How to Use Different Management Styles to Enhance Your Clients’ Returns

Financial advisors strive to grow their clients’ wealth through strategic asset allocation, thoughtful diversification, and ongoing portfolio management. While all advisors share this goal, the strategies they use to achieve it can vary widely.

For example, many advisors rely solely on stocks and bonds to construct their clients’ portfolios, even though alternative assets can offer valuable diversification and risk-adjusted returns. Likewise, some advisors adopt an active management strategy, while others prefer a passive approach.

In this article, we’ll explore different management styles and outline their pros and cons. After that, we’ll explain how you can leverage various management styles to enhance your clients’ returns and hone your competitive edge.

Traditional vs. Alternative Asset Classes

For decades, financial advisors have used Modern Portfolio Theory to construct portfolios that optimize risk and returns. Introduced in 1952 by Harry Markovitz, this theory primarily focuses on stocks and bonds.

Here’s a quick breakdown of these two traditional asset classes:

• Stocks have the potential to provide high returns over time, depending on companies’ growth, earnings, and dividends. While stocks offer liquidity and flexibility, they can be volatile, especially during market corrections or bear markets.
• Bonds provide reliable income through fixed-interest payments. They’re typically considered safer investments than stocks. While bonds offer stability, their returns can be quite modest, especially in low-interest-rate environments.

A 60/40 allocation (60% stocks and 40% bonds) is a popular choice for conservative investors, while a 70/30 allocation is commonly used for more growth-oriented portfolios. However, alternative assets are also gaining traction as investors seek higher returns, superior diversification, and stronger hedges against inflation.

5 Types of Alternative Investments

Alternative assets fall outside the scope of traditional asset classes like stocks, bonds, and cash. When used properly, they have the potential to provide greater diversification, improve risk-adjusted returns, and set your financial advisory apart from the competition.

Here are five popular types of alternative assets:

#1 Commodities

Commodities are raw materials or primary agricultural products that trade on specialized markets. They fall into two main categories:

• Hard commodities are natural resources from the earth, such as gold, silver, copper, platinum, aluminum, crude oil, natural gas, coal, or gasoline.
• Soft commodities are agricultural products or livestock that are grown or raised, such as wheat, corn, coffee, rice, cattle, hogs, or poultry.

Investors can purchase commodities directly or through futures, EFTs, or commodity-focused mutual funds.

When considering commodities for your clients’ portfolios, keep these pros and cons in mind:

• Pros – Commodities can serve as a hedge against inflation since their prices often rise during inflationary periods. They also offer valuable diversification, as their performance is rarely correlated with traditional stocks and bonds. Lastly, commodities trade in large volumes on exchanges, ensuring easy liquidity.
• Cons – Commodities can be highly volatile, as they’re subject to geopolitical events, natural disasters, and sudden changes in supply and demand. Some commodities can also be expensive to store and transport.

#2 Hedge Funds

Hedge funds are investment funds that employ a variety of strategies, including long and short positions, leverage, derivatives, and arbitrage. They aim to “hedge” against market risks while pursuing above-average profits.

Unlike traditional mutual funds, hedge funds typically have fewer regulatory restrictions, enabling them to pursue more aggressive investment strategies. As a result, they present the following benefits and drawbacks:

• Pros – Hedge funds have the potential to provide impressive returns, particularly during market downturns, due to their use of short-selling and other opportunistic strategies. They can also enhance diversification, as their performance typically shows a lower correlation with traditional stock and bond markets.
• Cons – Hedge funds often charge higher fees than traditional mutual funds or index funds. They can also limit liquidity, making it harder for investors to access their funds quickly. Most notably, many hedge funds require high minimum investments and use complex strategies that may be difficult for the average investor to understand.

#3 Private Equity

Private equity involves investing in private companies directly or buying out public companies and taking them private. After improving these companies’ performance, private equity investors can realize significant profits.

Some popular private equity investment strategies are as follows:

• Buyouts take place when an investor acquires a controlling stake in an established company.
• Venture capital involves investing in a company with high growth potential during its early stages.
• Growth capital investments provide funds for established companies that need to expand or enhance their operations through restructuring.
• Distressed asset investments contribute capital to struggling companies with the goal of restoring their financial health.

