Investors seeking new paths to diversify their portfolios are increasingly turning to alternative investments. But what exactly are they, who are they best suited for and what considerations should you keep in mind?
Goodbody & Associates
“Alternative investments are investment options outside of traditional investments such as stocks, bonds and cash,” said Heather Goodbody, CEPA, managing director, Goodbody & Associates, Merrill Private Wealth Advisor. “Alternative investments can include private equity, hedge funds, real estate and more.”
To complement a diversified portfolio, Goodbody & Associates have been investing in alternative investments for clientele for many years.
“In recent years, the reduced minimums for alternative investments have made them more accessible, however, you do need to be an accredited investor and/or qualified purchaser for the opportunities,” she said. “As investors become more informed of the opportunities, demand does increase. However, it is important to understand all details related to specific funds in space.”
When considering allocating to alternative investments – which are for accredited investors and qualified purchasers as defined by the Securities and Exchange Commission – Goodbody says it’s important to take into consideration a client’s risk tolerance, time horizon and liquidity needs.
“Investors should be very clear about the illiquid nature of alternative investments,” Goodbody said. “Oftentimes, there could be long commitments of capital, or, if you are invested in an evergreen like fund, you may be subject to specific timing and amounts related to accessing your capital.”
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In addition, she says it’s important to understand the actual investment being made. For example, is it a private equity fund, a hedge fund or a real asset fund? If so, how is the fund allocated and what is the investment objective of the fund?
“When working with an advisor team, it will be important to understand the due diligence process that is used to formally vet the alternative investment as a viable opportunity,” Goodbody said. “Such due diligence process not only encompasses the validity of the Fund, however, but the validity of the firm also offering the investment along with their respective management team.”
Thorley Wealth Management
Elizabeth Thorley, CFP, founder and CEO of Thorley Wealth Management reflects that the alternatives industry pre-great financial crisis was largely isolated to institutional investors and individuals of extreme wealth, but post-crisis there has been overwhelming demand from investors to expand their opportunity set via alternatives and with a proliferation of retail-friendly structures.
She cautions that while alternatives are becoming more accessible, they are not a panacea and bring with them unique risks that are often not broadly known.
“Alternatives are not solely for enhancing returns,” Thorley said. “In fact, most investors of alternatives are seeking them for diversification purposes as the main reason for addition to their portfolios followed by capital appreciation and income.”
She notes that many alternatives are designed to reward investors over a full market cycle rather than providing immediate large returns. This is due to several reasons such as managers are often focused on idiosyncratic opportunities which take time to play out rather than making directional calls on the market.
“I think people are attracted to alternatives because they see the high rates of results and the high rates of return, but those have been achieved over a period of time,” Thorley said. “They’re not typically something that you’re going to go into and see huge results in a short period. So, you should look at it as a longer-term investment in your portfolio.”
LVW Advisors
When it comes to alternatives, the goal is to diversify risk in a portfolio or improve returns, and in the best case you can do both, says , CIMA, and founder and CEO of LVW Advisors.
“LVW has been investing in alternatives since the 1990s; however, the demand has definitely increased as they have become much more well known,” Van Dusen said. “The tricky part is that the financial industry often oversimplifies alternative investments, potentially misleading investors. Many products marketed as ‘alternative’ may not provide true diversification or improve returns.”
Van Dusen cautions that because so much can get placed under the alternatives umbrella, it can be risky for investors if they don’t understand what the vehicle is and what they own.
“These investments need to be stress-tested within a portfolio and are best handled by professionals, as you could be layering more risk, diluting your returns, and paying more for the privilege,” VanDusen said.
She notes there are also legal classifications that allow an investor to buy and sell securities that are not registered with financial regulatory authorities and come with inherently higher risk.
“In my opinion, the wider availability of alternative investments to the average person is not necessarily a good thing,” she said. “There’s no magic bullet that you can put into a portfolio. You or a professional advisor must do the work to understand what already exists in the portfolio and how this investment will impact it.”
In addition to understanding that alternative investments require careful thought and understanding Van Dusen offers the following other considerations and actions for investors when it comes to alternatives:
• Thoroughly understand the underlying assets and strategies within an alternative investment. Simply relying on the ‘alternative’ label is dangerous.
• Evaluate how an alternative investment aligns with your specific goals and risk tolerance and consider factors like market volatility and interest rate changes.
• Look for alternative investments that offer access to specialized skills or strategies not available in traditional stocks and bonds.
• Understand that alternative investments often have limited liquidity, meaning it may be difficult to quickly sell them if needed.
• Assess your risk tolerance before investing in alternatives, as they can be more volatile than traditional investments.
• Know that alternative investments often have higher fees than traditional investments.
• Keep in mind some alternative investments utilize borrowing or financial leverage to amplify returns. This leverage can quickly work against you in an adverse environment and amplify the downside as well.
• Understand that alternative investments are generally more suitable for sophisticated investors who have the resources and expertise to properly evaluate them.
Caurie Putnam is a Rochester-area freelance writer.
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