What are Alternative Investments?

 

Within the asset management industry, the term alternative investments is applied broadly to encompass everything that exists outside of the traditional asset classes of equities (stocks) and fixed income (bonds and cash). Alternative investments tend to fall into four broad categories:

• Private Equity (includes Venture Capital)
• Real Assets (includes Real Estate)
• Private Credit
• Absolute Return Strategies

 

Alternative investments are largely synonymous with private investments, but there are caveats.

 

Certain alternative asset classes such as real estate and commodities have long been investible through public mutual funds and ETFs. Many strategies within alternatives, however, are incompatible with the regulatory constraints that apply to these highly-liquid, retail-oriented investment products. Alternative asset managers have historically avoided regulation by offering their strategies exclusively to “accredited investors” and “qualified purchasers.” Those labels are defined by the SEC, and signify that those investors possess sufficient investment expertise and/or sufficient financial wherewithal to take on the incremental risk and complexity associated with investing in alternatives.

 

The trend within the asset management industry is toward broader availability of alternatives.

 

Recent industry developments have made a greater number of alternative investment strategies available to a broader set of investors through mass-market investment products like mutual funds, ETFs, BDCs, interval funds, and others. Despite this trend, the most sophisticated and well-resourced institutional investors still primarily choose non-retail avenues, or private placements to gain exposure to alternatives. This reflects an implied belief that the best returns are more likely to come from the least-constrained forms of investment within alternatives. At 1834, we have built an alternative investment platform that provides our clients with access to institutional-quality strategies via private placement vehicles across each of the categories listed above—private equity, real assets, private credit, and absolute return strategies.

 

Due to their illiquid nature, participation in alternatives should be approached with a long-term mindset.

 

Commitments made to private capital funds (i.e. private equity, venture capital, private real estate, private credit) are legally binding. The documents signed by investors, called subscription agreements, typically lay out a ten-year plan for identifying investments, deploying capital, managing investments, and finally, liquidation and return of capital. Provisions commonly included in those documents also establish the manager’s ability to extend the life of the fund incrementally at their discretion. The life cycle of a private equity fund, therefore, has historically averaged well beyond ten years.

 

Harboring a long-term view from the outset leads prospective investors toward the best possible outcomes. In addition to illiquidity, investors must understand and anticipate other important aspects that are unique to alternative investments, including:

• Infrequent reporting from asset managers means going months without valuations or portfolio commentary, and when information is provided, it’s typically months after the relevant as-of date, all of which equates to a general lack of transparency and lagged information.
• Higher fees paid by investors to the general partner(s) who manage private capital and hedge fund assets; industry norm has long been 2% management fees, plus a “carry” fee, which is a share of positive returns kept by the manager, however the overall trend has recently been toward lower fees.
• Added complexity for annual tax reporting—in particular, Form K-1s are generated by the limited partnerships through which most private capital and hedge funds operate, and most are not provided to investors until after April 15th, meaning late tax filing for investors and requiring an extension each year.
• Vintage year diversification is a consideration unique to private capital investing, and requires investors to deploy their capital incrementally over time in a strategic manner to avoid over-exposing their portfolio to a particular entry point within the market cycle.

 

The long-term nature of private capital means that these new considerations will become a part of the investor’s financial life over the long haul, and this is something that should be understood with absolute clarity before proceeding. Whether the benefits of investing in private capital justify taking on this type of complexity is something each investor must weigh and decide for themselves. It cannot be determined with a mathematical formula.

 

1834 is here to help determine whether an investment in alternatives is right for you.