By Morey Stettner
‘Alts’ — including non-traded real estate, private debt, venture capital and hedge funds — can diversify your portfolio.
Almost every type of traditional investment lost money in 2022. Stocks, bonds, publicly traded real estate were all down. After that, it may be worth looking at alternative investments. These include non-traded real estate, private debt, venture capital and hedge funds.
For years, some financial advisers have woven alternatives into client portfolios. When traditional markets soar, as they mostly have since 2009, alternatives tend to underperform. But after the last year of declining markets, so-called alts are regaining traction.
Chasing higher returns, however, means embracing higher risk. That’s where alts come in. “Folks who were in a traditional 60/40 portfolio of stocks and bonds got clobbered last year and want to see better returns,” said Lorenzo Esparza, chief executive of Manhattan West, a Los Angeles-based wealth management firm. “They’re quite a bit more open to using alternatives.”
The firm provides individuals and institutions with alternative investments such as venture capital, private equity, private debt and real estate. It manages proprietary funds in each area.
While many investors understand the basics of stocks and bonds, educating clients about alternatives requires more effort. Take venture capital, where investments consist of tranches.
“If you commit $1 million in venture capital or private equity, it’s not like you have overnight exposure,” Esparza said. “It will take a few years to deploy that money. We might invest $250,000 at first and then hold the other $750,000 in Treasurys or munis” until the next investment round.
While Esparza favors all four categories of alts, he’s particularly attuned to venture capital because of its recent rocky history. “It’s so beaten up and valuations have gone down so much that I like it right now,” he said.
Alternative investments appeal to investors seeking a hedge against stocks. They want to know that at least some of their money will withstand a severe downturn.
Mark Wilson, a certified financial planner in Irvine, Calif., defines alternative investments as instruments that have little or no correlation to stocks and bonds. Examples include reinsurance, private real estate, infrastructure and “trend following” across asset classes.
All of these alternative strategies are not only non-correlated to traditional indices like the S&P 500 , but they’re also “non-correlated to each other,” Wilson says. That’s why he calls them “true” alts, as opposed to emerging markets, commodities and REITs that he sees as more correlated to market swings.
“Alts is a scary term for people so we spend a lot of time explaining why they’re in a portfolio and what they do,” Wilson said. “After 2022, people are seeing the value of alts.”
Wilson warns clients that these alternatives will drag down performance in years when stocks do well. That’s why he limits their exposure to 25% to 30% of their account. “But over longer periods, you’ll be happy,” he tells them.
His fondness for investments in infrastructure, farmland and timber, along with his use of reinsurance funds, underscore the importance of having a long-term time horizon.
Like so many other aspects of prudent financial planning, the key to success with alts is taking a proactive approach. If you wait until markets tumble to dip into these often risky and complex vehicles, it may be too late.
“I worry that people are chasing returns of the latest alts,” Wilson said. “Take managed-futures funds, which had a terrific year in 2022 as you’d expect [as the S&P 500 dropped 18%]. Jumping into them now, we don’t know.”
More: You want to move to a state with low- or no income tax. Your financial adviser might have another idea
Also read: This money coach gets pro athletes into top financial shape. Here are his 5 training tips for people who come into sudden wealth
-Morey Stettner
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05-01-23 0738ET
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