By Craig Covington
While the ultimate fate of the Department of Labor’s fiduciary rule remains unclear, one thing we can say about the emerging fiduciary era is that flexibility – in an advisor’s business model, the types of clients he or she serves and the platforms they utilize – has never been more valuable than it is today. Advisors whose practices are rigidly attached to commissions – or even to fees that comply only with the SEC’s existing fiduciary standard – are finding themselves potentially underprepared should the rule take effect without substantial changes.
Independent hybrid advisors have emerged as being perhaps best-positioned to weather further changes that may come about as we transition further into a period of heightened fiduciary expectations, thanks to their diversified revenue streams and familiarity with multiple client service models and regulatory structures.
The emerging fiduciary era, though, is not the only external factor placing a premium on flexibility within our industry. Retirees and pre-retirees remain under severe pressure due to the limited sources of potential income available in our ongoing yield-starved environment. Advisors who continue to cling to the idea that fixed income instruments and dividend-yielding stocks can somehow plug this hole are doing their clients a disservice. Simply operating a successful hybrid practice will not necessarily position an advisor to continue to thrive in the face of these challenges.
Retail alternative investment vehicles may provide a solution for many hybrid advisors seeking greater flexibility in their product offerings and service models. Many such vehicles – broadly based on asset classes such as real estate, credit, natural resources and others – prioritize income generation for investors and boast low correlation with stocks and bonds, providing critical risk management characteristics for investor portfolios.
Moreover, retail alternatives have become significantly more accessible for Main Street investors over the last 10 years. While only qualified investors and institutions had consistent access to such instruments in the past, the emergence of REITs, ’40 Act interval funds and other innovative structures has recently opened this segment of the investing world to the mass affluent population on an unprecedented scale.
As many advisors are aware, though, retail alternatives can introduce new wrinkles of their own. Valuation methodologies can be more esoteric than for stocks and bonds, and may vary depending on the type of asset underpinning the security. Different types of alternative investments may also serve significantly different roles in an investor’s portfolio, with some focused on tax mitigation, others on income generation and still others focused on return enhancement opportunities.
Given the challenges above – balanced against the clear importance of offering clients alternative solutions to help address their needs – what are the core factors hybrid advisors should bear in mind as they seek to integrate retail alternative investments into their practices for the first time?
- Understand valuation. Advisors who are new to the alternatives space can strengthen their personal due diligence processes – and their ability to credibly recommend alternative investments – by starting with a few basic questions: How often is the instrument valued? And are valuations determined or reviewed by a respected third party?
From there, advisors can further develop their knowledge of the space by digging into valuation processes for specific types of alternative assets. This does not mean running complex valuation models at the office, but it can help an advisor understand the assumptions behind an instrument’s value and enable him or her to recommend a particular investment with greater confidence. - Know how the underlying assets function – and how this affects the instrument’s role in investors’ portfolios. Especially for advisors who are new to alternatives, it can be helpful to stick to instruments whose sources of return they understand well. Some advisors may be comfortable utilizing commodities to hedge against inflation, for example, while others may have a strong understanding of the real estate market. Advisors should bear in mind that, while an alternative product may make it simpler to access a given market, it will not make that market – or the asset’s effect on an investor’s portfolio – any less complex.
- Liquidity is key. Hybrid advisors seeking to offer alternative investments for the first time should take care to investigate each instrument’s liquidity as part of their own due diligence. This includes researching the liquidity of the structure as well as that of the underlying asset. If the two are not similar, advisors will need to understand the potential effects this could have on the investment overall.
As independent hybrid advisors survey the road ahead for their businesses, many of them feel a well-deserved sense of satisfaction for building a level of flexibility into their practices that should position them to adapt quickly and successfully to major changes in the regulatory climate, including (potentially) the final DOL rule.
They are also in a strategically advantageous position to leverage that flexibility to expand the products they offer to include retail alternative solutions that can help meet their clients’ needs. Although the considerations for assessing, deploying and managing these instruments can be undeniably complex, the rewards are unquestionably worth it for clients who are still struggling to find consistent sources of income for retirement, along with low correlation and (in some cases) potential tax advantages. By being mindful of the key considerations above, independent hybrid advisors can integrate these vital investing tools into their practices with confidence and efficiency.
Craig Covington is Senior Vice President of Investment Products at Triad Advisors, the Atlanta-based, hybrid advisor-focused independent broker/dealer.