How alternative investments are redefining portfolio construction

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The 60/40 portfolio doesn’t quite cut it anymore. A standard allocation for portfolio management of 60 per cent equities and 40 per cent bonds revealed its warts in 2022. In fact, Morningstar Canada noted that every Canadian balanced index it tracks decreased in value for the first time since 2007.
That experience has reinforced the importance of alternative investments, which have long been the purview of institutional investors. Now, advisors and retail investors are using alternatives more widely to diversify portfolios further and deliver stronger performance. These include private debt and equity, commodities, infrastructure and real estate.
Alternatives are providing clients with an element of portfolio construction that pension funds have used for decades, says Adam Elliott, president of iA Private Wealth Inc., one Canada’s largest independent brokerages.
Advisors who want to turn to alternative investments – beyond the traditional offerings of mutual funds, exchange-traded funds (ETFs), investment-grade bonds and blue-chip stocks – are often finding them at independent brokerages and wealth management firms. For those firms, the availability of alternatives offers an edge, helping to attract top advisors and high-net-worth (HNW) clients from Canada’s largest wealth managers.
“Providing access for clients and advisors to a wide selection of private investments, with a relatively flexible approval process, is critical to being competitive,” Mr. Elliott says. “It’s no question the private space helps advisors differentiate their offerings. When advisors are looking to leave their current firm and choose a new dealer, we get specific questions about whether private investments are approved on our shelf.”
Investment in alternatives has soared, with assets under management (AUM) growing to about US$11-trillion globally as of March 2022 from about US$2-trillion in 2011, a report by Preqin shows. That growth is set to continue as AUM in alternatives is forecasted to double and exceed $23-trillion by 2026, a S&P Market Intelligence report notes.
Canada’s ultra-HNW investors have been early adopters of alternatives. Northwood Family Office in Toronto began offering clients access to alternative investments more than 15 years ago, says Eric Weir, its executive vice-president. “One of the main reasons alts have been a good fit is our clients don’t need short-term liquidity.”
Jay Bhutani, president and chief operating officer of Raintree Wealth Management in Toronto, says the firm is seeing more fee-only financial planners recommending alternatives to their HNW clients.
“They’re coming to us to access institutional alternative managers they wouldn’t be able to get off the retail street,” he says.
Even asset managers focused on long-only equity portfolio strategies now hear more frequent inquiries from their HNW clients about alternatives.
“The trick is helping them understand their total asset mix because they don’t always fully understand what they own,” says Emily Won, partner at Longview Asset Management Ltd. in Toronto.
Longview connects interested clients with alternative asset managers that align with its focus on long-term investing, transparency and strong communication with investors.
For some advisors, one appeal of working at independent investment dealers, portfolio managers, investment counsellors or family offices is the ability to offer direct access to alternatives.
“I could not offer my current lineup of alternative solutions at the big banks,” says Rob Tetrault, senior portfolio manager with Canaccord Genuity Wealth Management Canada in Winnipeg.
He notes that alternatives – ranging from music royalties to farmland funds – have served as a hedge for clients amid the current economic backdrop.
“There’s nothing I can do about inflation and interest rates. What I can do is find the absolute best investments on a comparative basis, so my clients are the furthest ahead possible,” Mr. Tetrault says.
Alternatives do just that, offering steadier real returns amid volatility, he adds.
Mr. Tetrault says alternatives reduced his downside exposure dramatically in 2022. A recent Morningstar Inc. report found that alternative funds, on the whole, were down less than 3 per cent last year compared with the 14 and 13 per cent drops for the U.S. equity and bond benchmarks, respectively.
Yet, the alternative universe is vast, and consequently, its asset classes can entail highly diverging returns. According to IFCreview.com, commodities were the strongest performing sector in 2022, up 19 per cent globally. Gold, private debt and infrastructure saw modest declines, while private equity and real estate saw declines similar to public markets.
Still, for some advisors, the rough year for private equity (notably venture capital) and commercial real estate offers future opportunities.
“There are some alternatives where the valuation has come down, which can present phenomenal entry points,” Mr. Tetrault says.
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