There are few trends in private wealth that are more talked about than the so-called death of the traditional 60/40 stock-and-bond portfolio. The reason? Though the 60/40 has served investors well for decades, the historic bull market on Wall Street is believed to be running out of steam, and the bond market has been dragged down by interest rates far lower than historic rates, (though that has changed over the past couple of years with Fed rate hikes).
Some industry observers suggest the 60/40 will be replaced by the emergence of more diversified portfolios containing a rich blend of alternatives and real assets. That could mean the 60/40 will be reformulated as a 50/30/20 or 40/30/30 portfolio.
While many RIAs still have yet to operate beyond the 60/40, others have already made the switch to alternatives and portfolio diversification, including BBR Partners, The Colony Group, Laird Norton Wealth Management, Mercer Advisors, Osaic (formerly Advisor Group), and Savant Wealth Management.
Here are the assets and strategies being used by those investment firms.
Talk about the role of alternatives and real assets in your clients’ portfolios.
BBR Partners: Alternatives and real assets exposure is key to achieving portfolio diversification. Public market alternative strategies allow clients to tactically lean into temporary market dislocations. Less liquid strategies such as private real estate and real assets look to contribute higher returns to client portfolios that compound over longer time frames, often with lower correlations to traditional asset classes like bonds and equities. Also, particularly important in today’s market environment, many of these strategies can provide a natural inflation hedge to clients’ portfolios.
The Colony Group: We construct portfolios from the top down, focusing on our clients’ return objectives, risk tolerance, capacity for illiquid assets and other factors. Our real assets exposure is designed to provide protection from unexpected changes in inflation, and, relative to equities, a degree of downside protection. More broadly, our alternatives allocations are intended to capture illiquidity and complexity premiums to provide diversification benefits through private markets exposure, and to position portfolios to benefit from manager skill.
Laird Norton Wealth Management: The broad category of alternatives (i.e., hedge funds and private capital) provide diversifying sources of risk and return. Real assets, while also considered a diversifying exposure, provide cash-flow generation and inflation-hedging characteristics to portfolios.
Mercer Advisors: Alternatives and real assets play two important roles in our client portfolios. First, they provide an illiquidity premium, an important extra source of return in a world of crowded markets and high valuations. Second, they provide important additional diversification benefits to portfolios whose holdings experience episodic high correlation, and are all too often dominated by public equity risk.
Osaic: We see the primary role of alternatives and real assets as a portfolio diversifier, where an investor can gain access to assets that are less correlated to the general market. This enables investors to build a portfolio to potentially have a more favorable return/risk profile by offering the opportunity to dampen portfolio volatility while holding assets that are less correlated to traditional equities or fixed income.
Savant Wealth Management: Alternatives play a material role in adding diversification to our portfolios to improve the overall risk-adjusted returns and increase resiliency across a wider spectrum of possible macroeconomic and market environments.
What alternatives and real assets has your firm been recommending to its clients?
Savant: Managed futures, event-driven investing, catastrophe reinsurance, direct lending and niche lending.
BBR: We have always considered alternatives and real assets as core parts of client portfolios, and they are offered to clients in two main forms of alternatives: (1) liquid strategies focused on public securities, and (2) illiquid strategies such as private equity, private real estate, real assets and longer duration private credit.
Colony: Recent recommendations have included stressed and distressed credit strategies, more esoteric strategies — such as music royalties, insurance-linked securities, sports private equity, carbon credits, etc. — value-add real estate, and tech and tech-enabled growth equity. We are also currently looking at select value-add and opportunistic infrastructure equity and debt strategies.
Laird Norton: We recommend a broad range of hedge funds, private capital, as well as public and private real assets investments to clients.
Mercer: We recommend a range of private asset solutions to clients, including venture capital, private equity, private credit, infrastructure and real estate.
Osaic: We offer a comprehensive set of alternative investments to our financial professionals for their clients. We have a wide selection of liquid alternative investments, including traded REITs and alternative mutual funds and ETFs with various strategies, such as managed futures, long/short equity and market neutral. We also offer a select menu of illiquid and semi-liquid alternative investments, depending on client suitability.
Which specific real asset subsectors have you been using?
Osaic: On the liquid side within mutual funds, ETFs and other products, we offer a comprehensive set of products that include subsectors such as real estate, agriculture, timber, infrastructure, energy, commodities and others. For illiquid alternatives, we offer real estate, credit, private equity, hedge funds and other strategies in the form of registered funds and private placements.
