Assets in liquid alternative funds have grown exponentially
in recent years, although from a small base, as investors sought greater
portfolio diversification and lower volatility in the wake of the financial
crisis. But the bloom may be coming off the rose. Despite the continued hype,
fewer RIAs are using alternatives in their client portfolios this year than
last, according to WealthManagement.com’s 2014 AdvisorBenchmarking RIA Trend
Report. Additionally, the number who say they will never recommend them grew.
Some say advisors may have become disillusioned with how alternative
investments perform in a bull market as investors clamor for performance over
The AdvisorBenchmarking survey of about 400 RIAs analyzed
the responses of advisors with client assets above $25 million—those more
inclined to use alternatives. The survey found that 70 percent of advisors
recommend alternatives for either many or a select few of their clients, down
from 75 percent in 2013. But the percentage of advisors reporting they are
unlikely to recommend alternatives increased from 17 percent in 2013 to 24
percent this year.
When asked what asset classes they’re considering for the
next year, only 23 percent of advisors said alternatives, down from 26 percent
last year. More advisors, meanwhile, are considering municipal debt for their
clients, with 17 percent of respondents compared to only 11 percent last year.
In addition, 61 percent of advisors expect their usage of
alternatives to remain the same in the next three years, up from 55 percent in
2013, while 37 percent expect to increase usage, down from 41 percent last
Over the last five years, alternative mutual funds have
lagged the equity markets. For example, multialternative funds posted 3.9
percent in annualized returns over the last five years, according to
Morningstar. Meanwhile, the S&P 500 returned about 16 percent over that
period, and large-cap growth funds returned 15 percent.
But alternative funds are not supposed to beat the broader
index in a bull market, Charney said. The funds offer lower beta and, ideally,
less equity risk.
The top reasons advisors use alternatives continue to be
portfolio diversification, volatility reduction and risk management, the survey
But the waning interest in alternatives runs contrary to
fund flows. In 2012, net inflows to alternative mutual fund categories were $20
billion, compared to about $95 billion in inflows in 2013.
Advisors may not be using the appropriate benchmarks to
measure these funds’ performance. Standard benchmarks, such as the S&P 500
Index, are most commonly used to compare alternative investments, according to
the Morningstar/Barron’s survey. Only 16 percent of advisors said they use
custom benchmarks or model portfolios to measure alternative investments
Many RIAs—even those with $1 billion or more in assets—have
only one research person for the entire firm, so they may not have the time and
resources to conduct the due diligence necessary on alternative investments,
said Dan Thibeault, president and chief investment officer of GL Capital, which
recently launched a liquid alternatives database. In contrast, the wirehouse
firms and other b/ds have large research teams vetting these investments.
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