Dispelling Seven Myths About Alternatives

With the growth of alternatives and the increased accessibility for the private wealth market, advisors can count on fielding questions from clients and having to refute misconceptions. Here are seven of the most common myths and how advisors can respond.

1. Alternatives, such as hedge funds, are too risky

As the name suggests, hedge funds were created to protect portfolios from large drawdowns and mitigate volatility. While it depends on the strategy, hedge funds as an asset class tend to seek risk-adjusted returns and can be a valuable component of a client’s portfolio.

Though hedge funds may be a client’s initial response when the conversation turns to alternatives, the asset class offers a generous array of investment opportunities, each with varying levels of risk.

Advisors know their clients best. They know their objectives, their investment timeframes and the appropriate levels of risk.

2. Alternatives are complex and hard to explain

This is strategy and fund-manager dependent. Some strategies are easier to explain (residential real estate) than others (long/short credit hedge funds).

Regardless of the strategy, there are resources wealth advisors can use to explain some of the finer points to a client, including manager presentations, tear sheets and due diligence reports.

Many platforms and funds partner with third-party due-diligence managers for an in-depth, unbiased view of the strategy and operations.

3. My clients don’t need alternatives in their portfolios

If we’ve learned anything in the past year, it is the importance of adding uncorrelated components of portfolios via alternative investments. Large multi-strategy hedge funds bolstered many portfolios in what was a dismal year for both public equities and fixed income. Over three-, five- and 10-year periods, a portfolio with a broad mix of alternatives added alpha and protected capital during drawdowns relative to the standard 60/40 portfolio.

The view is becoming clearer that allocating a portion of a portfolio to alternatives can be critical for potential outsized long-term returns.

4. Alternatives are illiquid

Generally, alternatives are less liquid than traditional public investments that trade continuously, but it ranges within the alts landscape. There is, however, an illiquidity premium that clients can capture, and it’s an important part of an allocation to alternatives.

Some other options have made headway in the last few years, including interval and tender-offer funds. But like all structures, they have their own limitations. Depending on a client’s liquidity needs, an advisor may allocate accordingly to traditional or semi-liquid alternative investment wrappers.

5. Alternatives are not transparent

For assets as simple as real estate, it is easy to see what you own and managers are generally happy to share those positions in the portfolio. Sometimes managers may showcase the portfolio with in-person tours and events.

Conversely, hedge fund managers are often wary of sharing information about short positions. In these situations, the risk lies in markets moving against them should that information become public.

Transparency varies by strategy. A good practice is to have an effective operational due diligence process behind each strategy to identify a comfort level for investors.

6. Minimum investments and fees are too high; they aren’t for the mainstream investor

The minimums in many cases may be high, but there are more cost-effective ways to gain entry.

Independent alternative investment platforms provide access to the same types of strategies and underlying investments as large institutions. The platforms aggregate investors into different types of strategies and can provide customized solutions.

Know the accreditation standards investors must meet to participate in these investments. The platform the wealth advisor uses will be able to answer any questions.

7. There’s not enough of a selection among alternatives

Quite the contrary. There are thousands of managers and strategies. In fact, there are more private investment managers than there are publicly available stocks. It is a question of how broadly a wealth advisor views the universe of private managers. If they limit themselves to mega-managers, the level of selection will be narrow.

Boutique managers can be quite complementary to larger brands. Alpha can be generated from smaller managers that may have more opportunities and can be flexible in their investment approach. The key is performing necessary and thoughtful due diligence.

Though alternatives have been misunderstood for years, they are increasingly more common in portfolio allocations. In a highly competitive market, alternative investments can differentiate an advisor and create beneficial outcomes for generations of family wealth.

Frank Burke is CIO and Anton Golding is fund manager analyst with PPB Capital Partners, a provider of alternative investment solutions and streamlined processing for we

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