Why (almost) everybody loves to hate alternative investments
The surge in popularity of alternative investments has been met by an equally powerful voice from investor advocates that question the merits and overall usefulness of these investments. For fund managers specializing in the alternatives arena and for wealth advisors who implement alternative investments in their client asset allocations, they are forced to answer the naysayers who question their role and value.
The Wall Street Journal posed the question “Should you hold alternative investments?” to a panel of experts back in September and the vast majority panned alternatives, citing high fees, relatively small long-term returns, and lack of income features as reasons why they don’t belong in an investor’s portfolio.
Keep in mind that hedge funds, managed futures, precious metals, commodities, currencies, real estate of all stripes, private equity, and collectibles have all been grouped into the “alts” category. This wide range of asset classes (and the vehicles designed to give investors exposure) are certainly not all created equally.
Nonetheless, alternatives do have an image problem and for professional investors and fund managers committed to them, there is a real need to address this issue for the sake of your business and professional credibility.
If you are a wealth advisor or an alternative investment manager looking to overcome the negative hype, consider taking these steps:
- Address the cost/expense issue up front. More than ever, investors are tuned into the impact that investment fees can have on overall return. Instead of skirting the issue, make the cost of the alternative investment clear to the investor on the front end. As the saying goes: “Cost is only an issue in the absence of value.”
- Don’t make the conversation about the investment, make it about the investor. In the dozens of meetings we’ve had with our clients telling us about their alternative investment strategies, nearly all go to great lengths to talk about how the alternatives interact with other investments. The best of the bunch articulates what they are trying to accomplish for the investor. Is he or she willing to give up portfolio income in exchange for the inflation hedge that comes with gold? Are they seeking investment cash flow outside of the bond market?
- Show the investor how to reasonably include the alternatives in their asset allocation. One knock against alternative investments is that cost and liquidity concerns make it difficult to determine the appropriate allocation. While each investor has their own unique risk tolerance, cash flow needs, tax sensitivity, time horizon, etc., the reality is that they all need to understand the impact of having a less liquid investment. If the investor has an emergency and needs to raise cash, will they have to dump their stocks at an inopportune time because they can’t unload their managed futures or non-traded REIT position? They are counting on you to tell them what makes sense.
- Evaluate the alternatives to the alternatives. For example, if you are championing real estate for a client portfolio, it’s worth identifying the different choices for your clients and showing them the pros and cons of each tool. Does it make sense for the client to own an individual property or is it better for them to have broader exposure through an ETF, mutual fund, or a REIT? Show the cost parameters, the liquidity constraints, the tax implications, etc., and let them see that you have a thought out rationale for your recommendation.
Failure to adequately address the image concerns of alternative investments can expose your business and damage your ability to grow. The reality is that alternative investments themselves are most often not the problem. Rather, it is the failures of communication and implementation that sabotage their reputation.