The Big Questions that advisors ask themselves as they go about the work of managing a client’s portfolio haven’t changed much over the years: Which asset classes to rely on, given a client’s age, risk tolerance, timeframe and retirement needs? And how, exactly, to allocate those assets to deliver the desired outcome?
Advisors still ask themselves those kinds of questions. Only today, “the answers are coming up different,” says Allan Katz, CFP, ChFC, CLU, president of Comprehensive Wealth Management Group in State Island, N.Y.
Here in the post-meltdown era, asset-allocation strategies more frequently involve a broad-ranging, increasingly accessible and in-demand class of vehicles known as alternative investments. Thusly named because they fall outside the traditional definition of equities and fixed-income vehicles, alternatives have emerged as a go-to diversification tool, capable of dampening volatility and increasing resilience within a portfolio, largely due to their ability to deliver non-correlated performance (relative to stocks and bonds, mainly). Whether the goal is growth, income, asset protection, wealth transfer or a combination of those, alternative asset classes are carving out a larger presence in a broad range of portfolios, including those of older investors.
Whether packaged inside familiar, publicly traded mutual fund or ETF wrappers or as stand-alone, private offerings, alternative investments have established themselves in the investment mainstream, largely because the financial upheaval of 2008 forced the investment community to rethink some of its long-held asset allocation strategies.
“No question, 2008 opened some eyes to how things that supposedly were not correlated actually were,” says Marta Shen, JD, CPA, CFP, AIF, principal at Spring Street Financial in Atlanta.
She estimates that most of the portfolios she manages for clients include anywhere from 10 percent to 30 percent alternative investments.
Alternative investment strategies include a wide range of instruments, with strategies built around managed futures, commodities (and commodity futures), arbitrage/market neutral, private equity, private real estate, volatility/options strategies, and long/short (equity or debt) being among the most popular among advisors and institutional investors.
What’s more, “vendors are really bringing alternatives more to the forefront,” notes Shen. This proliferation of alternative mutual funds and ETFs gives investors “the ability to buy even a few thousand dollars worth of an alternative investment.”
Once reserved almost exclusively for accredited and institutional investors, alternatives are now a viable tool for investors of varying profiles, including seniors, for whom they are often used to generate income and/or solid fixed returns while mitigating volatility.
To the extent they are non-correlated to the movements of the stock and bond markets, alternative assets provide “shelter from volatility,” an important consideration for people in or nearing retirement, says Katz.
For stable returns and income, advisors are turning to alternative investments where once they leaned heavily on bonds. “You can find a steady-as-you-go type investment that produces five, six, seven or eight percent returns,” says John Freiburger, CLU, ChFC, AEP, managing partner at Naperville, Ill.-based Partners Wealth Management.
REITs — publicly traded or private — are among the alternatives categories Shen, Katz and Freiburger favor for the income generation facet of a senior portfolio. The recent cratering of the real estate market “creates a lot of opportunity” with REITs, notes Freiburger.
Strategies built around long-short, energy, precious metals or business development companies are also worth considering for fixed income, Shen adds. Meanwhile, alternative investments in oil and gas as well as other parts of the energy sector are particularly attractive for the tax benefits they may offer, according to Freiburger.
What’s more, he says, alternative investments can also be more effective than traditional equity and fixed instruments at generating outsized returns, if that’s the goal.
Getting — and keeping — up to speed
The fast-growing lineup of alternative products, along with the issues of complexity, transparency, liquidity and fees that many of them raise, make due diligence not only more vital, but often more challenging for advisors.
Gaining and maintaining a strong working knowledge of alternative investments and new developments in that space “is time-consuming and labor-intensive,” Freiburger says. “Each one is a process in itself. There’s a lot of due diligence involved to make sure what you’re putting in front of a client is as good as it gets for that particular class of assets.”
When it comes to judging the suitability of an alternative investment, it’s all about doing your homework, says Katz. “You have to be really careful in how you use these things.” A senior for whom short-term liquidity is a priority probably isn’t well suited to a vehicle that locks up their principal for five or 10 years, for example.
Fees on certain alternative vehicles also can be relatively high. Be sure to consider fees, but don’t let them be the only factor to dictate an investment decision, Katz advises. “Think instead in terms of the net profit of owning that asset.”
Lack of transparency is another issue with certain alternative investments. “There is going to be an opaqueness with some of these,” acknowledges Shen.
Due diligence is the advisor’s best weapon against those issues. That means:
- “Leaning on the broker-dealer in a significant way,” suggests Freiburger, for details on a product and its provider, their management, strategy and track record.
- Talking directly with the vendor. “Ask them tough questions, like about what can go wrong,” Shen recommends.
- Speaking with trusted colleagues in the financial world for advice and guidance.
- Being wary of a vehicle with little or no track record.
- Reading the literature provided by the product vendor, then balancing that with additional information from objective sources, such as a broker-dealer and a research organization like Morningstar.
Answering the Big Questions
Seniors generally are more inclined to look beyond traditional fixed and equity investments than one might assume. “They are much more willing to listen and be educated about these types of investments,” observes Freiburger. “In many cases they are seeking it. They’re asking, ‘What else is there?’ ”
Still, given their unfamiliarity with alternatives and the complexity of some instruments in that class, it’s vital that advisors take the time to be sure clients understand the potential benefits and pitfalls associated with these investments. “Clients look to us to do our homework, then to give them the executive summary—what’s good and what’s bad, how it works and how we’re compensated,” explains Shen.
Oftentimes, says Freiburger, seniors are surprisingly open to the idea of an alternative investment, particularly when it involves a tangible asset such as real estate or a commodity. “There’s something enticing about brick and mortar, land, earth.”
Such an understanding of alternative investments gives advisors and investors a greater wherewithal to find the right answers to the big fundamental asset-allocation questions they inevitably will face.
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