Advisors And The Art Of Using Alternatives In Client Portfolios

July 31, 2014 Jeff Schlegel

Its one thing to add alternative investments to client portfolios, but its another thing to understand the different types of alternative strategies and products, how theyre designed to work in a portfolio, and how they can best address a clients fears and expectations.

The topic was conversation fodder at a panel discussion today at the Fifth Annual Innovative Alternative Investment Strategies conference in Denver, which is hosted by Financial Advisor and Private Wealth magazines and has more than 700 attendees.

The simplest way to explain alternatives to clients is to say were trying to find alternative sources of returns, said Cleo Chang, chief investment officer at Wilshire Funds Management, the global investment management business unit of Santa Monica, Calif.-based Wilshire Associates.

When we communicate alternative investing across the board regardless of whether its high-net-worth, mass affluent or institutional investors, we like to approach it by asking what do you currently not like about how your portfolios are constructed, and what risk do you think the current portfolio isnt properly addressing.

For folks with a traditional 60-40 stocks-and-bonds portfolio, Chang will ask investors whether theyre more concerned about rising interest rates or about equity beta, or both.

I think those are different issues and concerns that should be addressed differently, she said.

We believe there are ways to utilize alternative mutual funds to try to reduce interest rate exposure without adding on much more risk to the portfolio, and that can be achieved by some combination of relative value, global macro and event driven types of strategies, Chang explained.

But if investors still have 2008 on their minds and are worried about equity drawdowns, she added, one way to provide an equity-like portfolio with less drawdown risk is with an equity long/short strategy that she said has 20% to 30% less beta than a long-only equity fund.

Into The Pool

Dan Roe, chief investment officer at Budros, Ruhlin & Roe Inc. a RIA in Columbus, Ohio, said his firm starts the alternatives conversation with clients with a broad definition of alternative investments by explaining to clients theyre not stocks, bonds or cash.

That [the alternatives space] could include commodities and real estate for some people, he said.

But then they mention that those two asset classes will come with equity-like volatility, and that his firm favors splitting them off from the alternative bucket.

We want to make sure that clients understand were seeking an alternative source of returns from stocks and bonds, Roe said. Thats why the definition of alternatives becomes important.

These are allocations and a combined strategy meant to be a buffer, to achieve positive returns, and in this environment achieve positive returns greater than bonds while having volatility more akin to a bond allocation than to the equity markets, he continued.

Alternative investments can be either illiquid, private equity-type investments or more liquid 40 Act mutual funds and exchange-traded funds.