The term “alternative investment” can encompass a variety of investment strategies including real estate, private equity, hedge funds, infrastructure, leveraged loans etc. We often advocate for alternative strategies over traditional investment vehicles because alternative investing is highly dependent on the individual skill of a specific manager or management team. For example, private equity funds exist to pursue individual companies that often rely on the expertise of the general partners to select the best opportunities currently available in the private market. While active management could bring additional risk to a portfolio, it also provides investors with an opportunity to experience extraordinary gains. Achieving a successful outcome in an alternative investment portfolio demands expert advice which provides an opportunity for the Alternative Investment Store to add value for the advisors we serve.
A second reason that we prefer alternative investments to traditional asset classes is because alternative investment managers have greater flexibility to exploit market inefficiencies compared to their mutual fund counterparts. Imagine the angst experienced by managers of tech funds in 2001 and 2002, or Large Cap Mutual Fund managers in 2008 and early 2009. By prospectus, these fund managers were required to watch the value of their funds disappear. Their hands were tied.
Now imagine the hedge fund manager who had the freedom to go short against the same companies held long in mutual funds. Though freedom doesn’t guarantee profit or ensure against a loss, it does give the investment manager and their investors a fighting chance.
Most of the alternative investment managers with whom we partner have a considerable amount of their own net worth tied up in the fund they manage. This places the investors and the general partners on the same side of table; such a relationship rarely exists with traditional funds. It is perplexing as to why this aspect of alternative investing is often overlooked.
Alternative investments may carry risks that traditional strategies do not experience. Once an investor makes an allocation to an alternative manager, they often may not have access to those funds as alternative managers usually require investors to stay invested for a certain period of time. Greater investing freedom may increase the potential for fraud and misuse of funds. It takes time to develop trust between an investor and the general partners. It’s the reason why the capital raising cycle for alternative investments is often longer than funds raised in an open-end or close-end mutual fund. Finally, the greatest challenge investors and their advisors face with alternative investments are assessing the real values of the assets held in the portfolio. The performance of an alternative investment such as a private equity fund can only be determined upon the sale of the portfolio companies. Upon the sale of these portfolio companies, if the skill set of the manager is proven to coincide with the investment objective of the fund, investors should be rewarded for their participation. I
According to a Morningstar / Barron’s Report on Alternative investments that was completed in 2013, 22% of Financial Advisors hesitate to invest in alternatives because of a “lack of clarity on how strategy works in portfolio framework”. It seems to me, that if financial advisors do not use investments like the ones described in the preceding paragraphs, is not because the Investments are “bad” or “too risky” – but due to a lack of education in portfolio planning that includes these alternative asset classes. As I have repeated in prior articles, alternative investments are here to stay. I challenge the advisory community to begin to educate themselves and their clients, on the many significant benefits of utilizing alternatives in their portfolios.
We will outline these benefits in the upcoming weeks…