Advisors should consider using alternative investments even in the face of some lackluster returns, say two veterans of the business.

Jeanie Wyatt, chief executive of South Texas Money Management, and Bill Carter, president of Carter Financial Management, have used alternatives for years.

Speaking Tuesday at Financial Advisor magazine’s Inside Alternatives conference in Denver, the two advisors said that their peers using alternatives should be flexible with allocations and opportunistic with asset classes.

Wyatt uses alternatives to complement traditional portfolios of individual stocks and bonds. She invests in commodities, gold, currencies, REITs, small emerging managers, private equity and venture capital. Her larger accounts usually have more alternatives (up to 20 percent), but she does not have a static allocation.

“That is a mistake,” she said. “We don’t have a 5 percent allocation and then force ourselves to fill that bucket.”

She analyzes everything a client owns, such as real estate holdings, taking that into account before recommending an alternative.

Carter started his career in the 1970s bear market, so he immediately began looking for alternatives, which led him to some limited partnerships. In the early ’90s, he got more involved with alternatives after a fellow trustee at Texas A&M University heard what Harvard was doing with its portfolio. After a consultant looked into it, the conclusion “was very compelling,” Carter said.

He uses hedge funds, private equity, real estate and long/short funds. Carter, too, has no set percentage he uses with clients, but it’s generally 5 to 20 percent, depending on the client.

Advisors shouldn’t jump in without proper due diligence and understanding of what they’re getting into.

“Alternatives are not an asset class. They are going to perform very differently from each other,” Wyatt said. “A lot of people get into trouble defining alternatives as an asset class.”

You need to measure against the appropriate asset, like equities, commodities or debt, she said. If an alternative strategy is designed to be a hedge, be sure it is acting inversely to the hedged asset.

Carter likes to understand how alternative managers handle their mistakes, and how they recover from their biggest ones.

Advisors need to be careful, Wyatt warned. “You don’t have the luxury of making a mistake” because most alternatives are long-term investments and may be hard to get out of. “They require a high level of due diligence,” she said.

Investors should also be aware that the alpha being delivered by alternative managers “has gone down to its lowest level historically,” Wyatt said. “There are a lot of managers chasing a lot of strategies, and adding fees.”

Lower levels of leverage can explain some of the lower returns. “The early [hedge fund] managers had 10 or 20 times leverage [but] access to leverage has basically deflated” after the financial crisis and passage of the Dodd-Frank Act, Wyatt said.

Wyatt and Carter said investors should avoid funds of funds, which have layers of fees, too many managers who dilute performance, and difficulty following a large group of managers.

Clients need to be educated, Carter added, and prepared for periods of underperformance, while advisors should be sure to explain what hedge funds are before recommending them. Clients hear the phrase “hedge fund” and immediately think of risk and shady Wall Street operators, he said.

Carter and Wyatt are both opportunistic in using alternatives.

Wyatt, for example, is adding gold to client portfolios, as she did in 2007, and is also looking for opportunities to invest in infrastructure.

Carter likes to buy out-of-favor asset classes (he added real estate after the financial crisis) and likes the fact that alternative managers don’t have to be fully invested all the time.

“The main thing is value,” he said. “Is now a good time to be buying?”