Alternatives are the “It” Investment: What to know before you dive in.
Alternative investments aren’t so “alternative” anymore. Once the rarefied domain of institutional investors and some sophisticated individuals, alts—from hedge funds to private credit to cryptocurrency—have increasingly pushed their way into the investment portfolios of wealthy people. They’re now hitting the mass market, too.
In a sign of their growing popularity, global alternative assets under management are expected to jump to $29.2 trillion by 2029, up 74% from $16.8 trillion at the end of 2023, according to research firm Preqin. Meanwhile, nine out of 10 financial advisors now use alts in client portfolios, and half of advisors allocate more than 10% of client portfolios to the category, according to a recent survey by alternatives-investing platform CAIS and consulting firm Mercer.
Little wonder, then, that alts have become a big theme among advisors in the latest Barron’s Top 1,200 ranking. This listing, which ranks the top advisors in each of the 50 states and the District of Columbia, is the largest of Barron’s four annual rankings of advisors. The group of 1,200 is both a handy place to find an advisor and an excellent barometer of industry trends.
The argument for alternatives is that they diversify portfolios—lowering overall risk—and offer the potential for juicy gains. If publicly traded stocks and bonds are the steak and potatoes of investment accounts, think of alternatives as the chimichurri.
“If we can get our client families to accept the illiquidity that comes with private investments, we can unlock investment themes that they haven’t been exposed to if they’ve been a typical retail investor with a 60/40 portfolio,” says Charlie Maxwell, co-chairman of Cresset, referring to the traditional investment allocation of 60% stocks and 40% bonds. Maxwell is No. 1 in Arizona in this year’s Top 1,200 financial advisors ranking.
Yet alts aren’t for every portfolio, particularly those geared toward the middle class, financial advisors say. And investors need to bring a discriminating eye to these investments. “Just because there is increased supply and demand doesn’t mean alternatives are right for all investors, and it doesn’t mean that all hedge funds or private-equity funds or real estate funds are created equal,” says Christopher Toomey, a private wealth advisor at Morgan Stanley Private Wealth Management.
To make good decisions about alternatives, investors should understand where alts could fit in their portfolios, what the risks are, and what benefits they bring in return for often high fees.
What Is an Alt?
Technically, an alternative investment is any asset class you add to a stock and bond portfolio with the expectation that it might have higher returns than, and won’t correlate with, your foundational assets. Many alternative investments are funds made up of “private” investments—they aren’t publicly traded stocks or bonds, and they are largely outside the purview of regulators. Alternative funds may have complicated strategies and only be suitable for wealthy investors. Thus, asset managers typically offer them through financial advisors who can explain the details to clients.
There is nothing new about alternative investments. Generations upon generations have invested in real estate. Hedge funds and private equity were the rage in the 1980s and remain large parts of the alts landscape. Private credit gained traction after the 2008 financial crisis, when traditional banks were forced to reduce risky lending, and it has exploded since then. Many investors consider art, collectibles, and fine wine to be alts. And some are embracing cryptocurrency.
Alts historically have been reserved for investors who can afford to lock up big chunks of their wealth for long stretches. Hedge fund minimums can range from $100,000 to several million dollars, and investors may not be able to easily withdraw their funds for a year or more. The underlying securities are often illiquid (think how long it takes for a real estate transaction to close), so fund managers don’t let investors pull all their money out at once.
Then there are the fees: A private-credit fund might charge 1% to 2% of assets under management. On top of that, many alt funds often charge performance fees that can range from 10% to 20% of profits above a certain threshold of gains.
What Kind of Alt Is Right for You?
Among alts, private credit is having a moment. The market for lending outside the traditional banking system was estimated at about $1.5 trillion at the start of last year, up from $1 trillion in 2020, and is projected to grow to $2.6 trillion by 2029, according to Morgan Stanley.
“We’re seeing a lot of demand within private credit, particularly because you’re in an environment where interest rates are at elevated levels,” says Toomey. “If you look at traditional fixed income, spreads are relatively tight [meaning that corporate bonds aren’t yielding much more than Treasuries, which are less risky], while in the private-credit world, you can see low-double-digit type returns.” Those hefty returns are in contrast to traditional bonds, which currently have negative three-year returns.
Nucleus Advisors has more than one-third of its $3 billion of assets in alts, including much of its partners’ money. The New York–based firm currently owns “substantial amounts” of private credit in client portfolios but avoids large private-credit funds, says Jordan Waxman, founder and managing partner. “We focus on managers who are a little smaller, nimbler, and focused on senior secured credits,” says Waxman. “Typically these managers employ low-to-moderate leverage, and they generate income in a 10% to 12% range.”
On the hedge fund front, Waxman likes global macro funds, which can offer stock-like returns with low correlations to the stock market. Most of the best are closed to new money, but when they periodically open, Nucleus pounces. Waxman also likes royalties—investments that involve prepaying for a revenue stream from music, mining, or pharmaceuticals, for instance.
