Wirehouse reps have been steadily increasing client allocations to alternative investments in stride with the level of risk building in the overall stock and bond markets.
The latest research from the Money Management Institute and Dover Financial Research found that alternative investments through the wirehouse channels climbed to $205 billion last year, from $172 billion at the end of 2013.
A closer look shows that the fast-growing category of liquid alternative mutual funds has started to level off compared with pure limited partnership investments such as hedge funds and private equity funds.
For example, of the $156.5 billion invested in alternatives through wirehouses in 2012, less than 44% was represented by liquid alt funds. But a year later, the increased use of liquid alts pushed the category to 51.4% of the total.
The trend reversed a little bit last year, to a near even 50/50 split between liquid alts and pure alternative products, which has Dover President Jean Sullivan rethinking an earlier premise that liquid alts might be cannibalizing the hedge fund space.
“We're seeing the ratios level off, and that makes sense because the two segments are really still catering to two different sets of clientele,” she said. “Hedge funds tend to cater to higher net worth investors, and liquid alts are more for the mass affluent.”
What originally looked like a trend toward a cannibalizing of the hedge fund space by the liquid alts space was muted by the forces of both segments trying to move toward each other's primary markets, Ms. Sullivan explained.
“Hedge funds and private equity funds are doing things like lowering fees and reducing lock-up periods to try and move down market, and the mutual fund companies are launching liquid alt funds to try and move up market toward traditional hedge fund investors,” she said.
But even as the total amount of money invested in alternatives grows, Ms. Sullivan said the allocation to alternatives at the portfolio level is still hovering between 5% and 10% for most wirehouse clients. The increase, she added, can anecdotally be attributed to more investors adding alternatives, as opposed to investors increasing their allocation to alternatives.
“We don't get a sense the needle has moved significantly at the portfolio level,” she said. “There are probably more investors using alternatives, but these products are so different that a lot of education is involved because a lot of the products tend to be complicated.”
For a true believer in alternatives like Ed Butowsky, managing partner at Chapwood Capital Investment Management, anything less than 20% in alternatives is just noise.
“The growth of alts in portfolios is needed and long overdue,” he said. “If you're serious about managing risk in your clients' portfolios, then the percentage to alternatives needs to be at least 20%, and anything lower than that means you haven't been taught how to manage money or you have elected to ignore the irrefutable facts of portfolio management.”
Bradley Alford, chief investment officer at Alpha Capital Management, concurs but acknowledges the headwinds of higher fees and lower performance relative to the broad equity market.
“We're in the sixth year of a bull market for stocks, and that's a long time,” he said. “It looks like education around alternatives is starting to pay off. The smart money has been doing it, and now retail has some real access points that they should be taking advantage of.”
Dick Pfister, president and chief executive of AlphaCore Capital, said the trend toward increased use of alternatives is a positive sign, but it is likely being driven from top-level management at the wirehouses, and not the result of individual reps feeling the need to take some risk off the table.
“Most wirehouse reps are still only allocating about 5% to alternatives, and that's because they are still not comfortable straying very far beyond the 60/40 world of stocks and bonds,” he said. “That's due to a combination of things, including a bull market in equities.”
The real tipping point, Mr. Pfister added, will be when the stock market experiences a significant pullback.
“If the market was down 20%, that gravitation to alternatives would happen very quickly,” he said. “Right now, advisers are living in the past, just like their clients, because, in their minds, they think they can be complacent and not have to upset the apple cart by moving into things that they don't really understand and their clients don't really understand.”