Buzz is building within the financial services industry about alternative investment products, also called direct investment products.

According to a recent WealthManagement report, a growing number of independent advisors are investigating alternatives as a means of diversifying client portfolios.

Are you familiar with this market?

If not, here’s an introduction to the world of alternative investment products, and five suggestions about how to approach them.

Tip #1: Become familiar with the basics.

To begin, alternatives are financial assets that don’t fall into standard investment categories, such as cash, stocks and bonds.

The Alternative & Direct Investment Securities Association (ADISA), the industry’s largest trade association, lists several examples of non-traded products on its website.

Among them are:

  • Real estate investment trusts (REITs)
  • Business development companies
  • Energy, oil and gas interests
  • Master limited partnerships
  • Private and public funds (LPs and LLCs)

Investopedia, meanwhile, includes venture capital, managed futures, and even art and antiques – among other assets – under the alternatives umbrella.

CNBC notes liquid alternatives in particular offer investors a way to participate in a hedge fund strategy in a retail environment, while getting away from standard equity and fixed income products, and decreasing volatility.

To meaningfully impact assets, the author of the article recommends allocating 10% to 20%.

Tip #2: Alternative investment products are unique.

Many are not regulated by the Securities and Exchange Commission (SEC), increasing the risk of scams and fraud.

Generally speaking, alternatives do not fluctuate along with the stock market.

As the Motley Fool explains, it’s possible to invest in real estate and gold via funds. Or, you can actually buy gold or real property. However, it’s a complicated process.

Another aspect of direct products to consider, is they usually have high fee structures – which can exceed 2%.

Which brings us to perhaps THE most important factor to consider…

Tip #3: Know your clients’ financial goals.

One reason advisors are increasingly attracted to alternative investments, is because they can serve as a buffer in the event of a market disruption.

Though 10 years have passed, memories of the recession of 2009 remain fresh in many people’s minds.

Forbes asserts that while there are indeed signals the current economic expansion is waning, another recession is not inevitable.

In any case, the author of the article points out, it’s good to diversify one’s portfolio from time to time.

Be sure to carefully evaluate each of your clients and their investments, as some folks will have a higher tolerance for risk than others.

Investors with more time to recoup any losses prior to or after retirement, are probably better prospects for alternatives.

Tip #4: Work with an experienced partner.

You want to select an asset management firm with a history of success in the alternative product marketplace.

It should have a solid alternatives investment platform, along with a knowledgeable and responsive team who will closely monitor accounts and adjust portfolios if needed.

Even if your platform partner has a sterling reputation and a strong track record in the industry, though, advisors should confirm the company has no economic connections with the fund managers they invest with, WealthManagement suggests.

This is because fund managers typically receive a percentage of their funds’ average assets under management.

Tip #5: Pick alternative investment products with care.

As we noted earlier, real estate investment trusts, business development companies, energy, oil and gas interests, master limited partnerships, LPs and LLCs, are all classified as alternatives.

A ThinkAdvisor article based on a report by Cerulli Associates, a firm specializing in global asset management and distribution analytics and guidance, says private investments, private equity and real estate accounted for 40% of advisors’ alternative investments in 2017.

That number is projected to grow to 42% by 2020.

Meanwhile, REITs had the highest distribution in 2017.

Though they may see a slight drop  in 2020, analysts at Cerulli expect the REIT class to maintain its No. 1 distribution status.

Do your research before anything else

To summarize, more and more independent advisors are looking into alternatives as a way to diversify their clients’ portfolios.

As with most investment types, there are pros and cons to non-traded financial assets.

So, make sure you understand what you’re getting into.

Team up with an investment firm experienced in alternatives. Check their reputation and results.

For the people who trust you with their financial matters – and for your own sake – perform your due diligence before diving in.

We wish you – and your clients – many happy returns!

To learn more about the services we provide to financial advisors, click here.