ELECTRONICALLY REPRINTED FROM OCTOBER 16, 2014 Part 3: Objectives for Alternatives Section 3: The leading reasons for steering clients toward alternatives remain diversification, risk management and volatility reduction. Based on a comparison to 2013 responses, all three related drivers showed lower response rates, but nonetheless remained the dominant factors driving the use of alternatives. Superior return opportunities continues to trend downward as a driver for the use of alternative investments as only 16% of advisors cited return opportunities this year compared to 19% last year. This finding is likely at least partially driven by the fact that alternative strategies performance, in general, has lagged that of the market in general over the past few years. A majority of advisors, in this case 61%, continue to use them for satellite positions, a level consistent with the prior year observation. Additionally, a sizable and slightly increasing segment of advisors (33%, up from 28% in 2013) use alternatives as core portfolio positions. It is reasonable to assume that this group has considerable overlap with the minority who use alternatives assets for their superior returns. This indicates that, while superior returns are not a key selling point for the alternative investment category as a whole, there are targeted opportunities within the space that produce compelling returns for selected managers and their clients.
INTRODUCTION For more than a decade, the AdvisorBenchmarking RIA Trend Study has provided the financial advisory community with analyses of advisor performance and attitudes across a variety of areas critical to their business practices and offered a current assessment of how the top performing practices differ from their peers across these areas. This year, the study results are being published on WealthManagement.com in 8 individual chapters providing a comprehensive look at the survey s most relevant measures: practice management and operations; ETFs; alternative investments; marketing and client relations; financial performance; investment management; best practices; and economic and advisory business outlook. In this chapter we present key findings and insights from our survey questions on alternative investments, including how and why they are used, client comfort with the asset class, and the most popular risk measures used to evaluate managers. FIGURE 1: Percentage of Advisors Recommending Alternative Investments (2014 vs. 2013) 60% 50 40 30 20 46% 48% 31% 22% 17% 24% 2103 2014 ADVOCATING ALTERNATIVES For both years we analyzed the response of advisors with AUM above $25 million those more inclined to use alternatives and the majority indicated that they recommended the inclusion of alternative investments in their clients portfolios. In fact, 70% of advisors recommend alternative investments for either many or a select few of their clients. However, this does represent a decline from 2013 and a reversal in the trend of a higher percentage of advisors recommending alternatives. The most meaningful change year-to-year was among the advisors reporting that they recommend alternatives for just a select few: 22% this year vs. 31% last year. Also, the percentage of advisors reporting that they are unlikely to recommend alternatives increased from 17% to 24%. This apparent shift in advisors inclination to recommend alternatives may be indicative of generally lagging performance, increasingly complicated strategies, high costs, or some combination of these and other factors. 10 0 Yes, for many of my clients Yes, for a select few clients No, and I am not likely to recommend in the future 6% 6% No, but I will likely do so in the future
FIGURE 2: Client Comfort Levels in Using Alternatives (Change in the Last Two Years) Same comfort level 37% 41% More comfortable 27% 28% Less comfortable 4% 6% I don t use alternatives Not sure/ I don t know 9% 12% 16% 20% 2013 2014 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% We also observe advisors becoming less enamored with alternative investments in the responses to a question on client comfort levels. The percentage of advisors indicating that clients were more comfortable was up only slightly, while those indicating that comfort levels remained the same declined to 37% from 41%. Consistent with this last observation, 6% of advisors reported that their clients were less comfortable vs only 4% last year. That said, the shifts that we observe, while consistent in direction should not be viewed as conclusive because they could be explained by sampling error. If a true trend is emerging we would expect to see it validated in future surveys.
USAGE OF ALTERNATIVES Given that most advisors serve relatively diverse demographics, it is expected that alternatives would likely not be suitable for all of their clients. In fact, 39% of respondents indicated that they only allocate alternative assets to between 1% and 19% of client portfolios, a level fairly consistent with the prior year. Only 22% of advisors implement alternative asset strategies on behalf or 50% or more of their clients, with only 5% of respondents indicating that they utilize alternatives for all client portfolios. It is interesting to note that while the distribution does drop off as the percentage of clients increases, there is a spike in the number of advisors sitting in the right tail. These are likely the same managers using alternative assets in core portfolio positions for clients who are very comfortable with the concept. 30% FIGURE 3: Percentage of Clients with an Allocation to (2014 vs. 2013) 2103 2014 25 20 24% 23% 27% 18% 15 10 5 0 0 15% 12% 10% 9% 3% 4% 3% 2% 2% 2% 2% 1-9% 10-19% 20-29% 30-39% 40-49% 50-59% 60-69% 70-79% 80-89% 90-99% 100% 1% 5% 2% 8% 6% 6% 6% 5% 5%
When we examine the responses to the question about advisors expected change in the usage of alternative investments over the next three years, we see an interesting picture. One the one hand, the percentage of advisors indicating that they plan to increase usage declined to 37% from 41% last year. This appears consistent with our observations indicating a decline in current usage and recommendations. However, the percentage of advisors indicating that they expect to maintain their allocation going forward is up from 55% to 61%, continuing a steady multiyear trend upward. And, a smaller percentage of advisors indicated that they plan to decrease the use of alternatives. These data points, taken in the context of prior alternative asset allocation, may indicate that the advisors who use alternative investments are increasingly comfortable with them, but that increase in the share of assets allocated to alternative moving forward is beginning to slow. FIGURE 4: Expected Change in Usage of Alternative Investments in the Next Three Years 70% 60 50 40 30 55% 61% 41% 37% 2103 2014 20 10 5% 3% 0 Stay the same Increase Decrease
FIGURE 5: Reasons to Advocate Using Alternatives in Client Portfolios (2014 vs. 2013) As a portfolio diversifier 59% 65% To lessen volatility 44% 47% As a risk management tool 44% 50% Superior return opportunities 16% 19% Client request I don t use alternatives 7% 9% 17% 25% 2013 2014 0% 10% 20% 30% 40% 50% 60% 70% OBJECTIVES FOR ALTERNATIVES The leading reasons for steering clients toward alternatives remain diversification, risk management and volatility reduction. Based on a comparison to 2013 responses, all three related drivers showed lower response rates, but nonetheless remained the dominant factors driving the use of alternatives. Superior return opportunities continues to trend downward as a driver for the use of alternative investments as only 16% of advisors cited return opportunities this year compared to 19% last year. This finding is likely at least partially driven by the fact that alternative strategies performance, in general, has lagged that of the market in general over the past few years.
