It’s no secret that many informed observers of financial markets are increasingly convinced that the spectacular bull market that emerged in 2009 will run out of steam in the next few years. History, and the law of large numbers, indicates it is inevitable.

In his book Mastering the Market Cycle, Oaktree co-founder Howard Marks provides an in-depth view into the predictable gyrations of markets from one cycle to the next. As Marks, who created the world’s largest distressed debt fund, noted in his book, “Cycles have more potential to wreak havoc the further they progress from the midpoint.” Once markets move “back towards the midpoint [of sentiment and valuation], the swing imparts momentum to it that causes it to overshoot the midpoint and keep moving toward the opposite extreme,” the legendary investor wrote.

Of course, experts have been calling this market long in the tooth since it broke old records in 2014. Equities keep ridiculing the skeptics. In the 12 months following President Joe Biden’s election in early November, the S&P 500 has surged about 37%, more than triple its historical average return.

Little wonder that giant institutions and financial advisors alike are looking at asset classes outside of large-cap U.S. equities—including alternative investments. The category typically has been divided into two primary vehicles—private equity and hedge funds. The first has performed well since the Great Recession while the latter has delivered mostly disappointment.

U.S. equities aren’t the only pricey asset class. In November, J.P. Morgan Asset Management issued its annual long-term capital markets assumptions, labelling bonds “serial losers” after a 40-year bull market in global bonds. The investment complex was somewhat kinder to equities, cryptically predicting their performance would be “stable but cyclical.”

Echoing a growing chorus of large insfititutions, J.P. Morgan went a lot further when it came to alternatives. “Looking beyond public markets is increasingly essential,” the firm wrote. “The benefits of alternative assets—improving alpha trends, the ability to harvest risk premia from illiquidity, and the ability to select managers that can deliver returns well above what is available from market risk premia alone—will continue to attract capital over the coming decade.”

But that last observation about manager selection highlights the dilemma facing advisors. Unlike the children of Lake Wobegon, not all alternative asset managers are above average. And unlike their counterparts in public markets, the dispersion in their performance is much wider, elevating the risk of advisors who select a manager who has a string of bad years. Moreover, skeptics of private equity in particular note that its strong performance over the last cycle has closely mirrored public equity markets.

Investing in private markets is expected to remain lucrative in the year ahead. J.P. Morgan, in its 2022 capital markets forecast, predicted that private equity assets should see 8.1% appreciation in the coming year (compared to a projected 4.1% gain for domestic large-cap stocks). And private debt (also known as private credit) is expected to garner a 6.9% annual return. That exceeds the current yield on a broad range of high-quality public fixed-income investments such as government, corporate and municipal bonds.

Advisors and brokers haven’t totally ignored the alternative investments space in recent years. The granddaddy of alternative investments over the last five years has been Blackstone BREIT, a non-public, so-called NAV REIT that allows monthly redemptions of 2%, up to 5% quarterly and 20% annually.

Its investments in more than 1,700 properties has swelled to about $73 billion, or nearly 10% of Blackstone’s total assets. Since its inception in January 2017, the fund, which invests 90% of its assets in real estate and 10% in real estate debt, has returned 13.02% annually as October 31. Blackstone is the nation’s largest owner of real estate.

Some advisors question whether they can access the same elite managers who cater to billionaires and huge pension funds. Blackstone has steadfastly maintained retail investors in BREIT, along with its private equity and hedge funds, are getting the same investments as institutions.

iCapital has emerged as the industry’s largest alternative funds platform. It has cut distribution deals and received financial backing from firms such as BlackRock, Blackstone, BofA Merrill, Morgan Stanley, Singapore’s Temasek and most Wall Street brokerages. As of June 30, the platform serviced more than $80 billion in client assets across 750 funds.

iCapital also is offering retail investors access to institutional funds, most recently giant Bridgewater. Private equity firms and brokerages have partnered with iCapital to funnel smaller investments into “feeder funds” that are then deployed into institutional alternatives-focused funds.

Matt Brown, founder and chairman of CAIS group, says, “We’re clearly at an inflection point in terms of advisor adoption,” adding that “there’s a lot of product innovation underway because of what’s happening on the demand side.” His firm operates an alternative investment marketplace that provides an array of alternatives education modules coupled with a growing roster of alternative investment solutions that are far more accessible than the insular world of traditional hedge fund managers that serve institutional clients.

