We recently hosted a webinar with two industry veterans, discussing how financial advisors could approach alternative investments, and some of the key things they should be thinking about. You will find a summary of what was discussed and you may watch a recording of the webinar below.
For decades, the 60/40 allocation rule for stocks and bonds has served as a North Star of sorts for investors and their advisors. With 60% of assets in equities and 40% in bonds, clients are generally able to tap into the gains associated with stocks while ensuring a base level of predictability that comes with the more consistent performance of fixed income. But as the market has evolved in recent years, the old 60/40 rule has proven less efficient than it once was leaving many investors looking for new ways to diversify their holdings.
The marketplace is at a very interesting inflection point. It wasn’t that long ago with the introduction of endowment models that institutional investors started thinking about diversification that went beyond stocks and bonds to include alternatives like venture capital, private equity, commodities and hedge funds. These types of alternative assets are less liquid than stocks and bonds, leading to an illiquidity premium that has historically translated into greater upside versus public market benchmarks over time. And as more and more investors have found their way into these assets the market has become more liquid, paving the way for individual investors to find a place for them in their portfolios.
Why is this happening?
A number of factors have come together over the last decade-plus that have accelerated the embrace of alternative investments by the broader market. One is the low interest rate environment we’ve been experiencing since about 2009. Second is the march of technology that has made it easier, cheaper and more transparent for investors to participate in these markets. And third, there is more investable capital available today than there has been previously, thanks to factors including the red-hot real estate market and the bounce back of the S&P 500 following 2020.
Plus, investors simply have to do something.
Unlike previous generations when people could work for 40 years, retire with a gold watch and live off of a defined benefit plan for the rest of their life, today’s workers need to rely on the public markets to fund their golden years. And that may be more uncertain. Given a timid outlook for interest rates over the next 10 years there is a risk that a 60-40 portfolio could underperform. Clients and advisors who want to access the potential for greater returns will need to think outside of the current asset allocation matrix as more of the value creation that has historically taken place in public markets is happening in private markets.
Taken together, an uncertain outlook for equities and fixed income coupled with a growing interest in private markets, it’s hard to not conclude that the percentage of allocation to alternatives among retail investors and institutions could be higher in the years ahead and driving a lot of new participants into private markets.
That’s the good news.
The bad news is that operational and educational complexities remain that must be addressed in order for advisors and their clients to access these alternative markets at scale. Because alternative investment can be risky. They can be illiquid. And they can call for specialized knowledge and expertise to effectively navigate and benefit from them.
Advisors need to educate themselves and their clients on the pros and cons of alternative investments. There is also a need to adopt solutions that create more efficient markets for these assets as technology continues to evolve and provide investors with more user-friendly solutions for accessing private markets.
Alternative investments could be the right tool to address today’s evolving markets and it’s a way for advisors and their clients to tap into new asset classes. This will hopefully coincide with technology coming to the market that will enable access without the current operational complexity that investors may currently face.