Retail investors warned on piling into risky alternative products

Retail investors must be wary as a wave of alternative investment products comes to market because many carry high fees, lack diversification and offer poor quality investments, asset managers have warned.

Big institutional investors have racked up enviable returns in recent years with investments in alternatives, the catch all term for investments that are not publicly traded, such as private equity, private credit and real estate.

But the asset class had been largely out of reach of individuals because it requires large minimum investments and long lock up periods.

Now, as the industry seeks new sources of growth, a surge of retail-focused alternative investments are set to come to market in the next 12 months. Asset managers cautioned that these new products may not be as high quality — or affordable — as what is available to institutions.

“The products for retail are lacking . . . We haven’t democratised access at a price point that makes sense,” Michelle Seitz, chief executive of Russell Investments, told the FT’s Future of Asset Management North America conference in New York last week.

Retail investors may also be less clear about the additional risks they are taking on in terms of volatility and inability to access their cash, she said. “The benefit of a big institution is you have a CIO who is crystal clear about what their liability is. We haven’t provided all those tools . . . to the end individual,” she said.

Retail investors are vital to the sector’s growth because many institutional clients are already heavily invested in alternative products and some are seeking to reduce their exposure. Many institutions already have around 30-50 per cent of portfolios in alts, partly owing to years of strong returns and partly because of recent falls in public market valuations.

The average retail investor has just 2 per cent of their portfolio in alternatives, according to a McKinsey study that projects the figure could rise to 5 per cent in the next three years, The consultancy estimates could bring $500bn and $1.3tn in new capital to alternatives.

Retail investors will be entering the market at a time when the recent bear market in public equity and bonds will probably push down the value of at least some alternative investments.

That means diversification will be important to providing reliable returns. But retail investors are not being offered the same options as endowments and pension funds that have billions of dollar to invest. Many will end up choosing individual funds on trading platforms or investing with single providers owing to the sector’s high fees.

“Most institutional investors will have a portfolio of 20-40 managers in a diversified portfolio. Retail investors may just invest in one manager — that means taking on a lot of risk,” said George Walker, chief executive of $460bn US asset manager Neuberger Berman.

High concentration risk means some investors might win, while others will suffer outsized losses, he said. “If you took any institution and saw that their private equity allocation was all in one fund, you’d be shocked.”

“The growth we have seen in the democratisation of private markets has all happened in the last ten years, which was a benign market,” said Rohit Vohra, head of global wealth alternatives for Principal Financial Group. “There is a moment of truth coming in the next few months. We will see if they really understood what they bought.”

Done right, alternatives products will give retail investors more options, asset managers said, at a time when more companies are opting to stay private for longer. They also may offer more stable long-term returns as volatile markets make the traditional 60/40 mix of equities and fixed income insufficient for investors hoping to retire.

“We’re seeing progress, you’re seeing an increasing number of [retail alternatives] . . . but they’re still not as liquid, available and inexpensive as they need to be,” said David Hunt, chief executive of PGIM.

There is optimism that as alternatives go mainstream, product quality will improve. “What has changed is the calibre of the managers who have entered this space,” said David Levi, a managing partner of Brookfield Oaktree Wealth Solutions.

Still, “You may see firms that haven’t been building private equity portfolios for long, building compelling mousetraps to lure retail investors,” Walker said. “The more [these] programmes look like the institutional programmes and aren’t just the scraps, the better.”