Why have some light alternatives users run for the exits?

While some advisors who dabbled in alternatives space have been quick to exit the space, new research shows a small but growing trend of adoption that could go even further – and education could be the key.

That's according to Kristin Hall, the author of the latest edition of the annual "Trends in Alternative Investments" report from Escalent.

"The main purpose is to just get a grip on how advisors and investors are utilizing alternative investments within their portfolios and the interest levels [in those asset classes]," Hall told InvestmentNews.

As Hall explained , the research grouped advisors into three categories based on the amount of alternatives exposure they report in their portfolios. After non-users' 0% weighting, it defined light users as those holding 1% to 9% of portfolio assets in alts, while those with at least 10% were classified as heavy users.

"We've been viewing the light users' and heavy users' levels of sophistication," she says. "Light users have entered the space, but they may not necessarily have the same level of comfort and understanding [of alternatives] out of the gate."

The latest numbers showed non-users increasing by five percentage points from 2024, reaching 35% this year. Light users declined by seven points to 44%, while heavy users saw a more modest increase of 3 percentage points to hit 22%.

Digging into specific asset classes, Hall says interest in private equity and private credit has increased significantly in recent years. Meanwhile, the appetite for REITs and real estate declined amid broader struggles in commercial real state in the post-Covid era, though they remain the top alternative asset class used by advisors.

She also saw decreasing interest in real assets through master limited partnership and commodities, with just a quarter of advisors using them. Hall says that could be due to the complex tax reporting they may require along with the fact that "they haven't necessarily had the sexiest performance returns compared to the market."

"Direct investment in startups [has also slowed down] due in part to rising interest rates," she says. "We've also seen increased interest for digital assets and crypto, which has doubled over the past three years."

A snapshot poll by the Digital Assets Council of Financial Professionals conducted last June, whose findings were released last August, found one in four of participating advisors calling for a 2% crypto allocation in portfolios. More broadly, roughly nine-tenths said they'd recommend between 1% and 5% to be placed in digital assets.

Digging into advisors' concerns around alternatives investing, Hall says one of the leading challenges Escalent found among light users was limited interest from their clients, in contrast to heavy users who reported higher client interest. Similarly, when probed on what would move them to invest more in alternatives, she says light users focused on whether clients were requesting it.

"[That's] versus being more proactive and having that comfort level to be proactively selling alternatives," she says. "So they're going to need some additional education from asset managers."

Among other comments, Hall says some non-users flagged liquidity as a point of concern, pushing them to focus more on investments with daily trading. Of the easy-come, easy-go alts adopters, she said some got in only to find they didn't perform as expected.

While liquidity was the top issue, Escalent's research has also revealed a statistically significant jump in concerns around fees from 2022 to 2024, which run in line with other studies pointing to fees' detrimental impact on alternative investment returns. 

"The heavier users within that category, the national advisors and RIAs, they tend to be the most concerned about these fees versus regional independent advisors," Hall says. "I think it's just because they have more experience within the space."

By and large, the latest snapshot by Escalent showed alts holding a pretty humble 8% slice of advisors' total portfolio pie, though the firm sees that going up to 11% as more traditional assets like mutual funds and ETFs cede some ground and innovation continues among asset managers. However quickly or drastically the space evolves, Hall says financial advisors whil have an important role to play in shaping the narrative around alternatives.

"There's a definite difference between advised investors and self directed investors. Advised investors tend to just have a much higher level of interest within the alternative space: they're more likely to invest, they're more likely to put more money towards it," Hall says. "That guidance from the advisor is key. It's incredibly important to ensure that [people] are investing safely, and that it's appropriate for them, and that they're fully educated on what it is they're purchasing."