What do advisers look for in alternative investments?

As more retail alternative investments hit the market, financial advisers are doing more due diligence and seeking out firms that provide the most transparency and have solid performance. Indeed, a new study by Franklin Square Capital Partners shows advisers most prefer alternative-investment providers with a high level of integrity and transparency, with 92% ranking that factor as one of the top three most important criteria when selecting a provider. More than 90% also said strong, consistent investment performance was another main factor. “There's certainly a rush to be in the alternative space and lots of firms are launching alternative mutual funds,” said Michael Forman, chief executive of Franklin Square. “This is really confirmatory that advisers are looking for best practices and transparency.” Other critical criteria for advisers considering alternative investment providers included competitive pricing, the track record and a product's low correlation to other asset classes. Tom Karsten, president and chief investment officer of Karsten Advisors, said his firm uses a variety of alternative investments, including non-traded REITS, venture capital, and direct private placements in the real estate and oil and gas industries. When choosing alternative investment providers, he said his firm bases its decision partly on word of mouth. “I try to talk to other advisers who have used their program through the industry or through broker-dealers,” Mr. Karsten said. “The personal experience they've had, that's important to us.” LIQUID AND ILLIQUID Thirty-eight percent of the advisers surveyed said that they would choose a provider based on the liquidity of the product. Mr. Karsten said his firm uses a mix of both liquid and illiquid investments. For clients with smaller portfolios, he prefers publicly traded alternatives. Clients with portfolios in the $5 million-to-$10 million range have more opportunity for direct private placements, since liquidity isn't as much of a factor. Mr. Forman said Franklin Square sees potential in illiquid alternative investments, and the company sells shares in several nontraded business development companies. About 39% of investment advisers surveyed reported using these products. That compares with the nearly 90% who use mutual funds. Commodities and managed futures were cited as the least popular alternative investment strategy. “Folks are concerned about the stock market because there's been a lot of volatility and the indexes are being driven by just a few companies, and any fixed-income security is a scary place these days,” Mr. Forman said. “I think alternatives give folks some noncorrelation.” Mr. Karsten said his firm has been using alternatives more in portfolios this year as a replacement for bonds, which are under increasing pressure as the economy slowly improves and Federal Reserve officials discuss an end to the quantitative-easing program that has kept rates unnaturally low. Alternative investment providers are getting better at communicating with clients and providing information about the products — a positive development for the industry, Mr. Karsten added. “I do think we're going to continue to see alternatives increase not only because there's a demand there, but I think we're getting away from the older days when there wasn't much transparency,” he said. The survey gathered responses from 268 brokers and investment advisers with at least $75,000 in annual revenue and $10 million in assets under management.