While uncertainty is an inherent component of financial markets, there are opportunities that lie outside of equity and debt markets that provide uniqueness and can aid in meeting your financial goals. Alternative Investments are a way to gain exposure in new financial territories, while also lowering overall risk through diversification. By definition, an alternative investment, or an “alt,” is a financial asset that does not traditionally fit into the equity, debt, or cash categories. Some examples of alts include private equity, private credit, real estate, and hedge funds, among others. Each of these categories has their own characteristics and unique perks that make them stand out from one another. Below, you will find an overall description of the different types of alternative investments and their investment strategy. Reach out to your advisor to understand if alternative investments are a fit for your portfolio.
Private equity has grown in popularity over the last few decades and has upsides that entice investors. With the help of financial intermediary vehicles, an investor can purchase shares of privately owned companies with the hopes of receiving positive returns. A common misconception about this category of alt is that private companies are smaller than public companies and do not generate as much return. Historically however, financial databases present that some of the top private companies can amass billions in revenue. While stability in private equity can wane, like public equity markets, investment options and successes can be cyclical, and the timing of investments is important.
Private credit is essentially a loan. Institutional investors negotiate and provide capital, or funds, to companies in financial need, through non-bank loans. This type of investing is widely recognized by viewers of the show “Shark Tank,” where established startup companies pitch new, innovative projects to the Shark investors, with the hopes that the investors will loan them capital or participate in an equity negotiation that would help fund their business and operations (manufacturing, marketing, etc.). This happens quite often outside of the show, as institutional investors will lend to companies in need of capital in exchange for a return of some fixed or variable interest rate. Private credit investing can be beneficial because institutional investors strive to create value for companies by employing strategies to accelerate growth.
A private credit fund is a little bit different than private credit. Private credit funds take investor money and pool it into one big fund. This fund is then used to buy and sell private credit loans made by institutional investors.
Real estate is another alternative investment that allows investors to gain exposure outside of the traditional markets. Real estate in the alternative investment space is not as straightforward as simply buying a house or condominium complex. Your money is pooled into a fund that is offered by a finance company. This money is then invested in the construction or purchase of a building. There are different kinds of funds that serve different purposes. A real estate income trust, or a REIT, will buy a piece of property using the money from the fund and lease the space. That lease money will then be used as a form of fixed income to investors of the fund in the form of a dividend. REITs are one type of investment in the real estate market through alternative investing.
Another type of fund is real estate interval funds, which are investment vehicles that provide individual investors with access to strategies that are typically limited to institutional investors. These strategies may allocate funds for investment to asset classes that are less liquid, such as commercial real estate, than those typically found in mutual funds. Whereas these strategies could offer the potential to generate higher long-term returns, they may also pose strict limits on liquidity, and returns can be volatile.
Hedge funds serve many purposes in the alternative investment space. By definition, a hedge fund is a limited partnership of investors that uses high risk methods of allocation in hopes of realizing large gains. The term, “hedge,” was derived from an idea that managers employ certain tactics to trim, or “hedge,” the risk of volatility. They do this through longing an investment- hoping the investment will increase in value over time- and/or shorting – waging a decrease in the investment over time. This creates an advantage in and of itself because the risk of market volatility is diminished, which possibly fortifies returns over time. It is often found that hedge funds will tend to put their eggs in one basket, which lends to vulnerability and volatile returns in some cases.
Alternative investments may provide the opportunity for positive outcomes not otherwise realized through traditional investing; however, alternative investments are not suitable for all investors. Liquidity needs, time horizon, and risk tolerance are factors to consider when discussing alternative investments. Reach out to your advisor to understand if alternative investments are a fit for your portfolio.
Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.
Investing in Real Estate Investment Trusts (REITs) involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.
Fund of hedge funds involve special considerations and risks not associated with an investment in traditional mutual funds. Each fund’s investment program is speculative and includes risks inherent with an investment in securities, as well as specific risks associated with the use of leverage, short sales, options, futures, derivative instruments, investments in “junk bonds”, non-US securities, illiquid investments and limited regulatory oversight. Each fund is a non-diversified fund and invests in Hedge Funds that may invest a substantial portion of the assets managed in an industry sector. Higher fees, potential investor income qualifications and strategy limitations must be considered in any suitability determination.
All investing involves risk including the possible loss of principle. No strategy assures success or protects against loss.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Securities offered through LPL Financial, member FINRA/SIPC. Shepherd Financial Partners and LPL Financial are separate entities. Additional information, including management fees and expenses, is provided on Shepherd Financial Partners, LLC’s Form ADV Part 2, which is available by request.
Tracking #: 1-05321320