It’s one thing to want to include alternative investments in a client’s portfolio, but it’s another thing to understand how to do it properly. “Financial advisors understand the why, but they’re trying to get a better idea about the how [to implement alternatives into portfolios],” said Mike Wood, director of alternative investments at Charles Schwab.
Wood spoke on a panel focused on asset allocation with alternatives at the second annual Innovative Alternative Investment Strategies conference in Denver this week that was hosted by Financial Advisor and Private Wealth magazines. But given the topic’s importance, it was part of the conversation on other panels during the conference, too.
Asset allocation is essentially a risk management service, and the desire to mitigate risk has sparked greater interest in using alternative investments, said Rick Lake, co-chairman and treasurer at Lake Partners.
He cited a Cerulli study that found that investors use alternatives to optimize risk-adjusted returns.
From a practical standpoint, the game plan can include using various alternative strategies such as long/short equity or long/short bonds, which can take advantage of market volatility in their respective asset classes.
Event-driven strategies are another viable option. “Events happen in the business world than can be sources of return,” Lake said. “One example is merger-arbitrage, which can offer returns that are different from the marketplace.”
Lake said advisors can construct alternative sleeves in a portfolio based on products with different liquidity characteristics––daily liquidity with ’40 Act funds; periodic liquidity via hedge funds; or illiquid assets such as private equity and farmland.
Advisors can also seek out diversifier products such as managed futures that can deliver low correlation to traditional assets.
But Lake highlighted some of the challenges of including alternatives into an overall portfolio. One of them is the proliferation of offerings in the alternative space, which can make product selection difficult.
Another challenge can be the varying performance within certain alternative investment vehicles. Lake presented a slide that showed the huge dispersion of risk/return performance among long/short equity mutual funds since the market top in October 2007.