Private equity investments come with these unique risks and considerations:

• Pros – Private equity has the potential to offer higher returns than public equity investments. Additionally, private equity investors can often actively shape companies’ business strategies and governance, enabling them to influence their returns.
• Cons – Private equity investments can tie up investors’ capital for several years, limiting their liquidity. They also carry significant risks, as small companies and startups are more prone to failure. Due to these risks and the complexity of managing such investments, private equity is typically reserved for institutional investors or accredited individuals.

#4 Private Credit

Private credit involves providing capital to businesses in exchange for interest payments. It’s popular among companies that are too small, risky, or specialized to secure traditional bank financing.

Private credit can take several forms. One example is direct lending, where investors provide loans to companies for corporate needs, acquisitions, or capital expenditures. These loans are considered “senior secured” because they enjoy priority during liquidation.

Another common form is mezzanine financing, which bridges the gap between senior secured debt and equity. Mezzanine financing is typically unsecured or subordinated, which means it has a lower priority claim on assets in the event of liquidation. It offers the potential for higher returns to compensate for this increased risk.

Here are some pros and cons of leveraging private credit for your clients:

• Pros—Private credit can offer higher yields compared to traditional fixed-income investments like bonds, particularly in low-interest-rate environments. Its returns are less correlated with public debt markets, which can enhance diversification.
• Cons—Private credit investments are illiquid, so they can’t be easily bought or sold on secondary markets. Investors typically need to hold these investments for a longer period—usually three to seven years. Private equity investments are also subject to less regulatory oversight than traditional bank loans, which can increase their risk.

#5 Digital Assets

Digital assets are a rapidly evolving alternative asset class. They include cryptocurrencies, tokenized securities, NFTs, and decentralized finance (DeFi) products. While initially viewed with skepticism, these assets are quickly gaining widespread popularity.

In 2023, around half of investors planned to purchase cryptocurrencies. Now that Bitcoin has surpassed the $100,000 mark for the first time, interest in cryptocurrency will likely only increase. Ninety percent of advisors already receive questions about cryptocurrencies from their clients, though nearly 60% don’t offer advice due to credibility concerns or firm policies.

Learn more: Donald Trump’s Election Victory: The Stock Market’s Response and Economic Outlook

Despite digital assets’ volatility and risk, some have the potential to add significant value to a well-balanced investment portfolio. Just keep these pros and cons in mind:

• Pros – Digital assets offer the potential for significant capital appreciation and can enhance portfolio diversification. Additionally, they may serve as a hedge against inflation.
• Cons – Digital assets are highly volatile and subject to regulatory uncertainty, making them largely speculative investments. The market’s relative immaturity also increases their risk of fraud, hacking, and manipulation.

Learn more: The Role of the Modern Financial Advisor: How Technology is Shaping Their Success

The Yale Endowment Model: Alternative Assets in Action

One example of how alternative investments can enhance portfolios is the Yale Endowment Model, pioneered by David Swensen, Yale University’s Chief Investment Officer. Swensen’s strategy emphasizes diversification and employs a heavy allocation to alternative assets, including private equity, hedge funds, real estate, and natural resources.

The Yale Endowment Model has regularly outperformed traditional portfolios, providing lower volatility and better risk-adjusted returns. Just take a look at these statistics:

• Over the past ten years, Yale’s endowment achieved an impressive return of 9.5% annually, outperforming the median return for other university endowments by 2.4% per year.
• Over the past 20 years, the endowment achieved an annual return of 10.3%, outperforming the median 20-year return for university endowments by 3.0% per year.
• Yale’s endowment has outpaced a typical 70/30 stock and bond portfolio by 3.8% annually over both 10- and 20-year periods, highlighting the long-term benefits of its alternative investment strategy.

Yale’s Endowment Model demonstrates how diversifying beyond traditional asset classes can significantly enhance portfolios’ long-term performance.

How to Leverage Alternative Assets in Your Financial Advisory Practice

While alternative assets offer significant advantages, incorporating them effectively requires a degree of expertise that many financial advisors may not possess. Luckily, you can confidently leverage these asset classes for your clients by partnering with a third-party money manager specializing in alternative investments.

At Alden Investment Group, our experienced money managers have curated a carefully vetted selection of alternative assets through our Alden ALTS platform, including:

• Hedge funds
• Real estate offerings
• Limited partnerships
• Private placements
• Small-cap funds
• Digital assets
• Multi-asset commodities

Our seasoned investment team has selected these strategies based on their return potential and risk/reward profiles. Incorporating them into your clients’ portfolios may deliver uncorrelated returns and improve diversification.

