The How and Why of Alternative Investments

As an advisor, you’ve likely experienced an uptick in interest among clients seeking exposure to alternative investments (e.g., private equity, venture capital, direct lending, hedge funds, and real estate), and not just high-net-worth and ultra-high-net-worth investors. Alternatives are increasingly making their way into more and more client portfolios. In fact, assets under management (AUM) for alternatives have more than doubled over the last decade to an estimated $18.2 trillion in 2024. That could jump to $29.2 trillion by 2029, according to Preqin[1].

And for good reason. Alternatives can provide outsized returns compared with the public markets while being shielded from much of the day-to-day volatility that has been rattling the public markets recently.

Simply put, the opportunity to invest in private markets is enormous. Consider this: there are approximately 4,500 publicly listed companies in the United States. However, there are 1,200,000 private companies with greater than 1,000 employees, and nearly 7,500,000 private companies in total.

That said, it is critical that advisors guide their clients on both the opportunities - as well as the challenges - of investing in alternatives. We recently connected with John Murray, Principal with Robertson Stephens, to learn more about the how and why of alternatives and what advisors need to know when discussing alternative investments with clients.

John, as alternatives increasingly make their way into investors’ portfolios, how can advisors “make the case” for clients who may be new to private investing?

Even for advisors and clients who are already comfortable with alternative investments, the process of monitoring existing investments and making new investment decisions is dynamic and requires a persistent effort. For clients new to private investing, it is important that advisors take the time to discuss both the positives and negatives of alternatives.

That discussion should include a transparent look at longer time horizons, lack of liquidity, potentially uneven returns, the J-curve, and possible loss of principal. On the positive side, alternatives represent a large investment universe, active ownership, private decision-making, non-correlation to public markets, and increased diversification.

Tell us more about the “democratization” of alternatives, as it is sometimes called. Alternatives have historically been accessible primarily to institutional investors and large single-family offices. What has caused the shift in accessibility to more investors?

The democratization of alternative investments is an important industry trend, as it allows for greater access to private market investments to a larger audience of investors. One benefit of this trend is lower minimum investment levels, which enables a smaller investor to participate in private investments, previously only available to institutional-scale investors. In addition, using software platforms and fractional ownership structures means that individual investors now have access to a larger opportunity set of alternative investments. Fees, illiquidity, and risk of loss are all factors that must be considered, but regulators are aware of and paying attention to the democratization trend as well.

What is the role of alternative strategies in portfolio construction? What are the key purposes and benefits?

Alternative investment strategies are ultimately about the opportunity to generate higher returns. In addition, the benefit of portfolio diversification is a key role that alternative investments play in a portfolio.

Another important role for alternatives is thematic investing. Investors can access a variety of specific investment themes (think artificial intelligence and robotics) in the private market when such investments are not always available in the public market. Various stages of companies, from young early stage (hyper-growth) to mature late stage (cash-flowing), allow for different risk/reward characteristics and various potential return profiles.

What cautionary advice do you have for advisors when it comes to alternatives, such as illiquidity risk and capital calls?

Investors new to alternative investments need to be aware that these investments often do not offer liquidity. These investments are “illiquid,” and therefore, if a client needs the money quickly, it may not be available. Additionally, when investing in alternatives, investors must be prepared to make a capital commitment, track funded capital, and be prepared to fulfill all remaining unfunded capital commitments.

The timing of capital calls and any future return of capital distributions are often unpredictable. An investor must have cash available to meet capital calls when they come in and then be patient and wait (often for years) for return of capital (if any). Even with those restrictions, alternatives continue to generate enthusiasm among advisors and clients alike for their potential for outsized returns and portfolio diversification.  

There are many sub-categories within the alternatives universe and still many more funds and vehicles to explore. What is your advice for advisors when evaluating an alternatives fund?

Think back to the basic principles of wealth management. Start with the fundamental building of an investment portfolio from the bottom up. Start with a financial plan, understand the client’s long-term goals, design an asset allocation plan to meet those goals, and then determine the role of alternative investments within the context of a portfolio.

Alternative investments, as attractive as they may seem, are best suited when compiled into a portfolio and not viewed as a series of one-off opportunistic investments. Consider company equity strategies (at various stages of growth), lender’s debt (often structured), and real assets (for income & growth).

For advisors who are relatively new to alternatives, how do you recommend they begin to educate themselves on the topic?

First, become well versed with the ingredients of portfolio construction (for example, vintage year, industry sector, stage of company). Be mindful of risks due to illiquidity, diversification, drivers of investment returns, and total loss of capital. Educate yourself if needed on key concepts like the J-cure, partnership structures, incentive fees, etc. Ultimately, familiarize yourself with some of the asset managers themselves, many of whom are household names, as well as some who are emerging and not well known but will likely speak with you and help educate you on their strategies if you inquire.

[1] https://www.preqin.com/about/press-release/global-alternatives-markets-on-course-to-exceed-usd30tn-by-2030-preqin-forecasts