Traditionally the domain of sophisticated institutions with long-term time horizons, alternative investments are moving downmarket. This “democratization” comes at a time when managers are considering new ways to gather assets while providing advisors with more options for diversification and downside risk protection in client portfolios, according to Cerulli’s latest report, U.S. Alternative Investments 2019: Democratization of Alternatives. Penetration among advisors, however, remains low. While 45% of advisors report using the products, the average allocations across channels fall below 5%.
The move downmarket comes as retail client channel assets continue to grow at a faster pace than institutional client channel assets. According to Daniil Shapiro, associate director at Cerulli, “Offering alternative investment strategies to retail channels is sensible for asset managers. In 2007, retail client channels accounted for 37% of total addressable assets in the U.S. market. As of year-end 2017, that figure has climbed to 48%.” At the same time, the importance of risk protection and diversification to retail channels cannot be overstated. Shapiro explains, “Advisors are most focused on providing their clients with downside risk protection (57%) and portfolio diversification (55%)—objectives in which alternative investments can play an important role.” These two factors, coupled with the increasing incompleteness of exposures offered by public markets, are helping to enhance the appeal of distributing alternative investments beyond institutions and high-net-worth investors.
As a result of retail channel growth and need for the alternative exposures, managers are pursuing avenues to make such products available for retail clients and product development teams are seeking to bridge the gap between the canons of private capital (illiquidity and high minimum investments) and those of highly liquid public markets. Shapiro suggests three avenues for product manufacturers to participate in the democratization of alternatives: liquid alternatives, interval funds, and alternative platforms.
Offered to retail investors, liquid alternative strategies have a key advantage to asset managers: “Unlike more commoditized equity and fixed-income products, liquid alternative strategies are able to command heftier fees to the extent that they bridge the gap between expensive hedge fund exposures and increasingly inexpensive public market exposure,” according to Shapiro. Cerulli also believes that interval funds, which blend liquid and illiquid securities to provide a strategy with intermittent liquidity, have room to grow. Thirdly, alternative investment platforms can help asset managers reach retail advisors by offering streamlined solutions tailored to their channels.
In order to shore up adoption of alternatives, asset managers should also place a high priority on advisor and investor education, regarding both the mechanics of the strategies and what to expect of them—particularly that as diversifiers, many of the strategies are not meant to deliver outperformance to traditional markets. “Extensive efforts around alternative products should increase investor comfort with the strategies—which, in concert with product improvements (e.g., greater accessibility and lower fees), can lead to broader adoption of the necessary solutions,” concludes Shapiro.