Alternative investments offer many ways to strengthen portfolios, expert says

Alternative investments essentially are “less constrained active management” that expands opportunities to drive performance, Scott Welch, chief investment officer and investment committee chair at Dynasty Financial Partners, said at the Schwab IMPACT 2018 conference in Washington, D.C., on Monday.

“There's nothing complicated about alternative investments,” Welch said.

Advisors should reframe conversations with clients to focus not just on what alternative investments are in a portfolio, but why those investments are there, he said.

He urged the audience to think of alpha not in the traditional sense – “excess performance due to active management” – with regard to alternative investments, but to view it as “anything that you do with your client's portfolio that they think is valuable and are willing to pay you for.”

The incorporation of alternative investments into a portfolio should start with a multi-strategy solution that places diversified alternatives at the portfolio's core, augmented by strategy-specific solutions for alpha generation, which should total about 10% to 25% of a portfolio, depending on a client's goals, Welch said.

Concerning liquid alternatives, Welch said the “jury is out” 10 years after investors sought the products amid the volatility of the financial crisis. Now, rates are up, volatility is rising and intersecurity price dispersion is increasing. That creates an “environment where these things better deliver, because this is the environment [in which] historically they have done well,” and if they don't, it might be necessary to “rethink the thesis” about liquid alts, he said.

Welch also said that funds of hedge funds “are dead,” although fellow panelist Bob Rice, founder and managing partner of Tangent Capital Partners, had a more favorable view.

Welch said funds of hedge funds can no longer justify their fees based on diminished returns, but Rice noted their fees have “decreased rapidly” and that they were originally meant as a way to improve diversification and benefit smaller institutional foundations. Welch then added that funds of hedge funds could benefit from lowering their fees and avoiding overdiversifying.