I have been concerned for a long time that the rapid growth (number and type) of liquid alternative investment products being developed for the retail marketplace represents a potential problem. Many clients – and in fact advisors – don’t understand what these investments are, how they work and why they should invest in them – other than they are the flavor of the day.
A number of recent studies confirm my fears:
– Jackson National Life Insurance conducted a study of more than 300 investors who work with advisors and have more than $200,000 in investible assets. 43% admitted that they have no idea what the term alternative investments means. A larger study of almost 600 investors including those who work with advisors and those who don’t, yielded similar results.
– Invesco conducted a survey last year with Cogent Research which found that only 23% of 429 investors with at least $250,000 in investible assets and working with an advisor were familiar with the term “alternative investment.” 5% of the survey respondents thought that money market funds were alternative investments.
Yet the money keeps pouring in … As of May 31, net flows in five our of seven Morningstar alternative categories are up, led by nontraditional bonds.
I see two major problems. One is that there is really no industrywide consensus of what an alternative investment is. People often confuse an alternative investment with an asset class. This leads to the second problem – these surveys confirm that the education surrounding these investments has not kept up with their growth.
And this is where bubbles start. People feel like they have to invest in something so that they don’t get left out. They don’t really know what they have and they don’t even know why they have them in their portfolios. Do I have a long/short mutual fund in my portfolio because it diversifies risk or because it enhances return, or both?
Education has to start with the sponsors of these investments educating the distributors and their advisors – and providing the education materials in turn for advisors to educate their clients. I would have hoped the industry would have advanced further in this task by now; it should have.
But the education also has to incorporate the notion that liquid alternative investments are not for all investors and you can be successful without them in your portfolio. Even some sophisticated institutional investors shun alternatives for lack of a thorough understanding.
We can prevent the next bubble if we are smart about it. Lets hope the industry is! Given past history, however, I have my doubts. What about you?
