Not so long ago, only the ultra-wealthy and large institutions such as banks and public pensions had access to alternative investment opportunities. Today, almost any individual investor has access to these versatile investment tools. However, the key question is, are alternative investments right for you?
Before deciding, let’s take a look at what an alternative investment really is and its potential impact on an individual investor’s financial portfolio.
According to the Huffington Post[i], alternative investments are investments in assets other than stocks, bonds and cash, essentially investments using strategies that go beyond traditional ways of investing. Gratus Capital Chartered Alternative Investment Analyst and Director of Investments Todd Jones, MBA, CAIA agrees.
However, Jones takes the definition a step further.
“At Gratus Capital, to be considered an alternative investment, the investment vehicle must not exhibit a correlation of greater than 0.60 to either the stock or bond markets in any rolling three-year period,” said Jones. “Otherwise, we exclude the investment from our universe of alternative investments when making selections for client portfolios. Alternative investments are meant to provide diversification and a unique income stream return. In fact, we don’t expect alternative investments to outperform the equities or fixed income markets. Instead, our approach is to identify alternative investments that, on average, have returns that are no greater than the equities markets and no lower than the fixed income markets.”
Jones also believes that almost every portfolio should include at least a small amount of alternative investments because of the diversification value typically generated by this asset type.
Legitimacy of Alternative Investments
“There has been a multitude of alternative investments entering the financial marketplace compared to just three years ago,” said Jones. “Individual investors should be very cautious. Roughly 95 percent of alternative investments available today engage in strategies that provide minimal benefit to a portfolio. Far too often the investment doesn’t perform as described, the return is too low, or the fees are too high.”
Types of Alternative Investments
There are many different types of alternative investments. Sang H. Lee of The Street offers the following examples:
- Venture Capital
- Private Equity
- Hedge Funds
- Real Estate Investment Trust (REITs)
- Real Assets: precious metals, rare coins, wine and art
Jones cautions investors who are contemplating alternative investments such as art, rare stamps, or wine, because the values of these assets are mostly driven by personal taste and sentiment. Instead, Jones recommends that investors focus on alternative assets that can be deeply analyzed: specifically, assets that have ample data to forecast valuations and output key metrics and trends.
Today, we’ll discuss three alternative investment strategies:
#1 – Interval Mutual Funds
InvestmentNews offers the following definition: Interval Mutual Funds[ii] are mutual funds that offer daily purchase for investment but liquidity for limited redemptions at specific intervals (usually quarterly). This change to the mutual fund structure creates large advantages: the fund can simultaneously invest in both private and public assets in a structure that has a liquidity feature and a daily net asset value. This allows the sponsor to create a portfolio of investments that may provide higher levels of yield and noncorrelation to equities, but without the illiquidity and lack of price transparency.
#2 – Private Equity
Financial news giant Investopedia provides the following definition: Private Equity[iii] is capital that is not noted on a public exchange. Private Equity is composed of funds and investors that directly invest in private companies or that engage in buyouts of public companies, resulting in the delisting of public equity.
Typically, private equity investments have been limited to large institutional investors or a person or organization that can allocate at least five million dollars to one single idea or asset. However, access to private equity investments is becoming more of a necessity for mass affluent investors, said Jones.
Recent news coverage of disappointing IPO offerings for private companies such as Blue Apron[iv] and Snapchat[v] is spurring other profitable private companies to remain private, limiting investment opportunities for investors.
“Now, quality companies that would typically go public early in their business lifecycle are remaining private much longer,” said Jones. “This is problematic for investors, since it limits investment opportunities, especially ones that substantially help an investor to diversify their portfolio.”
Amazon went public in 1997. The company’s valuation at the time was approximately $300 million. Today, it’s roughly a $300 billion dollar company. However, all the growth that has happened since Amazon’s public offering has led to massive investment opportunity and growth for individual investors, according to Jones.
With many large private companies retaining their private status, financial advisory firms are creating new opportunities for their clients.
“Back in 2013, Gratus Capital began formulating ways to gain access to private investment returns,” said Jones. “We began forming limited partnerships for our accredited investors, in order to gain access to existing private investments. This past June, we raised capital and closed our first fund that focuses on private debt and credit as well as private real estate. Our subsequent funds will more likely have a capital appreciation focus. We see these limited partnerships as a necessary evolution of our services if we’re to help our clients achieve targeted rates of return. Specifically, we’re seeking to access illiquid markets that are private and that generate above-average market returns.”
#3 – Hedge Funds
Hedge funds use pooled funds of underlying securities to earn returns for investors. According to Investopedia[vi], the most cited reason to include them in any portfolio is their ability to reduce risk and add diversification. Also, a hedge fund that provides consistent returns increases the level of portfolio stability when traditional investments are underperforming or, at most, are highly unpredictable.
BarclayHedge[vii] reminds investors that hedge funds are not currently regulated by the U.S. Securities and Exchange Commission (SEC). The financial research firm adds that hedge funds can invest in a wider range of securities than mutual funds can. While many hedge funds do invest in traditional securities, such as stocks and bonds, they are best known for using more sophisticated (and risky) investments and techniques.
Choose Alternative Investments that Align with Individual Goals
- To mitigate the effects of stock market volatility
- To lower correlation to traditional stock and bond markets
- To invest capital for a longer time frame in exchange for higher return potential
- To hedge a portfolio against inflation or rising interest rates
At Gratus Capital, we believe that almost every financial portfolio should include some level of alternative investments specifically to sustain diversification and separation from the stock and bond markets.
Alternative investment strategies are not to be taken lightly, particularly when deciding between liquid and illiquid assets. Overall, it’s important to focus on what you’re seeking to achieve within your financial plan and how much risk you’re willing to take.
Alternative investments tend to come with higher risk; however, they can also come with greater than average returns. If you have questions about alternative investments or your overall lifetime financial plan, please contact us.
The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal, or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you or your business.