Baird: Offering Investors Alternative Asset Classes Is a Must in Current Environment

Baird Helps Advisors Navigate Alternative Strategies

MILWAUKEE, Aug. 18, 2011
Financial advisors who aren’t talking to their clients about alternative investments should be, according to wealth management experts at Baird. Baird’s Private Wealth Management Research team has also written a white paper, “Demystifying the Role of Alternative Investments in a Diversified Investment Portfolio,” as a tool for advisors who want to help their clients better understand alternative assets and the role they can play in their portfolios.

“Investing in alternatives has become more common for a much broader universe of investors,” said Laura Thurow, CFA, Co-Director of Private Wealth Management Research. A key driver is that there are more products available today, Thurow said, citing as an example the significant growth in the number of alternative funds and assets invested in the sector in just three years. “Excluding precious metals funds, the Morningstar Alternatives Category has almost doubled in three years, expanding from 129 funds to 245 funds and assets of $37.8 billion to $70.7 billion funds through June 30, 2011.”

Given increased market volatility and the fact that these strategies are low or non-correlated to the market, it’s not surprising that advisors are increasingly turning to alternatives to improve the overall risk-return characteristics of a portfolio. “Alternative investments are absolutely worthy of investors’ consideration, particularly as the outlook for traditional asset classes in the U.S. is stressed and unlikely to provide as attractive returns in coming years due to constrained U.S. gross domestic product growth,” Thurow said. In the past, a tough equity market might suggest increasing an allocation to bonds or vice versa. But today’s economic environment is unique in that the outlook for both equity and bond markets is strained.

Alternatives Can Give Advisors an Edge
Educating clients so they can avoid these pitfalls and successfully implement alternative strategies has become a competitive advantage for many advisors. “We are now talking to every client about alternative investing as a standard part of our practice,” said Tom Heidenrich, Senior Investment Consultant in the firm’s Chicago wealth management office. “We’ve seen a 180 degree change in the availability of alternative products and solutions over the last 10 years. As a result, more than 75% of our clients today have some alternatives in their portfolios up from 10% to 15% just five years ago.”

“We spend a lot of time discussing the merits of these products and helping our clients understand key aspects of these strategies,” Heidenrich said. “While the client education process takes more time, we feel it is important to offer strategies that can help diversify their portfolios and reduce risk without sacrificing much in terms of returns.”

Baird Favors Conservative Approach
Thurow suggests advisors think about alternative investment in two broad categories: (1) approaches that diversify a portfolio beyond traditional long-only investing (private equity, funds of hedge funds, managed futures and special situation mutual funds), and (2) vehicles to gain or hedge traditional long-only market exposure (structured products, exchange traded funds and hedging strategies).

In either case, advisors are encouraged to take a conservative approach to including alternative investments in their clients’ portfolios. “Many of these products – and their risk factors – are new to clients,” Thurow said. “A logical approach for advisors is to tread lightly for now, using alternatives more for diversification than alpha generation.”

Thurow offers the following additional suggestions for advisors:
  • Use a multi-manager approach. Even with a relatively small allocation, a multi-manager approach (such as a fund of funds) can help clients sleep at night by reducing the downside risk of one manager underperforming or, worse, blowing up. 
  • Determine the right asset allocation by client. Typically an allocation of 0% to 20% to alternatives is appropriate, but factors that should be considered carefully before deciding exactly how much to allocate to alternatives include a client’s net worth, liquidity needs, and risk tolerance/investment style.

While alternative investments can be volatile, when used appropriately, they can potentially enhance the overall risk-return profile of an already well-diversified investment portfolio, Thurow said. However, it is paramount that advisors help their clients give careful consideration to the unique risks associated with these non-traditional investment strategies.

Variance in Returns
While many clients are open to learning more about new opportunities to manage the risk in their portfolios, Thurow encourages advisors to be transparent with their clients about the variance in returns they can expect in alternative asset classes. “The data we see shows that returns to investors for alternative funds can vary sharply from actual returns due to factors such as fluctuating market conditions and imperfect timing (i.e. buying high and selling low),” she said. “The asset class is hardly immune from bad timing and investors who fail to consider historical valuation measures. It’s important that advisors counsel their clients to be patient and know what they are getting into and how their investments may perform in different market environments before they invest.”

A case in point is managed futures, which tend to have little to no correlation with equity markets. As such, managed futures typically protect value in down markets but will not keep pace in up markets. Past performance is no guarantee of future results, but investors who would have been invested in the asset class for the full trailing one year period ending July 31, 2011, would have captured +9.7%. However, actual investor returns in the asset class were just +3.8%, with the gap driven by inflows and outflows over the period. (Source: Morningstar)

About Baird
Baird is an employee-owned, international wealth management, capital markets, private equity and asset management firm with offices in the United States, Europe and Asia. Established in 1919, Baird has more than 2,600 associates serving the needs of individual, corporate, institutional and municipal clients. Baird oversees and manages client assets of $89 billion. Committed to being a great place to work, Baird ranked number 14 on FORTUNE’s “100 Best Companies to Work For” in 2011 – its eighth consecutive year on the list. Baird’s principal operating subsidiaries are Robert W. Baird & Co. in the United States and Robert W. Baird Group Ltd. in Europe. Baird also has an operating subsidiary in Asia supporting Baird’s private equity operations. For more information, please visit Baird’s Web site at