios and seem hesitant to start: Fewer than 10% of advisors surveyed by Cerulli put client money into hedge funds, limited partnerships, structured notes or private equity. Slightly more advisors use commodities (15%) and managed futures funds (13%).

Some advisors are increasingly turning to their broker-dealer's internal research teams through managed account programs that can offer client risk-profiling and incorporate a variety of strategies in one account, Cerulli found.

Rough says product providers--"whether it be mutual fund providers with some alternatives or an ETF provider or a managed futures shop or a commodity trading shop"--are taking on much of the responsibility for educating advisors. "Hopefully, that will broaden out in time so advisors have more sources to go to," he says.

Professional organizations, such as the National Association of Personal Financial Advisors and the Financial Planning Association, also help to educate advisors with seminars. Advisory firms that haven't worked with alternative investments often network with other firms that have more experience, Rough says.

Minimum investment requirements can be a hurdle for some advisors looking to use alternatives. Some broker/dealers are addressing that issue by creating sleeves of managed-account programs that provide a variety of alternative vehicles in one wrapper, Cerulli says. Also, the industry has created alternative offerings in vehicles accessible at all asset levels by structuring investments using exchange-traded funds or within mutual-fund wrappers, it says.

"For example, an advisor may use a direct investment in a hedge fund for a client with more than $5 million in investable assets, but opt for a fund of hedge funds or mutual funds using hedging strategies for a clients with less money to invest," Cerulli said in its report.