An Introduction to Alternative Investments

By Hightower Westchester on January 3, 2022

As holistic wealth advisors that firmly believe in asset allocation one area that we invest in but is often not fully understood are alternative investments. In our investment universe, there are four main investment areas: Stocks, Bonds, Cash and Alternatives. Now I can be a wise guy and say alternatives are anything that are not the first three on the list, and in full disclosure, that is usually my standard answer, but today I’m going to provide an overview as alternative investments are very broad in nature and when properly added to a portfolio, can provide a solid stream of diversified returns along with some very different risk profiles.

Let’s start with some broad categories and descriptions:

• Private Equity – these are investments in private companies. Generally, we use funds to invest in a diverse portfolio of private companies as opposed to trying to buy just one, and typically the only way to access these is in a private illiquid investment vehicle.
• Private Debt – fixed income or bonds in private companies, same as above but instead of owning the stock of a private company, you own the debt like a bond. Private debt would be accessed through an illiquid fund vehicle as well.
• Venture Capital – investments in newer private companies.  These companies tend to have rapid growth but little profit. Venture capital investments can provide great upside but come with lots of risk.
• Hedge Funds – these are like mutual funds in that the portfolios consist of pooled funds from multiple investors; however, they are only offered privately. Because of the different regulations, hedge funds come in all shapes and varieties and look at their investments through a very different lens. They can be very aggressive or very conservative, there is no one size fits all.
• Real Estate –These investments can be accessed via a public real estate investment trust (REIT) that trades like a stock, a mutual fund or in a private vehicle. Buying a publicly traded REIT can be more volatile even though the underlying asset value may not change in value, but the stock market will do that to any stock on any day. Think about real estate, the value doesn’t change minute to minute.
• Precious metals/Commodities – gold, silver, oil, etc.  Think of any type of single commodity, either precious or industrial. Most have some sort of investment vehicle where an investor can purchase them. However, many are not very indicative of the underlying price as many use futures to price the asset and the futures market. Some of these investments track the underlying asset very closely and others can vary widely, so be sure to understand what you are buying.
• Managed futures/CTAs (Commodity Trading Advisors) – these funds/managers invest almost exclusively in the futures markets. They can generally invest in futures of stocks, bonds, commodities, and many other areas. These are highly specialized and typically have a negative correlation to the equity markets, meaning when the markets go down, they generally go up. While these are typically a small allocation in our portfolios, we find them very important to help balance a portfolio and provide some level of risk mitigation.

This is by no means a complete list of alternative investments, but it covers a very broad spectrum of the types of investments one can make in the space.

Keep a few things in mind when investing in alternatives:

1. Liquid vs. illiquid. Some of the above can be purchased like any other stock or bond and have daily liquidity (the ability to be turned into cash). Some can only be purchased in an illiquid fashion, meaning that your ability to get your money out can be constrained. This is something we discuss with our clients prior to any investments being made so they know if the investments we are recommending are liquid or illiquid.
2. Some of the above investments that are liquid can be purchased by any investor regardless of net worth. Others, particularly illiquid investments, do require what is known as suitability, and the SEC has defined two types: Accredited Investor and Qualified Purchaser. Without going into the weeds, the difference has to do with net worth and income. Generally, Accredited investors have a liquid net worth of $1 million or more (excludes your home) and Qualified Purchasers have a liquid net worth of over $5 million.

Just like any investment, there are distinct risk and return characteristics of alternative investments and when blended into a diverse portfolio can enhance returns, reduce risk, and smooth the ride. As always, feel free to reach out with any questions or if would like to discuss this further. 

Peter Lang – Managing Director, Partner – Hightower Westchester

914-825-8631 – plang@hightoweradvisors.com