How to talk with clients about investing in alternatives

You may find that client interest in private markets has increased recently. Over the summer, President Trump signed an executive order titled “Democratizing Access to Alternative Assets for 401(k) Investors,” which aims to make alternative investments accessible through asset allocation plans within 401(k) plans.

Yet another factor behind client curiosity: dramatic growth in alternative assets over the past two decades. In 2000, global alternative assets were estimated at less than $1 trillion, but by 2023, they exceeded $15 trillion. Private equity and investment company KKR projects the growth will continue, to $24 trillion by 2028.

“As investor interest grows, investment vehicles that give investors access to private markets have evolved significantly in recent years,” says Siobhan Broadbery, a public-private solutions specialist at Capital Group. “We’re seeing more vehicles coming to market that blend public and private market exposure in ways that can provide improved liquidity relative to standalone alternatives.”

2. Perspective: Discuss potential advantages and risks of alternatives

Clients may be drawn to alternatives for their potential to enhance portfolio diversification, capture illiquidity premiums, access differentiated sources of return and hedge against traditional market volatility.

Diversification can be a powerful talking point. When you invest in private credit, for example, you’re investing in a broad universe of privately held companies that aren’t available through traditional public equity markets. Just how large this market is may surprise your clients: Approximately 87% of U.S. companies with annual revenue of $100 million or more are privately held, according to data from S&P Capital IQ cited by Apollo Global Management.

To amplify that point, consider private credit as a growing asset class within the broader fixed income market. “If your objective is to build a truly diversified approach to fixed income in a portfolio, with exposure across the fixed income landscape, you’re not getting that complete exposure if you’re not invested in private credit,” Broadbery says. 

Lower volatility is another potential advantage. Private credit, for example, has historically demonstrated lower volatility than other fixed income asset classes such as high-yield bonds, leveraged loans and even investment-grade corporate bonds. A variety of factors can help dampen volatility in private credit, including lack of daily price discovery, which means valuations are not subject to daily market swings driven by investor sentiment or headlines. 

Illiquidity premiums are also a reason to consider private markets, particularly private credit. Capital Group research indicates that over the past nine years, private credit investments have yielded roughly 3% more than low-grade bonds. 

However, it’s important to recognize the unique features and challenges of private credit:

• Fees and complexity: Private market investments often carry a reputation for high fees. Clients may worry about administrative, management and performance fees eating into returns. Some recently launched public-private funds, such as those offered by Capital Group and KKR, aim to reduce complexity and cost by avoiding leverage and simplifying tax reporting through 1099s instead of K-1s, for example.
• Valuation transparency: Unlike publicly traded assets, private credit investments and many other alternative investments cannot necessarily be sold daily. When evaluating a specific alternative strategy, make sure you and your client understand the process the investment manager uses to determine valuations. 
• Liquidity and time horizon: Private credit funds often have limited liquidity, which can restrict the ability of investors to buy and sell assets. Given limited liquidity, investors will want to consider their time horizon for such investments, a consideration that is not always a factor with investment vehicles that trade daily.

3. Confidence: Demystify alternatives and their potential role in a portfolio

Clients may feel overwhelmed by the influx of news about private markets. Your role is to demystify these offerings and explain how they can fit into a broader portfolio. 

You can help build confidence in the following ways:

• Explain that, as with public equity and bond investments, manager selection can help identify investment vehicles that have successful track records, long-tenured investment professionals and a rigorous, repeatable investment process. Of course past performance is no guarantee of future success.
• Provide clear, factual answers to questions about fees, liquidity and risk.
• Educate yourself so you can better help clients understand growth trends, fund mechanics and risk protections for specific alternative investment opportunities. For example, you can find numerous ideas to illustrate private credit trends and opportunities by taking Capital Group’s digital course for advisors.

4. Opportunity: Alternatives may fit clients’ long-term goals

Encourage clients to ask questions and explore whether alternatives fit their long-term goals. Remind them that thoughtful access to private markets through well-structured public-private funds can be a way to diversify portfolios and gain access to a broader section of the economy.

• Alternatives can offer differentiated sources of return and help hedge against traditional market volatility.
• For clients willing to accept some illiquidity, interval funds may provide access to attractive risk-adjusted returns and illiquidity premiums.
• Ask investors to determine their “illiquidity tolerance” by examining their annual spending rate, time horizon and risk appetite.  

“For some clients, particularly those who have invested only in public markets for decades, alternative investments can be daunting,” says Eddie Welch, a private markets specialist at Capital Group. “As an advisor you can deepen that client relationship by walking them through private markets in a way that acknowledges their questions and concerns and gives them perspective on how alternative investments can offer opportunities for clients to achieve long-term investment goals.”

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