Alternative Assets: Complex, Risky, and Rewarding

Alternative investments tend to be more complex and less burdened by regulations than traditional assets – public stocks and bonds. As one might expect, investing in greater complexity and risk can lead to higher returns. Within a broader investment portfolio, alternative investments provide diversification; alternative assets generally have low correlation to traditional assets – public stocks and bonds. Hence, alternative investments are becoming more mainstream.

50% of the US GDP, and 65% of new jobs, are created by private companies. Given the large contribution to the economy, private firms represent a massive investment opportunity. Therefore, private equities, despite being labeled as alternative, represent a significant portion of the economic landscape.

Fees, risks and complexities notwithstanding, alternative investments are a great option for pursuing above market returns in an environment where interest rates  hover near zero percent and over a trillion dollars remain “sitting on the sidelines”.

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Private Equities: How Lower Liquidity Leads to Lower Risk

Despite an abundance of evidence about the benefits of adding alternative investments to their portfolio, most investors continue to hold just traditional assets. Given the economic turmoil of the past few years, it’s no wonder investors remain risk averse. Many investors do not realize that what they consider “safer” actually adds more risk – and lower returns – versus a truly diversified portfolio.

Adding investments in illiquid private equities – companies that are not publicly traded – are a great option for achieving long-term wealth appreciation. While it may seem counterintuitive, if you have a long-term time horizon, illiquidity creates the benefit of lower volatility. Traders cannot move in and out of private equity investments in seconds, which has become a trademark of today’s stock market investor, whether an individual or financial institution. Valuations, in turn, are closer tied to company performance and fundamentals and suffer fewer shifts and shocks.

David F. Swenson, in Pioneering Portfolio Management, recognizes that liquidity should be avoided, not pursued, because in a properly diversified portfolio it results in lower overall returns. Swenson further suggests liquidity disappears when you need it most, and becomes available for private companies as they grow.*

Looking for a faster, more efficient way to find alternative investments for your portfolio? Grolio is your alternative assets marketplace. Join Grolio now and search investments in minutes.

Sources: https://en.wikipedia.org/wiki/David_F._Swensen and http://seekingalpha.com/

Overview of the Endowment Model

The endowment model, often referred to as the “Yale model,” refers to an investing strategy developed by David F. Swensen and Dean Takahashi. Swensen has been the Chief Investment Officer at Yale University for almost 30 years.

Consider three key theories behind this widely accepted strategy.

1.     Diversification. The endowment model teaches that by choosing a variety of uncorrelated asset classes you’ll yield higher returns. Investors are encouraged to divide their portfolio into five or six asset classes. The model also highlights a bias towards equity.

2.     Risk increases with similar or opposite funds. Swensen’s theory is that funds should be different, but not opposite, to decrease risk. Similar funds are too volatile because losses would be felt too greatly if that market takes a hit. Conversely, selecting funds that are opposite will not yield as much return because when one investment is doing well, the opposite one is most likely doing poorly. Gains and losses would ultimately cancel each other out.

3.     Less liquidity is good. This idea was quite revolutionary when Swensen revealed his model. The endowment model teaches that investors pay a premium for liquidity, thus lowering return. Swensen also suggests liquidity disappears when it is needed most. Thus, this strategy focuses more on alternative investments, such as private equities, hedge funds and venture capital.

The endowment model’s name comes from the long, successful track record on behalf of university and other endowments and family offices. These organizations are generally focused on long-term appreciation over immediate cash needs. The Yale and Harvard endowments have reported returns of between 15 and 16 percent over the last 25 years.

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Can You Hold Alternative Investments In Your IRA?

The Individual Retirement Account (IRA) has become one of the most popular tax-advantaged investment vehicles used by Americans today. It was recently estimated that four out of 10 U.S. households owned assets in IRAs[1], accounting for over a quarter over all U.S. retirement wealth[1]. Moreover, eight out of 10 households have retirement savings that may eventually rollover into an IRA[1]. Because IRA ownership is generally associated with higher net worth investors[1], properly diversifying IRA assets has become an integral part of any shrewd investors’ overall retirement savings strategy.

However, IRA assets must be held with a qualified custodian, and because most custodians lack expertise in alternative investments, IRA savings are commonly limited to traditional investment options like stocks, bonds, or mutual funds. For this reason, most investors are surprised to learn that the Internal Revenue Code has always allowed IRA owners to invest their tax-advantaged assets in a broad range of alternative investments. That’s right— diversifying your retirement plan to include hedge fund assets, private equity or other investments in private companies is within reach. As U.S. investors continue to seek out alternative investments to complement their retirement savings, more custodians are expanding the scope of investments they allow their customers to hold in their retirement accounts.[2]

Why consider alternative investments in your IRA? One must only look back a few years to the recent financial crisis for a startling answer. Retirement assets suffered some of the steepest losses during the financial crisis, in part because of the non-diversified traditional investments held therein. Allocating retirement savings to alternative investments — like hedge funds, private company investments or venture capital — is no longer simply fodder for cocktail-hour bluster, but rather a sensible way to broaden asset diversification, a proven strategy to reduce volatility in a portfolio’s performance, and even increase the potential for higher returns over time.

The mission of Grolio is to provide greater access to alternative investments. Grolio makes it easier and more efficient for all accredited investors to find, search, sort, and filter alternative investments to identify the best fits for their portfolio — whether the investable assets are qualified under an IRA or not. Grolio also offers the chance to interact with other potential investors.

Interested in adding alternative assets into your investment portfolio? Sign up for Grofolio now to be notified when we launch later this summer.

(Grofolio recommends talking to a qualified tax consultant before investing retirement assets in alternative investments).

[1] http://www.ici.org/pdf/per18-08.pdf

[2] E.g. Equity Institutional (http://equityinstitutional.com), or Millennium Trust Company (http://www.mtrustcompany.com)