A key area in financial planning is portfolio management, or the selection and monitoring of investments. We believe diversification, risk management, and yield optimization are paramount features to manage an effective portfolio of investments. In recent years alternative investment vehicles have become increasingly popular, doubling in AUM from 2012 to 2022. Among these, Interval Funds, Tender Offer Funds, Private REITs, and Non-Traded Business Development Company (BDC) Funds (collectively referred to as “liquid alts”) have emerged as innovative tools that offer unique benefits to retail investors not seen from traditional mutual funds or Exchange Traded Funds (ETFs).
Before the advent of liquid alts, only large investors could access institutional quality private assets. These investments were typically structured as partnerships, with no liquidity options, complicated tax reporting, and high investment minimums. For example, the minimum commitment to a popular private equity fund could be $10M or more, making them well out of the reach of most investors. However, now investors have access to well-diversified, quality products from those same managers with much smaller commitment amounts. While there can be subtle differences in the strategy, typically the liquid alts offering is the same as the marquee strategy that was previously only available to pensions, foundations, and family offices, etc. While the minimums vary, it is not uncommon for the liquid alt offering to be $1M, while its counterpart partnership fund at the same firm be $10M. Certainly, this is significantly lower and much more affordable, but $1M can still be a significant barrier to entry, especially when building a diversified portfolio. However, in most cases either explicitly stated by the asset manager as a benefit to advisors or through negotiation, an advisor can invest clients in the same liquid alt product for $25k (and sometimes less)1 without paying higher fees. Not just for product due diligence, but manager selection and client interests are other reasons why we believe using a trusted advisor like LGT Financial Advisors (“LGT”) can help you achieve your wealth goals.
Simplified tax reporting is generally an advantage of liquid alts. Most (not all) use Form 1099, rather than the more complicated Schedule K-1 for income reporting. This is due in part because the liquid alts are registered funds with the SEC, while the counterpart funds are typically partnerships that require all individual investors to have their share accounted-for via a K-1. This means the tax reporting for most liquid alts is the same as any other mutual fund or ETF.
The combination of lower investment minimums, more asset classes, and equal quality means portfolios can be constructed like those of the big college endowments or family offices within personal brokerage or retirement accounts. The benefits of incorporating liquid alts into a portfolio are numerous, as private asset classes often have different risk/return drivers compared to public market investments, and they and can be used to provide a portfolio with a superior risk/return tradeoff compared to those without. In other words, liquid alts offer diversification potential previously not available to the retail investor, without sacrificing performance or suffering from exorbitant fees.
There are still pitfalls and challenges when allocating to the private markets via liquid alts. Products can be difficult to access and trade without using a specialized platform such as CAIS or iCapital. The products themselves generally do not have much third-party research or database availability, so they can be difficult to source and conduct due diligence. Furthermore, some products are far more expensive than others in the same asset class, which is why an intensive due diligence process and communication with the manager is important. Given that most liquid alts are relatively new, some do not have much history to analyze, which makes it difficult to set performance expectations. These areas are where an advisor with keen knowledge in the alternatives field can add value. An astute advisor will have the expertise and contacts to both source and diligence funds run by managers that are in the top quartile from an operational and performance standpoint. Additionally, incorporating private assets into a portfolio is as much art as science, so having a good handle on how private assets will perform in different markets is important when constructing a portfolio and setting future expectations.
Another area that is important to have a trusted advisor’s support is the terminology used within the liquid alts space. For example, liquid alts are more liquid that traditional private partnership funds, but they are typically less liquid than a mutual fund or ETF. In normal markets, most funds will have quarterly liquidity using a percentage of their total value. Most funds offer 5% of their net asset value (NAV) per quarter. So, if more than 5% of investors wanted to liquidate in a single quarter, there could be delays in receiving your funds. And, depending on the structure, the fund manager may have the autonomy to delay liquidations for a significant period. The experience with Blackstone’s BREIT and now Starwood’s SREIT are good examples of this extenuating timeline for liquidity.
The benefits of liquid alts consist of less complicated tax reporting, lower investment minimums (especially when working with an Advisor), special liquidity provisions, and quicker deployment of capital compared to the traditional private funds. All these benefits lead to a higher multiple on invested capital (MOIC) than traditional draw-down structured alternative investments. In the past decade these fund structures have been adopted by more brand-name managers such as Apollo, KKR, Blackstone, BlackRock, Stepstone, etc., providing institutional quality management for the everyday investor.
As investors continue to seek optimum portfolio performance relative to their risk tolerance and goals, these alternative investment vehicles are likely to play an increasingly important role by providing diversification beyond traditional asset classes. Understanding the evolution, characteristics, and regulatory framework of Interval Funds, Tender Offer Funds, Private REITs, and Non-Traded BDC Funds is essential for investors looking to navigate the complexities of private assets in the portfolio management process. At LGT, we aim to alleviate these pain points of understanding these complexities and choosing products by using our extensive history of analyzing and investing in alternative investments to create a better client experience. Of course, private assets do not have a place in every portfolio. We believe a diverse portfolio tailored to your specific goals and objectives is the best strategy. Our team is ready to help guide your decision-making process, and we invite you to have a conversation about your wealth management needs at any point in time.
1 Investment minimums can vary depending on the Asset Manager and Fund Structure.
To learn more about liquid alternatives, contact one of our trusted advisors.
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