Advisor interest in alternatives tends to fluctuate with market behavior; when traditional asset classes fail to perform, advisors look for other options.
A changing market reality and projections of poor long-term performance for traditional fixed income have forced advisors to look beyond stocks and bonds for client portfolios, said panelists taking part in the discussion “Top Advisors Explain Where Alternatives Fit In” at Financial Advisor’s Inside Alternatives and Asset Allocation Conference at the Wynn Hotel in Las Vegas last week.
“We have assets across all categories: equities, fixed income and alternatives,” said Paul Pagnato, founder and CEO of PagnatoKarp. “Our mindest is, if you go back to Harry Markowitz and William Sharpe, the Nobel laureates who did the work that led to modern portfolio theory, the rule of thumb was a 60-40 portfolio. If you looked at all the assets available to you as a benchmark, you ended up with a 60-40 allocation in the S&P 500 and an aggregate bond index.
“Fast-forward to today, and only 5 percent of the investible world is in the S&P 500, and less than 10 percent is in U.S. fixed income. It's changed dramatically.”
Laura Tarbox, founder and CEO of Tarbox Family Office, said that she has used alternatives regularly since founding her firm, but traditionally used both equity- and bond-like alternative investments to diversify client portfolios.
Today, most of Tarbox’s alternative investments are in income-providing asset classes.
“We’re not looking for double-digit returns from one of our alternative allocations,” said Tarbox. “I believe in the equity markets for those. For the past 90-plus years, you consistently get 10 percent returns from stocks if you allocate through small- and mid-caps and international. I feel like, over time and through cycles, the stock market is going to give us good returns.”
Yet many advisors’ clients remain in balanced or target-risk portfolios that use heavy allocations -- sometimes 60 percent or more -- to fixed income investments to provide capital preservation and an income stream.
That choice makes little sense, said Pagnato, amid a low-but-rising yield environment. As things stand, there’s no guarantee that traditional bonds will provide sufficient income or the capital preservation clients demand.
“We have a hard time with our clients who have the stable portfolio model where so much is in fixed income, because that fixed-income allocation will be challenged going forward,” said Tarbox. “That’s pushed us into more fixed income-like alternatives. I have no bonds in my portfolio, I tell that to clients. Our alternatives have been outperforming our bond allocations.”