Alternatives demand patience, discipline and perspective

Alternatives have long promised diversification, uncorrelated returns and access to parts of the economy beyond public markets. As allocations rise across adviser portfolios, however, the conversation is shifting. The focus is no longer simply access, but implementation.

For Andrew Garrett, investment director at Perpetual Limited, the real challenge for advisers is understanding how alternatives behave through a full investment cycle. That includes periods when the asset class appears to lag.

Alternatives rarely outperform in every market environment. Their value instead lies in how they interact with the broader portfolio. That requires advisers to frame the allocation carefully. Clients need to understand the role alternatives play and what outcomes to expect over time.

Liquidity is the first question

The starting point for any alternatives allocation is liquidity. Many strategies involve long investment horizons and constrained redemption mechanisms. That structural feature separates them sharply from listed markets.

Garrett believes advisers often underestimate this distinction when building portfolios.

“You’re not dating these funds, you’re getting married to them,” Garrett says. “You need to take that question very, very seriously.”

Liquidity constraints tend to emerge most clearly during periods of market stress. Vehicles that appear liquid during normal conditions may tighten quickly when redemption requests surge.

“If push comes to shove and there’s a crisis, everyone rushes to the gates and they close up,” he says. “We’ve seen that happen many times.”

For advisers, the implication is straightforward. Alternatives cannot simply be slotted alongside equities and bonds. Liquidity budgeting, portfolio sizing and client education become central considerations.

Choosing managers carefully

Manager selection is another critical piece of the alternatives puzzle. The universe is large and often opaque, which places a premium on due-diligence.

Garrett says Perpetual tends to take a cautious approach with emerging managers. Track record matters, but operational strength matters just as much.

Waiting until a manager launches a third fund allows investors to observe how the business scales. It also demonstrates that the team has built sufficient operational infrastructure.

That capability becomes particularly important in areas such as private credit. When deals deteriorate, managers may need to take control of underlying businesses.

“You’ve got to ask whether they actually have the staff, the time and the willingness to do that sort of stuff,” Garrett says.

Operational resilience therefore becomes a central component of manager selection.

Diversification when markets struggle

Despite the complexity, alternatives can play a valuable role in smoothing portfolio outcomes. Their diversification benefits tend to emerge most clearly when traditional assets move in tandem.

The experience of 2022 offered a clear example. Both equities and bonds struggled simultaneously as inflation surged and interest rates rose.

“When markets were going down like they did in 2022, our alternatives program was the only asset class that went up,” Garrett says.

This outcome highlighted the limits of traditional diversification. A broader toolkit can help portfolios withstand periods of market stress.

However, Garrett notes that the same diversification can create relative underperformance when equities rally strongly. During periods dominated by large technology stocks, diversified alternatives strategies can appear underwhelming.

“When markets are rallying, when we’re sitting in at the Mag Seven take-off, our alternatives program looks comparatively worse,” he says.

That dynamic underscores the importance of evaluating alternatives across full cycles rather than short windows.

Managing client expectations

For advisers, the biggest challenge may not be portfolio construction. Instead, it is helping clients understand the behaviour of alternatives.

Investors often assess portfolios through a short-term lens. They look at the previous year’s winners and assume the same assets will lead again.

“Clients want to be in the thing that was hot last year because they assume it’s going to be hot next year,” he says.

The adviser’s role is to focus attention on forward-looking opportunities rather than rear-view-mirror performance.

Education becomes central to this process. Clients need clarity about why alternatives are included and how they are expected to behave.

Building a long-term allocation

Perpetual’s approach involves maintaining diversified exposure across multiple alternative sectors. Continuous engagement with managers allows the team to adjust exposures as conditions evolve.

Garrett says the objective is to position portfolios for future opportunity while avoiding emerging headwinds.

Ultimately, alternatives should be treated as a strategic allocation rather than a tactical trade.

When implemented with discipline, they can provide diversification benefits that traditional assets struggle to replicate. Achieving that outcome, however, requires patience, careful manager selection and a clear understanding of liquidity constraints.

For advisers and their clients alike, the allocation demands commitment. As Garrett’s analogy suggests, alternatives are less a short-term relationship than a long-term partnership.

Laurence Parker-Brown

Laurence Parker-Brown is head of content at The Inside Network and managing editor of The Inside Adviser and Investor Strategy News.