Many investors remain shell shocked from the Great Recession and are determined to prepare their portfolios for continued market volatility. This has led to growing interest in the use of alternative investments to help diversify portfolios, smooth volatility, and increase returns in an ongoing low interest rate environment.

Financial advisors have an opportunity to help clients understand a variety of options for adding alternatives to their portfolio. Before rushing to a mutual fund, exchange-traded fund, managed futures platform or hedge fund, advisors should help clients evaluate another option: variable annuities with alternative asset classes and strategies.

A strong understanding of the benefits of holding alternative investments within a VA will go a long way in helping you assess the suitability of this kind of product for clients, and explain why it may be a good fit for their portfolio. 

We all know that precious metals such as gold and silver have been hot alternative investments in recent years (until very recently, of course). So it should be easy to remember the term “M.E.T.A.L.S” when evaluating alternative investment VAs. Here’s how you can use this acronym to help yourself and your clients understand some of the key benefits of this type of product:

“M” is for Minimums. Many alternative investment VAs give investors access to alternative investments for as little as a $10,000 minimum investment. Compare this to purchasing alternatives though managed futures platforms or hedge funds, which typically require a minimum investment ranging from $50,000 to as much as a quarter million dollars.

“E” is for Expenses. Expenses for alternative investment VA products are relatively low when compared with managed futures platforms and hedge funds, which typically layer a performance fee on gains on top of an asset management fee. The most common hedge fund fee structure is "2 and 20," a 2 percent asset management fee plus an additional 20 percent fee on gains over a hurdle rate. These fees can be as high as 6 percent on assets and 50 percent on gains for some hedge funds and managed futures platforms, according to Morningstar.

The expense of an alternative asset VA can be more than offset by tax savings uniquely available in VAs (see below). The base product fee for an alternative asset VA can be as low as 1 percent, with additional fees on funds typically varying between 1 percent and 1.5 percent.

“T” is for Taxes. This is a product benefit that has become more attractive since the beginning of the year, particularly for affluent investors who are now facing capital gains tax rates of 25 percent and a new 3.8 percent Medicare tax. Annuities provide tax-deferral and tax efficiencies, allowing clients to take advantage of compounded returns. Trades within alternative investment VAs do not create a taxable event. Taxes are assessed only upon distribution.

VAs also have a simplified reporting process, so K-1s for limited partnerships are not required when investing inside an annuity. On the other hand, trading mutual funds and ETFs can create short-term capital gains or losses, which remove the effects of compounding and can create tax inefficiencies. 

“A” is for Accreditation, which is not a requirement when selling or buying an alternative VA. These products are considered a "know your client" sale. To qualify for hedge funds or managed futures platforms, clients are typically required to meet certain asset or income minimums. Some require as much as $1 million or more in investable assets and more than $200,000 in annual income.