End Of The Status Quo For Alternative Investments

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Alternative investments have been around for decades. For much of this time, however, large portions of the industry have held them at arm’s length, believing they were too risky, appropriate for only the ultra-wealthy and institutional investors. 

That’s undoubtedly true for a litany of alternatives, including many hedge funds and some private equity vehicles. But it’s important not to ignore other investor segments. Indeed, even mass affluent investors can benefit from having some part of their portfolio devoted to well-vetted products that can act as a counterweight to traditional stocks and bonds.

This year, as both the equity and bond markets have slumped, an expanding number of firms and advisors have started to embrace this reality. Still, two factors that have historically prevented wider swaths of the investing public from taking advantage of alternatives continue to complicate the landscape today. 

Platform Fit 
For one, even as growth within the RIA channel has snowballed in recent years, the advisory business model isn’t always the best fit for alternative investments. That’s because many fee-based advisors, not to mention the product platforms that cater to them, typically crave vehicles with at least some level of liquidity, which naturally requires them to undergo frequent valuations. 

Most alternatives, though, are illiquid for a reason. To appreciate why, consider the dynamics surrounding a nursing home development project. Normally, it takes a year or two to find the land, break ground and build it. From there, it takes another couple of years to fill the facility with patients and then the same amount of time to achieve an exit. 

From the sponsor’s point of view, a venture like that gets more complicated when you constantly have to worry about your capital getting depleted. The related issue, of course, is that anyone making a withdrawal—from what, again, should be a long-term investment—is cannibalizing their own returns.

Further, what do periodic valuations in an instance like the above actually reveal? It’s easy to argue, not much. After all, even if macroeconomic conditions are shaky a couple of years into a long-term project, the environment will likely improve a few years later.

No Small Sponsors Allowed
The other factor that has limited investor access to alternatives has been the reluctance of some platforms to consider anything other than the most prominent (i.e., larger) players in the space. This is the case even though some attractive alternative investment products come from less established companies run by either emerging entrepreneurs or experienced groups new to this distribution segment. 

Do some of these projects entail taking on more risk? Potentially. But in some instances, they also deliver more opportunities. The rub is that many platforms, whether on the broker-dealer or advisory side, refuse to give them a second look because they don’t enjoy much brand awareness in the marketplace. 

Remember, many alternative investment companies with a track record of managing successful projects started humbly. Granted, smaller players may experience higher rates of failure. Still, firms with strong due diligence processes can often prevent poorly designed projects from ever getting on their platforms in the first place—as is the case when vetting products from a company of any size. 

The End Of The Status Quo 
A cursory glance at the current environment suggests that none of the above issues will get sorted out any time soon. Alternative investments that, by their very nature, should be illiquid will continue to find a home on advisory platforms. Meantime, small providers will struggle to get shelf space because many in the industry will theorize that the stakes are too high to take a chance on them. 

Yet the good news is that the market is bound to respond to issues like this. It always does sooner or later. This cannot happen fast enough because the stakes—end investors reaching their goals—are too high for the status quo to linger for much longer.  

Clive Slovin is the president and CEO of the Strategic Financial Alliance, a privately owned independent broker-dealer and registered investment adviser based in Atlanta.