Savant: Real estate, infrastructure, farmland and timberland.
BBR: We consider a wide variety of real assets for client portfolios, including more traditional subsectors such as private real estate, agriculture, commodities and material mining/extraction. We will also invest in more esoteric real assets such as spectrum broadband and environmental assets such as carbon allowances. At the end of the day, our emphasis is on subsectors and strategies where you can earn appropriate illiquidity premiums, and where the risk and return characteristics of the strategies are appropriate.
Colony: We generally take a diversified approach to the asset class because various segments can perform differently throughout an inflation cycle. Generally, we include real estate, timberland, farmland and infrastructure — including transport and logistics, energy, renewables, water, and communications as part of our opportunity set.
Laird Norton: Private real estate, transportation and industrial assets, infrastructure, commodities, sustainable/renewable energy, and carbon credits.
Mercer: Infrastructure (renewal energy generation and transmission), and real estate (opportunity zones, timber and farmland).
What liquid alternatives and real assets are commonly used for your clients?
Mercer: We’ve begun making greater use of interval funds that invest in private credit, real assets and real estate. We like the transparency, increased investor protections and limited liquidity that come with such vehicles.
Osaic: The most widely used are inflation-protected securities and real estate investments.
Savant: Our global real estate allocation comes in the form of publicly traded REITs, where we use low-cost mutual funds and ETFs to obtain broad-based exposure. We also use daily-liquid vehicles for alternative strategies such as managed futures and event-driven investing, which allow us to deliver uncorrelated return streams without the hassles of private fund structures.
Colony: We utilize liquid alternatives focused on real estate, private credit, insurance-linked securities and real assets, including a diversified real asset strategy (commodities, natural resources and infrastructure).
Laird Norton: We do not recommend liquid alternatives at this time. Liquid exposures to real assets include traditional infrastructure equities, natural resource-related equities, sustainable/renewable energy and commodities.
What illiquid alternatives and real assets are commonly used for your client portfolios?
Laird Norton: We recommend a broad range of private capital and private real assets to clients.
Mercer: We utilize a broad array of private asset solutions for clients, but opportunity zone funds are probably the most popular and in-demand funds at the moment, followed closely by private credit vehicles.
Osaic: Real estate strategies, including 1031s and nontraded REITs, are the most widely used, but we also see significant use of credit strategies, including interval funds and BDCs. Evergreen private equity and private credit funds are growing in demand, while traditional hedge funds in the form of private placements round out our offerings.
Savant: Less-liquid asset classes such as middle-market direct lending, niche lending, reinsurance, and private market exposure to infrastructure, farmland and timberland are achieved using closed-end interval funds.
BBR: On the more illiquid side, we are big users of private real estate strategies. We tend to prefer vertically integrated specialists in real estate subsectors that have some sort of inefficiency or barriers to entry, (think affordable housing or luxury hospitality). Given that these investments fit in the “higher return” portion of our clients’ portfolios, we tend not to focus on core strategies, but rather value-add or opportunistic real estate strategies where our managers can take full advantage of their vertical integration and capture greater potential upside. In broader real assets, we are looking for investments that have attractive supply/demand dynamics (good examples are carbon offsets and wireless spectrum) and tend to prefer pre-institutional assets, again given that we are generally looking for higher returns.
Colony: We recommend a wide range of illiquid investment opportunities, including venture capital, private equity, private debt, hedge funds, real estate, timberland, farmland and infrastructure.
What separate accounts, club deals, etc., do you provide to your firm’s individual high-net-worth clients and families?
BBR: The vast majority of our real asset investments will be through commingled fund structures. However, we actively source co-investment opportunities with our high-conviction general partners as a way to increase our exposure with them, frequently at lower fees than in fund structures. One interesting area of focus for us on the direct deal front in the past few years has been opportunity zone investments. They are part of a unique federal program that enables investors to invest in economically distressed communities with some really attractive tax benefits, and we think the best way to access these investments is directly in real estate deals.
Laird Norton: For public equities and core fixed income, we can and do use separately managed accounts when appropriate. On occasion, we have established feeder access vehicles for our clients to aggregate client investments.
Mercer: We make extensive uses of unified managed account-compatible separate account solutions across virtually all major asset classes. We currently utilize approximately 100 different separately managed account solutions, virtually all of them unified managed account-compatible and customizable via a range of tax and ESG overlays.
What alternatives and real assets are you especially optimistic about over the next two to five years?
