Alternatives become bigger slice of client portfolios as advisers seek shelter

Market volatility and growing economic uncertainty are shining a fresh light on the diversifying potential of alternative investments.

“With inflation over 8%, a recently inverted yield curve and geopolitical concerns, the question isn't whether or not to utilize alternative investments, the question is how much alternatives an adviser should incorporate into his or her clients' portfolios,” said Thomas Balcom, founder of 1650 Wealth Management.

With alternative strategies representing more than 50% weightings in his clients’ portfolios, Balcom is at the extreme end. But across wealth management, the trend is definitely toward diversification away from the traditional, long-only stock and bond exposure.

“We utilize custom market-linked notes, private real estate investments and other nontraditional investments in order to smooth out the overall returns of our portfolios,” Balcom said. “Failure to incorporate alternative investments would be a great disservice to your clients.”

Keith Singer, founder of Singer Wealth, has been increasing client exposure to alternative strategies over the past three years and believes his clients are benefitting from the “illiquidity premium” that accompanies investments like private credit and private real estate investment trusts.

He referenced the early days of the Covid pandemic two years ago, when publicly traded REITs that were expected to be impacted by the economic shutdowns saw valuations drop by more than 40%, while prices on private REITs were dropping by around 5%.

The key difference, Singer explained, is the way that less-liquid strategies limit panic selling that drives down valuations.

“With more liquid investments, you’re paying for the privilege to sell your investment at the wrong time,” he said. “You get better returns and less volatility by giving up some liquidity.”

Singer said his client portfolios are between 20% and 30% weighted in various alternative investments.

The alternatives trend is highlighted in a recent report by Clearwater Analytics, which surveyed 110 institutional-level investors and investment managers on their use of alternatives.

Private credit, private equity and real estate represent the most popular alternative strategies among the survey respondents, with approximately 70% reporting some allocation to those strategies.

Asked about the appeal of alternatives, the institutional investors and managers listed diversification as the top benefit, just ahead of yield and returns.

The world of private markets and less liquidity is exactly what Paresh Shah, managing principal at PareShah Partners, is seeking in an alternative strategy.

“There are two alternatives that are particularly interesting at this moment that we are advising for our clients: private REITs and private floating-rate credit funds,” Shah said. “The advantages are stability compared to stocks and more returns than bonds. And the disadvantages are less liquidity and more risk compared to bonds.”

The alternatives space is old hat to Jeffrey Nauta, principal at Henrickson Nauta Wealth Advisors. 

“Our firm has been allocating to alternatives for 15-plus years, and we've made a concerted push to reallocate a portion of clients’ fixed income to alternatives over the past 12 months,” Nauta said. “Real assets such as farmland, timberland, infrastructure and transportation are performing well and can act as a hedge against inflation. Private funds focused on things like life settlements, litigation finance or cannabis direct lending are proving to be uncorrelated to the equity and bond markets.”