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White Paper Cautions Advisors on Underexposure to Alternative Investments

“At some point, if they're ignoring these markets, then, even if you follow a passive investing argument, then they’re no longer getting the market return by avoiding them,” Daniil Shapiro, associate director at Cerulli and author of a new report on alternative investments, told RIA Intel.

A white paper published this week by Cerulli Associates, a Boston-based research and consulting firm, rehashes much of what is already known or assumed about alternative investments: they are expensive, complex, and illiquid, and that’s why some financial advisors don’t consider them.

But advisors’ resistance to allocate more money to alternative investments is putting investors at risk, the report warns.

“Private markets have grown so quickly, and they've become so large, our argument is that advisors have to pay attention. Because if they're not allocated to [alternative investments], they're making a bet against these private markets,” Daniil Shapiro, associate director at Cerulli and author of the report, told RIA Intel

Low interest rates, and a worry that equities markets have become expensive, are also contributing to the need for alternative investments, according to the report. Private equity or debt, hedge funds, venture capital, and other alternatives can help address those problems, Shapiro said. 

Some advisors agree. More are getting the Chartered Alternative Investment Analyst (CAIA) designation. And the increasing use of alternatives is also driving growth at platforms like iCaptial Network (which raised $440 million in funding this fall) and CAIS (which has built an intuitive learning system to help advisors learn more about alts). 

Still, many advisors don’t allocate anything to alternative investments, and those who do aren’t making any substantial changes to how much they invest in private equity and debt, hedge funds, venture capital, and others. Advisors only plan to increase their allocation in alternative assets by 1.3 percent, from 10.5 percent to 11.8 percent, over the next two years, according to a survey by Cerulli.

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Eighty advisors, most from independent wealth management firms — including some employed by larger broker-dealers — participated in the survey. Cerulli did not track the location of the advisors surveyed, but the group is a good reflection of advisors across the U.S., Shapiro said. While independent broker-dealers may invest more in non-traded REITS than other alternative investments compared to RIAs, the challenges around alternative investments, like complexity and cost, are broadly similar for brokers and RIAs, according to Shapiro.

60 percent of the advisors would increase their allocations to alternatives if they were more liquid, and 43 percent said would allocate more if investment performance improved, according to the report. More than half (54 percent) of respondents said the lack of liquidity is not suitable for clients.

Liquid alternative investments represent 28.2 percent of advisors’ alternative investments and is expected to grow to 32.1 percent by 2023, according to Cerulli’s report, reflecting a desire for these products, even as some of these products are facing realization. Ninety-four liquid alternative mutual funds closed in 2020, according to the report.

However, the same attributes that make alternative investments attractive often make them illiquid.

“There's definitely this conundrum there that in order to have a true alternative investment allocation, something like private equity, you have to be able to lock funds up for a very, very long period of time and give managers complete discretion,” Shapiro said. 

However, some alternative investments provide some form of liquidity, like interval funds, tender offer funds, and non-traded REITS, which allow subscriptions and redemptions on some basis. The report calls these types of alternative investments convergence zone products because they are longer-term but provide some liquidity.

“You can't just sell [convergence zone assets] on a random Tuesday. But you can get — if you need the money in a month, or maybe if you need [it] at the end of the quarter — then you can actually get either the full portion back or you may be able to get some portion back,” Shapiro said.

Although alternative investments are set to increase slightly over the next two years, asset managers still need to offer alternative products that have more attractive fees, have enhanced liquidity, are better tied to client needs for income, and make convergence zone products more prominent, Shapiro said. 

This is important, Shapiro said, because access to and investment in private markets through alternative investments can help solve the needs of advisors.

“You have infrastructure, which can offer inflation protection, and advisors are very concerned about inflation. You have private equity, which has had tremendous returns over a long period of time, they can potentially serve as diversifiers for advisors. So, when you combine these together, it does make sense that advisors should be allocating more and more to alternative investments,” Shapiro said. 

Holly Deaton (@HollyLDeaton) is a staff writer at RIA Intel and based in New York City.

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