Gaining Access to Alternative Investments

How much do investors need to invest? 

Alternative investments can be accessed through a range of investment types and strategies that are designed to produce return streams outside of traditional stock and bond investments.

Investors typically access alternative strategies through private placements, which may be organized as limited partnerships (LPs) or limited liability companies (LLCs) for tax purposes.

Alternatives introduce unique and complex structures and fee arrangements for investors to consider. For example, alternative investments are typically less liquid than many other investments, have less transparency, charge higher fees and expenses and may involve complex tax structures, among other characteristics.

It is important that investors understand these complexities and the potential impact on financial outcomes. Financial advisors play a critical role in helping individual investors understand their options, choose the right strategies, and find suitable investment managers.

What are the advantages of LP and LLC?

The principal advantages of using a LP or LLC as an investment structure include:

• Tax advantages. LPs and LLCs are “pass-through” entities for U.S. federal income tax purposes. This means that the portfolio’s income, gains, losses, deductions, and credits are passed through to the partners and taxed only once at the investor level.
• Limited liability. One of the biggest advantages of an LP or LLC structure is that it limits exposure to liability. Generally, if the LP or LLC faces bankruptcy or lawsuits, the most investors can lose is the capital they’ve committed, subject to certain exceptions and applicable law.
• Flexibility. LPs and LLCs are managed according to the partnership or company’s governing agreement, which can be written to override, modify or supplement statutory provisions. This gives partners in a LP or LLC flexibility to structure the investment portfolio to meet a variety of economic and governing arrangements.

Note: This information is summary in nature and is in no way complete. Information presented is not intended to be specific legal or tax advice, and should not be regarded as such.

Who can invest in alternatives?

Alternative investments are typically restricted to “accredited” or “qualified” investors. These investors are believed to have both the investment experience and net worth needed to meet the typically high minimum investment requirements of private placements, as well as the ability to withstand the risks associated with alternative investments.

However, with the increasing popularity of alternatives, new opportunities for high-net-worth and individual investors are now being developed. A key driver of this development is technology.

New investment platforms designed for financial advisors, portfolio managers, and investors help reduce the operational challenges of offering alternative investments, removing the barrier of a high minimum investment requirement to levels that are more manageable for a wider range of investors.

What types of investment vehicles are available?

Many investment firms now offer new registered investment products, such as interval funds, as a way to give individual investors access to private placement strategies at a lower minimum investment threshold.

Interval funds combine some of the features of open-end funds with some of the investment flexibility of closed-end funds. Investors can typically purchase shares of an interval fund daily or monthly. However, interval funds offer limited liquidity to shareholders with the use of tender offers, or by offering to repurchase a certain number of shares at specified intervals, generally every three, six or 12 months. Because of fewer redemptions, portfolio managers can invest capital in private securities and other less-liquid investment strategies in an attempt to enhance risk-adjusted returns and provide differentiated sources of return and/or income.

As with any investment, there is no guarantee that any strategy or portfolio will achieve the investment objectives or that the desired results will be realized. In general, interval funds should be considered illiquid.

What should investors look for in an alternative investment manager?

Not all alternative investment strategies are created equal and there can be sizeable disparities in the performance of seemingly similar strategies.

Alternative investment strategies allow for a higher degree of manager discretion to vary market exposures than traditional benchmark-oriented investment strategies. They also allow the use of more leverage, for taking short positions, making significant and dynamic directional bets, and using financial derivatives.

The complexity and speculative nature of this market makes it imperative that financial advisors and investors choose reputable and experienced investment managers.

To choose high-quality managers, start by assessing these five key criteria:

• Performance: Can the investment manager demonstrate a consistent and reliable track record over a medium- to long-term time frame? Do they have a disciplined investment approach that is committed to the goal of delivering superior results? And has the investment manager provided uncorrelated returns over market cycles
• Expertise: Does the investment manager have dedicated expertise in alternative investments? Do they have access to a global network?
• Flexibility: Is the investment manager nimble enough to take advantage of evolving markets while still having the necessary investment process and controls in place?
• Innovation: How will the investment manager help devise solutions specific to investor needs? Does the manager view current market and regulatory changes as an opportunity to innovate?
• Infrastructure: Does the investment manager have disciplined risk management and operational processes? Is the manager supported by strong compliance, regulatory, and reporting oversight?