Morgan Stanley’s Toomey sees promise in funding the infrastructure needed to support the booming artificial-intelligence field. In addition, he points to opportunity in the private-investment secondary market, where many funds are in need of cash to pay out to their shareholders. “We’re hearing that this is a great time to be buying assets,” Toomey says.
Bitcoin and other cryptocurrencies have gradually gained acceptance among mainstream investors and financial advisors, although plenty of skepticism remains. The $3 trillion global cryptocurrency market is dominated by Bitcoin, with a more than 50% market share. Crypto famously holds the promise of big returns at the cost of wild volatility.
But Matthew Hougan, chief investment officer of Bitwise Asset Management in San Francisco, says that over crypto’s 15-year history, small allocations have boosted portfolios’ risk-adjusted returns if held at least three years and rebalanced as needed. “It isn’t for every investor, but for many investors with a long time horizon, allocating 1% to 5% to crypto can make a lot of sense,” he says.
Nucleus has been investing in the crypto space for about five years, but more in blockchain technology than cryptocurrency, says Waxman. “Crypto as a category is very interesting from the venture capital point of view,” he says. “There’s seed investing that’s also very interesting.”
Terms like “hedge funds” and “private equity” may conjure visions of outsize profits, but Waxman says alternative investments serve a dual role in his clients’ portfolios: “We are a big believer that you can get excellent returns and lower your overall portfolio risk if you find really good alternatives.”
Uncovering those gems means being clear-eyed about the risks. Management with a proven record is a must. And different assets carry different kinds of risks. Geopolitical events can affect commodities, regulation can impact crypto, and interest rates can affect real estate, for instance.
Although the payoff for taking those risks can be attractive, not everyone needs alts in their portfolio, says Matthew Somberg, owner of Gottfried & Somberg Wealth Management in Glastonbury, Conn. “Most retail investors, if they’re trying to achieve mid- to high-single digit returns, will be able to accomplish their goals through a traditional 60/40 periodically rebalanced portfolio,” he says. “And I don’t know that there’s a huge need for the person who has $1 million or $2 million in their investment portfolio to carve out a significant allocation to alternatives.”
Nonetheless, asset managers are coming for the mass market.
Alt-Flavored Exchange-Traded Funds
Liquid alternative investments are mutual funds or exchange-traded funds that provide exposure to alternative strategies but are relatively inexpensive, can be traded daily, and carry low investment minimums. Several ETFs have recently been proposed to or approved by the Securities and Exchange Commission to give retail investors access to private equity, private credit, and hedge fund–like strategies.
Although alt-flavored ETFs allow more investors to participate in previously exclusive markets, some financial advisors are skeptical about whether they can deliver the benefits of alts without the sacrifices—high fees, lockup periods, and gates on exits—required by most traditional alts.
But so-called liquid alternatives can also make sense for wealthy investors. Somberg uses them for easier diversification since they’re easier to buy and sell. “Rebalancing a portfolio is very important, and if you own something that isn’t liquid, it can make rebalancing the rest of the portfolio more complicated,” he says.
Well Suited for Volatile Markets
Investor interest in alts tends to surge when markets get choppy, says Sean Connor, president and CEO of global private wealth at Blue Owl Capital, a leading alternative-asset manager. “We have noticed that every time there’s a big selloff with high correlation and lots of volatility, we tend to see a pretty meaningful increase in interest in what we do,” says Connor.
If volatile markets do lie ahead, as many investing pros believe, and alts prove to have added value to portfolios, these funds should win new investors, Connor reasons. “It’s easier to prove your value” during such times rather than “when the markets are just up and to the right,” he says.
Advice Can Help
Don’t invest in alternatives just because your neighbor does. As with any investment, you should know whether and why they should be part of your portfolio, says Toomey. “I think a lot of times there is a sensationalism about investing in alternative asset classes,” he says, “and the investors don’t really understand how it fits within their overall investment plan.”
Connor encourages investors to ask their investment advisor about negative scenarios. “I think the first question you should ask about any investment is: What’s the worst that can happen?” he says. “How low can it go?”
Anyone recommending alts for your portfolio should be able to explain their specific benefits and risks, and how they align with your financial goals and risk tolerance. They should provide clear reports about the investment’s performance and fees.
Financial advisors such as Somberg say they are more likely to trust established managers that run larger funds. “I’m going to be more comfortable using a really well-known manager than some firm I’ve never heard of that is creating a private-credit fund,” he says. “If I saw something out there from a smaller firm that was offering 12% or 13% or 14%, I would get a little nervous.”
Alternative investments are catching on as investors learn about their potential to provide diversification and boost returns. But don’t just jump on the bandwagon. Which alts you buy, if any, depends on your unique situation and goals. As with any investment, making careful, informed choices is a must.
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