The world has been going through economic slowdown for quite some time. Its adverse effect has reached the capital market as well. According to a recent survey by the Financial Planning Association (FPA), a large number of advisors are now exploring alternative investments as a result of the poor performance of the stock and bond markets in 2022.
- The findings indicate that nearly 30% of advisors are actively seeking or investing in alternative assets for their clients.
- 30% of survey participants expressed familiarity with these vehicle types but had no intention of investing in them.
- 19% stated that they were actively following the latest research on alternatives and considering allocating a portion of their clients’ portfolios to this asset class within the next couple of years, although they had not taken action yet.
These alternatives typically encompass investments beyond the traditional realm of publicly traded stocks, bonds, and cash. One of the primary reasons for this growing interest in alternative investments is their potential to offer diversification, reduce portfolio risk, and enhance returns. Nonetheless, there is diversity in terms of risk and return within the choice of alternative investments, which include hedge funds, private equity, real assets like real estate and commodities, as well as packaged investments known as structured products.
- Private equity emerged as the primary alternative asset class, accounting for 23%.
- It is followed closely by structured products at 21%.
- The survey revealed that 3% of participants were engaged in real estate investments (excluding REITs).
- 1% indicated their utilization of private debt.
In addition to the provided options, respondents were given the opportunity to mention other asset classes of their choice.
Other Choices of Alternative Investments
Private debt is rapidly gaining prominence as a favored alternative investment among professionals. Over time, private debt has exhibited minimal volatility and generated substantial cash yields. Furthermore, a significant portion of the private debt market consists of floating-rate instruments. Consequently, during a period such as the previous year when rising interest rates negatively impacted traditional bonds, private debt showcased positive performance in absolute terms.
Interval funds have emerged as a viable option for those interested in alternative investments. These innovative financial products provide a transparent and convenient avenue for utilizing alternative strategies, all while featuring lower fees compared to other private market offerings. It also presents an attractive solution, enabling advisors to enter the market with greater flexibility and a better understanding of how their investments are performing.
Reasons Behind Choosing Alternative Investments
Investment professionals who strategically utilize alternatives don’t allocate substantial portions of their clients’ portfolios to the asset class, allowing them the flexibility to allocate from other assets as well.
- 55% of respondents mentioned diversification as one of their objectives.
- 41% of respondents stated that they are looking for risk mitigation.
- Around 25% of the respondents considered upside growth potential as one of their objectives.
- 24% of respondents mentioned protection against inflation as one of their objectives.
- 23% of respondents cited income generation as one of their objectives.
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What are the Challenges?
- The main challenge for about 48% advisors is the limited liquidity of these products, particularly during periods of economic uncertainty and when borrowing rates are high. Many investors do not fully grasp the risks associated with certain funds and find it difficult to exit those investments.
- Some survey participants expressed reservations about the long-term performance of alternative investments and raised concerns about compliance and limitations related to broker-dealers as barriers to engaging in alternative investing.
- While a survey by the FPA identifies private equity as the leading category of alternative assets, some advisors believe it is not suitable for most clients. Some experts are of the opinion that the best private equity deals are often inaccessible to average investors, as they are typically reserved for the richest individuals.
- When considering the initial foray into alternative investments, it becomes challenging to envision starting with a traditional private equity fund that typically requires a lengthy commitment of eight to 12 years, with limited visibility on performance for several years.
- Fees and expenses pose additional challenges for alternative assets for 41% of respondents, especially in certain products. However, higher fees can be justified if the value provided by the investment is substantial. On the other hand, if an investor is paying high fees for a money market fund, it would be advisable to explore other strategies instead.
The report emphasizes the significance of conducting comprehensive due diligence. It is crucial to have a clear understanding of the product, the reasons for purchasing it, and how it aligns with the overall portfolio.
Large number of advisors are now exploring alternative investments. Financial planners must consider the fees linked to them, as well as the distinctive tax consequences and the level of illiquidity that a client’s portfolio can tolerate. However, when coupled with financial planning, the diversification provided by alternative investments enhances planners’ ability to achieve favorable results for their clients.