Alternative Investments vs. Private Investments: Avenues for Enhancing Portfolio Performance

Alternative investments are a broad category of assets that fall outside the traditional categories of stocks, bonds, and cash. These investments offer investors exposure to a diverse range of assets beyond conventional securities and can include a wide variety of tangible and intangible assets. They are an attractive option for investors who are seeking to diversify their portfolios, hedge against market volatility, or potentially achieve higher returns.

Examples of alternative investments include hedge funds, private equity, real estate, derivatives, and commodities.

One benefit of alternative investments is that they often have low correlation with traditional asset classes like stocks and bonds. This means they can provide diversification benefits by reducing overall portfolio risk. When traditional investments perform poorly, alternative investments may perform differently or even positively, helping to stabilize a portfolio's return.

Alternative investments also offer investors access to unique opportunities that are not available in traditional markets. Investments such as venture capital, infrastructure projects, private companies, and certain hedge funds can offer diversification and the potential for higher returns.

Some alternative investments, such as commodities, can act as a hedge against market volatility. They may perform well during periods of economic uncertainty or when traditional assets are underperforming. They could also offer inflation protection. As the prices of goods and services rise, the value of tangible assets such as real estate and commodities may also increase, helping to preserve purchasing power.

Lastly, alternative investments often involve active management strategies. These can provide opportunities for skilled fund managers to add value through active trading, selection of investments, and risk management techniques. This active management approach could lead to outperformance compared to passive investment strategies in certain cases.

As with other investment vehicles, alternative investments come with inherent risks that investors should carefully consider before adding then to their portfolio. One of these risks is a lack of liquidity. Many alternative investments are illiquid, meaning they cannot be easily bought or sold on public markets. This lack of liquidity can make it challenging for investors to access their capital when needed, and they may face restrictions on withdrawals or have to wait for extended periods to exit their investments.

One of the benefits of alternative assets are that they are lowly correlated with traditional assets. However, because of this relationship, if traditional assets are performing well, there is the risk that alternative investments may perform differently at that point in time.

A third consideration for alternative investments is that they may offer limited transparency into underlying assets, portfolio holdings, and investment strategies. Investors may have limited visibility into how their capital is being deployed, the valuation of their investments, or the risks inherent in the portfolio. Due to the increased level of complexity that alternatives may bring, it is important that investors fully understand where they are allocating capital and, when necessary, engage a professional to enhance their understanding of the risks they are accepting for the return they are expecting.

Overall, while alternative investments can provide diversification, potential for higher returns, and access to unique opportunities, investors should be aware of the risks involved and carefully assess their risk tolerance, investment objectives, and suitability before allocating capital to alternative asset classes.

Private investments are a subset of alternative investments. These are investments made in privately-held companies or assets that are not publicly traded on stock exchanges. They involve purchasing ownership stakes or securities in private companies, partnerships, or projects that are not available to the general public.

Common types of private investments include private equity, venture capital, private debt, and private placements.

Like other types of alternative investments, private investments offer access to a wide range of unique opportunities that are not available in public markets. This includes investments in early-stage startups, private equity buyouts, real estate development projects, and infrastructure investments. These opportunities can provide exposure to sectors and industries that are not represented or are underrepresented in public markets.

Private investments often have a longer investment horizon compared to publicly traded securities. Investors in private companies or projects typically expect to hold their investments for several years before realizing a return. This long-term focus can align with investors' objectives, such as building wealth over time or funding retirement.

Lastly, private investments have the potential to generate higher returns than traditional investments over the long term. Investing in privately-held companies or assets allows investors to capture the value created by these entities before they become publicly traded. Additionally, because private investments are not subject to the daily fluctuations of public markets, they may offer a more stable and predictable long-term investment environment.

Because private investments are a subset of alternative investments, they come with many of the same risks as alternative investments, such as limited transparency and illiquidity. Certain private funds can be more volatile than private markets, while others may be much lower. Although not as easy to locate as public market investments, private market provide the investor with options that meet their risk profile -- if they know where to look. The financial media tends to focus on aggressively over-leveraged hedge funds and tend to ignore the funds that provide investors steady, stable returns through market cycles. Although these funds are not as exciting, these are the opportunities that many investors are looking for.

An additional risk inherent to private investments is concentration risk. Private investments often involve concentrated exposure to specific sectors, industries, or geographic regions. Concentration risk can increase the impact of adverse events or market downturns on investment portfolios and reduce diversification benefits.

Alternative and private investments share several similarities:

• Non-traditional asset classes: Both alternative and private investments involve asset classes that fall outside the traditional categories of stocks, bonds, and cash. Alternative investments encompass a wide range of assets such as hedge funds, commodities, real estate, and derivatives, while private investments specifically refer to investments in privately-held companies or assets that are not publicly traded.
• Diversification benefits: Alternative and private investments both offer diversification benefits to investors. By adding either of these assets to a portfolio, investors could reduce overall portfolio risk by spreading their investments across different types of assets with potentially low correlation to traditional investments.
• Potential for higher returns: Both types of investments have the potential to generate higher returns than traditional investments over the long term. Certain alternative assets, such as hedge funds or private equity, and private investments, such as venture capital or direct investments in private companies, may offer significant returns if successful.
• Less correlation with public markets: Private and alternative investments tend to have lower correlation with public market movements. This means they may perform differently from traditional investments during market downturns, providing potential diversification benefits and helping to reduce overall portfolio volatility.
• Longer investment horizon: These investments often have longer investment horizons compared to traditional investments. Investors in these assets typically expect to hold their investments for several years, allowing time for value creating and potentially higher returns.
• Access to unique opportunities: Both alternative and private investments offer access to unique investment opportunities that may not be available in traditional markets. This includes investments in early-stage startups, real estate development projects, infrastructure investments, and niche sectors or industries.

Incorporating alternative and private investments in a portfolio could be advantageous because they increase portfolio diversification. These types of assets offer exposure to different risk factors and return drivers compared to traditional asset classes. By diversifying across multiple asset classes, investors can reduce portfolio volatility and could enhance risk-adjusted returns.

These asset classes may also provide some level of inflation protection for a portfolio. Certain alternative investments, such as commodities, tangible assets, and inflation-linked securities, can serve as effective hedges against inflation. By including inflation-sensitive assets in a portfolio alongside private investments, investors can help protect their purchasing power and preserve wealth over time.

Including both alternative and private investments in a portfolio can also offer risk mitigation. These investments can help mitigate specific risks associated with traditional investments. For example, real assets such as real estate and infrastructure may provide stable cash flows and act as a hedge against interest rate risk, while hedge funds may offer downside protection and risk management strategies during periods of market volatility.

Lastly, having these investments in a portfolio allows investors to tailor asset allocation to meet specific objectives, risk tolerances, and liquidity needs. By combining different types of alternative and private assets, investors can create a well-rounded portfolio that reflects their unique financial situation. This can help investors achieve their investment goals, manage risk, and navigate changing market conditions effectively.

Alternative and private investments can offer many benefits for an investor's portfolio. However, it's essential to consult with a financial professional to carefully assess the suitability of these investments and ensure that your portfolio aligns with your overall investment strategy and objectives.

To learn more about the investment strategies we use for our clients, we invite you to contact one of our Wealth Advisors. Or, if you'd like to receive a complimentary Portfolio X-Ray to review your portfolio's current asset allocation and identify gaps and weaknesses, you can contact us here.