Alternative investments: Where can private wealth begin?

As traditional investment vehicles have shown limitations in recent times, the appeal of alternative assets – ranging from hedge funds to private equity and real estate – has grown exponentially. Erick Rawlings, Managing Director and Head of Research at Fiduciary Trust International, highlights on Zephyr's Adjusted for Risk podcast that, historically, these investment avenues were the province of the ultra-wealthy. Today, however, "access to alternatives is increasing through the private wealth channel," making these once exclusive investments more accessible to a broader audience.

A historical perspective and current trends

Reflecting on the role of alternatives, Rawlings notes, "David Swenson of Yale Endowment, the late revered investor, really put alternatives on the map". According to Rawlings, the landscape of the '70s and '80s saw these investments as a cottage industry used predominantly by high-net-worth individuals. However, the 90s brought a shift as many endowments, pensions, and institutions recognised the diversification benefits alternatives offered.

Currently, institutional investors find themselves "fully or overly allocated" to these mechanisms, shifting the growth dynamic to areas with new potential. This catalyses opportunities for the mass affluent and high-net-worth individuals to explore these investments as a complementary part of their portfolios.

Diversification and risk management

When discussing the attributes of alternative investments, Rawlings explains, "The diversification benefit is key to creating a portfolio robust to reasonable economic scenarios". This diversification is crucial, as it provides stability and potential returns even during times of market crisis. Whether through hedge funds that offer "absolute return and low correlation" or commodities that act as a hedge against inflation, the strategic integration of these vehicles can significantly enhance a portfolio's resilience.

Portfolio construction: Where to begin?

For those considering alternative investments, understanding portfolio construction is vital. "Start with just a basic 60/40 portfolio," Rawlings advises. From there, consider reallocating portions—perhaps reducing the fixed income component and allocating to hedge funds or private equity. It's an intricate balance of ensuring the investment aligns with a client's risk profile and long-term goals.

Rawlings emphasises that alternatives function as "tools that can help an advisor solve for a client's particular needs or circumstances" rather than a one-size-fits-all solution. It's about methodically assessing what portion and type of alternative complements a client's existing holdings and objectives.

Looking ahead: Attractive alternatives

Rawlings sees a promising future for alternative investments, particularly in the realms of real estate and hedge funds. With interest rates influencing market dynamics, he cites "real estate lending and secondaries in venture capital" as areas poised for growth. As always, robust manager research and due diligence remain paramount. “Understanding what you truly own and the processes behind the investments are critical,” Rawlings asserts.

Practical considerations for advisors

For financial advisors keen on exploring this space, Rawlings suggests starting with accessible formats like mutual funds, which offer daily liquidity and straightforward tax treatment. As comfort and knowledge grow, advisors can then explore interval funds or limited partnerships, mindful of their complex structures and liquidity considerations.

Conclusion: The role of alternatives

The integration of alternative assets into an investment portfolio presents both opportunities and challenges. As Rawlings aptly summarises, alternatives are "not a remedy for all portfolio issues" but crucial components to achieving diversification and managing risk effectively. They serve as sophisticated tools for investors and advisors to tailor strategies to the evolving economic climate.

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