Alternative investments have been gaining attention for some time, and this has only increased during the market volatility of 2022. In the wake of a market decline in which the traditional 60/40 portfolio has offered little shelter, investors are once again assessing future asset allocations. In particular, bonds may not be able to play the kind of stabilizing, if not additive role, that they have in recent years, especially if we see a return to the type of slow economic growth and high inflation that characterized the 1970s. The 10-year U.S. Treasury bond yield which bottomed at a record-low 0.51% last year on August 4, down from 0.9% at the beginning of 2021, rose to around 1.9% at the end of February and is almost 3.0% as of mid-May. Rising yields make bonds lose value and thus less able to cushion the more volatile equities portion of the 60/40 portfolio, a portion that not too long ago was trading at near-record valuation levels. How then can investors hedge their portfolios and avoid the kind of losses similar to those incurred in the 2008 bear market?
One likely beneficiary of any move to de-risk portfolios due to recent uncertainty is alternative investments. This ongoing search for non-correlated returns and safe havens is unlikely to abate as we move further into 2022, especially since newer investment opportunities such as crypto, which offered the potential promise of being uncorrelated to major asset classes, seem to be tracking ever more closely with the stock market as a whole. Perhaps not surprisingly, inflows into various liquid alternative categories in 2021 were seen at a scale not seen since 2013 and may bode well for those managers that have been able to build solid long-term track records. In fact, Morningstar has estimated net flows for the US Alternatives Category Group to be $28.9 billion in 2021, up from negative $2.5 billion in 2020 and positive $6.8 billion in 2015 (when the category was last positive). Interestingly, however, it is illiquid alternatives such as interval funds, non-traded REITs and non-traded BDCs that seem to be experiencing the largest increase in sales volume. According to Robert A. Stanger and Co., an investment bank that tracks flows into non-traded alternative investments, fundraising totaled $86.1 billion in 2021 compared to $27.3 billion in 2020, and they are projecting total sales of approximately $120 billion in 2022.
These increases mirror changes that we have observed in our industry-leading business intelligence tool, WalletShare for Alternatives, which also demonstrates a significant increase in illiquid alternative sales.
Naturally, investment managers have been working hard organically and via M&A to keep pace with growing demand, both in terms of product and distribution capabilities. Firms have upgraded their investment, sales, marketing analytics and technology capabilities to target wealth firms and platform providers that are actively shopping for alternative strategies to add to their rosters. And, as we have written about in previous blogs, creating effective sales territories and structures is an essential component of a successful sales strategy. This challenge is compounded by the fact that highly specialized products such as alternative investments require a relatively high level of knowledge and experience in order to successfully sell them to the smaller number of financial advisors who utilize them on a regular basis. The sales team will often consist of highly specialized experts who can speak at length about the technicalities of the product and work with clients and prospects to ensure they meet the specific needs of their businesses.
In the coming years, we believe investors will drive their advisors to add alternative investments across an increasing percentage of portfolios. However, while this growing appetite for less traditional asset classes will create opportunities, our experience suggests that the most successful investment managers will be those with sales teams able to use data to identify the relatively small number of advisers responsible for the majority of sales. It is increasingly apparent that this shift towards the efficient use of data to identify those advisors most likely to use a particular product will have major implications for investment managers. Furthermore, in a hybrid and virtual environment in which prospecting is even more difficult than it was previously, we believe tools such as SS&C’s WalletShare for Alternatives will be increasingly valuable as data becomes an ever-greater catalyst for change.
Written by Michael Andrews, CFA
Head of Investment Products Research & Consulting