Outpace the Herd with Alternative Investment
Call it an age of democratized alternative investment. Investors like you have increasingly demanded access to alternative investments—from venture capital and private equity to private opportunities, like infrastructure and debt. Now, finally, more financial providers are hearing that demand and increasing their alternative offerings.
Why the desire for alternative investment? It offers portfolio diversity, limits exposure to public volatility, and outperforms public returns (by 3.4% per year over the past decade, according to a McKinsey report).
Now we see a trend, albeit gradual, of wealth management groups getting involved in this space. According to a UBS Global Family Office Report, 35% of family offices now allocate at least 30% of their portfolio to alternative investments. It marks a stark climb from 10-15 years ago, when CM Wealth was considered highly niche for specializing in alternative assets.
If you want to benefit from outperforming classes, use the primer below to learn about the many types of alternative investments out there and the expertise you should look for in a wealth management team before you trust them to steer your financial future in this space.
Honest Drawbacks of Alternative Investment
Before we get into specific alternative investments, let’s acknowledge potential drawbacks that can apply across all types of alternative investment.
As mentioned, alternative investments can lead to illiquidity. Compared to the public market, these investments require patience, as they can be held for several years. Your wealth management team should be able to give you a realistic assessment of notice periods and lockups. A team experienced in alternative investment will be able to create a portfolio that balances your illiquidity just as they balance your risk.
Another downside to alternative investment can be its fee structure. Some wealth managers tack on a higher management fee (1-2% of AUM) as well as a performance fee (sometimes called an “incentive fee”) to your alternative investments. Make sure to review the ways your provider benefits from your movement and performance. You want to know they will guide you to a private opportunity for the right reasons, with the only incentives in mind being yours. (At CM Wealth, for instance, we use a no-fee, no-carry approach to better ensure we’re giving you a fiduciary perspective.)
Finally, the reporting that comes back to you on alternative investments can be lacking with some providers. With many alternative investments have a long-term outlook, some wealth managers will settle for providing reports that lack benchmarks, making it tough for you to stay informed about performance.
At CM Wealth, we keep you knowledgeable through Addepar, a sophisticated investment management platform that tracks investments in real time, and we talk with you about investment’s benchmarks, like an its internal rate of return.
So while one can make points against alternative investment, most detractions can be traced to the behavior of the wealth management team. With an honest, informed wealth management team, you can avoid these pitfalls.
Private Equity
Moving ahead, we can look at alternative investment categories that you can inquire about with any alternative investment program.
The most popular class within alternative investment is private equity. A wealth manager may offer private equity by partnering with firms that invest in established companies. This is like flipping a house, in essence. Private equity firms aim to buy controlling stake in companies that are undervalued or facing limited growth prospects with their current cash flow. Once they have a controlling stake, the firm makes operational changes to improve performance and bottom line. They hold onto these investments for a longer period—commonly five or seven years—and then sell for profit.
As you evaluate a wealth manager’s private equity offerings, it is fair to ask what private equity firms they work with, what sorts of history and rapport they have with those firms, and what track record of success they and their firms demonstrate in getting high returns.
Five to seven years is a long time to wait for an unproven return. Given that opportunity cost to other potential investment, you deserve to know your team is well networked and connected to vetted, proven firms.
Venture Capital
Some people prove savvy when it comes to projecting which companies will make it big before they do. But the nature of public investing limits the chances to capitalize on such insight. That is because the average age of a company issuing an IPO is between 8 and 10 years, yet the best year-over-year trajectories in a company’s history tend to be earlier, well before a public offering.
Enter venture capital. This is your way to be part of good businesses at the right time, before opportunities break open for the masses. Venture capital firms invest in early-stage companies with high growth potential, usually in their pre-revenue stage. These investments tend to be smaller than private equity and more in their drastic risk-reward profile. Illiquidity in venture capital investments often ranges from three to seven years, culminating in returns through an IPO exit or when selling stake to another investor.
