When It Comes to Alts, 30% May Do the Trick

The 30% allocation is on the high end for most advisors working with retail clients. A survey conducted by Morningstar and Barron's last year found that 63% of responding advisors allocated 6% to 20% of clients' assets to alternatives; only 4% allocated more than 40%.

Still, Clark's calculations showed that a 30% allocation produced better significantly better results than a 5% allocation. "At the 5% level there is hardly any change in any of the (portfolio) metrics. At the 30% level, return, volatility, downside deviation and risk-adjusted return are better. Skewness tends to be better, while kurtosis is typically worse, especially for commodities and world equity. This better performance at the 30% level is typical of all the alternatives tested, i.e. arbitrage, global macro, market neutral, and long/short equity funds, and seems to indicate that a higher allocation to alternatives can improve the performance of a portfolio more than a lower level of investment in alternatives," he explained.

The data build a solid case for including alternatives, says Clark, provided investors are willing to make an adequate allocation.

"When I talk to financial advisors and to other people who deal with alternatives, the number that's often bounced around, in terms of a good alternative allocation for a risk averse to moderately risk averse investor, is somewhere between 20% and 30% to make the magic work," he says.

Investors also need to understand that most alternatives' defensive nature.

"What happens is that the good alternatives, meaning the ones that will give you that sort of protection, very typically don't perform as well as the stock market in general does," he cautions. "In fact, it can severely underperform it. So, to get that downside protection you have to be able to tolerate (and be) comfortable if the stock market made 20% last year, you may only end up making 10 or 15. You pay something for the insurance basically."