“From the standpoint of alternatives, it’s about how you communicate with your clients in terms of how you work them into their portfolios,” Deschaine said. “I think long/short equity investing in the small-cap space probably is a better way to approach small caps rather than just being long given their inherent volatility.”

To make a difference in a portfolio, Deschaine offered that alternatives should be somewhere in the area of 15 percent to 30 percent. “Some of you might think that’s huge, but it’s easier to get there than you might think,” he said
 
Anthony Caine, founder and chairman at LJM Funds Management, said choosing an arbitrary allocation amount isn’t the right way to go.

You don’t want it to be a case of the tail wagging the dog. Let your abilities to find high-quality alternatives dictate what the portfolio allocation should be,” he noted.     

Agreed, said Deschaine. “Putting alternatives into a portfolio for the sake of it is a mistake. Just don’t have a placeholder in there because you think you need something in this area. That’s a recipe for disaster.”

Caine said the challenge for advisors is finding alternatives that don’t have correlation with equities and fixed income in all scenarios because in extreme periods, such as 2008, they can become very correlated.

Along with finding the right products, he added, it’s equally important to find the right alternative investment managers. “Due diligence is critical,” he said. “We meet with a number of financial advisors, and very few do the proper due diligence.”

Caine gave a laundry list of items to consider and questions to ask when evaluating asset managers:

• Make sure the firm has sufficient infrastructure—do they have compliance officers, the right audit firm and the right cybersecurity in place?

• Does a firm have the proper risk systems in place? Does it have a chief risk officer who has autonomy from the portfolio management operations?

• Does the firm eat its own cooking? When a fund manager has a significant portion of their own money in their funds, they’re less inclined to take undue risk if a fund faces headwinds.