For decades, many retail investors allocated their portfolios among standard options such as stocks, bonds and mutual funds with exposure to those traditional asset classes. Currently, many traditional rules of thumb, including a 60%/40% stock-to-bond portfolio, are becoming somewhat obsolete.
Seeking to diversify away from traditional markets and beat inflation, investors, financial advisors and traditional brokers are turning to alternative investments. These options may include derivatives such as futures contracts on commodities; private equity; blockchain; environmental; social and governance (ESG); and international investment.
Because of these factors, liquid alternative funds are on track to break last year’s record net inflows of $38.3 billion.
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Alternative investments may justify higher fees
Several decades ago, it was not uncommon for stock brokerages to charge 8% per trade. The Internet, index funds and robo-advisors have changed the model, with most major brokerages offering commission-free trades in US stocks and ETFs.
Many financial advisors charge asset under management fees (AUM), which can range from 0.20% to 2% for managing a client’s portfolio.
Currently, many advisors will face fee compression, as the average client account fee in 2021 was 0.69%. Some investors rely on their own research or robo-advisors improvement For financial planning. Betterment charges a portion of the AUM fee that the advisor starts at 0.25%.
Many alternative investments, including private equity and real estate, require more strategy and can carry higher risk. Unlike index funds, alternative investment ETFs can be actively managed.
One of the main reasons brokerages create these funds is so they can justify charging higher management fees along with performance-based fees.
For example, the ProShares Global Listed Private Equity ETF PEX is a popular ETF that invests in private equity companies and carries a hefty 2.67% expense ratio.
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Brokerages can diversify revenue streams
American stock mutual funds were very common in investors’ portfolios. Due to high fees, commissions and low performance, many investors are opting for low-cost ETFs and index funds instead.
As a result, net flows to U.S. long-term mutual funds have been negative in seven of the past eight years, according to the Investment Company Institute. A good portion of these flows are allocated to low-cost ETFs and index funds, which are less profitable for brokerages.
Offering alternative investment funds provides these companies with different, more profitable revenue streams. Unlike old mutual funds, alternative investment funds are seeing high demand from both investors and advisors.
According to a 2022 CAIS Group survey, 34% of participating advisors thought the traditional mix of stocks and bonds was no longer an effective investment.
Fidelity launched two alternative investment funds
Fidelity recently created Fidelity Advisor Risk Equity Fund FAPZX and Fidelity Advisors Macro Opportunities Fund (FAQFX).
Fidelity Advisor Risk Equity Fund (FAPZX)
The fund invests in US stocks, bonds, international stocks and bonds, exchange traded products and mutual funds. It also has exposure to futures contracts on commodities.
The five classes of this fund – A, M, C, I and Z – have expense ratios varying from 0.64% to 1.69%.
Fidelity Advisor Macro Opportunities Fund (FAQFX)
Like risk parity funds, macro opportunity funds have five classes – A, M, C, I and Z, with expense ratios varying per fund class. These range from 0.80% to 1.85%. It seeks to provide investors with diversification from the traditional 60%/40% stock-to-bond portfolio.
A macro opportunity fund differs from a risk parity fund because it includes more leverage and uses a mix of both long and short positions across asset classes. These strategies ensure that it is minimally correlated with traditional equity markets.
Other asset managers are following Fidelity’s lead
In addition to Fidelity, other top financial institutions, including BlackRock and Invesco, are creating more alternative investment funds. Some of these focus on specific, popular niches such as blockchain or ESG.
For example, BlackRock just started it iShares Blockchain and Tech ETF IBLC. This ETF invests in US and foreign companies involved in the development and innovation of blockchain, along with crypto-based technology.
Some of its largest holdings include Coinbase Global Inc. coins and Marathon Digital Holdings Inc. kill. Unlike other actively managed ETFs, it has a relatively low expense ratio of 0.47%.
Besides blockchain, ESG is another growing niche. It is becoming more popular due to increased interest in environmental sustainability and social causes.
A third of millennials and 19% of Gen Z investors prefer to invest in companies that support positive social change, innovation and sustainability. Like some household names Microsoft Corporation MSFT and Apple Inc. AAPL Qualify as ESG companies.
While companies need to meet several criteria to be considered ESG, the main one is that the company is not involved in business activities in the following industries – alcohol, cannabis, weapons, gambling, nuclear power, oil and gas and tobacco.
The Invesco ESG NASDAQ 100 ETF QQMG Tracks the Nasdaq-100 ESG index, and some of its holdings include Apple, Microsoft, DocuSign Inc. DOCU and Zoom Video Communications Inc. ZM. Since it is an index fund, it has a relatively low expense ratio of 0.20%.
In addition to this ETF, which launched in late 2021, Invesco offers other ESG ETFs, including ESG Nasdaq Next Gen 100 ETF QQJG and ESG S&P 500 Equal Weight ETF RSPE.
Traditional brokerages are increasingly creating unique, alternative investments
The world and markets are changing rapidly. Traditional investment strategies such as a 60%/40% stock-to-bond portfolio are becoming increasingly outdated, especially as this model is projected to have its worst quarter since 2008.
New industries, including blockchain and ESG, offer more innovation and investment opportunities, which explains why BlackRock launched its iShares Blockchain and Tech ETF.
Other funds, such as the Fidelity Macro Opportunities Fund, are being used to diversify away from standard asset classes such as U.S. stocks and bonds, which have seen significant losses this year.
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