Where to Begin: Advisors' Guide to Alternative Investments

IN THIS ARTICLE:

• The Question Behind Every Allocation
• Signs a Portfolio May Need a Second Look
• How Alts Strengthen Client Relationships
• What Comes Next

For decades, a mix of stocks and bonds did most of the work of diversifying a portfolio. Stocks drove growth. Bonds provided income and a cushion when equities fell.

That relationship has weakened. Post-pandemic inflation, supply-chain disruptions, and geopolitical competition have pushed stocks and bonds to move together more often than they used to. Meanwhile, a handful of mega-cap names now drive the major indices, so a portfolio can hold hundreds of stocks and still rest on a few underlying economic risks.

Alternative investments, or alts, offer a way to broaden those sources of return and risk. They've also become far more accessible, with structures that fit many more client profiles than earlier generations did. For most advisors, the real question is where to begin.

The Question Behind Every Allocation

When considering whether to add an alternative investment to a portfolio, start with the problem. Is the client overexposed to equity valuations? Short on income? Worried that inflation will erode their bond returns?

Alternatives work best when they answer a clear question. A defined goal makes the client conversation easier, too. It's simpler to explain why a strategy belongs in a portfolio when it solves something the client already cares about.

Signs a Portfolio May Need a Second Look

A few signals tend to show up when a portfolio is less diversified than it appears:

• It leans heavily on public equity valuations. If most of the portfolio's growth depends on stock prices, especially those of a few mega-cap names, a downturn may hit harder than the client expects.
• Bonds are the main source of stability. With stocks and bonds moving together more often, a traditional fixed income allocation may not cushion equity losses the way it once did.
• Income depends almost entirely on fixed income assets. Clients who need steady cash flow may be relying on a single source, leaving them exposed to shifts in rates and inflation.
• The client has little exposure to companies staying private longer. As more companies stay private for longer, a portfolio built only on public markets may miss a growing share of economic activity.

Each of these signals is a reason to look more closely at what the current allocation is doing for the client, and where it falls short. Once the gap is clear, the goal usually follows. Most fall into one of three buckets: growth, income, and diversification.

Given the breadth of the overall alts category, this is where alts can really shine. From hedge funds and venture capital to private credit, real estate, managed futures, and more, there is an array of tools advisors can utilize to pursue a client’s objectives. The key is understanding where a client’s goals and an asset’s attributes intersect.

Where Alternatives Strengthen Client Relationships

Alternatives make it possible to deliver a targeted strategy for a specific need, whether that's lowering portfolio volatility, supporting a tax goal, or providing access to an investment the client can't find anywhere else.

Addressing those needs well can build trust. A client who watches an advisor solve a real problem tends to be more likely to bring over more of their assets.

The next generation of clients will likely expect it. For example, 20% of Millennials invest in alternatives,¹ compared with 6% of Boomers.² As those younger clients inherit wealth, fluency in alternatives may become part of what they look for in an advisor.

What Comes Next

Portfolio construction is likely to keep getting more complex. Advisors who build a clear process now, starting with the client's goals and working toward the right tools, will be better prepared for whatever the market does next. Alternatives are not intended to replace stocks and bonds. Used with purpose, they can help portfolios hold together across a wider range of outcomes.

To take a deeper dive, explore the alternative investments white paper. Learn how to weigh their strategic considerations, ways to navigate the full range of options and how each can fit into a client’s strategy.

Advisors at LPL don't have to navigate alternatives alone. From the specialized alts team to a centralized platform that integrates all aspects of alternative management into one space, there are dedicated resources to support advisors every step of the way. Schedule a consultation to learn more.