Reimagining investment strategies with alternatives

Traditional investment strategies, such as stocks and bonds, face increasing volatility and uncertainty in the market. Factors such as high inflation, rising interest rates and policy changes create instability and erode the reliability of these traditional avenues. Therefore, financial advisors are turning to alternative investments, such as private equity and hedge funds, to mitigate market unpredictability and enhance client portfolios.

Defining alternative investments 

Alternative investments are assets that lie outside the realm of conventional stocks, bonds and cash. These include private equity, hedge funds, real estate, commodities and exotic options such as art or collectibles. Cryptocurrency stands as the largest and most prominent alternative asset class, drawing the attention of investors and institutions. However, mainstream adoption of crypto is being delayed by several challenges related to its practical utility, including regulatory uncertainty and high energy consumption.

The primary appeal of alternative investments lies in their ability to diversify client portfolios and boost overall returns. By incorporating assets with less correlation to traditional markets, advisors can better help clients weather economic storms. For example, during periods of high inflation, tangible assets such as commodities and real estate can serve as a hedge, preserving purchasing power when traditional investments may struggle.

An example of an alternative investment is real estate investment trusts, which offer attractive income potential by giving individuals a way to invest in real estate without directly owning or managing properties. These companies own or finance real estate across retail, residential and health care sectors. They provide liquidity and diversification when publicly traded, making them an accessible and professionally managed alternative. Private equity is another option providing access to high-growth companies not available in public markets. Meanwhile, hedge funds, which can be bought and sold later at a higher price or sold to be bought later at a lower price, offer downside protection in volatile markets. 

When to consider alternative investments

Not all clients are equally suited for alternative investments. Financial advisors typically recommend these strategies for high net worth individuals, accredited investors, and those with higher risk tolerance, and longer investment time horizons. The complexity and illiquidity of many alternative investments make them less suitable for clients who may need quick access to their funds or have a lower risk capacity.

Consider various factors when selecting alternative investments, including the client’s risk profile, investment goals and overall portfolio composition. As you are an advisor, due diligence is crucial, as many alternative investments lack the transparency and regulatory oversight of traditional assets and require the evaluation of underlying assets and have the potential for liquidity constraints.

Education is vital in helping clients navigate the world of alternative investments, including clear communication, using analogies to explain complex concepts and being exposed gradually to options. For example, start with more familiar alternatives, such as REITs, before introducing more sophisticated strategies such as hedge funds and private equity. It is crucial to dispel common misconceptions, such as beliefs that all alternative investments are high risk or guarantee superior returns. Instead, clients should view alternatives as tools for diversification and potential return enhancement.

As the investment landscape evolves, alternative investments are poised to play an increasingly important role in portfolio construction. These investments provide the ability to achieve a balanced financial plan based on a client’s situation such as providing diversification, mitigating risks and creating opportunities for nonlinear growth with the liquidity and simplicity traditional investments provide. By carefully considering client needs, conducting thorough evaluations and providing comprehensive client education, financial advisors can help clients harness the potential of these nontraditional opportunities to build more resilient portfolios

Brandon Wellman, CFP, RICP, is a financial planner at Prudential Financial. He is a six-year MDRT member with four Court of the Table qualifications. Contact him at [email protected].