Years ago, advisors recommended a tried-and-true formula for most people’s retirement portfolios: 60% stocks and 40% bonds. But ultralow interest rates, have popularized alternative investments, particularly with high-net worth investors.
“Over the last fifteen years, private markets have grown twice as fast in terms of asset growth compared to public markets,” said Rodney Sullivan, a professor of business at University of Virginia Darden School of Business and editor of the Journal of Alternative Investments. Advisors use them to diversify away from the more “traditional stock and bond portfolio.”
RIA Intel previously wrote that “Only 45% of advisors allocate any client money to alternative investments and advisors who do might not be allocating enough.” Why not more? Securities and Exchange Commission rules restrict which investors can access alternative investments. To ensure the financial safety of client portfolios, its rules stipulate that eligibility is based on having $200,000 in income and $1 million in net worth, which eliminates a large swath of potential investors.
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Alternative investments “are still perceived as a risky asset class. But risky isn’t bad as long as that risk is diversified and offers a consistent return,” Sullivan said. “There’s an expertise that is required, and a fiduciary obligation among advisors to put forth recommendations that are best for their client’s interests.”
To attain that expertise and meet their clients’ needs, advisors are increasingly gaining the Chartered Alternative Investment Analyst (CAIA) designation. The organization added 3,587 members since the beginning of 2018 bringing the total to a recent 11,500. In September 2020 alone, 4,230 people signed up for the test, a 33% year-over-year increase. And last year the CAIA matriculated its largest ever new member class (1,193).
The test, which consists of 200 multiple choice questions, covers a wide range of topics including an introduction to alternative investments, real assets, hedge funds, private equity, and structured products.
For institutional investors alternative investments mostly revolve around hedge funds, private equity, private debt, and private markets. For select retail investors they can include art, wine, collectibles, cryptocurrencies, real estate, Broadway shows, peer-to-peer lending, and commodities.
Yields for the 60/40 portfolio have dipped in recent years necessitating investment in growing private markets that offer higher yields, explained Lawrence Calcano, CEO of iCapital Network, a New York-based technology platform for advisors and institutions that encourages alternative investing. “There are over 130,000 private companies you can invest in.”
With bonds’ paltry yields, investors are turning to alternative investments to augment cash flow and reduce portfolio volatility, asserted John Bowman, managing director at CAIA, which administers the certification program. Hence, most institutional investors and endowments seeking higher returns are turning to private equity and private debt.
Because of the high minimums for some of these investments, even investors with $1 million to $5 million portfolios may not qualify, Calcano said. Moreover, when advisors recommend private equity or hedge funds they might allocate just a modest amount. Moreover, many of these private investments are illiquid and must be held for five to ten years, he said. Venture capital eludes most private wealth managers and that might never change.
Most institutional clients including pension funds and endowments have focused investing in what Bowman calls the four pillars: hedge funds, private equity, private debt, and real estate. “When you get into art and cryptocurrency, these types of investments tend to be more retail-oriented,” he points out. “You don’t see institutional investors owning these types of asset classes.”
Fractional ownership of high-price collectibles makes them appealing to retail clients. “It’s hard to buy a 1955 Ferrari or $20,000 bottle of wine,” Bowman notes. Retail clients can own one of 10,000 shares of the 1955 Ferrari.
Having earned her CAIA certificate in 2018, Katie Sheehan, a senior portfolio strategist at Key Private Bank in Cleveland, pointed out, “Having a better understanding of alternative investments and knowing how the industry works is critical since fixed income and equities aren’t what they used to be. Understanding alternative investments is more important every day.”
Acknowledging that not all clients can meet SEC requirements, she noted there are more “mutual funds packing these investments that appeal to retail investors and have more daily liquidity.”
Furthermore, alternative investments can act in a portfolio “as an uncorrelated return generator; it won’t move with the overall market and provides protection should stocks fall.”
Having taken the course, Sheehan learned “the underlying structure of hedge funds and what fees the clients will ultimately pay. That leads toward better portfolio construction integration.”
Overall, it adds to her “repertoire and gives me an additional holistic view of how to serve my clients.”
Bowman acknowledged that “These complex investments are still just as opaque and risky as they were ten years ago.” Hence, it’s clear for advisors that “due diligence and proper allocation to these alternative investments is crucial.”
Calcano said hedge funds can act as shock absorbers in a retirement portfolio market. “Last year, when the market was getting crushed, some hedge funds performed remarkably well. Hence they can provide a stabilizing role in your portfolio.”
Due to limited liquidity some alternative investments might not make sense for certain seniors, Calcano said. But “As you get older, you might want to shift into short-duration assets such as private credit, middle-market lending, which are less risky than different products in the alternative landscape.”
Gaining the CAIA designation differentiates the advisor, observed Sullivan, the Darden professor. “It establishes their credentials.” If a client were hiring someone to do their taxes, “wouldn’t they prefer a CPA? The CAIA imprimatur helps an advisor stand out with regard to knowledge of investing, specifically in alternative investments,” he said.
In addition, Sheehan from Key Bank felt the designation made her more marketable if pursuing another position.
Bowman from CAIA said the SEC is considering expanding the requirement for entry into alternative investments. It has been exploring “how they might revise this rule to democratize access to private capital and hedge funds.” CAIA has advocated for establishing alternative investing limits based more on “education instead of wealth,” he said.
But many advisors already have a slew of acronyms next to their names including CFA, CPA, CFP, and CIC, so how much difference does it make adding CAIA to the list? Aaron Filbeck, CAIA’s director of global content development, said the designation conveys a special expertise, and will appeal to clients seeking “a properly diversified portfolio and shows that an advisor knows how to allocate investments across many asset classes.”
Calcano says the steady rise in alternative investment specialists is no fluke. “This is now a core part of the investment landscape,” he said, whether it’s 5% of one portfolio or 30% of another. “It’s here to stay and therefore you’ll see steady growth in the CAIA certificates.”