Brown adds that his firm’s ecosystem makes it relatively easy to learn about and then transact alternative investments. “CAIS streamlines the end-to-end transaction process, making investing in alternatives simple,” he says.

Demand for alternatives has been rising as stock markets have become more expensive and interest rates threaten to move up from historic levels. Ken Heinz, president of HFR, notes that the hedge fund industry’s asset base has swelled from $3 trillion to $4 trillion in just the past 18 months.

Broaden the scope to include all alternative assets owned by all stripes of investors, (which hedge funds are a part of), and the figures grow far larger. Research firm Preqin predicts assets under management in alts could grow from $10.7 trillion last year to $17 trillion by 2025.

For advisors who have just begun to learn about all of the various alternative approaches, a quick primer may be helpful. Key categories include: private equity, private debt, real estate, infrastructure, relative value arbitrage, event-driven or activist investing, hedged equity and global macro.

Some of these approaches provide exposure to assets that are non-correlated with stocks and bonds, helping to tamp down volatility. Other approaches aim to deliver superior returns to their public market counterparts. “There are a range of opportunities, from high beta to neutral beta or even negative beta,” says HFR’s Heinz. Certain categories such as activist investing, distressed assets and special situations are the kinds of approaches that were most easily accessed by institutional investors but are becoming more readily accessible to advisors these days.

The Hamilton Lane Private Assets Fund (PAF), available to U.S.-based investors, is just one of the many funds that can now be bought on a platform such as iCapital. The firm’s platform, which includes PAF as well as its Global Private Assets Fund (GPA, available to non-U.S. investors) was launched in 2019 and has already attracted more than $1.6 billion in assets. Since its launch, PAF has garnered a 21.07% annualized return, with a blend of private market investments including direct equity (33%), direct credit (18%) and secondaries (49%).

That impressive gain shouldn’t be compared to funds that are strictly focused on public equities. The blend of assets, including private credit, is what makes that performance so impressive. Stephen Brennan, head of private wealth solutions at Hamilton Lane, says that “private equity and private credit have outperformed their public counterparts in 19 of the past 20 years.” His firm has historically focused on institutional clients and only recently opened up its focus to a broader set of investors—including financial advisors.

Still, he cautions that the PAF fund and other private-market focused funds shouldn’t be seen as short-term trading vehicles. “The holding periods for private market investments are longer, and it’s important to have consistent exposure to be positioned to capture the long-term benefits,” says Brennan.

Hamilton Lane and other firms that focus on private markets have a “target-rich environment,” says Brennan. He notes that there are 17,000 privately held companies in the United States with at least $100 million in revenue, compared to around 2,600 publicly traded firms.

Firms with a long history in sourcing alternative investments bring a wealth of insights that small advisory teams simply can’t muster. “We look at 1,500 investments per year,” says Christopher Zook, founder and chief investment officer of Houston-based CAZ Investments. The overwhelming majority of those scoured investments will receive a hard pass. Investments under scrutiny include private credit, real estate, venture capital, and other assets that are not strongly correlated with equity markets.

CAZ’s sweet spot is a hybrid approach toward client access. CAZ provides access to unique alternatives and partners with external advisors, allowing those advisors and their clients to invest alongside CAZ. Like iCapital, this approach enables CAZ to boost its collective buying power, “allowing it to access more proprietary investments, often at preferred terms, for everyone involved,” Zook noted.

Zook adds that his firm is in the process of developing a new fund geared towards risk mitigation, the specifics of which can’t yet be publicly disclosed due to SEC regulations. As Howard Marks has observed, risk mitigation could prove to be a savvy survival strategy in the period ahead. “Portfolios need insurance too,” Zook says.

Private debt funds have become increasingly popular over the past decade. Through the 10 years ended September 2020 (the most recent data available), private credit assets under management worldwide have almost tripled from $341 billion in 2011 to $975 billion, according to Preqin.

Private credit has steadily grown in popularity due to low interest rates and reforms resulting from the 2008 economic crisis. At that time, many banks moved to sharply reduce their exposure to direct lending in order to pass stress tests.

