By Jerilyn Klein Bier
Investors are about to be bombarded with advertisements from alternative investment product providers, and advisors need to be ready to steady their clients amidst all the hype, according to experts.
"The noise level is going to get ramped up tremendously here, so it's going to really be an important, crucial thing to have that steady, calm, trusted voice," said Bob Rice, managing general partner of Tangent Capital, during the opening roundtable of Financial Research Associates' recent Advisor & Broker-Dealer's Forum on Retail Alternative Investments.
Speakers at the conference said there are a number of reasons why advisors should already be introducing their clients to alternatives. Historical data suggests these types of investments are the best way to reduce risk and enhance returns in a still-shaky economy, they said. There are also many new alternative products in the pipeline, they added.
But the need for both advisors and clients to get educated on alternatives has become more urgent because of the expected media blitz. Investors are likely to be bombarded with advertisements from alternative investment providers after Regulation D is amended to remove the ban on general solicitation and advertising of private offerings. The amendment is part of the provisions of the recently signed Jumpstart Our Business Startups (JOBS) Act. Speakers said the SEC is expected to implement the Regulation D rule changes within a few months. It will open the door for alternative product providers to do general advertising, so long as they take "reasonable steps" to verify that all purchasers are accredited investors.
Staying ahead of the learning curve can help give advisors a competitive advantage, speakers said.
Retail investments such as mutual funds and ETFs that use alternative strategies are also finding appeal among high-net-worth accredited investors, speakers said.
"They're willing to give up some juice to have liquidity," said Thomas Meyer, CEO of Meyer Capital Group, a fee-only investment management and planning firm.
"Our clients don't want to see a stack of paper to sign, whatever income level they're at," said Thomas Balcom, founder of 1650 Wealth Management. Instead, it's a lot easier to buy a 40 Act fund with a market neutral or managed futures focus, he said.
Kevin Mahn, president and CIO of Hennion & Walsh Asset Management, said his firm accesses alternative strategies through ETFs and ETNs because they're reported to be tax efficient, transparent, liquid and low cost. It also uses closed-end funds a lot since they allow the use of leverage.
Chris Mills, executive vice president of Kovack Advisors, said more of the RIA firm's advisors are using ETFs and mutual funds in the alternative space. The firm shies away from anything with lockup periods. "We think it's more of a compliance and liability thing than anything else," he said. "From where we sit, it's not necessarily worth the risk."
Meyer, who has roughly 30% of client assets in some type of alternative strategy, said he tries to cocoon each asset class. For example, in large-cap growth he may have a long-only manager wrapped around a long-short manager. He uses at least four alternative managers on the fixed income side to bring some stability for what will eventually happen when interest rates rise.
Balcom's firm, which also has about a third of client assets in alternative investments, looks at the most risky asset classes-emerging markets, some REITs and U.S. small-cap stocks-and uses structured notes to help mitigate risk. The firm also uses structured notes in commodities, has a hedging bucket and uses a variety of mutual funds to hedge risk.
Balcom examines how managers have performed during volatile periods, including 2008 and the third quarter of 2011. "If the correlation is high with equities, they're not really doing their job," he said.
Integrating illiquid alternative vehicles-such as private equity, non-listed REITS and venture capital-into client portfolios was also discussed.
Many speakers emphasized education, for advisors and clients. "I think you have to have an open mind and an open-door policy," said Meyer. He suggested calling managers to ask questions, such as what they'd do if faced with a mass redemption. He likes managers who'll go through their books from a negative standpoint, share what they've learned from mistakes and explain their processes.
With clients, education can help gain trust and prevent them from being paralyzed by the media, said Balsom. He and others stress the need to keep things simple. "Clients are not going to understand if you try to explain to them a long-short, a global macro or a merger arbitrage, but they get volatility, they understand risk," Mills said.
Speakers said comparative analysis-showing models of portfolios with and without alternatives and their side-by-side performance-is often an effective tool with clients. So is encouraging clients to look at blended fees rather than the fee of a particular vehicle, they said. Advisors need to focus more on building a model portfolio that helps meet a client's objectives and less on justifying what the individual components are, Mahn said.
Advisors must also manage client expectations about what alternative vehicles can do. "It's got to be understood here there's no silver bullet," Meyer said. "You're there to limit risk, not to eliminate risk."