Over the past couple of years, investors have demonstrated a strong appetite for alternative investments such as private equity, private credit, real estate, collectibles and more.
According to research and analytics firm Prequin, the global market for alternative investments will be $18.3 trillion by 2027, up from $9.3 trillion at the start of 2022. From 2015 to 2021, the market grew at a rate of 14.9% annually.
The increasing demand for alternatives — once exclusively the province of institutional investors — comes as investors seek to inject alpha into portfolios following a historic double-digit down year for both stocks and bonds. With the rise of fintech platforms, these opportunities, which were previously reserved only for well-connected, ultra-high-net-worth investors, are now fully available to the masses.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
But are alternative investments right for everyone? Unlike public markets, alternative investments are far more complex and can potentially tie up investor money for years at a time. While there are many benefits to alternative strategies, investors must also understand the downsides. Here are five aspects to consider when determining whether to invest in alternatives:
1. Longer time horizons. Alternative investments are inherently illiquid, meaning investor money could be tied up for roughly five to seven years — or even up to a decade.
Despite the rise of liquid alternatives (liquid alts), which make alternative investments available through mutual funds or ETFs, the investments themselves are illiquid, so funds must limit redemptions to prevent them from having to sell the underlying asset.
2. The potential for “gates” and fees. To limit redemptions and prevent a run on a fund, liquid alternatives funds will often impose a “gate” if more than 5% of investors want to exit the investment per quarter. This means that once a fund reaches the 5% threshold, investors will not be able to exit the investment.
Investors may also have to pay higher fees on these strategies, which limits their potential return value.
3. Complex tax reporting. Unlike stocks and bonds, which are reported to the IRS via a 1099-B form, alternative assets are partnerships that require investors to file Schedule K-1 forms. These are far more complex than 1099 forms because there is no standard format.
Additionally, since the underlying company must file its business tax return first, the forms arrive much later, typically in March or April, or even as late as the fall if the company files an extension, making tax filing more difficult.
4. Lack of control. Since alternative investments are limited partnerships, the fund manager holds all the control and can decide how long to invest and when to sell.
This might work well enough for an endowment or an ultra-high-net-worth investor who is sitting on piles of money, but it might be a problem for someone with less cash on hand.
5. Potential for underperformance. Data from Dimensional found that from June 2006 to June 2022, U.S. liquid alts funds have underperformed broad indexes that track equity and fixed-income markets.
In addition to underperformance, liquid alts may not offer appropriate diversification — which has long been a key reason for investing in this asset class in the first place — as these funds build on the same foundations as the global stock and bond market.
Investors should think carefully before diving in
While alternatives have become more popular and mainstream, investors should think carefully about all the factors before investing in this type of strategy. Will you need access to your money in the near term? Are you willing to pay higher fees or potentially run into gates that prevent you from exiting the investment? Do you have the wherewithal to manage complex tax reporting requirements?
Alternatives can be an effective strategy for institutions, endowments and ultra-high-net-worth investors that have excess cash reserves and can leave the management of these strategies to their larger teams. But smaller investors should think carefully about their goals and strategies before making a commitment. You can often achieve the same financial outcomes through well-diversified portfolios composed of traditional equities and fixed income.
ALINE Wealth is a group of investment professionals registered with Hightower Securities, LLC, member FINRA and SIPC, and with Hightower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities, LLC; advisory services are offered through Hightower Advisors, LLC.
RELATED CONTENT
-
How Another Trump Presidency Will Impact the Stock Market in 2025President Trump will have little direct impact on the stock market, but his policies, initiatives and posts certainly can make prices move. Here's how.
-
Stock Market Today: Stocks Are Mixed Ahead of CPICool wholesale inflation numbers provide only slight relief before Wednesday's release of December Consumer Price Index data.
-
Irrevocable Trusts: So Many Options to Lower Taxes and Protect AssetsIrrevocable trusts offer nearly endless possibilities for high-net-worth individuals to reduce their estate taxes and protect their assets.
-
How to Organize Your Financial Life (and Paperwork)To simplify the future for yourself and your heirs, put a financial contingency plan in place. The peace of mind you'll get is well worth the effort.
-
Financial Confidence? It's Just Good Planning, Boomers SayBaby Boomers may have hit the jackpot money-wise, but many attribute their wealth to financial planning and professional advice rather than good timing.
-
Will You Be Able to Afford Your Dream Retirement?You might need to save more than you think you do. Here are some expenses that might be larger than you expect, along with ways to ensure you save enough.
-
Three Steps to Simplify Paying Your Taxes in RetirementOnce you retire, how you pay some of your taxes can change. Here's how to get a handle on them so you don't run afoul of the IRS and face penalties.
-
More SECURE 2.0 Retirement Enhancements Kick in This YearSaving for retirement gets a boost with these SECURE 2.0 Act provisions that are starting in 2025.
-
Saving for Your Emergency Fund: As Easy as 1-3-6An emergency fund that can cover six months' worth of expenses is far easier to build if you focus on smaller goals at first.
-
The Wrong Money Question to Ask After Trump's ElectionIf you're wondering what moves to make with a new president moving into the White House, you're being dangerously shortsighted. Here's what to do instead.