A majority of advisors, in this case 61%, continue to use them for satellite positions, a level consistent with the prior year observation. Additionally, a sizable and slightly increasing segment of advisors (33%, up from 28% in 2013) use alternatives as core portfolio positions. It is reasonable to assume that this group has considerable overlap with the minority who use alternatives assets for their superior returns. This indicates that, while superior returns are not a key selling point for the alternative investment category as a whole, there are targeted opportunities within the space that produce compelling returns for selected managers and their clients. FIGURE 6: How Firms Use Alternatives in Their Allocations For satelite positions 62% 61% For core portfolio positions Other 12% 16% 28% 33% 2013 2014 0% 10% 20% 30% 40% 50% 60% 70%
MEASURING RISK Advisors were asked to compare their specific risk indicator usage this year to what they used two years prior. As observed in prior surveys, standard deviation and its related metric, the Sharpe ratio, along with maximum drawdown, are the most widely used risk indicators used by advisors evaluating alternative investments. Not surprisingly, the use of these three popular measures is consistent with the leading reasons advisors recommend alternatives to begin with: diversification and risk management. In addition, while each have their shortcomings as reliable measure of risk, they are easy to understand and relatively simple to articulate to clients. Other measures have also seen relatively little change in overall risk indicator usage, with semi-deviation, the Sortino ratio, and the Treynor ratio each being utilized by 10-15% of managers. FIGURE 7: Risk Indicator Use by Advisors (2014 vs. 2012) 50% 45 45% 47% 2103 2014 40 35 38% 39% 40% 37% 39% 38% 30 25 20 15 10 15%15% 11% 11% 10% 11% 5 5% 5% 0 Standard deviation Maximun drawdown Sharpe ratio Sortino ratio Treynor ratio Semideviation Other Haven t used/ not applicable
PROVIDERS MOST CLOSELY ASSOCIATED WITH ALTERNATIVE INVESTMENTS Given the specialized nature of many alternative investment strategies, the industry tends to be more fragmented than mutual funds and ETFs. As such, we would expect to see many different types of investment management firms listed in response to this question. AQR, pioneers of the risk-parity approach to investing, stands out as the provider most closely associated with alternative investments, with 46% of respondents listing the firm. This is consistent with advisors citing risk management and portfolio diversification as the main reasons to use alternatives. Other managers that resonate strongly with advisors include Altegris at 32%, Direxion at 28%, and Calamos at 24%. FIGURE 8 - Providers Most Closely Associated with AQR 46% Altegris Direxion 28% 32% Calamos 361 Capital 17% 24% Hatteras Alliance Bernstein Pioneer Red Rocks Capital Aston Funds 7% 7% 8% 14% 16% William Blair Jackson National 6% 6% Highland 4% Dynasty 2% 0 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
KEY TAKEAWAYS Seventy percent of advisors recommend alternative investments for their clients, down slightly from last year and possibly representing a change in direction relative to the long term upward trend. In 2013, 17% of respondents indicated that they do not recommend alternative investments for their clients and had no plans to recommend them in the future; this number increased to 24% in 2014. Thirty-nine percent of advisors allocate alternative assets to between 1% and 19% of client portfolios and only 22% do so on behalf or 50% or more of their clients. Nearly 37% of advisors stated that they intend to increase their usage of alternative investments in the next three years, with 61% indicating they would at least hold their usage constant. The main reasons advisors use alternatives continue to be portfolio diversification, volatility reduction and risk management. Sixty-one percent of advisors use alternatives for satellite positions within portfolios and 33% do so for core positions. Standard deviation, Sharpe ratio and maximum drawdown remain the risk measures most widely used by advisors evaluating alternative investments. AQR, Altegris, Direxion and Calamos are the managers most closely associated with alternative investments. Sponsored by Posted with permission from REP. magazine, Penton Media, Inc. Copyright 2014. All rights reserved. For more information on the use of this content, contact Wright s Media at 877-652-5295. 114381