The investment landscape has undergone a dramatic transformation over the past two decades. While traditional asset classes like stocks and bonds continue to form the backbone of most portfolios, alternative investments have emerged as a critical component of modern wealth management strategies. For financial advisors, understanding and incorporating alternative investments has become essential to meeting evolving client needs and delivering superior risk-adjusted returns.

The Alternative Investment Revolution

Alternative investments, broadly defined as any investment outside of traditional stocks, bonds, and cash, have experienced unprecedented growth. According to Preqin, global alternative assets under management will eclipse $30 trillion by 2030.

While the benefits of incorporating alternative investments in investment portfolios are more widely known due to increased education and awareness, gaining access and the implementation of alternative investments is more difficult. The democratization of alternative investments has been facilitated by innovative access vehicles designed specifically for financial advisors and their clients. Here are some of the vehicles that financial advisors can use to create modern investment portfolios.

Modern Access Vehicles for Financial Advisors

Interval Funds

Interval funds represent one of the most popular access vehicles for alternative investments, offering a balanced approach between illiquid alternative strategies and investor liquidity needs. These registered investment companies under the Investment Company Act of 1940 provide periodic redemption opportunities, typically quarterly or semi-annually, allowing investors to redeem between 5% and 25% of outstanding shares during each interval period.

Learn more about the different alternative investment asset classes here.

The structure enables fund managers to invest in illiquid assets like private equity, private credit, and real estate while providing some liquidity to investors. Popular interval fund strategies include business development company (BDC) approaches, real estate investments, and multi-strategy alternative portfolios.

Advisors must carefully manage client expectations regarding liquidity limitations and potential redemption queues during stressed market conditions.

Business Development Companies (BDCs)

Business Development Companies provide direct access to middle-market lending and private equity strategies through publicly traded structures. BDCs are required to distribute at least 90% of their taxable income to shareholders.

There are two primary BDC structures: publicly traded BDCs that offer daily liquidity through exchange trading, and non-traded BDCs that provide exposure to similar strategies without daily price volatility. Publicly traded BDCs may trade at premiums or discounts to net asset value, creating additional opportunities and risks for investors.

Non-traded BDCs typically offer more stable net asset value reporting but with limited liquidity, often providing redemption opportunities quarterly or annually with various restrictions.

Closed-End Funds (CEFs)

Closed-end funds investing in alternative strategies offer another liquid access vehicle for advisors. These funds issue a fixed number of shares that trade on exchanges, providing daily liquidity while enabling managers to invest in less liquid alternative assets without facing redemption pressures.

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CEFs often trade at discounts or premiums to their net asset value, creating additional risks and opportunities for investors. Alternative-focused CEFs may invest in master limited partnerships (MLPs), real estate investment trusts (REITs), convertible securities, or employ covered call strategies. The closed-end structure allows fund managers to use leverage, potentially enhancing returns but also increasing risk.

Alternative Mutual Funds and ETFs

Alternative mutual funds and ETFs represent the most accessible vehicles for incorporating alternative strategies into client portfolios. These daily liquid funds employ alternative investment techniques within traditional registered investment company structures, making them suitable for clients across various wealth levels.

These funds provide professional management of complex alternative strategies while maintaining daily liquidity and transparent reporting. Popular categories include absolute return funds, long-short equity funds, and managed futures funds.

Alternative ETFs have expanded rapidly, offering exposure to commodities, currencies, volatility strategies, and factor-based alternative approaches. These vehicles provide intraday liquidity, transparent holdings, and typically lower expense ratios than actively managed alternatives.

Additionally, there remain liquidity requirements for ETFs and mutual funds. ETFs and mutual funds cannot invest more than 15% of the fund assets into illiquid investments. So, the question remains, do these popular liquid vehicles offer significant enough exposure to alternative investments due to the liquidity requirements?

Feeder Funds and Fund-of-Funds

Feeder funds provide access to institutional-quality alternative investment managers by aggregating capital from multiple investors to meet high minimum investment requirements. These structures typically invest in a single underlying master fund, allowing smaller investors to access strategies that might otherwise require $1 million or higher minimums.

Fund-of-funds structures offer diversified exposure to multiple alternative investment managers and strategies within a single vehicle. Professional fund-of-funds managers conduct due diligence, monitor performance, and provide ongoing oversight of underlying investments.

However, they typically involve additional layers of fees, including both the fund-of-funds management fee and underlying manager fees. Advisors must carefully evaluate whether the additional diversification and professional oversight justify the incremental costs.

Separately Managed Accounts (SMAs)

Alternative investment SMAs provide customized exposure to alternative strategies through separately managed account platforms. These vehicles offer transparency, customization, and daily liquidity while employing alternative investment techniques like long-short equity, market-neutral, or tactical allocation strategies.

SMA structures allow for tax-loss harvesting, customization around client restrictions, and transparent reporting of underlying holdings. However, they typically require higher minimums than mutual funds or ETFs and may have limited access to truly illiquid alternative strategies due to daily liquidity requirements.

Learn more about the benefits of Separately Managed Accounts here.

Tender Offer Funds

Tender offer funds represent a newer structure that provides periodic liquidity through tender offers rather than continuous redemptions. These funds may conduct tender offers quarterly, semi-annually, or annually, allowing investors to sell shares back to the fund at net asset value during specified periods.

This structure enables fund managers to invest in illiquid assets while providing more predictable liquidity events than interval funds.

Key Considerations

When selecting alternative investment access vehicles, advisors must consider several key factors from liquidity and suitability requirements, different fee structures, tax implications and regulatory considerations.

The diverse array of alternative investment access vehicles provides financial advisors with unprecedented flexibility to incorporate alternative strategies into client portfolios. By understanding the characteristics, benefits, and limitations of each structure, advisors can select appropriate vehicles that align with client objectives, risk tolerance, and liquidity requirements while enhancing overall portfolio construction and risk-adjusted returns.

The Future of Alternative Investments

For financial advisors, staying current with alternative investment developments and maintaining robust due diligence processes will be essential to serving clients effectively. The firms that successfully navigate this evolution will be best positioned to deliver superior outcomes and build lasting client relationships in an increasingly competitive marketplace.

Alternative investments have transitioned from niche strategies for institutional investors to essential portfolio components for advisors serving sophisticated clients. By understanding the diverse universe of alternative investment vehicles and their appropriate applications, financial advisors can enhance portfolio construction, improve risk-adjusted returns, and better serve their clients' evolving investment needs.

Ryan Nauman is the Market Strategist at Zephyr, which helps investment professionals make more informed investment decisions on behalf of their clients. Connect with Ryan on LinkedIn.