Alts are everywhere, and advisors must understand them

Because privately assets have grown so much in scale, and because some of the negative correlation between stocks and bonds appears to be shifting into a more positive relationship, Johnston believes that investors now need these private assets to achieve adequate diversification. He argues that the common wisdom of a 60/40 equity bond portfolio is reverting back to performance from the early 20th century, when higher resting inflation resulted in positive correlation between stocks and bonds. He also highlights concentration risk on public equity markets, namely in the Untied States where growth-oriented tech names now dominate the major market indices, presenting alts as a diversifier away from that risk.

For all the appeal that investors may now see in the broad alts category Johnston highlights perhaps the most important aspect of alts that he wants all investors to understand: managers matter. Where public markets tend to be more efficient and see minimal outperformance by specific managers over significant time horizons, private markets are far more differentiated. Managers can outperform by up to 20 per cent over the long-term, he says, which makes assessing an alts manager a crucial stage of any investment in this space.

That work is all the more crucial as access to alternative strategies gets easier to obtain. Johnston notes that retail investors and advisors might have normally used closed end funds to gain access to alternative asset classes. Now, however, there is a growing shelf of evergreen funds that may offer greater utility for these investors. As more of these fund models emerge, he stresses the importance of assessing the right evergreen fund based on the quality of its management.

For advisors, learning how to assess alts managers begins with availing themselves of the educational opportunities out there. Johnston highlights iCapital’s own educational efforts, including a dedicated research team publishing on the subject of alts. They’ll offer insights into broad market trends and specific funds that advisors can make use of. Johnston emphasizes the importance of that education because he sees risks for investors and advisors who see the importance of alts but fail to fully grasp the risks in this market.

Beyond the assessment of management quality, Johnston stresses the inherent illiquidity in alternatives. That’s a feature of the space, he explains, and the illiquidity of private assets results in a premium to their price. Still, investors who may assume greater liquidity in these assets than there is could be at some risk. He suggests looking at the underlying construction of an alts fund to assess what tools it uses to maintain required liquidity levels and whether those tools could result in a mismatch with the underlying strategy in the fund. Transparency, he says, is key to assessing these funds and while the broad alternatives category tends to be less transparent than public securities, Johnston says that some of the better managers will offer a great deal of transparency into their funds.