An increasing number of financial advisors advocate using alternative investments in client portfolios as a way to increase diversification, according to the 2010 Rydex|SGI Annual AdvisorBenchmarking Study.

Approximately 71% of the advisors surveyed advocate using alternatives for their clients, with 19% having at least half of their clients invested in alternatives. Diversification is continues to be the main driver for advisors using alternatives. In 2007, 60% of advisors surveyed cited diversification as the primary reason for investing in alternatives. In 2009 that number rose to 76%.

The study also showed that advisory firms that use alternative investments often have more clients and assets under management compared with those who use little to no alternative investments. Firms that allocate at least 10% of client portfolios to alternatives had on average 536 clients and $651 million in AUM. Those with less than 10% allocated to alternatives averaged 436 clients and $223 million in AUM.

The study suggests that the use of alternatives will only increase in the coming years. More than half (61%) of advisors expect to increase their use of alternative investments in the next three years, while only 2% expect to decrease their current usage. The average advisor’s typical client portfolio had 8% invested in alternatives and 11% invested in alternative asset mutual funds. Most RIAs surveyed currently advocate using alternative investments either for many clients (46%) or for a select few clients (24%).

Salvador Flores, principal of Flores Capital Management in Chandler, Ariz., began investing in alternative assets three years ago. Every one of his clients has some form of alternatives in their portfolio. Allocation depends on the person—age, where they are in terms of distribution, etc.—but they have at least 10% allocated to alternatives as an introduction. This could mean hedge funds, commodities, private equity, real estate or other alternative strategies.  Flores says that alternatives are an effective way to introduce another sleeve of investments in portfolio that can give consistency to a portfolio and help mitigate risk.

“Back in the old days you could buy stocks and bonds and some real estate and do ok, but today you have to look at some alternative investments as well,” Flores told Financial Planning magazine in October.