Why advisers need to educate clients about alts

By Robert M. Hussey

Mar 19, 2012 @ 6:12 pm (Updated 8:33 am) EST

Alternative investments play a growing role in the portfolios of many sophisticated individual and institutional investors, yet a majority of affluent Americans admit their knowledge about these investments is scanty at best. This is both a challenge and an enormous opportunity for financial advisors who wish to help their clients build more durable, all-weather portfolios as the best method to address concerns about risk and volatility. By seeking to avoid performance extremes in the market, a durable portfolio can make it easier for an investor to stay invested for the long run.

In a recent survey of affluent American investors1 commissioned by Natixis Global Asset Management (NGAM), more than two-thirds of the respondents said they only understand alternative investments a little or not well. More than 40% of investors confessed they don't understand alternatives at all.

By definition, alternative investments are any investments other than the traditional asset classes – stocks, bonds and cash. Alternatives can offer a low level of correlation with fixed-income and equity markets, and they are gaining popularity with investors seeking to add another dimension of diversification to an investment portfolio. Improving diversification may lower overall risk because different types of investments respond differently to market conditions.

Once only available to the super-wealthy and institutions, alternative investments are now offered in many different types of mutual funds using strategies ranging from investing in currencies, interest rates and commodities to the use of hedging techniques such as holding short positions or using derivatives. These products continue to capture a growing market share; a recent study (by SEI) shows that during the first eight months of 2011, more than $61 billion was funneled into alternative strategies. Still, despite the recent proliferation and growing popularity of alternative products, it remains a challenge to get the word out. The NGAM survey found that more than 15% of individual investors still believe they don't have access to alternative investment strategies, and more than 20% of investors continue to believe that alternatives are appropriate for only the wealthy and institutions.

Although few would argue with the growing importance of alternatives, investors and many financial professionals often are intimidated by these complex products. However, knowing how to deploy mutual funds with alternative investing strategies so they work well alongside a traditional portfolio of stocks, bonds and cash is a topic of vital interest to a growing number of investors seeking to construct a more durable portfolio. When investors were asked by the NGAM survey about how today's uncertain market makes them feel about investing, almost half of respondents said they were concerned about losing money in the current volatile markets and two-thirds of them said they were changing their expectations about future investment returns.

Ultimately, the real key is that people invest in what they know and trust. If investors are uncertain or not familiar with alternative investing strategies, they are less likely to consider incorporating them into their portfolio, no matter how helpful, accessible or cost-effective these products may be. More than three in five investors surveyed said they will invest only in products with which they are familiar. Two-thirds said they need to learn more about alternatives before investing in them, and nearly half said the greatest barrier to considering alternatives for their portfolio was a lack of “enough information about them.”

It's no surprise, therefore, that four in five high-net-worth investors surveyed – including 71 percent of those who work with an advisor! – say they have not discussed alternative investments with a financial professional. This “information disconnect” is a call to action for advisors – a call that represents both a challenge and an opportunity for those seeking to proactively initiate a conversation with their clients to discuss alternatives. The challenge for advisors is to suitably educate themselves about alternative types so that they can successfully navigate these complex and varied products and link clients with investment vehicles that can best strengthen their portfolios. The opportunity presented advisors is inherent in the ability to grow business by educating clients about products that have the potential to diversify portfolios and improve risk-adjusted returns.

Today's markets combine complexity and volatility in ways that are unprecedented and disorienting for even the most sophisticated financial professionals. In addition, since the 2008 financial crisis, advisors are often being held to a higher standard by both investors and regulators. Thankfully, there are a number of resources available to financial professionals in search of continuing education about alternatives. Outsourcing consultant services which offer expertise in the area is one answer; tapping alternative investment providers for information is another, as is choosing from a wide array of information available in whitepapers, webinars and portfolio manager conference calls. By using these tools, a knowledgeable and experienced intermediary can add significant value and not only strengthen a client's financial position, but also strengthen the trust and regard the client holds for the advisor. Despite some of the complexity inherent in many alternatives, the demand for these dynamic and sophisticated strategies is on the rise. Advisors who offer access to alternatives that complement a client's portfolio holdings and align with their investment goals and risk tolerance are best positioned to grow their business while their clients prosper.

Robert M. Hussey is the executive vice president, Institutional Services Group for Natixis Global Asset Management.