Growth in Alts Highlights Importance of Active
September 26, 2023
“We are approaching another inflection point” in the growth of alternatives, argues John Bowman, executive vice president of CAIA Association, the Chartered Alternative Investment Analyst Association. “High net worth, family offices, and even the upper end of the mass affluent” are increasingly turning to alternatives as they look for “diverse sources cash flows and risk structures and return expectations,” he added.
Bowman was speaking with Tony Davidow, senior alternatives investment strategist with the Franklin Templeton Institute, in the most recent installment of the Alternative Allocations podcast, which is produced by Franklin Templeton.
He explained the reasoning behind his optimistic growth forecast. By CAIA’s reckoning, in 2022, alternative investments totaled about $5 trillion, equal to just 6% of global investable assets. Over the past 21 years, investments in alternatives have more than quadrupled, reaching $22 trillion, and now account for approximately 15% of the investment universe.
Bowman’s remarks highlight the active nature of alternatives investments, in terms of both manager selection and alternatives portfolio investing. Given the lack of indexes, passive investing is not feasible in this sector.
The growth in alternatives has occurred through significantly increased use of alternatives by institutional investors, such as university endowments and sovereign wealth funds, noted Bowman. CAIA reported that the average endowment today invests “well over 60%” of their assets in alternatives.
But institutional investors’ share of the global investment pool pales in comparison to the 50% of investable assets held by individual investors, he added. Today, wealth managers typically invest only around 5% of their retail clients’ assets in alternatives. Even a small increase in individual investors’ exposure to alternatives would result in continued strong growth, argued Bowman.
Product innovations – in the form of interval funds and aggregated investments – are making it easier for wealth managers to recommend alternatives for their individual clients, said Bowman. Interval (or tender) funds allow investors to have access to some liquidity on a quarterly basis, even while investing in the less liquid alternatives.
Aggregators combine smaller investments to provide access to alternatives with high minimum investments, while handling the operational issues associated with these complex investments. In addition, aggregators perform due diligence on alternatives managers, which is critical because returns can vary significantly.
Of course, Bowman emphasized, investing in alternatives is “not for the faint of heart.” Alternative investments are generally opaque and can include idiosyncratic features that are quite different from those found in public markets. In addition, fees are generally higher, though return expectations can be higher as well. On the positive side, the restricted liquidity of alternatives forces investors to focus on the long term and helps them avoid emotional decision-making.
Even with these caveats, Bowman is confident that “this wave will continue,” and the alternatives sectors will grow significantly. Of the sector’s next $10 trillion, “the large majority will come from wealth managers,” he summarized.