Can alternatives shelter US retail investors from a market turn?

Alternative investments are a delicacy for independent advisers — highly valued by a select few yet uncommon, even exotic, for many. But greater appetite from high-net-worth investors, fears of a stock market downturn and a wider offering of funds are enabling the products to edge their way into retail investment portfolios.

However, before alternatives — which include property, private equity, infrastructure and hedge funds — can become a staple, registered investment advisers (RIAs) say they need deeper research and educational resources for private funds; new products to address investor concerns around fees and liquidity; and a bigger selection of successful funds in order to be able to demonstrate how these strategies can fit into client portfolios.

David Copeland, principal at Strategic Wealth Partners, which is based in Illinois and manages $2.1bn, says alternatives offer return streams that are less correlated to long-only stocks or fixed income. “With interest rates so low and people nervous about the stock market, investors are open-minded about alternative ways to generate returns,” he says.

Advisers cannot rely on the standard 60-40 equity-bond portfolio in today’s market, says Lori Van Dusen, chief executive at LVW Advisors, a $1.8bn RIA based in Rochester, New York. “We’re doing a lot of work, particularly in private credit,” she says.

Still, usage among RIAs is limited, with fee-only advisers on average reporting they had 2.5 per cent of client portfolios in alternatives strategies in 2017, according to Cerulli Associates. That figure is expected to rise to more than 3 per cent next year. Hybrid independent advisers, with both fee-only and commission-based business, reported slightly higher allocations, with 4.2 per cent in 2017.

Interest in alternatives is up in part because many RIAs and their clients see listed equity as highly priced. Others fear an equity market downturn and are seeking protection in products with a lower correlation to stock indices, says Brendan Lake, president and chief executive at PPB Advisors, a platform that delivers alternatives products to RIAs. Advisers often still lack basic information on the asset class, he says. “They’re interested but they are reaching out to managers to better understand how these strategies work.”

Appetite among advisers spans private equity, hedge funds and real estate, says PPB’s chief investment strategist Frank Burke. “Income-producing funds and anything with low correlation to the markets — that’s where the assets are going,” he says.

Many investors find aspects of some funds unappealing such as greater volatility and long lockups, Mr Copeland says. Some balk at private equity vehicles that lock up capital for eight to 12 years without a cash distribution, he adds.

Performance is also a concern for some. While hedge funds on average beat the S&P 500 index over the past decade on an annualised basis, they trailed in three- and five-year timeframes, according to data provider Preqin.

Cost is another sticking point, with the best managers commanding fees of 1.5-2 per cent for management and 15-20 per cent for performance. Private fund fees are hard to justify when equity index funds are performing well, says Rubesh Jacobs, associate principal at ZS Associates, a strategic consultant.

Another risk is lack of access to top managers, Ms Van Dusen says. “It’s super-hard to find the better product,” she explains.

Having enough products to choose from is a cause for concern, says Mr Copeland. Regulatory restrictions on private fund marketing requires advisers to do much more work than picking mutual funds off a Morningstar list, he says.

However, managers and alternatives platforms have started to address some concerns about product access and structure. For instance, managers such as Blackstone Group, Carlyle Group, AQR Capital Management, and KKR have added sales and education resources aimed at the adviser market, and some — especially Blackstone — are targeting RIAs. Mr Copeland says: “A lot of firms now approach us, where there were very few willing to involve the RIA community 10 years ago.”

His firm also uses alternatives platforms to access funds that do not usually take on individual RIAs as clients, often benefiting from lower investment minimums and institutional due diligence resources.

Such efforts by managers help explain the spread of alternatives among RIAs, Mr Jacobs believes. He cites JPMorgan Asset Management’s move, announced last month, to create an alternatives platform that reduces investment minimums on its private funds to $100,000 from as high as $10m, to appeal to high-net-worth investors. “There has been an explosion of [products], a large investment in distribution to build access for advisers,” he adds. “I think that trend will continue.”