If financial advisers want to attract the wealthiest clients, they should be fluent in investments that go beyond traditional stocks, bonds and cash — but they also need to be aware of increased regulatory scrutiny.
High-net-worth investors allocated about 26% of their portfolios to alternative investments in 2020, while ultra-high-net-worth investors allocated about 52%, Stephen Soper, senior vice president at Wright Investors’ Services, said Monday at the Financial Planning Association annual conference in Seattle.
“If you want to speak to these target markets, you better have alternatives in your mix,” Soper said.
Alternative refers to any investment outside traditional securities and can include private equity, hedge funds, venture capital, private debt, real estate, managed futures, structured products and collectibles. They can be complex — for instance, relying on derivatives — and produce counterintuitive payouts.
Alternatives, which often aren't correlated to the stock and bond markets, are used to manage portfolio risk and return. Soper recommended that advisers consider alternatives because adding them to a traditional portfolio boosts the portfolio’s performance.
“The average return that I would be looking for in these alternative spaces in the next three to five years — if you diversify the portfolio and do your homework — [is] a 12%-15% return,” he said. “That should be your goal.”
Many alternatives can only be sold to investors who meet certain wealth and income thresholds. But regulators are not leaving sophisticated investors on their own.
The Securities and Exchange Commission, the Financial Industry Regulatory Authority Inc. and state regulators have all been taking a harder look at complex products over the last year or so. The SEC has targeted them in enforcement cases. Finra is reviewing public comments about oversight in the area. The North American Securities Administrators Association is considering strengthening rules for nontraded real estate investment trusts.
Regulators are concerned about the lack of liquidity in the alternatives market, the fees and expenses associated with the products, and the extent to which financial advisers and clients don’t grasp them.
Soper cautioned the FPA audience to make sure they’re selecting alternatives that align with an investor's objectives and risk profile. They also need to demonstrate that they’re monitoring the investments’ track records on the appropriate timeline.
“Yes, it’s become more of a concern,” Soper said of regulation. “Make sure that your compliance manual is up-to-date and that it addresses these issues, too.”
So-called liquid alternatives — mutual funds and exchange-traded funds that use alternative strategies but can be sold to retail investors — for the most part don’t pose a regulatory risk, Soper said.
But for the most complex investments, advisers should hire firms that specialize in them as sub-advisers.
“I wouldn’t go in it alone, unless it’s a liquid alt,” Soper said. “I would recommend you use a third party, if you’re going to go into the non-liquid alt space.”
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