Navigating U.S. Wealth Management: How Advisors Are Using Alternatives In Client Portfolios


Historically reserved for institutional investors and ultra-high-net-worth clients, alternatives are now becoming almost mainstream in high-net-worth and mass-affluent client portfolios. Providing access to these complex investment strategies enables financial advisors to deliver more robust investment solutions and differentiate their product offerings in the increasingly competitive marketplace for financial advice.

However, what an alternatives allocation includes and how these strategies are being used in portfolio construction differ widely within the wealth management industry. Here, Eric Mogelof, PIMCO's head of U.S. global wealth management, and Aimee Almeleh, an account manager specializing in alternatives, discuss the ongoing evolution of alternatives strategies.

Q: What exactly are alternative investments?

A: While most investors can agree on the definitions of a stock and a bond, there is little consensus on what defines an alternative investment.

Some investors go strictly by investment vehicle, with public mutual funds falling under traditional investments and limited partnerships or private equity drawdown vehicles viewed as alternatives strategies. Using this definition, however, can be limiting, as non-traditional investments can be wrapped in public mutual funds; for example, interval funds, which are increasingly popular with financial advisors, use mutual fund structures with liquidity features similar to those of some limited partnerships. Other investors distinguish between traditional and alternative investments based on whether the securities are public or private. And still others define anything outside of stocks and bonds as alternatives.

At PIMCO, we typically frame the discussion of alternatives around what types of assets are being bought and sold and how investment returns are generated. This offers flexibility in evaluating potential investment solutions. For example, an alternatives strategy may include only public market securities but employ a long/short trading or arbitrage strategy. A drawdown vehicle that takes exposure to privately negotiated and structured debt or illiquid real estate securities may also be an alternative investment. Yet another could be an interval fund that invests in both public and private market securities and uses leverage to try to optimize returns.

We think the most important features of an alternatives strategy are how it is expected to behave within a portfolio and what risks an investor is taking to achieve that outcome.

Q: Should every client consider including exposure to alternatives in an investment portfolio?

A: Before considering any investment, and especially alternatives, financial advisors will want to develop a deep understanding of a client's overall financial situation, key investment objectives, risk/return profile and near- to medium-term liquidity needs. Based on these factors, financial advisors can then determine whether a specific alternatives strategy may be appropriate for a client.

Certain alternative investments - such as hedge funds and private equity held in a limited partnership - are only available to investors who meet minimum net-worth and income requirements. Many alternatives managers also establish high investment minimums, typically upward of $5 million. These requirements have historically served as barriers for many investors, even when alternatives strategies may have been appropriate from a portfolio and risk/return perspective.

More recently, however, an increase in interval funds, tender-offer funds and nontraded REITs (real estate investment trusts), as well as the rise of new financial technology (fintech) platforms, have helped "democratize" alternative investments, making them available to a much broader universe of investors. These offerings have preserved some of the attributes we consider typical of alternatives strategies, but in structures that are governed by the 1940 Investment Company Act (which covers mutual funds, among other registered investment vehicles). In addition, many distribution firms are streamlining the alternatives subscription process and significantly reducing investment minimums to levels that are accessible for a larger range of investors.

Q: How are advisors using alternatives in portfolio construction, and what objectives are they pursuing?

A: We see three key reasons why financial advisors are utilizing alternatives in their client portfolios.

First, alternatives may offer higher return potential; we see this motivation most in ultra-high-net-worth client portfolios. This higher-return potential is often driven by investing in less liquid and/or more complex assets, along with greater concentration in high-conviction ideas. Returns may also be driven by the use of leverage to varying degrees.

Second, alternatives have potential diversification benefits. Some alternative strategies take different risk-factor exposures than traditional stocks and bonds. This may help build portfolio resiliency and mitigate drawdown risk.

Third, exposure to the esoteric asset classes in alternative investments can provide alternative betas - non-traditional investment exposures - that are not easily replicated or accessed in other ways.

