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After struggling with declines in stock and bond markets, more and more financial advisers looking to further diversify their clients are turning to alternative investments, according to a recent survey by Cerulli Associates.

Outside of traditional asset classes, alternative investments are commonly added to portfolios for more diversification, income generation, and the possibility of higher returns.

The report, which surveyed 100 advisers in the first half of 2022, found average alternative allocations of 14.5%, with advisers aiming to increase the percentages to 17.5% in two years.

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While industry average allocations for alternatives and commodities may be closer to 10%, Cerulli sees a “Goldilocks moment” for these assets amid demand for income, higher yields and protection against volatility as more products become available.

According to the report, almost 70% of respondents said the main reason for alternative allocations was to “reduce exposure to public markets” and 66% were to “mitigate volatility” and “protect against downside risk”. . The other main reasons for the alternatives were revenue generation, diversification and growth.

Where advisors invest

Alternative investments can be classified into four categories: hedge funds, private equity, “real assets” such as real estate or commodities and pre-packaged investments called “structured products”.

“We’ve been using alternatives for some time,” said Ashton Lawrence, certified financial planner at Goldfinch Wealth Management in Greenville, South Carolina, whose firm has used event-driven assets and corporate mergers. as well as funds offering downside protection through put options. .

“When interest rates were extremely low, we wanted to have something that would anchor the portfolio but not be tied to interest rates,” he said.

Scott Bishop, executive director of wealth management solutions at Houston-based Avidian Wealth Solutions, said his firm uses private equity, private debt, some hedge funds and some “smaller investments” that are less attractive to investors. Wall Street banks.

The most popular alternative assets are liquid alternative mutual funds and exchange-traded funds, offering hedge fund-like strategies to mainstream investors, according to the Cerulli survey, as well as non-traded real estate investment trusts, which do not are not purchased. and sold on the stock exchange.

The risks of alternative investing

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With a range of assets falling under alternative investing, it’s easy to misunderstand what you own and what you’re supposed to do, Lawrence said.

Before diving into alternative investments, you should have a clear understanding of the underlying asset and the environment in which it may perform best. Otherwise, you might have inconsistent expectations, he said.

“A hammer is a tool and a spatula is a tool,” he said. “But if I take a hammer and try to flip pancakes in the kitchen, I’m going to have a bad experience.”