More advisers use alts, but few understand them

Alternative investments are complex and difficult to define, let alone explain to clients

Apr 28, 2018 @ 6:00 am

By John Waggoner

Even as adviser use of alternative investments is on the rise, one overriding problem remains.​ Advisers often don't understand them, according to a panel of investment experts at the InvestmentNews Innovators in Investing event and webcast in New York.

"About 67% of advisers say lack of understanding is one of the main reasons why they don't invest more heavily in alternatives," said Frederick Gabriel, InvestmentNews editor and moderator of the discussion.

The panelists were Tom Daley, managing director of custody services at Millennium Trust Co.; Eddie Sempek, chief innovation officer at Orion Advisor Services; and Kevin White, head of investment strategy in the Americas for alternatives at DWS (formerly Deutsche Asset Management).

That lack of understanding starts with the definition of alternative investments: The category has no universally agreed-upon definition, Mr. Gabriel said.

Broadly speaking, alternative investments involve hedge fund strategies such as long-short, market-neutral and low-volatility portfolios. But they also include investments in commodities, precious metals, currencies, volatility and real estate.

Nevertheless, it's an amorphous space that could include any number of investments and strategies.

Making matters even more complex, alternative investments come in two flavors, publicly traded and non-traded. It's the latter that causes most of the consternation.

"You've seen a rise in adviser use of alts. They're easy to find, and they are more tradable than nonliquid alts," Mr. Daley said. "You see more complexity in the non-traded side, which creates challenges to advisers and clients who want to invest in those nonliquid alts."

Often, advisers have to choose between traded and non-traded alts that invest in the same area, such as real estate.

"In our case, real estate is a big part of our business," Mr. White said. "Non-traded real estate has a lot of the same structure and investment strategy as a listed real estate investment trust. The difference is one is traded on the New York Stock Exchange and the other isn't. What's interesting is that they can behave very differently because of the fact that one is listed on an exchange and the other isn't."

Difficult tasks

For an adviser, evaluating those differences and explaining them to clients are difficult tasks. For example, when investing in a non-traded alternative investment, clients obviously give up liquidity.

"But with non-traded alts, they have less liquidity, but you gain a lower correlation to stocks and other listed assets," Mr. White said.

The complexities of dealing with alts, and particularly non-traded alts, are further compounded by differences among advisers.

"Non-traded alts present challenges for broker-dealers and compliance officers, so broker-dealers tend to go toward more readily tradable products," Mr. White said. "What we see on the RIA side is more appetite for non-traded alts because we see more opportunities, and the RIAs have greater flexibility and ability to do due diligence and research."

Alternatives are typically about 10% of institutional investors' portfolios, and getting individual clients to that level has an additional challenge: finding the technology to capture data about non-traded alts.

"If you can't receive the data, it becomes increasingly difficult to report it to clients," Mr. Sempek said. "Advisers aren't able to find a platform that can put a comprehensive wrapper around the client conversation."

But that technology is on the way.

"Technology is going to play an instrumental part in bringing these investments to the world," Mr. Daley said. "We have 14,000 things individual investors can invest in. We leverage technology so an RIA can manage alternatives and as a fiduciary can make sure that it's appropriate."

Despite all the hurdles, alternatives are getting increasingly popular, and it's likely your clients will ask you about them.

"Client conversations are no longer just, 'How are my stocks and bonds doing?'" Mr. Sempek said. "They want to expand out and invest in other opportunities. Clients out there are doing their own research and asking their advisers for an opinion. They are self-aware, doing their own research and trying to make sense of what's going on around them."

What kind of alternative investments are clients asking about?

Real estate. Many of the problems with alternative real estate investments have been addressed by the industry, Mr. White said.

"One criticism has been that they have limited transparency, low liquidity and high fees," he said. "The industry has taken that feedback and evolved."

Private equity. "We're seeing a lot of interest in the private equity space," Mr. Daly said. "And they're looking at private equity for diversification. The days of looking solely at return are behind them."

Environmental, social and governance investing. "People want something that has an impact on their whole community," Mr. Sempek said.

Alternatives are no longer just for accredited investors and institutions.

Mutual funds and ETFs offer hundreds of opportunities for small investors. And even non-traded alternatives are dropping investment minimums to as low as $5,000.

What is the appetite for alternatives among small investors?

"There were more investments in initial coin offerings last year than in venture capital," Mr. Sempek said. "These are everyday people getting into these investments. You could say those investments are not suitable for them, and that's where investment advice comes in. But people are interested in new opportunities."

The popularity of cryptocurrencies clearly indicates an interest among investors, but it also sets off alarm bells for most advisers.

The road ahead for alternatives
Panelists at the InvestmentNews Innovators in Investing event give their take on the next five years:

To conclude, panelists offered these suggestions to advisers and investors on the fence about alts.

"It's important to understand the needs and constraints of clients," Mr. White said. "And they need to understand the liquidity constraints and other considerations in alternatives."

"The main thing to do is to educate yourself," Mr. Sempek said.

If you don't have time, consider outsourcing your alternative investments to someone who can deliver the data and information you need.

"Learn," Mr. Daly said. "The individual investors will come to you."

Experts may not agree on the definition of alternative investments, but most conclude that they are becoming an increasingly important part of investors' portfolios, particularly for those who want to reduce volatility over the long term.

New technologies and increasingly sophisticated custodian services will help advisers implement alts in client portfolios and explain the investments to customers more efficiently than they have in the past.

Go to to watch "Cracking the Making Sense of Alternative Investments," sponsored by DWS, Millennium Trust and Orion Advisor Services.


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