Alternatives research gets harder as private markets open up

The growth of alternatives has created a familiar tension for advisers. Clients want access to private markets, real assets, private credit and other return sources beyond listed equities and bonds. But the research burden is heavier, the structures are more varied, and the risks are not always obvious at first glance.

For Chetan Trehan, sector head, real assets, alternatives, and multi-asset funds at SQM Research, that complexity is part of what makes the sector compelling. It also makes it harder to assess properly.

“Obviously, there are implementation issues and liquidity issues that need to be managed,” Trehan says. “That’s, I think, a focus point for everybody, including us.”

For advisers, this is where alternatives differ from traditional listed assets. The question is not only whether the return objective is attractive. It is whether the fund can be understood, governed and explained to clients through the full cycle.

That makes research more than a compliance input. It becomes part of the advice process itself. Advisers need to know what problem the allocation is solving, how the strategy behaves under stress, and what the exit pathway looks like if conditions change.

Don’t stop at the rating

Ratings houses have become more important in alternatives because many advice firms lack the internal resources to run deep manager research across an expanding universe of products.

Trehan says the relationship between a ratings firm and an adviser is partly about support, especially where an advisory firm does not have a centralised research function. But he warns against treating a rating as a substitute for understanding.

“Read the important parts of the report, for example, strengths and weaknesses, not just look at the rating of strategies.”

That is a useful warning. A high rating can help advisers narrow the field. It does not remove the need to understand the trade-offs. In alternatives, the trade-offs can include liquidity gates, valuation lags, leverage, asset concentration, manager key-person risk, and operational complexity.

Trehan notes that SQM reports can run to 20 pages, which is a lot for busy advisers. But the length reflects the nature of the asset class. A private asset strategy needs more interrogation than a plain vanilla listed exposure.

“The level of due diligence involved is a bit more in the private assets slash alternative sector compared to listed,” he says.

That due diligence should cover more than performance. Trehan points to valuation processes, independent valuation mechanisms, investment committees and whether the decision-making structure is institutional or overly dependent on one or two individuals.

These details matter because many alternative strategies are priced less frequently than listed assets. If valuation discipline is weak, client reporting may look smoother than the underlying risk warrants.

Private credit leads, but basics still matter

Private credit remains the fastest-growing part of the alternatives market. It has been pulled forward by the search for income, the retreat of banks from some lending markets, and investor appetite for floating-rate defensive exposures.

Trehan expects that conversation to continue. “Private credit continues to be that sector that is growing the fastest,” he says.

The problem is that growth attracts new entrants. Some will be highly capable. Others may lack the track record, infrastructure or cycle-tested discipline advisers should expect before allocating client money.

Track record is therefore critical. So is diversification. A fund that looks attractive at the headline level may still carry uncomfortable exposure to a small number of borrowers, assets or sectors.

Trehan is blunt on this point. “If fund is highly risky in one position, that’s not a good idea,” he says.

That comment goes to the heart of portfolio construction. Alternatives are often sold as diversifiers, but not every alternative fund is diversified. Some are highly concentrated, carry hidden correlations, or rely on benign credit markets and stable asset values.

Advisers need to test the claim, not just accept the label. A private credit fund should be assessed on borrower quality, security, loan-to-value ratios, sector exposure, arrears, manager workout capability, and liquidity terms, while a private equity fund should be assessed on deal concentration, valuation discipline, exit assumptions, and manager experience.

Alternatives can add real value to client portfolios. They can provide income, inflation linkage, lower correlation and access to opportunities unavailable in public markets. But they require a more forensic research process.

The lesson for advisers is straightforward. Use ratings, but read the report. Ask about liquidity, not just return. Understand valuation, not just volatility. Look at governance, not just manager pedigree.

As alternatives become more mainstream, the winners will not be the advisers who allocate first. They will be the ones who allocate with discipline.