Advisors See Increased Thirst for Alternative Investments

As stock market volatility picks up—a classic September scenario—it's common for investors and financial advisors to refocus on ways to hedge certain risks and lean more heavily on diversification. 

In many cases, that line of thinking points to a direct route toward alternative investments, which concentrate on nontraditional or niche opportunities. 

“Alternatives have become very, very popular, and for good reason,” said Chuck Failla, principal at Sovereign Financial Group. 

While Failla sees benefits to diversifying beyond public markets, he also believes investors should know the trade-offs that come with introducing alts into a portfolio. 

“It is paramount for advisors to be sure clients understand that alts are generally less liquid,” he said. “That’s not inherently bad; however, it does make it important for advisors to guide clients on how to deploy alts into their overall portfolios.” 

 Failla said his shop is looking closely at private credit strategies to compete with equities as interest rates remain high. 

Alternatives a 'Vague' Category

Sumit Roy, senior ETF analyst at etf.com, said part of the challenge with alternative investments centers on the general vagueness surrounding the category. 

“To me ‘alternative’ is a catchall term for strategies that invest in anything other than traditional financial assets like stocks and bonds,” he said.  

ETFs that would fit the definition of an alternative include the First Trust Long/Short Equity ETF (FTLS), which is up 9.5% this year; the iMGP DBi Managed Futures Strategy ETF (DBMF), which is down 1.5% this year; and the IQ Hedge Multi-Strategy Tracker ETF (QAI), which is up 5.5%. 

In essence, not only is the concept of an alternative vague and varied, but there is also nothing simple about migrating into alternatives. 

“There’s no simple answer to whether an investor should add alternatives exposure to their portfolio,” Roy said. “All the strategies are so different that they have to be evaluated on their own merits.” 

Pros and Cons of Alternative Investments

Matt Chancey, a private-equity consultant at Coastal Investment Advisors, said his firm uses private equity, private credit and venture capital to inject alternative exposure into a portfolio. 

As he sees it, reduced liquidity represents the biggest downside, but even that can be turned into a positive. 

“Less liquidity might seem like a bad thing to investors until they understand the benefits of the illiquidity premium or excess returns,” he said. “They can earn for the liquidity trade-off and the ability to not make an emotional decision if or when economic circumstances change, which they always do.  

“For most investors the pros outweigh the cons due to increased returns and decrease in price fluctuations over a predefined hold period.”.” 

Angie Spielman, founding partner at Manhattan West, never thinks of alternatives as an allocation for one particular market cycle because her clients are trained to appreciate the allocation all the time. 

Every client who comes in the door is introduced to portfolios with equal parts equities, bonds, and alternatives that include real estate, private equity and venture-capital investments. 

In terms of how her portfolios stand out from more traditional models of 60% stocks and 40% bonds, Spielman quipped, “I don’t know if the norm is necessarily the right place to be. 

“Clients find that alternatives are a sexy place to be, and we can give them access to firms they might not otherwise have access to,” she said.