ADISA Video: How to Allocate to Alternative Investments

Ever wonder how to properly construct an investment portfolio to include alternative investments?

“Just about everybody seems to be throwing out the old 60/40 portfolio allocation theory and are scrambling to learn about alts and how you can allocate them properly in clients’ portfolios,” said Damon Elder, publisher of The DI Wire.

As part of ADISA’s Focus on Alternatives video series, Greg Mausz – chief operating officer and senior managing director of Skyway Capital Markets – shared best practices with Elder on allocating to alternative investments.

After working with thousands of financial advisers applying alts over the years, Mausz said the benefits are numerous: portfolio diversification, reduced portfolio volatility, tax planning, capital preservation and inflation benefits, and income.

“People, especially retirees, are looking for income and looking for yield, and coming outside of bonds for alts for yield is a great play. There’s also total return options and growth so if you don’t need income, you can go for growth or a blend of the two,” said Mausz.

When considering initial steps advisers and firms should be taking when considering alternative investments and evaluating products, Mausz said it’s important to be clear on the manager’s principles and operations and know their track record. The next thing is understanding the offering:

• What are the features of the offering?
• What are the benefits of the offering?
• Is this the right time in the market cycle for this type of offering?
• How is it taxed?
• What are the liquidity options that you have?
• What’s the timeframe?

The pair discussed fiduciary matters and suitability perspectives.

“You really need to be looking at that investor holistically. What is their investment objective and their time horizon? What are their liquidity needs? Because a lot of these investments are illiquid. What other investments do they have? What’s their overall risk tolerance? What’s their age? … [It’s crucial to] really know the product, really know the investor, and then you can make that right match,” added Mausz.

Video Transcript

Damon Elder 00:10

Welcome to another edition of Focus on Alternatives, hosted by ADISA, the Alternative and Direct Investment Securities Association. I’m Damon Elder, publisher of theDIWire.com, and I’m joined today by Greg Mausz, senior managing director with Skyway Markets. Thanks for joining us, Greg.

Greg Mausz 00:25

Good to be here.

Damon Elder 00:26
So today we’re going to talk about Alts, how the portfolio allocation construction theories have changed in recent years. Alts are clearly that a hot topic in the investing world, just about everybody seems to be throwing out the old 60/40 portfolio allocation theory and are scrambling to learn about alts and how you can allocate them properly into their client’s portfolios. You’ve been in the industry for 20 years, you must have learned a lot in that time, the hard way, the easy way. Let’s start with the basics. What are the basic potential benefits that alternatives and portfolio can bring?

Greg Mausz 00:59

Yeah, and this is really kind of lessons learned. I’ve had the opportunity to work with thousands of financial advisors over the years in applying Alts. So, some of the benefits, first off, you got portfolio diversification. It’s outside of the 60/40 model outside of the traded markets. Okay, then by having this kind of non-correlation, it reduces the volatility of the portfolio. You know, the other potential benefit is income. You know, people, especially retirees, are looking for income and, and looking for yield and coming outside of bonds for Alts, for yield is a great play. There’s also total return options and growth. So if you don’t need income, you can go for growth or a blend of the two. There’s capital preservation benefits, there’s inflation benefits. A lot of these Alts strategies are hard assets, and those are great during inflationary times. And lastly, tax benefits. So, kind of across the board there’s something that can help all investors.

Damon Elder 01:59
So when you’re considering allocating to Alts, you know, how does investor psychology, behavioral finance, how does that kind of factor into the process?

Greg Mausz 02:07

You know, DALBAR has been doing research around investor behavior and returns for over 20 years, and what they’ve found is that investors responding emotionally to markets buying at the highs and selling at the lows, erode their returns according to the indexes, right? When you apply Alts and it lowers that volatility, it allows investors to not be so nervous and to stay with the course or with the plan that they’ve put out there so that it creates a, a better dynamic between the client and the financial advisor and then controlling those emotions.

Damon Elder 02:47
So again, factoring in the transition, we’re seeing into Alts, you know, heavily by a lot of folks. What are some of the most important initial steps advisors and firms should be taking when they’re considering entering Alts and evaluating products?

Greg Mausz 03:02

Yeah, so there’s really two components to this. First, you have to know the alternative investment, and then you really got to know the client. So when it comes to the alternative investment, it starts with the manager, you know, who is that manager? Who are the principles, what’s their track record? How do they operate? That’s what you really need to dig into and understand that manager. And then the next thing is that the offering, is this the right time in the market cycle for this type of offering? And if it is, great. So, what are the features of the offering, the benefits of the offering, how is it taxed? What are the liquidity options that you have? What’s the timeframe? So, you must kind of dig into all of that and fully understand the offering and the sponsor.