Among advisors using alternatives for their clients, we see allocations typically ranging from 10% to 30% of portfolios. For ultra-high-net-worth portfolios, we have seen allocations as high as 50%.

In sizing alternatives allocations, we go back to understanding client goals and objectives. We see advisors building diversified alternative portfolios that span hedge funds, alternative risk premia, private equity, private credit and real estate strategies. We think alternatives allocations should be large enough to move the needle for an investment portfolio but also maintain diversification across strategy, liquidity and asset class exposures.

Q: What about the tax treatment of alternative investments?

A: In addition to investment considerations, advisors need to consider their clients' tax circumstances and the tax treatment of different investment strategies. Alternatives strategies vary in tax reporting and after-tax return impact to investors. Although investors and their advisors should consult a tax expert for specific guidance, we can outline some key considerations.

  • Tax filing and reporting considerations: Alternatives strategies that are structured as limited partnerships, including most hedge funds and private equity funds, will "pass through" the distributive shares of taxable income, gains, losses, deductions and credits from the partnerships and typically issue a Schedule K-1 to U.S. investors. In addition,various investors will need to make additional state tax filings, depending on the fund's investment activity and strategy.
  • Strategy considerations that impact after-tax returns: In choosing an investment strategy, investors should be aware that certain investment management fees may not be deductible by investors. In addition, certain strategies may create more or less capital gains or ordinary income, and many alternatives strategies can create a tax liability for an investor that isn't matched by a cash distribution.

Given that tax treatment overall is highly specific to the investment structure, it is important for financial advisors and clients to conduct a tax analysis before making an allocation to alternatives.

Q: What else should advisors consider when allocating to alternatives?

A: Manager selection is always relevant in portfolio construction, but when considering strategies that offer lower liquidity and/or exposure to unique investment betas, manager selection may be critical.

Financial advisors should consider an investment team's capabilities and process to determine whether returns are generated by skill or luck and whether those results are repeatable. In addition, top-notch operational and risk infrastructures are essential as alternatives strategies often incorporate derivatives and esoteric assets. Legal and compliance functions also need to be assessed given the increasingly complex legal and regulatory environment for alternatives.

Q: How is PIMCO approaching alternative solutions for wealth management clients?

A: Alternative investment strategies, when used prudently, can be an important tool in both preserving and growing client portfolios, in our view. To that end, we are focused on broadening access to alternatives by creating new products, including interval funds and tender-offer funds, for a broader universe of investors.

We have also partnered with fintech providers to offer subscriptions into alternative funds with lower minimum investments. We envision a future where alternatives are accessible to more investors and financial advisors can integrate alternative solutions into client portfolios, where appropriate, with few or no barriers to entry.


All investments contain risk and may lose value. Alternative investment strategies may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. The performance of hedge funds and other alternative investments could be volatile and a hedge fund's fees and expenses may offset its trading profits. A single adviser applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. The strategies generally involve limited liquidity provisions as well as complex tax structures and there may be delays in distributing important tax information. Equity investments may decline in value due to both real and perceived general market, economic and industry conditions, while fixed income or debt investments are subject to credit, interest rate and other risks. Investments in interval funds are subject to liquidity risk as an investor may not be able to tender all of their requested shares and there is typically no secondary market to enable investors to sell the shares at an advantageous time or price.

Private credit and private equity is considered speculative and therefore subject to a unique set of risks. Private placements may only be suitable for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. Entering into short sales includes the potential for loss of more money than the actual cost of the investment, and the risk that the third party to the short sale may fail to honor its contract terms, causing a loss to the portfolio. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Diversification does not ensure against loss. Management risk is the risk that the investment techniques and risk analyses applied by a manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available in connection with managing the strategy.

PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.| Pacific Investment Management Company LLC (650 Newport Center Drive, Newport Beach, CA 92660) is regulated by the United States Securities and Exchange Commission. | PIMCO Investments LLC("PI"), a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission, serves as the principal underwriter for the U.S. registered PIMCO Funds ("Funds") and placement agent for the PIMCO-sponsored private funds (the "Private Funds"). No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2018, PIMCO.