Financial advisors on the pros and cons of alternative investments

August 18, 2023 3:45 PM

While many advisors looking to move beyond traditional 60/40 portfolios are turning to alternatives to add a dash of diversification, factors like cost and complexity continue to create headaches.

In its 2023 Financial Advisor Survey, New York-based fintech iCapital polled 400 U.S. registered financial professionals who use or are likely to consider alternatives within the next year about the pros and cons of weaving alts into client portfolios.

According to the study, the amount of capital invested in private markets has grown from $4.5 trillion in 2012 to $12.4 trillion by the end of 2022. And this capital has historically been from institutional investors, with Bain & Company's 2023 report on private equity finding that individual investors account for just 5% of assets under management in alternative investments.

But iCapital CEO Lawrence Calcano said the gap has narrowed thanks to an increase in individual investor access.

Add tech advancements and lower minimum investment thresholds to the mix, and Calcano believes that alts like real estate, private credit and infrastructure have become more of a core component in individual investor portfolios.

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"We have seen a significant increase in appetite for alternative investments, but until relatively recently, a lack of access, understanding and education was impeding advisors' ability to put these assets in clients' portfolios in a thoughtful manner," said Lawrence Calcano, iCapital's chairman and CEO, in a statement. "I believe investors will come to see these assets not as alternative, but as a core part of their allocation. That's why it is important for iCapital and others to develop the tools, research, and education required for advisors to create core portfolios that are inclusive of alternatives for their clients."

Here's what advisors say is working — and what's still causing pain — when it comes to alts in 2023.

The good

The iCapital study suggests that continued growth in the use of alternative investments in the individual investor segment is expected.

When asked about future intentions, 95% of all polled advisors said they plan to maintain or increase allocations to alternative investments in the coming year, with 44% planning to increase. That figure climbs to 58% among advisors with at least $500 million in AUM.

As far as their reasons for taking the plunge, advisors say diversification is the top benefit of alternative investments selected by financial advisors, followed by the ability to offer a differentiated product set and having access to unique investments. Lower volatility and enhanced returns round out the top five benefits for alts among polled advisors.

The bad

When ranking the various challenges with this asset class, advisors cited lack of liquidity, high fees and complexities explaining these products to clients as the top barriers.

Those issues were followed closely by the amount of documentation/due diligence required and the lack of transparency around such investments.

iCapital says these challenges underscore the importance of education about alternative investments.

Despite the growing interest, only a quarter of advisors surveyed consider themselves "very knowledgeable" when it comes to alternative investments, and almost all advisors (95%) express interest in educational content on alternatives. This includes different types of education information and insights on fund specific content.

However, advisors say they're also looking for content in the form of foundational 101 level courses, advanced courses and practice management or "how to" guides.

Advisors aren't particular about the format, either. From webinars and white papers to short form videos and online courses, advisors say they're open to it all. However, education delivered in the form of "investor-friendly materials" is highly sought after.

They also see value in resources that can support their workflow, such as tools to analyze the impact of alternatives on a portfolio and guidance on selecting alternative investments. More than 80% of advisors rated these types of resources "very" or "somewhat valuable" when it comes to supporting their alternative investments business.

The growth

Across all alternative investment asset classes, real estate was the most widely used, with 78% of respondents confirming an allocation to real estate in their clients' portfolios. Private equity was the second most used, with 62% of respondents noting an allocation.

"However, when looking at the proportion of advisors with at least $500 million in AUM, over 85% reported a current allocation to private equity, demonstrating wider use of this asset class among advisors with higher AUM," the study says. "In addition, half of the advisors surveyed said they use private credit and/or hedge funds."

Private equity and private credit are the two asset classes with the highest proportion of survey respondents indicating they are likely to increase allocations to in the next 12 months, at 36% and 34%, respectively.

Real estate allocations showed the most dispersion with 14% of respondents planning to decrease and 30% planning to increase allocations over the next year.

"While some advisors are more opportunistic when it comes to the real estate sector, current market conditions in the commercial space may account for more advisors planning to decrease allocations to this asset class," the study says.