Morgan Stanley
  • Wealth Management
  • Jun 19, 2019

Alternative Investments for a Wider Audience

Concerned about volatility and low rates? Several types of registered funds can deliver attractive returns that are less dependent on traditional stock and bond markets.

As investors grow concerned about late cycle volatility and low yields, my team has been asked by financial advisors how they can offer alternative investments to a broader client base. These strategies aim to deliver returns not correlated with traditional markets, often through investments in private equity, credit or real estate.

In the past, alternative investments were mainly limited to institutional and ultra-high net worth investors who could meet the high investment minimums and other eligibility requirements associated with private funds. That has changed over the years, with an expansion in the types and quality of alternative investment offerings registered with the Securities and Exchange Commission providing a broader range of investors access to these strategies.

Indeed, as uncertainty over the market rises, investors may want to consider registered alternative investment funds for their potential to generate uncorrelated returns.

More Accessible Alternatives

Registered alternatives are typically available to investors with net worth of at least $1 million who can meet initial investment minimums of $25,000 to $50,000. While considerably lower than private fund requirements of $5 million in investable assets and initial investments of $100,000 to more than $1 million, the eligibility requirements for registered alternative investments are still significantly higher than that of most mutual funds.

There are other notable differences. Although registered under the same Investment Company Act of 1940 that governs mutual funds, the structures and underlying strategies of alternative investments can be quite different, particularly as they pertain to liquidity. For example, registered alternatives often have exposure to less liquid, lower rated or more complex asset classes, and generally do not offer daily redemptions to investors. This can protect such funds from having to sell positions in down markets, but it also means investors can’t sell their shares at any time, the way they could with mutual funds.

Here are some examples of registered alternatives:

  • Interval funds are typically income-oriented strategies, investing in less liquid credit sectors that may generate higher yields and returns over the longer term. Investors can redeem at set intervals, usually quarterly, and typically only up to 5% of the fund’s assets on an aggregate basis per period.

  • Funds of hedge funds are actively managed portfolios of hedge funds (private investment funds that aren’t registered) that are diversified across strategies. These funds of hedge funds offer access to high quality managers at lower investment minimums than typical hedge funds, with investors able to redeem on a periodic basis.

  • Private equity funds of funds raise capital from investors to make commitments to multiple private equity funds, benefitting from sector and strategy diversification. Many also offer exposure to direct co-investments and secondary investments.

  • Private business development companies lend to mostly private, midsized companies. Because they don’t trade on an exchange, they can avoid the daily volatility associated with publically traded business development companies.

  • Non-traded real-estate investment trusts (REITs), like public REITs, allow investors to earn a share of the income from a portfolio of stable, well-maintained and income-generating commercial real-estate assets. Since they don’t trade on public markets, the value of non-traded REITs isn’t tied to the kind of market sentiment that can affect public REIT shares. Non-traded REITs have improved over the years in terms of greater liquidity, transparency and lower fees for investors.

The Illiquidity Premium

Registered alternatives have a number of common traits. Many invest in illiquid securities, creating the potential for long-term investors to earn a greater return for holding less liquid assets. They also generally exhibit low correlation to stocks and bonds given the distinctiveness of the underlying asset classes. Finally, many of these vehicles can offer higher income than traditional stock or bond portfolios due to the underlying liquidity, complexity, credit and/or leverage risks. In a low interest rate environment, a higher yield may be an attractive feature for many investors.

Overall, registered alternative investments can provide high net worth investors with diversified, and potentially enhanced, sources of return that traditional stock and bond funds typically don’t provide. Eligible investors who don’t need access to daily liquidity for a portion of their portfolio may want to consider these offerings as part of their broader asset allocation mix.

This article is adapted from the Global Investment Manager Analysis (GIMA) report, “Democratization of Alternatives for High Net Worth Investors,” Mar 27, 2019. GIMA Alternative Investments Analyst Jason Park also contributed to the report. Ask your Financial Advisor for a copy.

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