Alternative Investments: a Primer

What are Alternative Investments?

Broadly speaking, alternative investments include all investments other than traditional stocks and bonds. They can be Private Equity, Treasury Inflation Protected Bonds (TIPS), Direct Real Estate Investments or REITs, Hedge Funds, Oil and Gas Limited Partnerships, Natural Resource Investments in Farming, Timber or Infrastructure, California Water Rights…the list is extensive, quite interesting and can be very esoteric. For right now it’s simplest to say that investing in alternatives opens your portfolio up to a new range of non-traditional, diversifying investments with very compelling characteristics.

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Why Invest in These Diversifying Strategies?

The simple truth is that many of the brightest investment minds work in these non-traditional areas of the market where they can manage companies and participate in active ownership. We believe investors benefit from investing alongside these individuals. Additionally, many of these non-traditional investment categories target very specific investment objectives like providing current income or performing well in periods of rising interest rates or high inflation. Finally, these non-traditional investments move differently than traditional stocks and bonds—they are less correlated—so adding them to a portfolio can reduce volatility. As a result, we believe having some exposure to alternatives gives you access to investment thought-leadership, helps reduce your long-term portfolio volatility without sacrificing returns, and strategically targets your investments to meet specific goals.

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How Much Should I Commit to These Non-Traditional Strategies?

This answer varies significantly, depending upon your goals, your time horizon, your liquidity needs and your other investments. However, a general range would be 10 to 30%. Stanford’s Endowment has a 2014 target allocation of more than 60% to alternative investments, however it’s unlikely that individuals and families should ever commit that much. Each individual investor is different, and we will tailor your portfolio allocations to your specific needs.

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Aren’t the Fees on These Types of Investments Very High?

Yes. Some of these non-traditional investments have high fees. The most talked about example is the 2% of assets and 20% of profits charged by many hedge funds. But remember—the universe of non-traditional investments is broad, and fees vary significantly depending upon the category of investment, the investment vehicle and the manager. That said, it doesn’t make sense to blindly avoid a high-fee asset class if it enhances the characteristics of your portfolio after paying all fees.

We encourage you to think about the fees you pay holistically, at your total portfolio level. Invest in low-fee products when the investment is unlikely to provide premium returns. So, for investments in traditional asset classes like large cap stocks, we recommend index funds and ETFs (Exchange Traded Funds) which typically charge significantly lower fees. However, it is our opinion that in certain circumstances it makes sense to pay a higher fee to access elite managers that we believe have the ability to achieve premiums to the market and lower your overall risk—the goal of managers in these non-traditional categories.

We are not paid for referrals to managers, nor do we take a commission or receive any revenue from our managers. We recommend managers and investments based solely on their ability to meet your needs. And we believe that for many investors, investing the majority of their portfolio in low-fee traditional investments, and a portion in higher-fee non-traditional investments, is an effective way to maximize investment opportunities while controlling overall costs.

Aren’t These Investments Illiquid?

It is true that some alternative investments are quite illiquid, while others trade actively every day. Remember, this asset category encompasses an extremely wide range of investments from securities issued by the US Government (TIPS) to direct private equity investments that can take 10 to 12 years before capital is returned. That is why understanding your investments, and doing the due diligence on the managers, is vital. Our first priority is making sure you understand and are comfortable with your investments. Next is giving you access to those we believe to be some of the most elite and established managers in the country. Finally, clear communications and manager due diligence will play a pivotal role in our on-going relationship.