The increasing popularity of alternative investments with advisers and wealth managers looks set to continue.
Seven in ten professional fund buyers say that alternatives such as private equity, hedge funds and infrastructure have become essential portfolio diversifiers, according to the Natixis Investment Managers (Natixis) Professional Fund Buyers Survey 2018.
Meanwhile most investors are planning to allocate more to alternatives in the short and long term, according to the latest investor outlook from Preqin.
One reason for alternatives’ popularity is the variety of important roles they can play in portfolios. According to the Natixis survey, 59% of fund buyers use alternatives increasingly to replace fixed interest as low bond yields make it harder to find a stable income.
Investors are also using private equity to seek alpha, and hedged equity and managed futures to control volatility, said the survey.
But there is scope to use them more. For example, some advisers may not have considered the attractiveness of certain alternatives to female clients. According to Natixis’ research, only 38% of women say they invest in alternatives; but 40% say their financial professional has not spoken to them about alternatives.
Yet 80% of female investors surveyed are concerned about short-term market results. Alternative strategies designed to protect against adverse factors may therefore resonate with them.
Andy Rowe, director at Harrow-based Evolution Financial Services, said alternatives have been more prevalent and more potent in his portfolios over the last two years.
‘Moderately adventurous clients now have 14% in portfolios, with scope to increase that,’ he said. ‘We use infrastructure as a natural hedge against inflation. And we use private equity for diversification as it tends to be uncorrelated with equities. That makes alternatives important even for cautious clients.’
Given the backdrop of increased volatility and economic uncertainty, alternatives with steadier, more predictable growth are particularly useful, said Rowe. Uncertainty also means that active management of alternatives is essential to select the right assets at the right time, he said.
Choose risk carefully
Will Dickson is head of investment management at Exeter- and London-based P1 Investment Management, the investment arm of wealth manager Prydis. He said: ‘Typically, we use alternatives to replace some fixed income exposure, given the current low-yield environment; or to reduce risk. We also focus on investments that diversify against equities and fixed income, and that protect against market volatility while enhancing returns.
‘One big [challenge in selecting strategies] is the significant dispersion of returns and risk in the alternatives sector. To mitigate this, we use a range of alternative strategies to reduce individual fund risk and diversify further.’
London-based Richard Stammers, chief investment strategist at KW Investment Management, said another reason for alternatives’ increasing popularity is that they are becoming more accessible and there is more detailed information about them available.
‘The hunt for income has pushed investors to look at alternatives for a higher yield,’ added Stammers. ‘It may also reflect a growing sense that we are nearing the end of a long equity bull run. Alternatives can [provide protection] at such times.’
Preqin’s research shows that private equity is the most popular alternative for future allocations among investors, but Stammers said his firm is wary of that asset class. It is also sceptical about whether hedge funds can deliver reliable returns; and about whether many absolute return funds can preserve capital in an equity correction. Despite this, KW has increased allocation to certain absolute return funds that it trusts over the last quarter.
‘There may be risk issues in alternatives such as around price volatility and liquidity,’ concluded Stammers. ‘The key to mitigating these risks is to understand [them through] detailed analysis.’
Natixis Investment Managers recommends five factors for better alternative investing:
Be mindful of behavioural investing. Using alternatives - for example, as diversifiers - can help investors avoid common cognitive mistakes.Be clear about what you want. For example, is it to guard against equity loss or interest rate risk? This understanding will help you select the right alternative strategy. Categorise, don't optimise. Many advisers rely on computer algorithms to ‘optimise’ the asset class mix in a portfolio. This can lead them to overlook the basics of how an asset class should work. Establishing clear financial goals can help them find the right investment categories.Win by not losing. Using alternatives to avoid or mitigate large losses means not having to ‘chase’ returns to recover.Keep a long-term view. Short-term performance may not indicate how a strategy is likely to perform over a decade or longer.
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This article was provided by Natixis Investment Managers and does not necessarily reflect the views of Citywire