When you hear the word investing, your thoughts may drift to stocks and bonds. But as much as we associate investing with the stock and bond markets, there’s a much broader world of investments out there, expanding beyond traditional assets traded in public markets. In fact, these alternative investments can go a long way toward helping investors build a well-diversified portfolio.
Beyond stocks and bonds
In the past, investors relied primarily on stocks and bonds. This tended to work well, since stocks and bonds often had an inverse relationship—when stocks went up in price, bond prices tended to fall. However, this relationship has gotten more complex over time. These days, it’s common to see stocks and bonds rise or fall at the same time. In other words, stocks and bonds are more correlated now than they have been in the past.
When it comes to building a diverse portfolio, uncorrelated assets are key. If one asset class falls, it’s helpful to have another investment that’s unaffected, or may even increase in value.
Part of the appeal of alternative investments is that they tend to be less correlated to the market than more traditional investments. Uncorrelated (or inversely correlated) investments can help protect investors from market volatility.
Another appealing quality of alternatives (often shortened to “alts”) is that they’ve grown in both popularity and accessibility over the past decade.
What are alternative investments?
Broadly speaking, alts are any investments outside the typical categories of stocks, bonds, and cash. It’s a term that can include investments such as:
● Private equity funds, including venture capital.
● Private debt.
● Real estate, including both physical property and funds.
● Hedge funds.
● Structured products, including mortgage-backed securities and swaps.
● Commodities, including gold.
● Digital assets, including cryptocurrencies, such as Bitcoin.
● Collectibles, including art, wine, vintage cars, and more.
While alts can refer to any of these things, the definition tends to shift with more sophisticated investors. Certain alternative investments require a minimum net worth or income to access. Keep this in mind when reading about alternative investments in mainstream media versus what an advisor might recommend based on your personal circumstances.
Can you invest in alts?
Many alternative investments are subject to different regulations than traditional investments in public markets. Different regulatory standards mean the SEC limits who can access these investments to protect retail investors. For instance, not everyone can invest in a hedge fund.
There are a few tiers of access for alternative investments. Each category can help you gain access to alternative investment opportunities.
● Accredited investors: Net worth greater than $1 million (excluding primary residence) or an income greater than $200,000 ($300,000 if married).
● Qualified clients: Net worth of at least $2.2 million and $1.1 million in assets with the advisor handling your investments.
● Qualified purchaser: Net worth greater than $5 million.
Keep in mind: These thresholds are subject to change; regulators adjust them periodically.
The pros and cons of adding alts to your portfolio
We started this article with some of the benefits of investing in alts, but there are more pros to consider:
· Diversification. Alts are one of the better methods of diversifying your portfolio. It’s a diverse category of assets, many of which aren’t correlated to the S&P 500—meaning when the stock market zigs, your alternative investments might zag.
· Access to private markets. Private markets contain some of the same risks as public markets, but they operate differently and have the potential to be highly lucrative.
· Potential for higher returns. The risk implied in some of these more sophisticated strategies is offset by the potential for higher returns.
Of course, there are drawbacks to consider as well.
· Illiquidity. Alternative investments tend to be less liquid than traditional stocks. Selling these investments can be complicated; your money may be locked up for a predetermined amount of time, and exiting early could come with penalties.
· Lack of transparency. Traditional investments tend to come with a certain amount of transparency that doesn’t necessarily translate to alts. Hedge funds have different reporting requirements than mutual funds, for example, and private companies may not share detailed financial statements on a set schedule.
· Complicated tax returns. The IRS hasn’t completely kept pace with the growing popularity of alternative investments. Depending on the type of alts you own, there may be tax complications, including delayed tax reporting. Working with a tax professional who specializes in this type of investing can help tremendously.
There are ways to invest in alts that avoid some of these drawbacks. For instance, you might buy a commodity ETF, which trades like a stock, offers significant transparency, and provides exposure to an alternative asset class. Real estate investment trusts can offer exposure to property markets without making a direct investment.
Should I invest in alts?
Generally speaking, yes. When added to a portfolio of stocks, bonds, and cash, alternatives can play an important role in diversifying a portfolio.
How a portfolio is allocated among those different components, and which alternatives make the most sense, will vary greatly based on you and your goals. For instance, if you aren’t qualified for more sophisticated alternative investments, there are other ways to add alternatives to your portfolio, including commodity ETFs, real estate investment trusts (REITs), and so on.
At Quorum, we’re constantly researching new alternative investments and determining which might make sense for our clients. We know alternatives are a vast and sometimes complex field, which is why we prioritize research and due diligence when considering new investment opportunities.
If you’re interested in alternative investments, we can help you determine which, if any, opportunities might work for you based on your unique tolerance for risk; cash flow requirements; goals; and other factors. Set up a call to discuss.
