The market volatility and paltry yields of recent vintage have boosted interest in alternative investments, even if some of the vehicles don’t have substantial track records and a sizable number of financial advisors don’t sufficiently know how to use them, said panelists at an alternative investments roundtable today in Manhattan.
“Because of the democratization of alternative investments, barriers are falling,” said Rick Lake, co-chairman and treasurer of Stamford, Conn.-based Lake Partners. “Alternative mutual funds are the new and better mousetrap due to liquidity, transparency, lower costs and regulation.”
Lake said the proliferation and democratization of alternative investments is being fueled by an increase in open-end mutual funds, ETFs, ETNs and even closed-end funds employing some form of alternative strategies.
According to a survey of financial advisors by Cogent Research, nearly three-quarters of advisors currently use alternatives. And the preferred weapon of choice for alternative investments is mutual funds (78%), followed by ETFs (59%).
Roughly 47% of advisors who use alternative investments do so to add diversification, while 25% use them for downside protection and 13% for absolute return.
Alternative strategies can include shorting or hedging, the inclusion of futures or derivatives, and non-standard techniques such as illiquid securities and leverage, which are limited under mutual fund regulation.
About 35% of alternative investment users incorporate managed futures, 33% avail themselves of long-short equity strategies and 29% use market neutral strategies, according to Cogent.
Cogent moderated the panel discussion, which was sponsored by Aston Funds, Direxion and Salient Partners.
“Increasingly, individual investors are including alternative investments into their retirement plans because they provide an additional source of return and reduce volatility,” said Jeremy Radcliffe, managing director of Houston-based Salient Partners.
To his thinking, investors and advisors should incorporate an alternative investment strategy to cope with the limitations of the current environment of slow growth and low yields.
“Retirees will have to look at non-traditional or alternative investments and alternative portfolio construction methods like risk parity if they want to achieve the level of returns that will afford them a comfortable standard of living,” said Radcliffe, co-manager of the Salient Alternatives Strategy Fund.
Risk parity is a portfolio construction technique that targets a specific risk level or volatility level and equalizes it with equal contributions of that volatility from each asset class. For example, in a portfolio made up of equities, commodities and bonds, each asset class would contribute one-third to the level of volatility.
Greater Access, More Due Diligence
Democratization of the broadly defined alternatives space is fine, but many of these vehicles haven’t been around long enough to show their stripes through different economic cycles.
“The downside of the advent of alternative investments—such as hedge funds, commodities, managed futures and currency—is the lack of a track record for a significant number of the alternative mutual funds,” said Edward Egilinksky, head of alternatives at Direxion, a fund company in New York.
He noted that Direxion uses rules-based indices to provide its alternative strategies with longer-term index data as a reference point.