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An Overview of Alternative Investments

Written by Nathan Kuhn August 13, 2020

An alternative investment is an investment that does not fall into the traditional asset class of stocks, bonds, and cash. The most common types of alternative investments are precious metals, oil and gas, venture capital, hedge funds, and real estate. An investment made into a DST to complete a 1031 exchange, for example would be considered an alternative investment.

At our firm, we have years of experience evaluating alternative investments, conducting due diligence and, importantly, implementing alternative investments into our client’s financial plans.

All alternative investments fall into one of two categories: public or private investments. An example of a public alternative investment is a Real Estate Investment Trust, or REIT. A private alternative investment may include:

• Hedge funds: funds that invest in a broad range of securities, generally limited to publicly traded investments
• Venture capital: equity investment into privately-owned companies
• Private equity: a broad category; this encompasses all other private investments, including real estate, infrastructure, oil & gas, debt, and more

Here, we will focus on private equity investments.

Potential Benefits of Alternative Investments

1. Their value is generally not correlated to the stock market

Alternative investments provide diversification, and their value will generally not change relative to the ups and downs of the market. This can help protect investor’s portfolios from market-related volatility.

2. Lack of volatility

Traditionally, the share price of a public investment fluctuates based on a variety of factors and is generally not tied to an actual asset. Private investments, though, lack the volatility of public investments and are typically backed by an actual asset.

Additionally, while time in the market may help long-term market investors, volatility can depress compounding returns.

3. Direct ownership

With a public investment, your purchase is a paper asset – your ownership is not in a tangible asset. Private alternative investments allow you direct ownership of whatever asset you purchase.

4. Direct tax benefits

Many alternative investments will allow you to keep more of your profit. As a part-owner of an alternative investment, tax benefits can be directly passed on to you. The most important direct tax benefits may include pass-through depreciation and long-term capital gains treatment, among others.

5. Potential for Income

Many alternative investments are cash flowing, with distributions generally paid monthly or quarterly to investors. The amount of cash flow in alternative investments can be substantially higher than what investors may find in public investments.

6. Passive investments

Actively managing a portfolio requires a tremendous amount of work and expertise. A private alternative investment offers funds that are passive and without requirements for ongoing management from investors. They also leverage the experience, knowledge, and skills of fund managers.

Disadvantages of Alternative Investments

While private alternative investments have many potential benefits, there are some disadvantages. As with all investments, there is the possibility that the investment will not perform as expected – thus resulting in loss of income or principal. Additionally, alternative investments are generally illiquid. Lockup periods may range from 3-10 years, which makes sense when you understand private funds are generally tied to an asset—and to liquidate an investment, requires liquidating the asset.

If you’re considering your overall investment strategy and interested in learning more or pursuing an alternative investment, we can help. Please call us at (224) 245-5281 or schedule an introduction today.