Private wealth and the embrace of an ‘alternatives culture’

Institutional investors have had a multi-decade head start on individual investors when it comes to incorporating alternatives investments into diversified portfolios. Their size and scale have allowed them to efficiently invest across multiple risk premia and generate attractive risk-adjusted returns for their constituents over multiple economic regimes.

While they remain important as ever, institutions are not the only investors in the marketplace. The role of the individual investor’s relationship with capital markets has grown in significance, representing (by some measures) nearly half of the world’s net worth. So why don’t they have access to the same opportunities as the institutions?

It wasn’t until the 2010s when democratized access to alternative investments began in earnest, starting with the ‘liquid alternatives’ trend that made hedge funds strategies available to the masses. On average, the results were mixed – many product providers sought to take complex products and retrofit them into regulated vehicles (e.g., mutual funds or UCITs) that placed significant protections (and, as a result, restrictions) on what the manager could or couldn’t do within them. Since then, hedge funds have grown alongside a booming private markets industry, which has seemingly made efforts to approach product development a bit more thoughtfully this time around. While liquid alternatives are still an option, many other product types and technologies have widened the opportunity set, allowing more direct access to uncorrelated risk premia.

Yet, for all the efforts of the industry, private wealth allocations remain lower than institutional investors on average. We believe this presents an opportunity for individual investors, as there’s plenty of room to further diversify multi-asset portfolios.

While some hurdles remain, we believe there are three considerations advisors should consider as they begin the journey of investing in alternatives. We highlighted these in our most recent thought leadership report, Crossing the Threshold: Mapping a Journey for Alternative Investments in Wealth Management:

• Keep it strategic and long term. Integrating alternative investments into investors’ portfolios requires long-term thinking and implementation. These illiquid strategies take many years to fully and properly integrate into a portfolio and the temptation to time markets may be high.

• Prioritize purpose over product labels. The label of a certain product or strategy becomes less relevant in a total portfolio context, especially the more heterogeneous the underlying strategies become.

• Embrace an ‘alternatives culture'. One of the many reasons the Endowment Model was so successful in its heavy implementation of alternative investments was the fact that it leaned into its strengths and competitive advantages. While most firms cannot (and should not) attempt to replicate the Endowment Model, there are some important cultural lessons to be learned from it. Investors should not underestimate the importance of operational and cultural considerations when implementing alternative investments. These strategies are more complex and require more thoughtful integration than traditional investments.

Of course, education is the foundation of these action items. It’s impossible to implement a long-term investment plan, invest sophisticatedly, and embrace an ‘alternatives culture’ within your organization if you lack the knowledge, skills, and resources to get started. The investment case is merely one piece of the puzzle, and there are several additional steps one must take to move from ideation to implementation.

About
Aaron Filbeck, CAIA, CFA, CFP®, CIPM, FDP oversees UniFi by CAIA™, a learning platform dedicated to educating the private wealth management industry on alternative investments.

_{This article originally appeared in Hedge Funds Q2 2024: Preqin Quarterly Update. The opinions and facts included in the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin and CAIA accept no liability for any decisions taken in relation to the above.}