To fill the void, private lenders stepped in to provide short-to-medium term loans to condo developers, warehouse builders and other large real estate projects. Private debt funds have typically delivered 5% to 10% annual returns, typically yielding several percentage points more than public debt funds. Funds that deploy leverage have been able to deliver the strongest yields.

In a 2020 survey of expected returns for the decade ahead, with respondents including Vanguard, Goldman Sachs, J.P. Morgan, BlackRock and others, Horizon Actuarial Services found that private debt should be expected to generate a 7.75% annualized return over the next 10 years, compared to 2.70% for U.S. corporate bonds.

So far, those returns have historically been comparatively modest. Private debt lenders often require at least 60% equity in a project. If the project runs into trouble, the lenders can simply take ownership and unload the assets for at least the size of the loan.

Michelle Connell, a CFA who runs Dallas-based Portia Capital Management, has made extensive use of the relatively high yields offered by private credit funds. She counts a number of non-profit foundations among her clients.

“I can’t afford to see them lose any money on their investments,” Connell says. She has also been able to garner double-digit yields through investments in real estate-focused private credit funds, though she concedes that as more funds flow into that category, yields have begun to fall from the double-digit range.

Tapping into private credit funds as a source of robust fixed-income yields has enabled Connell to meet or exceed the hypothetical returns of a 60/40 public equity/debt portfolio (comprised of a 60% weighting in the MSCI World index and 40% in the Bloomberg Barclays U.S. Bond Aggregate) in each of the past four years. Through the first six months of 2021, the approach has outperformed the 60/40 benchmark by roughly 6%.

To generate those returns, Connell has invested in private credit and equity funds such as the CION Ares Diversified Credit Fund (CADC), and the Strategic Wireless Infrastructure Funds offered by Strategic Capital Fund Management.

Industry titans such as Blackstone, KKR and a host of niche lenders such as Lone Oak Fund and Anchor Loans also offer access to private debt funds. It’s important to note that private equity and private debt can sometimes carry elevated levels of interest rate risk, as buyers may pay for assets (or make loans) with a healthy dose of borrowed funds. “Lower rates have pushed up valuations, and rising rates would certainly impact valuations,” says Hamilton Lane’s Brennan.

Private market funds can also have a complex set of fees, including feeder fund fees, in place. Hamilton Lane’s GPA fund, for example, charges management fees in excess of 1% (though with breakpoints), and also levies performance fees once hurdle rates have been met.

Advisors can also find those kinds of fees on the funds offered on trading platforms such as iCapital and CAIS. For that matter, the typically stiff fees charged by the broad array of “liquid alt” mutual funds and ETFs have also been a challenging hurdle for advisors to navigate with their clients.

In response, some advisors and family offices have created their own bespoke alternative funds for clients. Jeff Nauta, a principal at Henrickson Nauta Wealth Advisors, has been able to develop internally managed alternative asset funds for around $25,000. Hendrickson Nauta’s funds invest in assets such as real estate, transportation (railcar leasing, helicopter leasing, inland marine insurance) life settlement funds and other esoteric asset classes.

To be sure, advisors need to educate clients on what to expect. Blackstone has created Blackstone University to educate advisors, brokers and family offices.

But the experience of some advisors and their clients in the alternatives space has been disappointing. One advisor began placing some clients into private equity funds a decade ago when he was at a wirehouse. Though the funds delivered low double-digit returns for several years after the Great Recession when bargains were plentiful, clients are now getting returns in the 5% to 7% areas.

Feeder fund structures and creative return calculations prompt critics to doubt whether financial advisors and their clients are receiving anything close to the double-digit returns they were sold on. In particular, some believe that many private equity firms use leverage via credit lines to juice returns in the early years. “Be sure to show your clients month by month ‘net net’ returns over the lifetime of the prior funds before suggesting they invest in alternatives,” New Jersey advisor Kurt Stein says.

Some academics also maintain that private equity firms overpromise and under-deliver. That’s the view of Ludovic Phalippou, professor of financial economics at Oxford University’s Said Business School and author of Private Equity Laid Bare. Phalippou argues in the book that returns from private equity have not exceeded those of relevant indexes for public markets since 2006. However, he argues that private equity funds have created spectacular wealth for the PE firms themselves.

That’s food for thought for any advisor that has delivered solid returns for clients in this bull market.