Alternatives
The prospect of integrating alternatives can be daunting for many advisors due to the complexities involved, including numerous strategies, managers, and differing operational and tax processes. Nonetheless, there are key considerations for advisors navigating this terrain such as understanding that not all alternatives are alike, categorized broadly into growth, income, and diversifiers, allows for tailored allocations to meet client objectives. Also accessibility to alternatives has increased substantially, with platforms like iCapital and CAIS democratizing access and simplifying investment processes.
Additionally, the inadequacy of the traditional 60/40 model has led advisors to seek non-correlated strategies to bolster portfolio resilience, particularly during market dislocations. Historical analysis indicates that adding a 20% allocation to alternatives in a 60/40 portfolio can enhance returns and lower volatility, supporting the case for inclusion.
Shifting perspectives on longevity and retirement planning diminish the importance of liquidity, making less liquid investment opportunities, like private equity, viable options for younger investors. Overall, as accessibility to alternatives grows and traditional strategies face challenges, advisors are primed to deliver superior performance and resilience to clients through diversified portfolios.
Finsum: Advisors have more options and opportunities in the alt space than ever and should pass those uncorrelated returns on to investors.
The number of alternative investment options continues to increase, and many now consider it an essential ingredient to optimize portfolios. However, there are significant challenges that come with evaluating these investments, given that there is more complexity and advisors have less experience with the asset class.
The benefits of alternatives are higher returns, especially in high-rate, high-inflation environments, and less correlation to equities and bonds. The two biggest drawbacks of alternatives are reduced liquidity and price discovery. There are additional potential tradeoffs, such as limited transparency, higher fees, and restrictions on redemptions. Further, some alternatives use leverage or derivatives, which can increase tail risk during certain periods.
Therefore, it’s important to study how the investment performed during periods of market volatility, such as 2020 or 2008. With some illiquid investments, the asset may look like it’s outperforming until actual transactions start taking place at lower levels. Many skeptics contend that the diversification and volatility-mitigating effects of alternatives are overestimated due to the absence of mark-to-market pricing.
Another consideration is that evaluating alternatives has a qualitative element. This includes studying the reputation and track record of the management team. Overall, advisors and investors should understand that many of the traditional tools and methods used to evaluate public investments are not suitable for alternatives.
Finsum: Alternative investments continue to grow and are increasingly a core part of many investors’ portfolios. However, there are many unique challenges that come with evaluating these investments.
Over the last few years, Wall Street banks have been losing market share to private lenders. Recently, they have been looking to win back business by serving as intermediaries between private lenders and companies.
Previously, leveraged buyouts were financed by a combination of high-yield bonds and/or leveraged loans, arranged by a major bank or group of banks. And this accounted for nearly a third of investment banking revenue on Wall Street.
However, private lenders have muscled in on this line of business, forcing banks to adopt and come up with their own strategies to remain viable. Banks like Wells Fargo and Barclays have partnered with private credit funds to source deals, advise lenders, and help companies navigate the right steps to secure financing.
Banks also have preexisting relationships with many privately held companies. According to Barclays, private credit funds have $430 billion in uninvested capital. Since the 2008 financial crisis, banks have had more stringent capital requirements. This means it is more desirable to advise and provide services to borrowers rather than take on additional balance sheet risk.
It’s also helping Wall Street banks get through a dry period for deals due to high interest rates, impeding M&A activity. They are able to collect fees from lenders and borrowers. Typically, direct lenders will split fees with the banks that originate the deal, between 25 and 75 basis points.
Finsum: As private lending has displaced a major chunk of Wall Street’s investment banking revenue, banks are adapting by serving as intermediaries for private lenders and borrowers.
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- Rowe Price made an aggressive bet in 2020 by increasing exposure to equities in its target return funds, as equities were crashing due to the pandemic. At the time, the asset manager was criticized for this move; however, it’s paid off in spades, with the S&P 500 hitting new, all-time highs earlier this month. As a result of its success, T. Rowe Price now has the third-most assets in terms of target-date funds behind Fidelity and Vanguard.
Further, T. Rowe Price has remained up to 98% invested in its target-date funds, which is higher than its peers. According to an analysis from Cerulli, retirees hold up to 55% of their portfolio in equities at T. Rowe Price. Compare this to Fidelity and Vanguard, where equity allocations are 38% and 30%, respectively.
Despite its recent success, some continue to believe that T. Rowe Price’s target-date funds are taking on too much equity risk. According to Ron Surz, the president of Target Date Solutions, “80% of assets should be risk-free at retirement. Virtually all target date funds are way riskier than the theory they follow." However, some believe that higher allocations to equities are necessary given that lifespans are increasing, which increases the risk that retirees could outlive their savings.
Finsum: T. Rowe Price is pursuing a more aggressive strategy than its peers when it comes to equity allocations in its target-date funds. So far, it’s worked well, but there are some skeptics.
Buffered ETFs are seeing explosive growth. The category had less than $200 million in assets and now has $36.7 billion. The major appeal is that they allow investors to remain fully invested while offering downside protection.
However, they do tend to have higher costs and may not be appropriate for many investors. Buffered ETFs follow a benchmark while also using stock options to limit downside risk and capping gains on the upside.
These products are modeled after structured notes, which have proven to be popular among high net worth and institutional investors. Like structured notes, buffered ETFs follow some sort of lifecycle, which means that advisors and investors have to consider market conditions when making a decision. This means they are not appropriate for rebalancing or dollar cost averaging strategies. An important consideration is the start date of the buffer ETF and the performance of the underlying index since the start date, as this could affect the value and desirability of the buffer.
According to Jeff Schwartz, president at the investment analytics firm Markov Processes International, “There is a lot to understand with buffer ETFs, and the history of structured products shows that both advisors and investors often do not fully understand the nuance of these vehicles."
Finsum: Buffered ETFs are experiencing a surge in growth. The upside is that they allow investors to remain fully invested while capping the downside. However, there are also some downsides to consider.
KKR recently shared its growth strategy for alternative investments geared towards wealthy individual investors. Initially, it plans to offer products focused on private credit, private equity, infrastructure, and real estate and aims to distribute them through financial advisors. The firm has noted strong interest from wealth managers and registered investment advisors. It believes that its 48 years of experience in the space and strong legacy will differentiate KKR from its competitors.
According to Eric Mogelof, KKR’s head of Global Client Solutions, “Private wealth is a transformational opportunity for KKR. Private wealth is large, it’s growing quickly, and importantly, allocations to alternatives in this space are only going in one direction, and that is up.” KKR sees alternatives accounting for 6% of the private wealth market by 2027, a sharp increase from its 2% share in 2022.
This series of products will offer qualified investors the same type of access as institutional clients without any additional fees. KKR also believes that these products will be more liquid than competing alternatives. The firm also sees momentum to offer even more alternative product types in the near future. This is in response to their conversations with advisors, banks, wirehouses, and brokers, who have found that allocations to alternatives are increasing.
Finsum: KKR sees a big opportunity in alternative investments and is launching a suite of products. It hopes to target wealthy investors through financial advisors.