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How to Succeed in Practice With Alternative Investments

Savant Wealth Management CIO Phil Huber dives into the challenges advisors face when working with alternative investments and how that drove him to write his new book.

Phil Huber joins Morningstar's The Long View podcast, to discuss his new book, "The Allocator's Edge: A Modern Guide to Alternative Investments and the Future of Diversification."

Here are a few excerpts from Huber's conversation with Morningstar's Christine Benz and Jeff Ptak:

What Are Investors Asking About Alternatives?

Benz: You've said that one of the reasons you wrote the book is because you do get a lot of questions from clients about alternatives. What do they tend to ask? Is it mainly performance-related, like, why are you recommending this asset even though its track record doesn't look that great? Or are the questions about things that they own or that they don't own but maybe wish they did? What do the questions tend to be about?

Huber: Some of it's just very basic, like, "Tell me more about what this is; I don't understand what's going on underneath the hood." And so, it's incumbent on us as the advisor, particularly in my role and my team's role, to help advisors tell the story without getting too far in the weeds, without getting into investment jargon when they're trying to translate an inherently more complex asset class to an end client that might not have the sophistication level to understand that at a very deep level. We want to make it understandable, so they can get a sense for why should I expect this strategy to make money over time, why am I paying a premium for it, what role does it play relative to the other assets of my portfolio?

And I think the other element just has to do with the questions that come up is always going to be a bit of a function of the market environment you're in. When you've got a backdrop of a pretty steady bull market for stocks, anything that's detracting from performance, whether it'd be bonds, or different types of other diversifiers, you're just going to have a closer lens pointed at them. Our mutual friend Brian Portnoy has coined the saying of, “Diversification always means having to say you're sorry.” And so, the more line items you have in a portfolio, the more likely it is there might be something you had to say sorry about.

Part of it is getting advisors comfortable communicating about the portfolio as a whole as opposed to the individual components. Because we know that not every asset plays the same role, similar to a sports team. If you look at a basketball team, and you look at the newspaper the next morning after a game, you could look at the points for a certain player. And if they had no points, you might assume they had a bad game. Then if you look a few columns over, and they had 10 rebounds and 5 steals, that's a pretty valuable contribution to that team. And it's just a different role at a different position he might play at. I think the same goes for alternatives. If your expectation is that something like managed futures, for example, is going to outperform your stocks, you're likely going to be disappointed because that's not what it's in the portfolio to do. So, I think a lot of the questions that we get are just, again, clients just want to understand more of these things that are a little bit more novel to them that they've not had experience owning in the past. And it's our job to get them a little bit more comfortable with the uncomfortable.

Behavioral Aspects of Alternatives

Ptak: What about the behavioral aspects of alternatives? Do you find that incorporating alts into a client's allocation makes things easier from a client-behavior standpoint? Are they more manageable per se? It seems like it could go either way. But has your experience led you to conclude that maybe clients are likelier to stick with the plan than otherwise?

Huber: I think it does cut both ways. I think for some clients the additional line items, the additional tracking relative to common indexes or benchmarks, makes it a little bit more challenging to hold for a certain audience. That being said, I think for the clients that have really strong views on where they think the stock market is headed, or they don't want to own any more bonds because rates are so low, there's more of an openness there to other types of asset classes--especially if we've got clients that maybe come into a lump sum that they're looking to allocate but are hesitant to, because they're afraid of putting it into stocks at all-time highs, or they don't want to put it in bonds and earn basically nothing in yield. And so, I think having a dedicated allocation to other types of investments gets them a little bit more comfortable putting that money to work as opposed to sitting on the sidelines and cash, where we know that the real returns are going to be negative.

So, I think both cases come to the surface, but probably more so the former in terms of it being more of a behavioral impediment. But that's the challenge that advisors face. That's a large part of why I wrote the book is to help advisors try to address those challenges.

This article was adapted from an interview that aired on Morningstar's The Long View podcast. Listen to the full episode.

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