Alternative investments: a portfolio diversification strategy
If you feel you need a finance degree and a corner office on Wall Street to invest in alternative assets, you’re not alone. The reality though is that anyone can invest in alternatives with more knowledge and a little curiosity.
There may be benefits to looking beyond traditional assets like stocks and bonds when investing for retirement.
"Some investors may want to expand their horizons and think about alternative asset classes that have different return patterns than traditional investments," Thomas Kurinsky said. Kurinsky is senior director of custody services at Millennium Trust, and a Certified Alternative Investment Analyst.
Put simply, alternative assets may be a good diversification strategy to distribute risk in a portfolio.
There are many types of alternative investments. Examples include real estate, hedge funds, private equity, commodities, marketplace lending, and precious metals.
Also, some alternative investments have low correlation to traditional assets, such as stocks and bonds. This means there is little to no relationship between the movement of one with the other. For example, if a traditional asset like a stock has a down month, an alternative asset like private equity may go up, down, or stay in value that month. Plus, some alternative assets are less likely to be as volatile as stocks, which are valued in real time and often impacted by the latest news.
“The reason investors are interested in alternative investments, generally, is that they don't zig when the market zags,” Kurinsky said.
Can an average investor take advantage of alternative assets?
Many people believe alternatives are just for large, institutional investors. However, average investors can use a self-directed IRA to invest in a variety of alternative asset classes.
Research shows that ultra-high-net-worth investors and institutions have embraced alternatives as a diversification strategy. According to a 2021 report1 from KKR, a global investing firm, “families that have over one billion in assets under management have from 51-54% of their total assets in some type of alternative product.”
So, what is holding everyday investors back from tapping into this diversification strategy?
Mostly, it’s due to a lack of knowledge.
High net worth (HNW) investors show high levels of interest in alternative investments — but there is a significant gap between investors’ interest and their ownership of these assets. For example, according to a 2018 Millennium Trust survey of 500 investors, 63% of HNW investors are moderately or extremely interested in owning real estate investments (exclusive of personal residences), while only 37% actually own real estate investments.
The knowledge gap
One reason for this gap may be that HNW investors simply don't know enough about alternative investments. According to the same survey:
-
42% of HNW investors have only slight or no familiarity with hedge funds
-
33% have only slight or no familiarity with private equity
-
49% have only slight or no familiarity with other alternatives such as marketplace lending and crowdfunding
"This survey tells us that people want to invest in alternatives, but often they aren't sure how to do it," Kurinsky said.
Often, alternative investments may feel complex or inaccessible to the average investor. There isn’t a central S&P-type index for alternatives. Many alternative assets aren’t publicly traded. “There isn't a natural space for people to gain the knowledge they need for alternative investments," Kurinsky said.
Thankfully, that’s changing. With investor awareness, alternatives are growing and becoming more mainstream. According to a 2020 report from CAIA2, from 2003 to 2018, alternative investments grew from 6% to 12% of the global investment market and forecast this will grow to 18% to 24% of global assets by 2025.
Learn more about alternative investment options
Here’s a high-level overview of some of the most popular types of alternative investments and how they may help you diversify your portfolio.
Real estate
Investors interested in real estate can choose among:
-
Investing directly in properties
-
Pooling funds with other investors to purchase a property
-
Purchasing shares in a real estate investment trust (REIT)
Real estate has a low correlation with other asset classes, so when the stock market is down, real estate can continue to thrive, making it a valuable diversification tool.
For more information, check out our resources on investing in real estate:
Hedge funds
A hedge fund is a private pool of capital whose managers can buy or sell basically any asset. Although they resemble mutual funds, hedge funds are not regulated in the same manner and are limited to sophisticated investors, such as institutions and individuals with significant assets. They are popular with experienced investors who have substantial investable assets and are seeking additional returns and diversification.
For more information, check out our resources on investing in hedge funds:
Private equity
Similar to venture capital, private equity firms are investment partnerships that invest and manage promising private companies to sell at a profit. Many new investment platforms are making private equity more accessible to investors at lower minimums.
For more information, check out our resources on investing in private equity:
Commodities/Futures
Commodities come in different categories, including:
-
Energy
-
Livestock
-
Agriculture
-
Metals
They tend to have low or negative correlation to traditional equity markets, so when markets are volatile or down, commodities may provide stability. Investors can trade commodity futures or use a managed futures fund.
For more information, check out our resources on investing in futures:
Marketplace lending
Marketplace lending is a tool that matches investors with borrowers via online platforms. It can include various types of loans — including consumer, small business, and education — as well as real estate deals.
For more information, check out our resources on investing in marketplace lending:
Crowdfunding
Crowdfunding pools money from individuals to fund new business ventures. It can be debt-based, as with online lending, or equity-based, as with private security offerings. By pooling money, crowdfunding platforms allow individuals to invest at a lower entry point than typical private equity or debt deals.
Utilizing retirement funds for alternative assets
"There is a ton of wealth in the retirement sector, but some retirement savers don't know that you can utilize retirement funds to open a self-directed IRA to take advantage of tax-deferred gains with traditional assets and alternative investments," Kurinsky said.
According to Investment Company Institute3, as of March 31, 2023, United States retirement assets totaled $35.4 trillion. This accounts for 31% of all household financial assets in the U.S.
"There is an opportunity for individuals to seek additional diversification with their retirement assets, especially if there is a longer duration for them to hold those positions,” Kurinsky said.
Saving Your Way
When it comes to investing in alternative assets, in short: "People want it. Institutions are doing it. There are a lot of resources, and Millennium Trust can help you use a portion of retirement for alternatives if you want more diversification of your overall portfolio,” Kurinsky said.
Looking for a way to invest in alternative assets as part of your retirement strategy? Millennium Trust offers self-directed IRAs.
Before investing in alternatives, investors should consult their investment, tax, and/or legal adviser.
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Millennium Trust Company performs the duties of a directed custodian, and as such does not offer or sell investments or provide investment, legal, or tax advice.