3 Tips for Talking to Clients about Alternative Investments
Written by: Jason Plucinak
If you’ve been advising clients for more than a decade, alternative investments probably haven’t been on the list of options you’ve discussed with most of them.
Sure, a handful of clients may have been interested in and understood the value of leveraging alternatives, but the majority of your clients’ portfolios likely consist of equities, bonds, and cash instruments. There’s a reason for that: they make sense.
And for decades, these traditional options have delivered on their promise of generating a consistent return on investment. But now times have changed. The Great Recession drove home the need for greater diversification, and an extended low-interest-rate environment has nearly wiped out expected returns on bonds and cash investments. In the wake of such a shift, many advisors are looking to reallocate client portfolios from a traditional 60/40 model to include at least 20% in alternatives. The question is this: How can you introduce alternatives to clients to get them on board?
Here are 3 tips to help you guide the conversation with even the most traditional investors:
1. Present alternatives that are easy to understand.
When considering anything new, investors need to understand where their money is going and how it will deliver a return on investment. That means complexity is your nemesis. By presenting options that have a story your clients can relate to, you can help them feel more attached to what they are investing in. Present easy to understand options and your clients are much more likely to feel at ease.
2. Focus on transparency.
Even the most trusting clients aren’t (and shouldn’t be) willing to invest their hard-earned dollars in something that isn’t completely transparent. Point your clients to offerings that are publicly registered and have public, audited financials. If you do like an investment offering that is structured as a Private Placement, use only those with public, audited financials. Transparency allows you to “look under the hood” to easily understand and explain the fundamentals of the offering. What is the risk exposure? How are assets invested? What is the source of the return on investment? When transparency is a given, your clients know what they’re investing in, so you never have to utter the words, “take my word for it.”
3. Follow up with written details—online or off.
Talking through the details of an alternative investment is a great start, but following up with details can support your client’s decision by confirming what they heard in your meeting. Always include the investment’s official prospectus and be sure you are following your firm’s compliance and advertising guidelines. If your website features a client portal, create a webpage devoted to specific alternatives you recommend. Include clear bullet points covering the features of the offering, a brief commentary stating why you recommend the product, and links to relevant articles by third parties. If you don’t offer a firewalled content area on your website, you can provide the same information in a handout or brochure for your client to take home. Regardless of how you deliver the information, don’t try to sell the product; simply provide the research and information your client needs to make a well-informed decision.
Of course, recommending alternative investments to your clients should always be based on your own clear understanding of the value of each offering and how it fits into each client’s portfolio and overall financial goals. To be sure you know the facts yourself, the Alternative & Direct Investment Securities Association offers a broad array of information about a variety of options
Once you have the knowledge you need, remember to keep it simple when walking through your recommendations with your clients. The result: your clients will not only have a clear picture of how alternative investments can help strengthen their portfolios, they’ll also have the confidence that you’re exploring all the options as their trusted advisor.
Jason Plucinak has over a decade experience as a financial professional in the life insurance, securities, and alternative investment industries. Currently Sr. Vice President of Business Development at GWG Holdings, his background includes wholesaling, sales management, and Broker Dealer due diligence. Mr. Plucinak holds his Series 7and 63 license with Emerson Equity LLC a FINRA registered broker dealer.. Mr. Plucinak earned a Bachelor of Science degree in finance from St. Cloud State University in Minnesota.
Building a Better Index With Strategic Beta
Written by: Yazann Romahi, Chief Investment Officer of Quantitative Beta Strategies and Lead Portfolio Manager of JPMorgan Diversified Return International Equity ETF at J.P. Morgan Asset Management
With the global economy warming up, but political uncertainty remaining a constant, it’s more important than ever for investors to position their global portfolios to navigate long-term market volatility. That’s where the power of diversification comes in, says Yazann Romahi, Chief Investment Officer of Quantitative Beta Strategies at J.P. Morgan Asset Management and Lead Portfolio Manager of JPMorgan Diversified Return International Equity ETF (JPIN).
Not all diversified portfolios are alike
In their search for diversification, many investors turn to passive index ETFs, which track a market cap-weighted index. But these funds aren’t always the most effective way to steer a steady course through volatile markets—and there are two key reasons why.
First, traditional market cap-weighted indices are actually less diversified than investors may think. For example, in the S&P 500, the top 10% of stocks account for half the volatility of the index. Within sectors, while you might assume that sector risk is distributed across the ten major sectors fairly evenly, it is a surprise to many that at any point in time, one sector can be as high as 50% of the risk.
