A new report shows demand for alternatives is growing across the board as investors seek to grow their portfolios at a quicker pace than what traditional investments are offering in current market conditions. Linda York is a senior vice president in the Cogent Syndicated division at Escalent, which has been producing its US Institutional Investor Brandscape report for more than 10 years. York leads the wealth management syndicated research and consulting practice at Cogent Syndicated, and has more than 20 years of experience in financial services spanning responsibilities in finance, marketing and business strategy.

Your report says investors are turning to alts at unprecedented levels. Why?

Investors are looking for ways to increase diversification, minimize downside risk and protect their portfolios against inflation, and they’re finding that traditional asset classes, such as public equity, fixed income and cash, are just not cutting it. Between inflation, geopolitical uncertainty, the risk of a global recession and ongoing stock market volatility, investors are increasingly adding alternative investments to their portfolio allocations. They’re exploring other options to generate higher returns while balancing their fiduciary responsibilities, and they’re finding compelling solutions in alternatives.

What types of alternatives are gaining the most traction?

Three-quarters (75 percent) of institutional investors are using private equity, while nearly eight in 10 (78 percent) now hold real assets or commodities, up from 67 percent a year ago. Moreover, 42 percent of institutional investors report allocations to digital assets and cryptocurrencies, significantly higher than the 28 percent recorded in 2021. Investors are poised to increase their use of a variety of alternative investment opportunities, including digital assets, private equity, and real assets. Additionally, investors report renewed interest in increasing the level of assets allocated to real estate, as many consider real estate an area of expanding opportunity that is likely to benefit from the current inflationary environment. Notably, interest in alternative categories appears to be coming at the expense of passively managed investments, as institutional investors maintain their conviction in the value of active management.

What surprised you about this trend?

I was surprised at how universal this interest in alternative investments is across all segments of the institutional market. Historically, we’ve observed that pension investors behave very differently than those in the nonprofit sector, for example. However, this year we see demand for alternatives growing across the board — even among investors overseeing defined contribution 401(k) retirement plans. Yet not all in the institutional market are diving in head-first. Even prior to the DOL cautioning plan fiduciaries to exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plan’s investment menu, many consultants deemed digital assets/cryptocurrencies as speculative, with too much volatility for institutional platforms. That said, consultants are not discrediting the supporting technology being developed and believe that crypto-adjacent activity is poised to take off.

How is this shift changing how investors evaluate managers and strategies?

While there’s no substitute for a proven track record of strong investment performance, many investors are relying more on consultants for searches and recommendations in these more niche-type mandates. Underlying this is increasing focus on environmental, social and governance (ESG) investing. Nearly two-thirds (65 percent) of institutional investors have already implemented an ESG strategy or are likely to do so in the next 12 months, compared with just 28 percent a year ago. Additionally, institutional investors are growing more aware of diversity, equity and inclusion (DE&I) investments, which are likely to follow the rise of ESG investments closely over the coming year as attention grows. Nearly one-third (30 percent) of institutional investors indicate DE&I is a highly important aspect influencing their allocation decisions.

Do you consider this a fleeting or abiding trend?

I believe this appetite for alternative investments is here to stay. While the impetus was market volatility, a prolonged period of low interest rates, the threat of recession and rising inflation, investors are gaining experience and confidence with alternatives. They’re having success in integrating alternatives into their portfolios, balancing liquidity needs with diversification and return-generating strategies. And asset managers are noticing, building out their alternative investment capabilities accordingly to accommodate this growing demand. Instruments like private debt and real assets are much more accessible now, which makes for more competition and more choice for investors.