Damon Elder 03:46
So obviously suitability standards come into play, fiduciary matters come into play. What kind of points should people be considering from the fiduciary and suitability kind of perspective?

Greg Mausz 03:57

Yeah, so one’s more BD focused. One’s more RIA focused, but really they, they overlap quite a bit. You know, you really need to be looking at that investor holistically, okay, what is their investment objective and their time horizon? Of course. But what are their liquidity needs? Because a lot of these investments are illiquid. What other investments do they have? What’s their overall risk tolerance? What’s their age? What’s their kind of tax status and tax issues that need to be taken into account? So again, really know the product, really know the investor, and then you can make that right match.

Damon Elder 04:30
So, we’re talking about this, this big movement into the Alts space, but really alts have been around a long time. A lot of top advisors have been employing them successfully for years with their clients. What are some of those strategies and tactics that those advisors who employ Alts, you know, are utilizing?

Greg Mausz 04:45

There’s quite a few of them. And you’re right, institutions have been using Alts for decades, endowments have been using Alts for decades. So, it’s a proven model that works. So, here’s a few, you know, advisors should start small, make small allocations with investors that have never invested before in Alts, and start soon because there’s so many different benefits. There’s often some benefit for a lot of different types of investors. And again, some Alts are for accredited investors only and some are generally suitable. So again, that advisor can match that up. Another lesson I’ve seen out there in a best practice is laddering liquidity. You know, some Alts like NAV REITs or interval funds kind of have continuous liquidity. Others have a three-five year time horizon, others have a five-ten year time horizon, before that strategy may liquidate. So, I think it’s important that if you’re making an investment decision, you’d ladder out that liquidity. Life is unpredictable and you never know when investors may need some funds.

Another thing is making small bets. You know, there’s lots of different real estate strategies, and energy strategies, and sponsors, so you know, we don’t know what tomorrow holds. So make lots of little small bets with different sponsors, different strategies, some income, some growth, and then no matter what happens, you’re diversified. And again, that’s going to lower that volatility. Another one, you know, I say making lots of small bets, but the advisor’s got to have some type of custody and reporting methodology so that it’s easy for all everybody, the advisor, and the investor to track the investments and to report on them and so that there’s that consolidated view of how the whole portfolio is doing. Now, I know I just said make lots of small bets, but sometimes that’s not always practical. So, if you’re going to make a bigger allocation towards an alternative strategy, go with a bigger sponsor, maybe that has a public program that has a really good track record. Don’t try the little niche Alts when you’re trying to make a bigger allocation.

And then lastly, a kind of a thing to really watch out for is seniors, you know, that adds a layer of complexity. Life is more uncertain, you’re potentially dealing with heirs, so you may want to be very conservative as you’re applying alternative investments. That said, you know, using 1031 exchanges and deferring until somebody dies can be a real wealth creation. So, it’s not a cut and dry rule that Alts shouldn’t be avoided for seniors.

Damon Elder 07:43
Well, I mean, I think that’s a perfect segue into talking about, you know, a real important aspect of Alts tax strategies. I mean, Alts can be ideal for tax planning. What do we see there? What are kind of the best practices?

Greg Mausz 07:55

So, I just mentioned 1031’s, so where you’re able to swap property again and again and again and defer those taxes. Another one is the qualified opportunity zones, where you’re able to take gain from any source and put it into a qualified opportunity zone and leave that in there for 10 years. I’ve seen advisors taking passive income and offsetting it with passive losses and be able to create tax-free strategies there. And then another big one is oil and gas, where it has intangible drilling costs that can offset AGI. So again, Alts can be very powerful when you’re dealing with investors and looking at not how much money you make, but also how much money you keep.

Damon Elder 08:38
I was just going to say, it’s great to invest and to get a yield, but you better keep as much of that as you can, or it’s all for not.

Greg Mausz 08:44

Right.

Damon Elder 08:45

So, I mean, clearly the landscape has changed and is changing continually in Alts favors, and we’re seeing a big infusion of retail investors coming into the space as well, which is great. So, thanks again, Greg, I really appreciate your insights. And thanks to you for tuning in for another episode of Focus on Alternatives, brought to you by ADISA. For all things Alts, visit adisa.org and for your Daily News regarding alternatives, go to theDIWire.com. Thanks so much.

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