Traditionally, when we think about building a robust investment portfolio, our minds often gravitate towards familiar territory: stocks and bonds. These have long been considered the foundational building blocks for investors.
Yet, in many ways, our economy is built on private markets. Consider this: over 87 percent of domestic companies with annual revenues over $100 million are private. This means that by solely focusing on public markets, investors are missing out on a vast majority of the economic activity within our country. Gaining exposure to the full economy happens through private markets, not just the 13 percent that you see in the stock market.
Additionally, stocks and bonds do not always provide investors with sufficient diversification or deliver the long-term risk-adjusted returns many investors are seeking. To further diversify a portfolio and explore additional sources of potential return, it’s worth considering alternative investments.
1. Alternative Investments Explained
So, what are they? Simply put, an alternative investment is an investment in a private market. Conceptually, it’s not drastically different from investments in public companies. Unlike publicly traded stocks or bonds, however, these assets aren’t bought and sold on major exchanges every day.
Alternative investments can include a diverse array of categories, including private equity, private credit, infrastructure, and private real estate. Essentially, it’s about investing in private companies with a long-term focus to add value and diversify portfolio exposure.
2. Benefits of Alternative Investments
“Alternative investments may offer certain advantages for investors seeking diversification beyond public markets. One of the most significant benefits is their low correlation to the public stock and bond market. This can help lower volatility within your overall portfolio. When traditional markets experience downturns, alternative assets often behave differently, providing a valuable cushion and reducing overall portfolio swings.
Furthermore, depending on the asset class and strategy, certain segments of the private markets have historically exhibited higher risk-adjusted returns compared to traditional investments, particularly over longer time horizons. This combination of return potential and lower correlation to public markets may help enhance diversification and contribute to more stable long-term portfolio outcomes, depending on the overall strategy and market environment.
Beyond these core benefits, alternative investments offer several other attractive features, including the potential to:
- Serve as an inflation hedge, helping to preserve purchasing power during periods of rising prices.
- Provide income for portfolios through consistent distributions.
- Bring appealing tax benefits through pass-through depreciation and long-term capital gains, which can further enhance after-tax returns.
3. The Breadth of the Economy: Beyond Public Markets
For years, traditionally institutional investments like pension plans, endowments, foundations, and single-family offices have been allocating to these private markets for many years and realizing their benefits. They understood the long-term value and diversification opportunities. However, accessing these investments was once a significant hurdle. It took significant research, access to the right networks, and large chunks of capital to really gain access to these investments.
Fortunately, the landscape is evolving. Recently, we’ve seen the democratization of the alternatives market through the following three trends:
- Increased technology
- Product innovation
- Lower minimums
These developments have expanded access for high-net-worth investors, allowing them to consider incorporating alternative investments into their portfolios and explore strategies that align with their long-term financial goals. This increased accessibility means that a wider range of investors can now tap into the broader investment opportunities available in private markets.
Newer fund structures, such as interval funds and tender offer funds, have also played a key role in making alternative investments more accessible to individual investors, offering periodic liquidity events that were previously unavailable in traditional private equity or real estate funds.
4. Understanding the Risks
While the benefits are compelling, it’s important to acknowledge that there are certainly risks associated with alternative investments. One of the primary concerns is a lack of liquidity. Since these are investments in private companies, we want a longer time horizon to give those companies a chance to grow and realize return on the investment. Unlike public stocks that can be sold with the click of a button, divesting from alternative investments often requires a longer timeframe, potentially years.
There’s also risk through the complexities of these investments. It can be more difficult to value companies in the private markets versus in the public markets where they’re being traded every day. So, there’s a difference in pricing and some lack of transparency. This inherent complexity demands a higher level of due diligence and understanding from investors. The performance of alternative investments can also be highly dependent on the skill of the fund manager, making manager selection an integral component of success.
5. The Importance of Due Diligence
As alternative investments become more accessible, they offer qualified investors opportunities to diversify beyond traditional public markets. While these strategies can introduce valuable portfolio benefits, they also come with unique considerations, including limited liquidity, complex structures, and a higher degree of manager variability. That is why due diligence is essential. At Moran Wealth Management®, we take a disciplined approach to evaluating alternative investments, with a focus on understanding the underlying strategy, assessing operational integrity, and ensuring alignment with our clients’ long-term financial objectives.
To learn more, check out our educational video [here], where Chelsea Ganey, CFA® and Chief Strategy Officer at Moran Wealth Management®, breaks down the world of alternative investments and why they might deserve a place in your portfolio.
Sources
Advisorpedia: “Number of U.S. Public Companies v. Private” Jan. 12, 2024
https://www.advisorpedia.com/chart-center/number-of-public-companies-v-private-us
This commentary is for informational purposes only and does not constitute investment advice, a recommendation, or an offer or solicitation to buy or sell any securities. The views expressed are those of the author(s) as of the date of publication and are subject to change without notice. Past performance is not indicative of future results.
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