Venture capital puts you in an episode of Shark Tank, essentially, with a chance to capitalize on the next big idea. But what type of team does your family office have to evaluate startups across wildly different sectors?Having done this for more than 20 years, our CM Wealth team has had time to foster a network with sector experts across many industries, so we critically assess an investment in ways that would be impossible for a family office new to alternative investing. We have also carved out a healthy relationship with some of the venture capital market’s most elite firms, securing our clients access to exclusive properties.
Commingled Funds
Popular with many investors in recent years, commingled funds let investors pool money together to access a diversified portfolio of assets. This approach can reduce risk, but commingled funds tend to mimic the health of the public market, so you should be ready to weather fluctuation over time.
If your wealth management team offers commingled funds, find out which specific person manages the investment and what record of success that person shows.
Beyond Private Equity, to Private Opportunity
We have noted how more family offices are ramping up private equity and venture capital options. But there are other alternative classes—most of them in the bucket of “private opportunities”—that family offices still fail to provide, and you should know about these too.
Real estate
If a family office is going to carry any private opportunity, it is likely to be real estate.
A lot of the real estate opportunities you find through a family office are commercial—strip malls, office complexes—and they offer a steady return. If the real estate investments vary in industry and geography, you can mitigate risk, but many family office staffs will be limited in their scope and connections.
Ask a wealth manager about the breadth of regions and building types they invest in and you will gain clues as to how suited they are to handle these investments.
Infrastructure
Pipes and bridges may not be the most scintillating assets, but they can pay off. According to a PwC report, global infrastructure is expected to grow to $4.8 trillion by 2025, up from $3.4 trillion in 2017. This growth is driven by infrastructure investment in emerging markets, as well as by the need to modernize and maintain existing infrastructure in developed markets.
Ask your wealth manager what proven experience they have with infrastructure and what practices they have for diversifying to mitigate risk.
Debt
One of the top private opportunities available is the purchase of debt. The private debt market has popularized in the past 15 years, with the global market surpassing $1 trillion. Regulatory changes in this span have limited the extent to which public banks can invest in these areas—leading to a sudden need for private credit in a buyer’s market, with wealth managers being highly selective.
Private debt can be a risk mitigation tool for your overall portfolio, because if interest rates rise, so too does the rate charged to your borrower, whose limited liquidity should allow your wealth manager to negotiate favorable terms.
But would your family office have the experience to evaluate the risk profile of a potential borrower? This is where our CM Wealth team leans on more than 20 years of networking across sectors. We are tied in with experts who assess a borrower’s health and their growth potential.
Intellectual property
While it takes a batch of experts to navigate private debt opportunity, it can take a small army of them to inspect intellectual property opportunity.
Intellectual property infringements are commonplace. In many industries, giants do as they please, asking for forgiveness instead of permission, and later paying off a smaller company whose IP they violated.
There are opportunities to take on the smaller company’s IP case and finance their pursuit to rectify with the transgressing party, for a percentage of the settlement. But weight so many companies claiming IP infringements, and not all accusations holding weight in court, how would your family office team have the discretion to select the right cases?
At CM Wealth, we have occupied this space long enough to assemble a network of legal experts who weigh the merits of a claimant’s case. We coordinate with them as well as our sector gurus, because we want to accurately calculate the market value of IP that has potentially been violated.
Ask your wealth management team if they have private opportunities for you in IP, and if they say they do, inquire about their vetting process to determine the viability of a claim.
Gain Expertise and Experience to Maximize your Alternative Investments
With alternative investment, you can diversify your portfolio, protect yourself from market fluctuation, and outperform the public class. It is great that more family office teams are figuring out the value in this space. But as you make the personal decision of what wealth management team you want guiding your investments, determine how much proven experience you want.
In the past 20 years, CM Wealth has allocated more than $500 million toward alternative assets, so we know these spaces. It took years to forge our network of connections and to unearth top opportunities for our clients. Wealth manager new to these asset classes will not duplicate our relationships overnight.
Our team is passionate about alternative investment and the connections we can leverage for you. Want to walk through the pros and cons of a particular alternative asset or talk about strategies for diversifying risk? Contact our office and we will gladly make one of our alternative investment experts available to you.