Demystifying Alternative Investments

In this article, we explain alternative investments and why capital fundraising in this class now exceeds $73 Billion by retail investors as of 2023 ($115 Billion[1] estimated for 2024). ?What makes them different from other investments, and why has the industry grown in size over the recent decades?? Once perceived as suitable only for institutional, endowments, and ultra-high-net-worth investors, they’ve become increasingly popular and accessible considerations for retail portfolios.

“Alternative investments” differ from traditional investments typically represented in publicly traded markets, such as stocks, bonds, and cash.? Investments in “traditional” and “alternatives” have been available for decades, if not centuries.? What has changed is the availability and variety of alternative investment products and Sponsors, which will be covered later in this article.? Alternative investments include real estate and commodities, two of the oldest.

Today, such alternative investments include non-traditional approaches to investing within special vehicles, ?the flexibility to use derivatives and leverage, to make investments in illiquid assets, and to take short positions.? The design of certain alternative investment types, such as Delaware Statutory Trust, Opportunity Zone Funds, and others, may also have specific purposes in tax mitigation efforts.? Tax mitigation can delay the payment of investor’s taxes on capital gains and, in some cases, eliminate the obligation to pay entirely.

While there are exceptions, alternative investments are typically actively managed.? Alternative investments often have many of the following characteristics:

·???????? Restrictions on redemptions and lock-up periods (more extended hold periods).

·???????? Concentrated portfolios

·???????? Unique legal and tax considerations

·???????? The relatively low correlation of returns with those of traditional investments as measured by its “beta.”

·???????? Less regulation and less transparency compared to traditional investments

·???????? Generally deployed as a tool to moderate market and inflation risk.

·???????? Designed to outperform their benchmark, improved “alpha.”

Alternative Investments, a Deeper Dive

Definition:? To better understand an alternative investment classification, one must define what it is not.? A general definition of “alternative investment” is strategically investing in assets other than long-only stocks, bonds, and cash.? Being long-only has historically meant buying an asset with the expectation of price appreciation.?

The alternatives universe has five key asset classes: hedge funds, private capital, natural resources (oil & gas), real estate, and infrastructure.? While alternative investment purchases are intended for long-term hold, they can be complex, and their inherent benefit may not be solely price appreciation.? Many such investments have value to the investor as a tax mitigation strategy to offset other taxable events.? Alternative investments are frequently the result of a “Sponsor” or other such investment manager creating a project that may be a single property with a sizeable theoretical footprint that becomes fractionalized to many investors or a fractionalized fund that includes many assets that may differ by location or other demographic.?

Benefits of Investing in Alternatives

Many investors have become disappointed with the 60/40 portfolio model legacy, and alternatives tend to behave differently than typical equity and bond investments.? Adding them to a portfolio is anticipated (but not guaranteed) to help lower volatility (beta), provide broader diversification, and enhance returns (alpha).?? Some investors have reported that allocating a portion of their portfolio to alternative investments adds a hedge, a non-correlation, to the traditional market performance.? A potentially added benefit is that many such investments represent tangible assets that offer some inflation protection.

Reduced volatility results from the fund’s investment manager having a longer horizon to execute a plan and allow the underlying investment to develop, mature, and potentially reach the most opportune moment to capture the highest return.? By contrast, when investment managers have to meet more frequent demands for redemptions or reporting, they are obligated to short-term performance reporting or liquidity requirements that can cause diminished results.

Multi-asset funds have the inherent benefit of diversity of location, industry, or other characteristics that offset risks that affect the economic activity of a subset of properties but not all the fund’s assets simultaneously.? Delaware Statutory Trusts (DSTs), REITS, or UpREITS come to mind when a Sponsor assembles many smaller investments into a sizeable defined fund, sometimes exceeding 100 million dollars or more, with assets across many states.

With today’s alternative investments, smaller or more midsized investors often have investment opportunity exposure to projects or assets that would otherwise be beyond reach, available to only institutions, endowments, or other ultra-high-net-worth investors.? Professional skills and organizational efficiencies of their investment managers often result in lower costs and enhanced revenues.

What is Behind the Proliferation of the Alts

It’s estimated that the global alternative investment market (Assets Under Management, AUM) in 2023 is $15 trillion, a three-time increase from $4 trillion in 2010.? The continued popularity of Alts is seen as an exciting trend born out of the growing demand for alternatives versus the publicly traded markets.? In addition to those discussed earlier, other driving factors, such as the increase in private credit due to the pullback of traditional lending, give investors significant avenues of participation.? Private lenders are stepping up to the opportunity created by the vacuum of banks and conventional lenders, who find the new lending business model impossible to sustain.??

Reimagining Portfolio Rebalancing with Alts

Today, reapportioning retail investors’ portfolios to include alternative investments is becoming increasingly commonplace; however, managers have been following alternative investment models for decades for large portfolios.?

Modern portfolio theory has experienced considerable study and reengineering over the last 50 years.? Most notably, since 1985, David Swensen[2] and Dean Takahashi began stewardship of the Yale University endowment when its books showed assets of $1.3 billion.? Over the next 36 years, the endowment grew to over $40 billion, emphasizing diversification and a more long-term horizon to profit and earnings.? Known as the “Yale Model,” the methods and investment analysis have become a benchmark theory with those advocating alternative portfolio rebalancing.

Investment advisors recognize the need to prepare their tools, technologies, and practices to meet the demands of today’s investors.? Advisors are also increasingly aligning themselves with industry organizations such as the Alternative & Direct Investment Securities Association (ADISA) for training, support, and the public good.

Sourcing Alternative Investments

The private market nature of some alternative investments can be an obstacle to an investor’s acquisition.? Information about these investments tends to be decentralized and not readily available through traditional means.? Advisors avail themselves of industry conferences where valuable industry participants and Sponsors present their latest offerings.? In addition, multiple third-party due diligence firms are platforms that aid Registered Investment Advisors, Broker-Dealers, and Family Offices in disseminating information.

Conclusion

For many investors, incorporating alternative investments into a portfolio helps reach goals not otherwise addressed in a traditional 60/40 allocation.? The unique risk-return qualities of alternative investments can address gaps and vulnerabilities in conventional portfolios.? In addition to these portfolio benefits, certain alternative investments such as DST 1031s, Opportunity Zone, UpREITS, Oil and Gas, and other programs may provide significant tax benefits.

Alternative investment solutions seek enhanced alpha to generate income, mitigate inflation and tax exposures, achieve investment goals, and diversify portfolios.

Kenneth Millar is the Principal Managing Partner for Solomon Real Estate Investment (SREI) Group, which has offices in South Carolina and Arizona and offers national sales.? Over the past 20-plus years, Kenneth has immersed himself in the securities and real estate industries.? Kenneth holds licenses in Securities (7, 63, and 65), Arizona Real Estate Broker, and Arizona Life Insurance.

Securities are offered through Cabin Securities, Inc., Member FINRA/SIPC. ?Advisory Services are offered through Cabin Advisors LLC, a state registered advisory.? SREI Group and Cabin Securities |? Cabin Advisors are not affiliated.? Investing in alternative securitized products and properties involves material risks. ?Past performance is no guarantee of future results. ?Estimates of future performance are based on assumptions that may not be realized. ?Asset allocation does not ensure a profit or protect against a loss in declining financial markets.? Our firm and its financial advisers do not provide tax or legal advice. ?Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust, estate planning, and other legal matters.

[1] Kevin T.Gannon, Chairman of Robert A Stanger & Co, Inc July 24, 2024

[2] Pioneering Portfolio Management, David Swensen, January 6, 2009