Stocks and bonds not working for you? These alternatives might help — but pay attention to fees.

Stocks and bonds not working for you? These alternatives might help — but pay attention to fees.

By Morey Stettner

‘Alts’ — including non-traded real estate, private debt, venture capital and hedge funds — can diversify your portfolio.

Almost every type of traditional investment lost money in 2022. Stocks, bonds, publicly traded real estate were all down. After that, it may be worth looking at alternative investments. These include non-traded real estate, private debt, venture capital and hedge funds.

For years, some financial advisers have woven alternatives into client portfolios. When traditional markets soar, as they mostly have since 2009, alternatives tend to underperform. But after the last year of declining markets, so-called alts are regaining traction.

Chasing higher returns, however, means embracing higher risk. That’s where alts come in. “Folks who were in a traditional 60/40 portfolio of stocks and bonds got clobbered last year and want to see better returns,” said Lorenzo Esparza, chief executive of Manhattan West, a Los Angeles-based wealth management firm. “They’re quite a bit more open to using alternatives.”

The firm provides individuals and institutions with alternative investments such as venture capital, private equity, private debt and real estate. It manages proprietary funds in each area.

While many investors understand the basics of stocks and bonds, educating clients about alternatives requires more effort. Take venture capital, where investments consist of tranches.

“If you commit $1 million in venture capital or private equity, it’s not like you have overnight exposure,” Esparza said. “It will take a few years to deploy that money. We might invest $250,000 at first and then hold the other $750,000 in Treasurys or munis” until the next investment round.

While Esparza favors all four categories of alts, he’s particularly attuned to venture capital because of its recent rocky history. “It’s so beaten up and valuations have gone down so much that I like it right now,” he said.

Alternative investments appeal to investors seeking a hedge against stocks. They want to know that at least some of their money will withstand a severe downturn.

Mark Wilson, a certified financial planner in Irvine, Calif., defines alternative investments as instruments that have little or no correlation to stocks and bonds. Examples include reinsurance, private real estate, infrastructure and “trend following” across asset classes.

All of these alternative strategies are not only non-correlated to traditional indices like the S&P 500 , but they’re also “non-correlated to each other,” Wilson says. That’s why he calls them “true” alts, as opposed to emerging markets, commodities and REITs that he sees as more correlated to market swings.

“Alts is a scary term for people so we spend a lot of time explaining why they’re in a portfolio and what they do,” Wilson said. “After 2022, people are seeing the value of alts.”

Wilson warns clients that these alternatives will drag down performance in years when stocks do well. That’s why he limits their exposure to 25% to 30% of their account. “But over longer periods, you’ll be happy,” he tells them.

His fondness for investments in infrastructure, farmland and timber, along with his use of reinsurance funds, underscore the importance of having a long-term time horizon.

Like so many other aspects of prudent financial planning, the key to success with alts is taking a proactive approach. If you wait until markets tumble to dip into these often risky and complex vehicles, it may be too late.

“I worry that people are chasing returns of the latest alts,” Wilson said. “Take managed-futures funds, which had a terrific year in 2022 as you’d expect [as the S&P 500 dropped 18%]. Jumping into them now, we don’t know.”

Costs and fees

There’s also the issue of cost. Investment management fees for alternative investments are higher — sometimes much higher — than for plain-vanilla stocks and bonds.

In addition, many types of alts incentivize managers or general partners to reap some of the profit from investment gains. Before committing any cash, review both the management fees (which can range from 1.5% to 2% of invested assets in hedge funds) and any profit-sharing cut that the investment manager pockets. Sometimes called carried interest, it can equal 20% of the general partner’s share of profits.

In recent years, a growing number of mutual funds are making alternative investments less costly and more accessible to individual investors. Yet they remain risky and often serve as a hedge to help diversify portfolios for high-net-worth investors.

“Some of these funds have cheaper fees and lower minimums [to invest] than direct investment with a hedge fund or through a limited partnership,” said Tim Ralph, an adviser in Boca Raton, Fla.

For instance, he cites two funds from AQR Capital Management: a managed futures fund and a long-short equity fund . While these funds are relatively inexpensive ways to delve into alternative strategies, their expense ratio is still far higher than, say, a standard S&P 500 index fund.

More: You want to move to a state with low- or no income tax. Your financial adviser might have another idea

Also read: This money coach gets pro athletes into top financial shape. Here are his 5 training tips for people who come into sudden wealth

-Morey Stettner

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.


(END) Dow Jones Newswires

05-06-23 0949ET

Copyright (c) 2023 Dow Jones & Company, Inc.

Source link

Scroll to Top