Alternative investments have gathered the attention and interest of financial planners. According to a Financial Planning Association Survey, nearly half of advisors reported using or recommending some form of alternatives. While alternative investments may not be a silver bullet for difficult times, they can provide the diversification sought by long-term investors.
When it comes to alternative investment competency, however, the private wealth management industry needs focused tools and education. Broader consumer access to alternative investment options is here and will continue to grow. Financial planners, in turn, require additional tools to educate themselves and help their clients understand these investment vehicles.
Alternative investments have grown considerably over the past two decades, accounting for an estimated 50% of global revenue in the asset management industry, despite representing only 21% of global assets under management (AUM), according to a Boston Consulting Group study. The growth in interest and AUM can be attributed to increased capital formation and value creation in private markets, a global decline in bond yields for the better part of a decade, and, more recently, volatile equity markets. Moreover, private equity and credit strategies have grown from cottage to mature industries, further widening the appeal of available investment options.
However, 2022, the worst year for a U.S. 60/40 portfolio in decades, highlighted the importance of expanding an investment toolkit beyond public equity and bond markets and a renewed focus on building better portfolios, embracing illiquidity, and emphasizing objectives.
Over several decades, large asset owners, including endowments, foundations, pensions, and sovereign wealth funds, embraced alternative investments, often allocating significant portions of their portfolios to these strategies. The most aggressive endowments were early adopters, the largest of which allocated upwards of 50% to alternative investments. In contrast, individual investors generally allocate less than 5% of their portfolios to alternatives. According to Bain, individual investors hold approximately 50% of global assets under management. Yet, those same investors represent just 16% of AUM held by alternative investment funds. As demand increases from prospective buyers, technology improves access. When new fund vehicles become available, the opportunity is significant but is also a clarion call for individual investor education.
Financial planners must understand alternative investments before recommending (or dissuading) their clients from investing. Planners and clients face challenges and concerns regarding liquidity, fund structures, tax implications, and fees associated with alternative investments. Addressing these concerns and enhancing comfort levels within the industry will require collaborative educational efforts across asset management, service providers, and advisors directly.
One such effort is the recent partnership between the CAIA Association, the global professional body for the alternative investments industry, and FPA, the membership organization and trade association for CFP professionals, which aims to provide broader access to educating the financial planning community on these topics.
Education is essential for financial planners and the long-term outcomes for their clients, even more so when considering alternative investments. The professionals closest to individual investors can diagnose and recommend what is appropriate for their clients, which lends to the value of adding to a planner’s toolkit. In doing so, financial planners continue to facilitate the learning path of individual investors and serve a vital role in contributing to financial literacy across American households.
Aaron Filbeck, CAIA, CFA, CFP®, CIPM, FDP, is managing director and head of UniFi by CAIA at CAIA Association. UniFi by CAIA is a learning platform dedicated to educating the private wealth management industry on alternative investments.
Patrick D. Mahoney is chief executive officer of the Financial Planning Association (FPA), the leading membership organization and trade association for Certified Financial Planner professionals and those engaged in the financial planning process.