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Wealthy investors are particularly interested in so-called alternative investment asset classes because they are hoping they can play distinct roles in diversifying a portfolio.
But there are no short-cuts when it comes to selecting investments in assets such as hedge funds, private equity, real estate, commodities and alternative mutual funds, says Alexander Williams, an adviser at UBS Private Wealth Management in New York, whose team runs $2.7bn.
“We’re spending more and more time figuring out the right mix of alternative managers that are truly doing something different,” he says.
One of the first steps is determining whether alternative investments are appropriate for a client.
Very wealthy clients — typically with at least $5m-$10m to invest — are the most likely candidates for private funds.
These clients often do not need to generate income, and are instead aiming to grow assets over the long term. This means they can take on illiquid strategies that lock up capital for months or years at a time, says Aimee Cogan, an adviser at Morgan Stanley Wealth Management in Sarasota, Florida, whose team runs $685m in client assets.
“The ultra high-net-worth client has the ability to take on illiquidity and a longer investment timeframe,” she says.
Clients’ preference for this investing approach can vary according to their lifestyle, family circumstances and charitable goals. These are all factors in determining cash needs and whether clients can commit to investing in illiquid holdings, Mr Williams says.
For less wealthy clients with portfolio sizes closer to $1m, advisers rely less on illiquid vehicles, says Susan Kim, an adviser at Ameriprise Financial Services in Vienna, Virginia. Her team, which oversees $1.1bn for 850 households, does not recommend alternatives to most investors until they approach $1m.
“It isn’t for everyone,” she says. For each individual, tax and liquidity considerations differ based on age, risk appetite, and investment time horizon, she adds.
Advisers are more likely to consider alternatives if they are active in building investment portfolios rather than broad financial planning, says Erlend Bø, head of distribution for Angel Oak Capital Advisors, an Atlanta-based manager with traditional and alternative funds that runs $6bn. Those involved in broad financial planning are more likely to rely on models provided by the companies for whom they work.
“But [portfolio manager] advisers pride themselves on knowing what’s going on in the markets,” Mr Bø says. “They’re very interested in ‘nichey’ alternative strategies.”
Once advisers opt for alternatives, they must set the scale of allocation. Morgan Stanley recommends setting alternatives at 20 per cent of a very wealthy client’s portfolio. But Ms Cogan says in today’s market, her team aims for 25-30 per cent. “We like alternatives in more volatile markets, and post-[quantitative easing], volatility is back,” she adds.
Mr Williams says his team aims to invest 20 per cent of a client’s portfolio in alternatives, while Ms Kim says her practice targets a 10-15 per cent allocation at most. A big reason is that alternative fund fees can be higher for the $1m client, which puts a damper on net returns, she says.
The advisers then decide on types of products. For Mr Williams, the menu includes hedge funds, private equity and alternative mutual funds, otherwise known as “ liquid alts”, which have “slightly less in returns expectations . . . but similar exposures”, he says.
The main elements for Ms Cogan’s team are heavier tilts to hedge funds and private equity, and lesser amounts allocated to managed futures — also known as commodity trading advisers or CTAs, which generally take long or short positions in futures markets — and to precious metals. “Managed futures and precious metals are . . . more tactical,” she says.
Alternative mutual funds and real estate investment trusts (Reits) are staples for Ms Kim’s team, which also has a preference for open-ended funds, she says.
Ms Cogan’s team currently favours managed futures — which “have been one of our better performers and have helped smooth the ride” — as well as private equity investing in distressed companies and direct lending funds.
Private credit — which typically involves investing in funds that originate or buy corporate loans — is also a theme for Mr Williams, as well as sector-specific opportunities, such as a fund focused on the aviation industry, he says. “Funds like that can . . . fill in pieces of the puzzle,” he says.
His team is also looking at master limited partnerships in the hard-hit energy sector that pay investors through regular agreed distributions.
Long-short, managed futures, and alternative exchange traded funds are primary tools for Ms Kim’s team, along with non-traded Reits. “We like [managers] that can go into individual sectors or stocks, and that can short,” she says.
Developing alternative investing expertise has brought new business to Ms Cogan’s team, both from prospective clients as well as other advisers seeking assistance, she says.
“The biggest factor is client education,” Ms Cogan says. “The fund managers we work with have been very accommodating.”