Active vs. Passive Investment Strategies

Along with optimizing your clients’ asset allocation, you need to decide whether you want to take an active or passive approach during your investment management:

• Active management involves actively selecting securities with the goal of outperforming the broader market.
• Passive management seeks to replicate the market index performance, typically at a lower cost.

Both approaches have their strengths and weaknesses. Active management offers the potential for higher returns, particularly in inefficient markets or specialized asset classes. However, passive strategies are generally more cost-effective and have a history of strong long-term performance, especially in established markets.

No matter which approach you prefer, we can supercharge your chosen strategy at Alden Investment Group. Financial advisors who join our Registered Investment Advisor (RIA) gain access to a wide range of active and passive investment strategies, enabling them to swiftly tailor solutions to their clients’ objectives, whether they prioritize high-growth potential or steady, long-term accumulation.

For example, our Alden PLUS platform can connect you with a wide variety of actively managed strategies designed to generate alpha and outperform the market. Meanwhile, our Alden EDGE Models can provide low-cost, diversified portfolios that replicate market indexes, making them ideal for steady, long-term growth.

Learn more: What is a TAMP and Should You Use One?

High- vs. Low-Turnover Strategies

Lastly, you need to consider the impact of portfolio turnover on your clients’ returns:

• High-turnover strategies, which involve frequent buying and selling of securities, can generate significant transaction costs and tax liabilities. As a result, you may want to focus on low-turnover strategies instead.
• Low-turnover strategies minimize costs by holding investments for longer periods, which can streamline tax liabilities and transaction fees. Thus, incorporating low-turnover strategies into your clients’ portfolios is a smart way to optimize their financial outcomes over time.

At Alden Investment Group, our team can help you identify low-turnover strategies that align with your clients’ goals while minimizing unnecessary costs.

Start Leveraging Different Management Styles Today

Whether you focus on traditional assets or alternative investments, active or passive management, or low or high turnover, successful portfolio management ultimately comes down to client customization.

For example, a young professional may prefer a growth-oriented allocation focusing more on stocks and alternative assets. In contrast, a retiree who wants a stable income may benefit from a higher allocation of bonds and cash equivalents.

By tailoring your management style to your clients’ unique circumstances, you can increase your chances of delivering satisfactory returns and retaining their long-term business. Doing so is easier when you have the right resources and support at your disposal.

Learn more: How to Attract and Retain Clients as a Financial Advisor

How Alden Investment Group Can Help

At Alden Investment Group, we help advisors of all sizes navigate the complexities of modern portfolio management. As an RIA and broker-dealer, we can offer you access to a comprehensive suite of innovative resources, investment strategies, and tech solutions.

With our support, you can carve out more time to focus on your client relationships while ensuring top-notch investment management. Additionally, our broad network of third-party managers can empower you to diversify your clients’ portfolios with alternative investments when appropriate.

Want to see how partnering with Alden can drive your clients’ long-term success? Contact our team today.

Sources:

Investopedia. Modern Portfolio Theory: What MPT Is and How Investors Use It.
https://www.investopedia.com/terms/m/modernportfoliotheory.asp

Investopedia. The Correlation of Commodities to Inflation.
https://www.investopedia.com/articles/investing/020816/importance-commodity-pricing-understanding-inflation.asp

Financial Planning Association. Are Financial Advisers Asleep at the Wheel When it Comes to Cryptocurrency?
https://www.financialplanningassociation.org/learning/publications/journal/JAN24-are-financial-advisers-asleep-wheel-when-it-comes-cryptocurrency-OPEN

New York Times. Bitcoin Hits a Milestone: $100,000.
https://www.nytimes.com/2024/12/04/technology/bitcoin-price-record.html

Bitcoin.com News. Financial Advisors See Strong Interest in Crypto — 90% Receive Inquiries About Crypto Investing, Survey Shows.
https://news.bitcoin.com/financial-advisors-see-strong-interest-in-crypto-90-receive-inquiries-about-crypto-investing-survey-shows/

Yale Daily News. Yale’s endowment, explained.
https://yaledailynews.com/blog/2022/10/24/yales-endowment-explained/

Yale. Yale reports investment return for fiscal 2024.
https://news.yale.edu/2024/10/25/yale-reports-investment-return-fiscal-2024