17 October 2017

Are Advisors Disillusioned with Alternatives?

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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 low-volatility portfolios.

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 year. 

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 found.

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 performance.

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.

 Click here to access the full article on WealthManagement.com

 

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