The term alternative investment may sound odd at first, but it is simply any investment outside traditional asset classes which include stocks, bonds and cash. Alternative investments may include a venture capital firm investing in a biotech startup or owning interest in a professional sports team. The practice is much more common than you may think, with approximately 45% of wealth managers investing client money in these unique assets.
Below are outlined three major considerations one should take before investing in alternative investments.
A Value-Add Tool
Perhaps the most obvious reason that people invest their money is to increase the value of their portfolios and build upon their wealth goals. With alternative investments, advisors are able to individually tailor client needs and find investments that may not exist in traditional public offerings. Alternative investments make things like adjusting or improving risk levels, diversifying portfolios and bringing social and environmental considerations into view much more simple.
For example, if a client priority included increasing expected returns of an equity allocation, an advisor might consider investing in venture capital to do so more efficiently.
Before jumping into alternative investments, it is important to be aware of the disparity in performance between different advisors and fund managers. Investing requires a lot of trust, especially as it involves someone else managing your money. Thus it is important to be informed and choose your advisors carefully.
While top managers are able to outperform traditional public markets, less experienced managers will often underperform. Much of investing success depends on the advisor’s ability to pick the right manager and investment. This is especially important in venture capital, where top tier managers most often produce the best funds.
Alternatives are not Mythical Creatures
Alternative investments are not a secret special form of investing. These types of investments follow the same rules of the game as any other investment. This means that economic growth and decline, as well as public debt levels and interest rates are all factors that can impact these alternatives. Taking this into account, wealth advisors must be careful not to oversaturate portfolios with too many investments that may be impacted by the same external economic risks. Even within alternative investments, advisors should be diversifying portfolios.
Finally, a question of complexity arises, as alternative investments can become the cause of a conflict of interest between client and advisor. Because alternatives are much more complex than traditional investment forms, there can be short-term gains and expense fees that come into play. It is important to have an advisor that can weigh these outcomes and choose the most appropriate course of action.
Alternative investments can be a great way to further your portfolio’s goals by offering better returns and diversification. One must keep in mind, however, that market risks are still a factor of consideration, and that much of investment success depends upon the advisor and manager that you choose. It is vital that the wealth advisor you work with is unconflicted and can determine the costs and benefits of these investments in a way that leads to your financial success.