Alternative assets have become an increasingly important component of model portfolios, offering investors unique opportunities to invest in private market assets that are typically available only to large institutions. While the asset class is broad, alternatives are typically illiquid investments such private equity and private credit, along with real estate, commodities, and managed futures. Both alternative assets and model portfolios have seen a significant rise in popularity in recent years. Private debt assets under management grew by more than 460% from 2010 to 2022, reaching $1.4 trillion.1 The global alternative investments market is projected to reach $24.5 trillion by 2028, up from approximately $16.3 trillion at the end of 2020, according to figures from RBC Wealth Management.2 This rising interest in alternatives may be driven by the prospect of generating yields that exceed those of publicly traded stocks and bonds, their historically low correlation with public market price volatility, and their increasing availability to investors through vehicles such as model portfolios.
Alternative Assets in Model Portfolios
The breadth of alternative assets allows investors to use them to pursue a variety of their financial goals such as risk mitigation or return enhancement. Conservative portfolios may leverage alternatives to manage volatility (by attempting to reduce equity correlation via managed futures), while aggressive portfolios might use them to seek higher returns compared with publicly traded assets.
A key challenge – and benefit – with alternative investments is their inherently low correlation with traditional asset classes such as public equities and fixed income. While this diversification can be valuable, it must be carefully balanced to avoid inadvertently sacrificing long-term return potential. Properly funding alternative allocations is critical to ensuring they complement, rather than detract from, overall portfolio performance.
"Integrating alternative assets into portfolios offers several key benefits: the potential for higher returns due to illiquidity premiums, enhanced diversification through lower correlations, strong performance during market downturns, and access to non-correlated income streams.” says Patrick Jamin, Head of Platform Channels at Kovitz Investment Group Partners, a Focus Partners Firm. While the use of the asset class now includes various vehicles for liquidity, Jamin cautions that alternatives should be applied only when they make sense "While alternative investments were historically limited to LP structures, investors now have access to more liquid vehicles such as nontraditional ETFs and innovative structures like interval 40 Act funds. Still, careful attention to liquidity constraints and thorough due diligence remain essential to ensure suitability.” say Jamin.
For example, market-neutral liquid alternative strategies may offer appealing return opportunities while maintaining low correlation with traditional assets. However, they should be funded strategically to maintain portfolio balance. Managed futures and CTA strategies for instance, are often funded from fixed income – sometimes even more than 100% – with the remaining allocation offset by an overweight position in equities.
This approach ensures that diversification benefits are captured without compromising the portfolio’s risk-return profile.
Demand among advisors for model customization and alternative assets is on the rise, says Karl Desmond, client portfolio manager at Invesco. “Some of the new, unique requests we’re getting are related to how financial advisors may position custom model portfolios for their high-net-worth clients. For example, these advisors are asking about how we might include exposure to individual stocks and/or bonds via separately managed accounts (SMAs), as well as less liquid alternative asset classes, into their broader model portfolios.”
Recent research confirms the demand for alternative assets in model portfolios among advisors and their clients. In a 2024 study from BlackRock and Institutional Investor’s custom research group, a solid majority of the 500 wealth managers in the study say they’d like to have private equity or private credit available to clients through model portfolios (see figure below).3 In the same study, a majority of the 250 wealth management clients participating say they are “eager to invest in sophisticated financial assets such as private market assets, hedge funds, private equity, etc. which are typically available only through investment professionals.”
Advisors seek private market alternatives delivered via model portfolios
“Alternative assets are a common topic when we develop custom model portfolios with our clients”, says Karl Desmond of Invesco. “The benefits of model portfolios are fairly well known: it’s all about saving time in your day as a financial advisor, and deploying that time with existing clients and building your business. Custom model portfolios are beneficial because advisors can co-create the portfolios with a firm like Invesco, versus taking portfolios off-the-shelf, which a lot of the time have no exposure to alternative asset classes.” Thoughtful customization – that is, when an advisor combines and tailors various models and other instruments to meet client needs – is a compelling use case for alternative assets. Advisors are likely to “have preferences for some investment vehicles, such as ETFs or mutual funds. They may have views on the use of alternative assets like private equity or private credit too,” says Desmond. Accordingly, by customizing model portfolios, advisors are able to bring in their viewpoints on these asset classes, and combine it with our institutional asset allocation process.”
1https://alterdomus.com/insight/alternative-asset-annual-review-how-markets-performed-in-2023/?utm_source=chatgpt.com
3“Model Portfolios: A New Generation of Investment Solutions for Wealth Managers and Their Clients,” published by Institutional Investor Custom Research Lab, 2024.
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Investing in digital assets involves significant risks due to their extreme price volatility and the potential for loss, theft, or compromise of private keys. The value of the investment is closely tied to acceptance, industry developments, and governance changes, making them susceptible to market sentiment. A disruption of the internet or a digital asset network would affect the ability to transfer digital assets, and, consequently, would impact their value.
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Alternative investments present the opportunity for significant losses and some alternative investments have experienced periods of extreme volatility. Alternative investments may be less liquid than investments in traditional securities.
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