How much should advisors allocate to alternative investments? More than they have now, according to panelists at the Inside Alternatives conference Monday in Denver, an event sponsored by Financial Advisor and Private Wealth magazines.
“We recommend a 25 percent allocation” in model portfolios, said Ryan Tagal, director of product management at Envestnet. But many advisors are starting from a traditional 60/40 mix of stocks and bonds and have a long way to go to boost their alternatives exposure, he said. 
The exception is in the ultra-high-net worth space, Tagal said, where some advisors have 40 percent to 50 percent of their clients’ assets in alternatives.
The typical advisor has less than a 5 percent allocation to alternative products, said John Cadigan, head of national sales at Behringer Securities, “even though the research groups in your firms are telling you to allocate 10 percent to 15 percent.”
Even with the low adoption rate, “advisors are ahead of their clients by a country mile” in accepting non-traditional investments, said Bill Miller, chief investment officer at Brinker Capital.
“Clients can often be disappointed with poor performance with liquid alts,” Miller said, “so start with a 10 percent to 15 percent allocation instead of 25 percent or 30 percent. Even if the experience is bad, they can stick with it.”
Alternative investments tend to be the first things jettisoned when they don’t perform, Cadigan said, in part because they’ve been positioned as “outliers” in a portfolio rather than as critical tools to reduce volatility. 
With equity markets at risk with the end of quantitative easing in the U.S., and bond yields non-existent, alternative asset classes and hedging strategies can help reduce volatility and allow a portfolio to generate income, the panelists said.
“You can increase the distribution rate from portfolios by incorporating alternatives” such as senior secured notes, long-short strategies, global macro products and managed futures, Cadigan said. 
Those areas haven’t performed well after the financial crisis “because the Fed took the risk out of markets,” he added. “As the market starts to re-risk, lo and behold global macro, long-short and [managed futures] have done well.”
What should advisors be wary of in the alternatives space?
Convertible-arbitrage and distressed debt strategies don’t convert well to liquid funds, said Jason Cross, global head of equity strategies at Whitebox Mutual Funds. Convertible arbitrage requires too much leverage and distressed managers often take an active role in restructurings, which isn’t well suited to a liquid product, he said.
Liquid private equity might be something to pare back, Miller added. “You should tell clients that [private equity] is not a permanent allocation,” he said. Instead, it’s something to allocate to during a recession and remove from a portfolio late into an expansion.