Despite the recent debacle over cryptocurrencies, some advisors are recommending other sorts of alternative investments for their everyday retail clients. It’s become easier to access these largely unregulated assets, but are they really a good idea for retail investors?
What Are Alt Investments?
For the most part, alt investments are assets that aren’t publicly traded the way stocks, bonds and even currencies are. In the past, they were only available to institutional investors and accredited individuals—i.e., those people classified by the SEC as qualified to invest in complex or sophisticated types of securities because of their wealth or some other reduced need for regulatory protections.
Broadly speaking, alternatives include private equity, private debt, venture capital, hedge funds, managed futures, commodities, derivatives, real estate, and tangible assets such as antiques and art.
The Appeal Of Forbidden Fruit
The temptations are enough to make any investor’s mouth water.
“In the past 10 years, venture capital investments have returned in excess of 22% annually, and private equity has returned in excess of 17% annually,” said Michelle Connell, president and CIO of Dallas-based Portia Capital Management, citing figures from JPMorgan and Bloomberg. In contrast, the average annual return of the S&P 500 over the most recent 10-year period was about 8.3%.
Still, these investments aren’t right for everybody.
Alt Funds
Often, the easiest way to access alternatives is through dedicated mutual funds and exchange-traded funds. Alt mutual funds operate “just like any other mutual fund—you can easily buy and sell them, incorporate them into model portfolios and rebalance them,” said Jeff Nauta, a principal and chief compliance officer at Henrickson Nauta Wealth Advisors in Grand Rapids, Mich. “Because mutual funds offer daily liquidity, they are generally only going to focus on the most liquid alternative classes.”
A less liquid option is the interval fund, a closed-end fund (with a fixed number of shares) that has a high minimum investment (usually $10,000 on up) and high expense ratio. Interval funds can invest in almost any type of alternative asset, and some have applied to the SEC to become more publicly available.
“Generally, you can buy an interval fund on a daily basis but can only redeem shares on a quarterly basis,” said Nauta. This lack of liquidity, however, can also mean higher returns. “Because they can invest in less liquid assets, interval funds can provide access to a broader range of uncorrelated sources of return,” he said—meaning the investments won’t perform in lockstep with mainstream capital markets.
Private Alt Funds
Nowadays, retail clients also have access to a variety of private funds. Essentially, these are “feeder funds,” said Nauta, which channel money to investments that normally require high minimum investments.
If you’re not ultra-wealthy, the way to access these private funds is through a technology platform. For a fee, these platforms are able to accept lower minimum investments because they pool capital from different investors.
Technology Platforms
For instance, New York-based iCapital is a technology platform that recently announced a suite of private equity funds “specifically tailored to the lower end of the high-net-worth investor profile,” said Steve Houston, the firm’s managing director and head of investment products.
These funds, he said, “offer strong diversification, have lower investment minimums than traditional private equity funds, and have near-term distributions [meaning your money isn’t tied up for years on end], all of which are characteristics that are important for wealth managers who are working with clients a little farther downstream” from the ultra-wealthy.
CAIS, another New York-based fintech company, provides access to hedge funds, private equity, private credit, structured notes, digital assets, real estate and a variety of other alternative assets. In addition, it assists advisors in creating their own customized alt funds.
Diversification Benefits
Andrew Snyder, a director in product and research unit at CAIS, said alternative assets generally offer diversification benefits.
Private equity funds, for example, frequently outperform their publicly traded counterparts, he said, while hedge funds can provide protection during economic downturns. “Specific alternative investments can often be utilized to solve for specific portfolio outcomes,” he explained, “such as enhancing returns, diversifying risk and supplementing income.”
Christopher Zook, chairman and CIO of Houston-based CAZ Investments, argues that private credit funds are a good way to generate yield without the same degree of risk as private equity funds. With private credit, you lend money to a company in exchange for interest payments, and you can secure that debt with collateral, whereas private equity involves owning all or part of a company. Private credit is also comparatively short-duration, said Zook, and therefore somewhat more liquid.
Ramin Kamfar, the founder and CEO of New York-based Bluerock, said his firm offers several alternative funds designed to provide “new sources of tax-efficient income while combating volatility and rising inflation.” They include Bluerock’s Residential Growth REIT, a real estate investment trust focused on developing and acquiring high-end residential properties; Bluerock’s Total Income+ Real Estate Fund, a diverse portfolio of private equity real estate securities; and Bluerock’s High Income Institutional Credit Fund, a collection of collateralized loan obligations—securities backed by diversified pools of debt.
Other Options
Steve Brennan, head of private wealth solutions at Hamilton Lane in Conshohocken, Pa., favors private equity. “Our data shows there are over 95,000 private companies around the world with revenues over $100 million, compared to only 10,000 public companies with similar revenues,” he said. “That disparity creates a target-rich environment for private equity.”
But traditional private equity opportunities could require a minimum initial investment of $5 million or more, he said, and a commitment of at least 10 years. In contrast, his firm created a private equity fund with initial investments of $50,000 and up, and the withdrawals “can be requested on a monthly or quarterly basis,” Brennan said.
At FS Investments, an alternative asset manager in Philadelphia, chief market strategist Troy Gayeski said a “credit REIT strategy,” as opposed to an equity REIT strategy, can produce “higher income [with] less downside risk. … Everyone who embraced the right alternatives as a substitute for fixed income the past six years has a big smile of their face.”
A Variety Of Shapes, Colors And Sizes
Clearly, alternative investments “come in a variety of shapes, colors and sizes,” said Ashton Lawrence, a partner at Goldfinch Wealth Management in Greenville, S.C. “It’s best to evaluate each individually … to know what exactly you are investing in and in what environment it can work well.” He compares it to choosing the right tool for a specific job. “If I take a hammer and try to flip pancakes in the kitchen, I’m going to have a bad experience,” he said.
Because of the wide range of choices, though, alt investments “can be suitable for a wide range of investor types and risk tolerances,” said Rob Young, senior investment analyst at Telemus Capital in Chicago.
Caveats
Still, the need to exercise caution cannot be overstated. Most alternative investments aren’t regulated, and they can be confusing. “In most cases, there is limited transparency [in] the underlying financials,” said Robert Davis, partner and chief investment officer at Round Table Wealth Management in New York.
For the uninitiated, the management fee may come as a shock, too. “It can range from a higher flat fee to a management fee plus profit percentage, called ‘carry,’” said Jennifer DeSisto, chief investment officer at Boston-based Anchor Capital Advisors.
Thais Gruenwald Gaspar, global alternative investment strategist at Brainvest Wealth Management in Miami, is similarly cautious. “Unless an investor is willing to hold the asset for years, he or she should not invest in alternatives,” she stressed.
With Greater Diversity Comes Greater Costs
Some take a more philosophical approach. Alternative assets “can help improve the diversification of a portfolio, [but] a long-short fund that mimics hedge fund strategies is not an asset class but a trading strategy,” said Michael Finke, professor of wealth management at the American College of Financial Services in King of Prussia, Pa.
Thus, he said, it’s a strategy whose time may have passed. “Even institutional investors have had a hard time earning excess returns from hedge funds in recent years,” said Finke, adding, “This is good news for most investors, since they don’t need to feel like they’re missing out.”
Dan Ziznewski, a director at Homrich Berg in Atlanta, suggested clients and their advisors consult an expert who “has experience investing in alternatives, dedicated resources focused on sourcing and performing due diligence, and the ability to provide clients compelling opportunities across alternative asset classes without charging any additional fees.”