Second, cap-weighted indices come with some inherent weaknesses, including exposure to unrewarded risk concentrations and overvalued securities. So, while these indices provide investors with exposure to the equity risk premium and long-term capital growth, as is the case with any other investment, investors can also experience painful downturns, which increase volatility and reduce long-term performance. For investors seeking equity exposure with broader diversification—and potentially lower volatility—strategic beta indices may be better positioned to deliver the goods.
How do we define strategic beta?
Strategic beta refers to a growing group of indices and the investment products that track them. Most of these indices ultimately aim to enhance returns or reduce risk relative to a traditional market cap-weighted benchmark.
Building on decades of proven research and insights, J.P. Morgan’s strategic beta ETFs track diversified factor indices designed to capture most of the market upside, while providing less volatility in down markets compared to a market cap-weighted index. Rather than constructing an index based on market capitalization—with the largest regions, sectors and companies representing the largest portion of the index—our strategic beta indices aim to allocate based on maximizing diversification along every dimension—sectors, regions and factors. The index therefore seeks to improve risk-adjusted returns by tackling the overexposure to risk concentrations and overvalued securities that come as part of the package with traditional passive index investing.
So, how do you build a better index?
As one of just a few ETF providers that combine alternatively-weighted and factor-oriented indices, our disciplined index methodology is designed to target better risk-adjusted returns through a two-step process.
First, we seek to maximize diversification across the risk dimension. This essentially means that we look to ensure risk is more evenly spread across regions and sectors, which balances the index’s inherent concentrations. As uncontrolled risk concentrations are unlikely to be rewarded over the longer term, we believe investors should strive for maximum diversification when constructing a core equity exposure.
Second, we seek to maximize diversification across the return dimension. Research shows that there are a number of sources of equity returns beyond growth itself. These include risk exposures such as value, size, momentum and quality (or low volatility). When creating a diversified factor index in partnership with FTSE Russell, we seek to build up the constituents with exposure to these factors. We therefore select securities through a bottom-up stock filter, scoring each company based on a combination of these return factors to determine whether it is included in the index. These factors provide access to a broader, more diversifying source of equity returns as they inherently deliver low correlation to one another, providing diversification in the return dimension.
So, whereas traditional passive indices allow market cap to dictate allocations, the diversified factor index seeks to ensure that we minimize concentration to any source of risk—whether it be region, sector or source of return.
How are you currently weighted versus the market cap-weighted index, and how have your under- and over-weights enhanced risk-return profiles?
Crucially, our weightings don’t reflect specific views on sectors or regions and are instead, by design, the point of maximal diversification. It is important to remember that market cap-weighted indices typically carry a lot of concentration risk—for example, at various points in time, a single sector can explain half the risk of the index when left unmanaged. At the moment, three sectors explain two-thirds of the risk of the FTSE Developed ex-NA Index—these being financials, consumer goods and industrials. In contrast, the FTSE Developed ex-NA Diversified Factor Index—or strategic beta index, which JPMorgan Diversified Return International Equity ETF (JPIN) tracks—is explicitly designed to maintain balance and therefore these sector allocations range from 8% to 12%. In the short term, any concentrated portfolio can of course outperform a more diversified one, if the concentrated bet paid off.
Investing wholly in a single stock may outperform over short-term periods. At other times, it may significantly underperform an index. However, it is well understood that an investor is better off diversifying across lots of stocks for better risk-adjusted long-term gains. The same applies here. From a pure return perspective, if financials, for example, account for half of a cap-weighted index in terms of market cap and have a strong run over the short term, of course, this index would outperform over this period. Over the long run, however, it is fairly uncontroversial to suggest that the more broadly diversified index could achieve better risk-adjusted returns.
Seeking a smoother ride in international equity markets?
For investors targeting enhanced diversification through a core international equity portfolio, JPMorgan Diversified Return International Equity ETF (JPIN) targets lower volatility by tracking an index that more evenly distributes risk, enabling them to get invested—and stay invested.
Learn more about JPIN and J.P. Morgan’s suite of strategic beta ETFs here.
Call 1-844-4JPM-ETF or visit www.jpmorganetfs.com to obtain a prospectus. Carefully consider the investment objectives and risks as well as charges and expenses of the ETF before investing. The summary and full prospectuses contain this and other information about the ETF. Read them carefully before investing.
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