A Guide to Alternative Investments

Alternative investments are an excellent way for investors to diversify their portfolios, mitigate risk, and grow their wealth. In this guide, we will explore the landscape of alternative investments and identify the various asset classes available. We will also discuss the suitability considerations for these investments and share how Adero Partners has integrated alternatives into client portfolios.

What are Alternative Investments?

Alternative Investments are a tapestry of non-traditional assets that extend beyond the familiar realm of public stocks and bonds. They include an assortment of asset types and investment strategies and offer enhanced return opportunities, diversification, and inflation protection.

What Asset Classes Are Available?

  • Credit: Income-focused investments in private company debt including direct lending and a variety of opportunistic and more specialized strategies.

  • Private Equity: Growth-focused investments in privately held companies including early-stage venture capital, late-stage growth equity, and buyouts.

  • Real Estate: Investment options include direct property ownership, real estate investment trusts (REITs), and private equity real estate.

  • Natural Resources: Investments in tangible goods such as gold, oil, or agricultural products. It also includes investment in the infrastructure that supports the production and transport of natural resources.

  • Hedge Funds: Pooled investments in a wide range of public and private assets. Managers use a variety of trading strategies and complex instruments, often including a “short” position against the market to provide downside protection.

  • Art and Collectibles: The acquisition of valuable art, antiques, or collectibles, often with the potential for substantial appreciation.

  • Cryptocurrencies: Digital assets like Bitcoin and Ethereum, known for their volatility and potential for remarkable gains.

Suitability Considerations for Alternative Investments

Alternative investments are complex and require careful planning to ensure that liquidity constraints and tax considerations are clearly understood. Furthermore, they are less regulated than the public markets and require additional upfront diligence and ongoing monitoring. Here are some key considerations for evaluating alternative investments:

  • Diversification: Alternative investments provide access to a much broader set of assets. They are typically less correlated to the public markets and may provide a smoothing effect to the overall portfolio.

  • Liquidity: Alternative investments are often purchased with pooled contributions from multiple investors through a limited partnership. The underlying assets are generally not traded on a public exchange (ex. crypto) and the fund may impose lengthy lock-up restrictions. If liquidity is important, an interval fund can be used to provide periodic redemption opportunities.

  • Time Horizon: A typical limited partnership fund investing in real estate or private equity will last for 10-12 years. Credit investments may have a shorter time horizon and will focus on providing current income.

  • Diligence: Private funds are subject to less regulation and transparency, requiring careful manager selection and monitoring.

  • Active Management: There is a wide dispersion of returns across the various managers investing in each asset class. Working with an advisor with institutional relationships and scale can provide access to top-quartile funds.

  • Costs: Actively managed funds have higher operating costs and include performance incentives for the general partner. Investors should compare net returns to a public market equivalent (e.g. private equity vs S&P500 index) to determine if the higher costs and illiquidity are justified.

  • Tax Reporting: Private funds report income on a Schedule K1 after April 15th, requiring investors to file for an extension of their personal tax return. Estimated K1s may be available earlier to help with tax projections.

  • Tax Considerations for IRAs: Investors considering an alternative investment through their IRA should be aware of unrelated business income tax (UBIT). This tax is levied against the IRA and requires an early distribution and Form 990-T filing. Private real estate acquired with debt is a common trigger for UBIT. Private equity, credit, and hedge funds are typically structured with a blocker corporation to avoid this tax.

  • Eligibility: Most private funds only accept accredited investors with $1m+ in net worth. Some have a much higher threshold and require investors to be qualified purchasers with $5m+ of investments.

  • Enhanced Returns: History has shown that select alternative asset classes have outperformed traditional investments, providing the opportunity for better risk-adjusted returns.

Adero Client Case Study 1

Highly Compensated Executive Nearing Retirement

Meet Austin, a highly compensated executive and diligent saver nearing the end of his career. Austin has maintained a simple investment strategy over the years, investing heavily in public stocks for long-term growth. While these investments delivered excellent returns, Austin was frequently exposed to the ups and downs of the stock market. As a forward-thinker, he recognized the need to begin restructuring his portfolio for retirement to find a better balance of growth and income.

