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After battling downturns in the stock and bond markets, more financial advisors looking to further diversify their clients are turning to alternative investments, according to a recent survey from Cerulli Associates.
Falling outside of traditional asset classes, alternative investments are typically added to portfolios for more diversification, income and the possibility of higher returns.
The report, surveying 100 advisors during the first half of 2022, found average alternative allocations of 14.5%, with advisors aiming to boost percentages to 17.5% in two years.
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While average industry allocations for alternatives and commodities may be closer to 10%, Cerulli sees a “Goldilocks moment” for these assets amid demand for income, higher returns and volatility protection as more products become available.
Almost 70% of respondents said the top reason for alternative allocations was to “reduce exposure to public markets,” and 66% aimed for “volatility dampening” and “downside risk protection,” according to the report. Other top reasons for alternatives were income generation, diversification and growth.
Alternative investments may fall into four categories: hedge funds, private equity, “real assets” like real estate or commodities, and pre-packaged investments known as “structured products.”
“We have been using alternatives for a while,” said Ashton Lawrence, a certified financial planner with Goldfinch Wealth Management in Greenville, South Carolina, whose firm has used assets focused on events and company mergers, along with funds offering downside protection through put options.
“When interest rates were extremely low, we wanted to have something that would anchor the portfolio, but not be tied to interest rates,” he said.
Scott Bishop, a Houston-based CFP and executive director of wealth solutions at Avidian Wealth Solutions, said his firm used private equity, private debt, some hedge funds and some “smaller investments” that are less attractive to Wall Street banks.
The most popular alternative assets are so-called liquid alternative mutual funds and exchange-traded funds, offering hedge fund-like strategies to everyday investors, according to the Cerulli survey, along with non-traded real estate investment trusts, that aren’t bought and sold on a stock exchange.
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With a range of assets falling under the alternative investing umbrella, it’s easy to misunderstand what you own and what is designed to do, Lawrence said.
Before diving into alternative investments, you need a clear understanding of the underlying asset and the environment where it may perform the best. Otherwise, you may have mismatching expectations, he said.
“A hammer is a tool and a spatula is a tool,” he said. “But if I take a hammer and try to flip pancakes in the kitchen, I’m going to have a bad experience.”