Historically reserved for institutional
investors and ultra-high-net-worth clients, alternatives are now becoming
almost mainstream in high-net-worth and mass-affluent client portfolios.
Providing access to these complex investment strategies enables financial
advisors to deliver more robust investment solutions and differentiate their
product offerings in the increasingly competitive marketplace for financial
However, what an alternatives allocation includes and how these strategies are
being used in portfolio construction differ widely within the wealth
management industry. Here, Eric Mogelof, PIMCO’s head of U.S. global
wealth management, and Aimee Almeleh, an account manager specializing in
alternatives, discuss the ongoing evolution of alternatives strategies.
Q: What exactly are alternative investments?
A: While most investors can agree on the definitions of a stock and a bond,
there is little consensus on what defines an alternative investment.
Some investors go strictly by investment vehicle, with public funds falling
under traditional investments and limited partnerships or private equity
drawdown vehicles viewed as alternatives strategies. Using this definition,
however, can be limiting, as non-traditional investments can be wrapped in
public funds; for example, interval funds, which are increasingly popular with
financial advisors, use fund structures with liquidity features similar to
those of some limited partnerships. Other investors distinguish between
traditional and alternative investments based on whether the securities are
public or private. And still others define anything outside of stocks and
bonds as alternatives.
At PIMCO, we typically frame the discussion of alternatives around what types
of assets are being bought and sold and how investment returns are generated.
This offers flexibility in evaluating potential investment solutions. For
example, an alternatives strategy may include only public market securities
but employ a long/short trading or arbitrage strategy. A drawdown vehicle that
takes exposure to privately negotiated and structured debt or illiquid real
estate securities may also be an alternative investment. Yet another could be
an interval fund that invests in both public and private market securities and
uses leverage to try to optimize returns.
We think the most important features of an alternatives strategy are how it is
expected to behave within a portfolio and what risks an investor is taking to
achieve that outcome.
Q: Should every client consider including exposure to alternatives in an
A: Before considering any investment, and especially alternatives, financial
advisors will want to develop a deep understanding of a client’s overall
financial situation, key investment objectives, risk/return profile and near-
to medium-term liquidity needs. Based on these factors, financial advisors can
then determine whether a specific alternatives strategy may be appropriate for
Certain alternative investments – such as hedge funds and private equity
held in a limited partnership – are only available to investors who meet
minimum net-worth and income requirements. Many alternatives managers also
establish high investment minimums, typically upward of $5 million. These
requirements have historically served as barriers for many investors, even
when alternatives strategies may have been appropriate from a portfolio and
More recently, however, an increase in interval funds, tender-offer funds and
nontraded REITs (real estate investment trusts), as well as the rise of new
financial technology (fintech) platforms, have helped
“democratize” alternative investments, making them available to a
much broader universe of investors. These offerings have preserved some of the
attributes we consider typical of alternatives strategies, but in fund
structures. In addition, many distribution firms are streamlining the
alternatives subscription process and significantly reducing investment
minimums to levels that are accessible for a larger range of investors.
Q: How are advisors using alternatives in portfolio construction, and what
objectives are they pursuing?
A: We see three key reasons why financial advisors are utilizing alternatives
in their client portfolios.
First, alternatives may offer higher return potential; we see this motivation
most in ultra-high-net-worth client portfolios. This higher-return potential
is often driven by investing in less liquid and/or more complex assets, along
with greater concentration in high-conviction ideas. Returns may also be
driven by the use of leverage to varying degrees.
Second, alternatives have potential diversification benefits. Some
alternatives strategies take different risk-factor exposures than traditional
stocks and bonds. This may help build portfolio resiliency and mitigate
Third, exposure to the esoteric asset classes in alternative investments can
provide alternative betas – non-traditional investment exposures –
that are not easily replicated or accessed in other ways.
Among advisors using alternatives for their clients, we see allocations
typically ranging from 10% to 30% of portfolios. For ultra-high-net-worth
portfolios, we have seen allocations as high as 50%.
In sizing alternatives allocations, we go back to understanding client goals
and objectives. We see advisors building diversified alternative portfolios
that span hedge funds, alternative risk premia, private equity, private credit
and real estate strategies. We think alternatives allocations should be large
enough to move the needle for an investment portfolio but also maintain
diversification across strategy, liquidity and asset class exposures.
Q: What else should advisors consider when allocating to alternatives?
A: Manager selection is always relevant in portfolio construction, but when
considering strategies that offer lower liquidity and/or exposure to unique
investment betas, manager selection may be critical.
Financial advisors should consider an investment team’s capabilities and
process to determine whether returns are generated by skill or luck and
whether those results are repeatable. In addition, top-notch operational and
risk infrastructures are essential as alternatives strategies often
incorporate derivatives and esoteric assets. Legal and compliance functions
also need to be assessed given the increasingly complex legal and regulatory
environment for alternatives.
Q: How is PIMCO approaching alternative solutions for wealth management
A: Alternative investment strategies, when used prudently, can be an important
tool in both preserving and growing client portfolios, in our view.
We envision a future where alternatives are accessible to more investors and
financial advisors can integrate alternative solutions into client portfolios,
where appropriate, with few or no barriers to entry.