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Despite unique risks and considerations, alternative investments can be useful tools to improve the risk-return characteristics of an investment portfolio. They can increase diversification and reduce volatility, given historically low correlations to more traditional investments; they can offer the potential for enhanced returns due to the wider investment opportunity set; and they can hedge certain portfolio exposures, thereby reducing concentration risk.
The question then becomes why are investors unwilling to include alternatives in their portfolios. Is it because they do not fully understand the benefits, risks, costs, and liquidity of the opportunities? While the answer is different for every investor, the principals of Breakwater Capital can help you determine if alternative investments may be right for you.
Qualities of Alternative Investments
HISTORICALLY LOWER MARKET CORRELATION
TYPICALLY LOWER VOLATILITY
CAPITAL APPRECIATION POTENTIAL
This includes real estate funds, property portfolios, and individual properties. Real estate funds typically focus on one or more property types such as multi-family, student housing, retail, office, healthcare, assisted living, self storage, industrial, and parking facilities.
Fund strategies may include acquiring existing properties, ground-up development, and value-added whereby the goal is to increase rents/occupancy and ultimately value by repositioning the property. If your preference is to invest directly into one or more single properties or if you are looking to defer capital gains through a 1031 exchange, we can provide a number of choices for you to evaluate.
An asset class focused on equity and debt securities in private companies oftentimes associated with leveraged buyouts. In reality, private equity is much more complicated and has significant risk as well as the opportunity for generating substantial returns which is why institutions and wealthy individuals have been participating in private equity funds for years. Recently, new funds have been developed allowing a wider range of investors the opportunity to participate in private equity.
Investments in this area can offer the opportunity for attractive returns and significant tax benefits. Opportunities include drilling (developmental, working interest, enhanced recovery) and royalties whereby an investor receives a percentage of any revenues generated from production. Investing in oil and gas royalties can include funds that participate in royalty interests as well as directly purchasing individual royalties. The direct purchase of royalties may be eligible for a 1031 exchange.
Small business lending by banks has been declining for many years. Because of this trend, there are short-term opportunities to lend to small businesses in addition to firms looking for pre-IPO funding.
Results show funds with the highest percentage of assets in alternative investments have historically performed the best over 10 and 20 year periods.
Given the potential benefits of alternative investments, we find it interesting that the typical individual investor has little to no exposure to alternatives. Whereas large institutions have a significant portion of their portfolios allocated to alternatives.
One reason for this may be that while many investors will acknowledge that they are worried about losing money due to market volatility they are still unwilling to consider alternative investments even though their portfolios might benefit from their inclusion despite the high risk profile of such investments.
Source: “Investing Like the Harvard and Yale Endowment Funds” by Michael W. Azlen, CAIA and Ilan Zermati of Frontier Investment Management. “The referenced study includes only those funds identified above. There is no guarantee that any investment or fund will achieve similar performance or its stated objectives, and they may, in fact, lose money including the potential of all principal invested.”
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Real Estate / 1031 Risk Disclosure: • There is no guarantee that any strategy will be successful or achieve investment objectives; Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments; Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities; Potential for foreclosure – All financed real estate investments have potential for foreclosure; • Illiquidity –These assets are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments; Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions; Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits. Stated tax benefits – Any stated tax benefits are not guaranteed and are subject to changes in the tax code. Speak to your tax professional prior to investing.
All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future performance. There can be no guarantee that any investment or strategy will achieve its stated objectives. Speak to your tax and/or financial professional prior to investing. Securities and advisory services through Emerson Equity LLC, member FINRA and SIPC and a registered investment adviser. Emerson is not affiliated with any other entity identified herein.
