Advisors reassess their alt stakes after loading up

Use of alternative investments skyrocketed when stocks and bonds tanked in 2022, but advisors are still standing behind those positions as stocks rally.

This question may sound sudden, but is it already time for advisors to scale back their alternative allocations?

When both legs of the 60/40 portfolio buckled in 2022, advisors gorged themselves on alternative assets as if there were no tomorrow: real estate, crypto, credit, anything and everything alt or alt adjacent. They took whatever private route they needed to escape the thrashing they were taking in public markets.

Tomorrow finally arrived scarcely a year later in 2023, when the S&P 500 returned approximately 24 percent and the yield on the benchmark 10-year Treasury note rose well above 4 percent, providing comfort for speculators and savers alike.

This new investing environment, as well as an economy that seems intent on a soft landing, raises the question of whether advisors should start reducing their stakes in those illiquid alternatives that once provided them safe harbor. A Cerulli survey from last fall of more than 200 upmarket advisors showed 54 percent of those surveyed maintained an alternatives allocation of five percent or higher.

“Even after a great 2023 for stocks and bonds, we still believe that owning alternative investments as part of a properly diversified portfolio makes sense,” said Paul Camhi, senior financial advisor at The Wealth Alliance. “We include these strategies as part of our strategic, long-term allocation, not as tactical short-term investments.”

NOT SO ALTERNATIVE ANYMORE

Lawrence Calcano, CEO of alternative investment provider iCapital, said that demand for alternatives has remained strong even in the face of a raging bull market and steepening yield curve. In a study last August, iCapital asked advisors about their plans for alternatives, and nearly 95 percent said they plan to maintain or increase their investments in the space. Furthermore, the iCapital survey revealed that approximately 60 percent expected alternatives to outperform the public markets in 2024.

As to which types of alternatives are attracting the most attention on his platform, Calcano says private credit has dominated flows over the last six to 12 months.

“We’re seeing that because most of those instruments are floating rate,” he said. “And so, in a rising interest-rate environment, they effectively protect or hedge you. In fact, with Treasuries where they were, people were getting high single-digit or low double-digit returns by investing in private credit.”

Calcano says most major banks and wealth managers generally recommend a 15 percent to 25 percent allocation to alternatives.

Jake Miller, co-founder of alternatives provider Opto Investments, said surging equities and high valuations make this a great time for investors to up their stakes in private markets. He suggests a 12 percent to 15 percent allocation as a starting point for investors with a budget for illiquidity.

“We recommend creating robust exposure across managers and asset classes, optimally via scalable customized structures, and over multiple vintages,” Miller said.

All those allocation recommendations are on the low side compared to those of Joe Spada, private wealth advisor at Summit Financial. Approximately 30 percent of his personal portfolio is in alternatives, and, more importantly in his opinion, he puts his money where his mouth is, investing in the same private-market vehicles as his clients.

“When it comes to alts, it behooves an advisor to own the investment personally to get a client to buy into the concept,” Spada said. “Study the complexities of the investment so that you can boil it down and explain the pros and cons in simplistic terms.”

Joey Feste Jr., partner at KM Capital Management, says his firm primarily serves professional athletes who have long investment horizons, so the illiquidity aspect is less of an issue for him, especially as compared to the diversification and return benefits.

“Every client is unique so the percentages will vary, but as a fiduciary, we primarily consider our clients’ investment objectives, liquidity, risk tolerance and capacity, and time horizons,” Feste said. “Our clients are younger than most affluent individuals, so we generally tilt toward growth alts like venture, private equity, and real estate.”

On the other hand, Robert Pearl, co-founder and wealth advisor at G&P Financial, prefers alternatives that offer simultaneous protection and growth, notably buffered ETFs, which participate as the market grows but also provide a buffer on the downside during times of market volatility.

“I have not found a single economist or market strategist that predicts the market will go straight up in 2024,” Pearl said. “For our retirees who are in the decumulation phase of retirement, we are positioning 10 percent to 20 percent of their portfolio into buffered ETFs like the ones offered by First Trust.”

Jina Yoon, chief alternative investment strategist at LPL Financial, recommends a 5 percent to 15 percent allocation to alternatives, with the caveat that the exact percentage should be decided based on the end investor’s investment objective as well as risk tolerance. Within private markets, Yoon is positive on private credit and infrastructure.

When it comes to her favorite liquid alts or hedge fund strategies for the coming year, she said she’s bullish on those that will benefit from the “macro and fundamental dispersions, reasonable level of volatility as well as medium to high interest rates, while staying nimble.

“For the macro dispersion, global macro would be the most direct player of the dispersion you will be seeing across the regions and countries,” Yoon said. “For the micro dispersion, low net equity long-short or equity market neutral strategies can be the ones benefiting the most from this company fundamental-driven dispersions. Multi-strategy should have a stable spot in a portfolio, especially for those investors who might have constraints on the number of alternatives they can have.”

Finally, Evan Bloomberg, private wealth advisor at UBS, said that one of the most interesting recent developments in the alternatives space is the opportunity to invest in “evergreen funds.” These include exposure to high-quality private equity investments with immediate investment, increased liquidity, and a more efficient structure that doesn’t require matching distributions with new allocations or commitments.

“For new investors in private equity, clients can start compounding returns right away versus waiting four to five years for capital to be called in a traditional private equity structure,” Bloomberg said. “A core position in evergreen funds complemented with satellite positions for ideas with higher return expectations is an ideal balance for many of our clients.”