Morningstar's Papagiannis: Alts allocation should be at least 5%

Any move into alternative investments should start with an allocation of at least 5%, but in order to have any kind of real impact, that allocation should grow to at least 20%, according to Nadia Papagiannis, director of alternative fund research at Morningstar Inc.

“Five percent is really not going to make a difference, but 20% will start to make a difference,” Ms. Papagiannis said as part of her presentation Monday at the InvestmentNews Alternative Investments Conference in Chicago.

As part of a pre-conference presentation designed to provide a lay of the land with regard to alternative investments, she told the audience of financial professionals to be diligent and to diversify into alternative strategies.

“If I were doing it, I would pick an equity long-short strategy, a managed-futures strategy and a market-neutral strategy as a kind of bond substitute, and I would equal-weight them into the portfolio,” Ms. Papagiannis said. “Prior to 2008, a lot of investors were too heavy into equities, and now a lot of advisers are telling me their clients are too heavy into bonds.”

As she detailed the growth and fast-growing popularity of alternative strategies, Ms. Papagiannis reminded the audience that the definition of “alternative” is evolving constantly.

“What we think of as alternatives today might not be what we think of as alternatives 10 years from now, and the legal structure doesn't help to define it,” she said, citing real estate and emerging markets as examples of asset classes that used to be considered alternative investments.

Ms. Papagiannis advised against bear market strategies that bet on down market cycles because historically the market is up more than it is down.

She also was critical of funds identified as “absolute return,” describing that term as a “misnomer.”

“If it looks too good to be true, it probably is,” Ms. Papagiannis said. “Nothing makes money all the time.”

Ultimately, it comes down to liquidity for most investors, and that is where the mutual funds and exchange-traded funds have stepped up to provide a vast list of options, Ms. Papagiannis said.

“Everybody needs liquidity in a portfolio, and you can't be like a foundation and put 40% of assets in illiquid strategies,” she said.