Austin asked a close friend for an advisor recommendation and was introduced to Adero Partners. After completing a financial plan to determine the optimal asset allocation, Austin’s advisor presented several alternative investments to help achieve his growth and income goals. The chosen path led him to two distinct but complementary asset classes: Private Credit and Private Real Estate.

  • Private Credit: Austin’s highest priority was creating a diversified income stream to replace his salary and serve as the bedrock of his retirement portfolio. His advisor combined traditional bonds with several types of private credit investments including: corporate direct lending, consumer alternative lending, and opportunistic investments in healthcare royalties and sports franchises. The opportunistic investments have an independent return profile less correlated to traditional investments and offer capital appreciation potential.

  • Private Real Estate: Austin’s advisor also recommended investing in multi-family private real estate to provide near-term cash flow and long-term value appreciation. The selected fund pays quarterly distributions of cash flow and provides an 8% preferred return before the manager receives a partial share of the excess profits. The fund invests in properties with value-add potential; assets that have been under-managed and would benefit from capital investment and renovation.

Austin's case underscores the synergy that can be achieved through a carefully crafted blend of alternative investments. By choosing assets that complement each other, his advisor helped secure his bedrock capital while maintaining the potential for long-term growth.

Adero Client Case Study 2

Technology Engineer Investing for High Growth

Meet Juliana, a high-income technology engineer with monthly vesting Restricted Stock Units (RSUs). Juliana’s cash compensation covered her lifestyle, and she didn’t need additional income from her equity. With a long time horizon and ample liquidity, Juliana wanted to explore making investments in private companies with high growth potential.

Juliana's primary challenge was finding enough deal flow to fully invest the net proceeds from her RSUs. She also needed to complete thorough diligence on each opportunity. Time constraints and a lack of expertise in scrutinizing private company transactions led her to seek professional guidance. Juliana met with her advisor to discuss alternatives to direct investing. The recommended strategy included Private Equity and Co-Investments, using funds with periodic capital calls to align with her RSU vesting schedule.

  • Private Equity: Juliana’s advisor provided access to a multi-stage fund comprised of a variety of managers with expertise in venture capital, growth equity, and buyouts. This diversified mix provided a wide array of opportunities, with the objective of building a core private equity portfolio. Sarah chose to invest in several fund vintages across time, gradually deploying her wealth as the RSUs vested.

  • Co-Investments: To further enhance returns and growth in the portfolio, Juliana invested in a Co-Investments fund. These opportunities are characterized by lower management fees and reduced carried interest, with a higher concentration in select companies. This satellite holding complemented her broader private equity strategy.

In addition to sourcing the investments, Juliana’s advisor provided comprehensive back-office support. These time-consuming activities included fund subscriptions and investor questionnaires, capital calls, and managing tax reporting and distribution tracking.

Juliana’s case underscores the value of partnering with an advisor to make alternative investments. She was able to leverage her advisor’s institutional relationships, manager diligence, and administrative support. This level of service streamlined her investment experience, enabling her to focus on her career while her advisor managed all the details.

Conclusion and Resources

In conclusion, alternative investments offer a compelling option for increasing diversification, managing risk, and enhancing returns. To navigate this intricate landscape effectively, consulting with a financial advisor is essential, ensuring that alternative investments align seamlessly with individual financial goals and circumstances.

Discover how Adero Partners can help
Optimize Your Wealth with Alternative Investments

Contact Aaron White - aaron@aderopartners.com

The material presented is for educational and illustration purposes only. The case studies provided are meant to reinforce the understanding of the educational material provided. The material presented is not meant to be a recommendation and or solicitation to buy or sell any securities. Adero Partners is an investment advisory firm registered with the Securities and Exchange Commission (“SEC”). SEC registration does not imply a certain level of skill or expertise.

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