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Advisors Are At Odds on Alternatives to Stocks

By Chris Latham May 20, 2013

Advisors are using alts to address all kinds of client problems these days, from domestic-stock jitters to low-yield fatigue.

The trouble is, it’s hard to find anything that beats good old American equities right now.

For instance, Raymond James’s chief investment strategist, Jeffrey Saut, says clients are sitting on mounds of cash. They have doubts about the U.S. stock market rally’s longevity and are worried about inflation — but they're also aware that many alternatives are struggling to match the S&P 500. “I’ve been doing this over 40 years, and I’ve never seen this kind of a boom,” Saut says of the climbing index. “We like alternative investments, but quite frankly the best investment for the past six months has been U.S. equities.”

Still, now that quantitative easing has gone global, everything from REITs to emerging markets to private equity is on the table for investors who can’t stomach plain-vanilla domestic holdings. Experts say the proper alternative strategy depends on the client’s risk tolerance and investing time frame. Alts are generally used either to intensify or to counteract a particular portfolio strategy, and advisors give them a relatively light allocation.

Extra Yield

Adam Nugent, at Foresight Wealth and Risk Management in Salt Lake City, is finding that clients are willing to pay a premium for certain fixed-income instruments in order to get higher yields. One example: senior floating-rate funds. “You do not want to use these when rates are going down, but given that rates can't go much lower, there is little interest-rate risk,” says Nugent, whose firm oversees about $180 million for 150 clients.

Nugent also favors REITs, as a good inflation hedge. But Michael Byman, a senior wealth advisor at Alexandria Capital in Washington, D.C., thinks many REITs may be near their highs, with the Vanguard REIT Index ETF up slightly more than the S&P 500 so far this year. Instead, Byman’s firm, which oversees about $400 million for 250 clients and mainly holds ETFs, has been adding small allocations of commodities and emerging-market equities to some clients’ portfolios.

For clients who don’t want to worry about market timing and don’t need liquidity, Keith Amburgey recommends considering private equity and structured settlements. He advises for Rutherford Asset Planning, a Tampa-based firm managing about $150 million for 50 families. Amburgey explains the nature of these structures to clients and gets their explicit permission before investing in them, because of the unique risks of non-traded firms and liability-based annuities.

Private equity returns have outpaced the S&P 500 by seven percentage points on average for the last decade, according to a Cambridge Associates index. And structured settlements can have yields well above Treasuries.

“One nice thing about these alternatives, particularly private equity energy, is that they tend to be longer-term investments,” notes Amburgey. “It’s sort of a forced discipline, because [clients] can’t get out so easily.”

The Anti-Alt View

Yet some advisors question whether alternative investments serve much purpose at the moment, given that the stock market keeps setting records and virtually every developed nation is stimulating its economy. In fact, Matt Woolley, a vice president at Robert Baird Private Wealth Management in Dallas, doesn’t just look askance at alts. He says advisors should be paying attention to deflation, because that will depress commodity prices — which in turn will depress other alternatives.

Indeed, the blogosphere is packed with essays connecting falling commodity prices, global quantitative easing and deflation. Woolley, whose firm manages about $1 billion for 100 clients, points out that copper — crucial to most sectors of the economy — has dropped in value by more than 11% this year.

That’s Woolley's inflation barometer, and it doesn’t bode well for alternative investments. So he tells clients to stick to stocks. “It’s either you are in the market — equities side — or you are not. There’s no other real quest for yield.”