Clients, product manufacturers and even major custodians are all pushing the advice industry toward alternative investment products, but some registered investment advisers are still holding back.
Alternative investments, which generally include nontraded real estate investment trusts, hedge funds,
private equity and other products with low correlation to stocks and bonds, have become all the buzz among RIAs, even though many haven't embraced them for their own clients.
About 1.7% of RIA assets are in REITs, for example, compared with 2.8% of assets in the independent broker-dealer channel — where brokers can receive a fat commission for selling the product — according to data provided by Scott Smith, a director with Cerulli Associates.
“It's been amazing to see how quickly all these new products have come out and everyone wants to talk about alternatives,” said Adam Larson, investment manager at Savant Capital Management, a fee-only RIA with about $4 billion in assets under management. “Everyone is looking for a way to increase yield on their portfolio, and we're just very cautious.”
There are at least three reasons alternative product sponsors are targeting RIAs. First is the need for diversification following the 2008 financial crisis. Second is the search among advisers for high-yield products in a low-interest-rate environment. And third, a lot of brokers are moving into the RIA space and want to be able to offer their clients the same products they did before, including alts.
Indeed, industry conferences hosted by the major custodians have included a number of panels on how to incorporate alternatives into client portfolios. In November at its IMPACT conference, Charles Schwab & Co., for example, included two panels with executives of American Realty Capital and American Realty Capital Properties Inc., speaking about how to use real estate in client portfolios. An affiliate of American Realty Capital, Realty Capital Securities, was a diamond sponsor of the event.
Other panels included "Think outside the box: Crafting an income stream from noncorrelated asset classes."
“The alternatives and REITs are seeing the potential there and are willing to pay the fees to get prime placement on the showroom floor,” Mr. Smith said.
David Lindenbaum, vice president of managed accounts and alternative investments at Schwab, said sponsors who pay more can get speaking privileges, although he did not mention ARC or other companies specifically.
Mr. Lindenbaum said he was seeing higher demand for alternatives as RIAs sought them out as a tool for diversification.
“At a high level, we do see more usage of alternatives,” he said. “Alternatives are growing in popularity and RIAs have been at the forefront of that for a long time.”
He attributed the increase, however, mostly to product manufacturers' coming out with more liquid alternative funds. Schwab has created its own alternative investment platform that offers RIAs access to
private equity, hedge funds and other nontraded, registered funds. Mr. Lindenbaum said use of the platform has jumped 70% in the past two years.
Mark Hurley, a consultant with Fiduciary Network, agreed alternative use has been growing with the advent of more liquid options, and also because clients are searching for products with lower correlation as a lingering effect of the financial crisis of 2008.
“When really bad things happen, human instincts are to assume the probability of it happening again,” he said. “Whenever a plane crashes, sales of flight insurance go through the roof even though the likelihood of another crash has not gone up.”
Mr. Larson said he is still approaching with caution.
“Clients are asking about them, and then if I go to conferences with other RIAs, a lot are voicing the same caution and [are] moving slowly,” Mr. Larson said.
Still, the two main issues that “give him pause” are the higher fees associated with the products and the lower liquidity, he said. Most of Savant's clients are individuals preparing for retirement, and they are not good candidates for less liquid alternative products.
“Liquidity can be a big discussion point that we need to talk to them about,” he said. “And since we work with them as a fiduciary, we are standing right there beside them working to reduce their investment cost.”
Dan Bernstein, chief regulatory counsel at MarketCounsel, said RIAs need to have a higher level of caution on some alternatives products because the diversity of offerings requires greater due diligence.
“You can't just say, 'I'm going to start using alternatives,'” he said. “There might be leveraged products and there are a lot of things that fall into the umbrella of an alternative. You need to look at what those funds are really doing.”
