Advisors should be incorporating alternative investments more into their clients’ retirement portfolios because the traditional 60/40 allocation is no longer a viable option, according to an investment strategist.
Tony Davidow, senior alternatives investment strategist at Franklin Templeton Institute, told the audience at the “Inside Alternatives and Asset Allocation” virtual event sponsored by Financial Advisor magazine and Money Show yesterday that the way advisors think about retirement must change because of the turbulence the economy experienced over the past few years.
“Short of having a broader sort of toolbox, the 60/40 is an insufficient set of tools to meet client needs over the long run,” he said.
In traditional allocation, 60% of the assets went to the S&P 500 and was focused on growth while the 40% went to bonds and yielded income.
The 60/40 portfolio has been under increased scrutiny after last year, when both stocks and bonds slumped and the portfolios were down about 16%, Davidow explained.
“The whole premise behind the 60/40 portfolio and the whole premise behind modern portfolio theory is to find investments that do not move in lockstep with one another,” he said.
In addition, the correlation among public funds has been increasing and the best way to provide that differentiation among investment behaviors is by incorporating more alternatives into the investment portfolio, according to Davidow.
He emphasized that there is a greater need for advisors to rethink retirement not just in the accumulation phase, but also in the deaccumulation phase. People are living longer and are more active throughout their retirement. It is no longer simply having enough money to reach retirement, advisors have to ensure that their clients can live through retirement, Davidow told the virtual audience.
Alternative investments are ideal products to handle the current economic environment and can achieve a number of investment objectives, including growth and income, similar to the traditional 60/40 allocation, he said.
“We don’t need to make a generalized decision about it. We can use these more precise tools in a more precise fashion because we can isolate our exposure to private equity where I can get more growth,” he said. “I can look at my real estate exposure to provide growth and income.”
Private credit can also offer another income source while real assets including real estate, infrastructure, and natural resources can provide a natural hedge on inflation, Davidow added.
“If we expand our toolbox, alternatives are ideally suited for challenging market environments like the one we’re in now,” Davidow said.
The next hurdle is talking to clients and explaining to them how best to use alternative investments in their portfolio. In many instances, delving into the details about those investments can cause investors to zone out or lose interest, he said.
“I think if we’re being honest, we sometimes make investing much more confusing than it should be [and] the discussion of alternatives is very confusing,” Davidow said. “Something that’s complicated and confusing often infers risk or at least the client perceives risk and consequently they say they’re not interested in it.”
To alleviate that confusion, Davidow urged advisors to simplify how they talk about asset allocation with their clients. The client knows that a portfolio includes growth, income, defense and an inflation hedge and normally what investments satisfy those categories. Advisors can introduce alternative investment options that can also work in each of those categories.
“We now fixate on the goal that each one of these individual investments play into the portfolio,” Davidow said.
Finally, it has become easier for advisors to consider alternatives because of new products that are available that have opened access to alternatives to a wider range of investors, he said.
“Product innovation has really made it much more accessible for all of us,” Davidow said. “[They] have made these once elusive investments more available through broader group investors typically with lower minimums [and] more flexible liquidity features.”