Colony: We are looking closely at the private debt markets to capture higher base rates and take advantage of opportunities arising from a tighter lending environment. We are also preparing to capitalize on any potential stress or distress resulting from higher rates, should growth slow more dramatically over the coming quarters. This has led us to look at opportunistic, stressed and distressed credit, real estate equity, and infrastructure debt and equity strategies.
Laird Norton: We leave the forecasting to others. Instead, we stick with our well-tested and disciplined investment approach based on being vigilant in monitoring and researching the broad range of capital market opportunities and risks that can present themselves over our clients’ long-time horizons.
Mercer: We think renewable energy generation, transmission and storage continue to show exceptional promise for investors. Growing assets under management that are subject to ESG mandates, new ESG reporting requirements, and recent scientific and technological breakthroughs all suggest renewable energy should do well in the years ahead. We also like private credit and real assets (specifically, timber and renewal energy generation, storage and transmission). Private credit is interesting given the heavy regulatory burden on banks, which is forcing them to retreat broadly from traditional lending activities. That void is being filled by private credit.
Osaic: With the preface that this is strictly on an informational basis and not investment advice or a recommendation, we believe macro and market uncertainty will be top of mind during 2024 with inflation, interest rates and economic growth as major points of concern. As such, the diversification benefits of alternative investments will become more prominent as investors seek higher returns and new sources of income. We have seen significant changes in the U.S. banking industry as it has reduced lending to certain segments of our economy. This presents a unique opportunity for private lenders who offer a variety of alternative investment strategies and funds. The increasing differentials in valuation and relative performance globally bodes well for macro strategies that may provide downside protection. Real assets tend to be good hedges against inflation pressures and can provide current income while filling a variety of other needs in client portfolios. We have also noticed a shift in recent years to having more offerings from managers that typically focused on the institutional space. This is creating more opportunity as it provides more investment choice for financial professionals and downward pressure on fees for investors.
BBR: Real estate is undergoing potentially generational change as it relates to the ways in which we work, live and play. As an asset class, real estate is being impacted by several dynamic factors, including interest rates, financing markets and government regulations, all on top of recovering from a global pandemic. Today we are particularly excited about the opportunity set unfolding in commercial real estate. Thematically, we’ve positioned exposure around credit/distressed commercial real estate, acquisitions of high-quality, cash-flowing assets at historically attractive entry points, and opportunistic investments stemming from trends in deglobalization.
What are your concentration limits for alternatives?
Colony: We generally recommend that real assets comprise up to 10 percent of portfolios, uncorrelated alternatives comprise up to 10 percent, and private equity/private credit assets comprise up to 20 percent. Typically, we size positions so that single managers do not represent more than 5 percent of a client’s overall portfolio.
Mercer: As a starting point, we limit portfolios to no more than a 20 percent allocation to private assets and no more than 5 percent to any private fund. However, we often make exceptions for certain situations; for example, when clients need to tax shelter capital gains in an opportunity zone fund or need to diversify concentrated positions in public equities via an exchange fund.
Osaic: For illiquid alternative investments, the concentration limits are dependent upon the risk tolerance, net worth and age of the client, and range from 5 percent to no more than 30 percent of investable assets.
Savant: Typically, between 10 percent and 20 percent.
Do you expect alternatives and real assets to hold bigger positions in client portfolios in the years to come?
Mercer: Probably. More and more investors meet the SEC’s qualification requirements; technology providers are making alternatives more accessible for RIAs and individual investors; and asset managers are increasingly finding creative ways to access private assets through liquid, publicly traded products (e.g., interval funds). Critical to improving adoption by RIAs and consumers is better reporting for alternatives, including not just IRRs but also on unfunded commitments, especially as the profession moves toward higher quality balance sheet reporting.
Laird Norton: We have a long history of recommending allocations to hedge funds, private capital and real assets aligned, as appropriate, with a client’s objectives as well as ability, need and desire to incorporate semi-liquid and illiquid exposures. Generally, we anticipate real assets will continue to be a cornerstone of client portfolios in the future.
Osaic: We would anticipate that alternative investments will continue to grow relative to other investment types as investors continue to learn more about alternatives as they search for assets that are less correlated to publicly traded common equities and fixed-income securities.
Savant: We have a high degree of conviction that portfolios emphasizing alternatives will have greater odds of achieving investor objectives in the years ahead.
Colony: We expect more client portfolios to include private alternatives and real assets in the coming years. Allocations to these investments will remain strategic rather than dynamic, based on our client return objectives, risk tolerances and liquidity constraints.