Navigating Wealth Beyond Stocks: A Guide To Alternative Investments

Since the JOBS Act, the investment landscape has changed, allowing everyday investors access to alternative investments once exclusive to Wall Street’s elite. This shift democratizes opportunities beyond traditional stocks, enabling wider access to potentially lucrative investments in private equity, real estate, and more, making it more important than ever to understand alternative investments.

It seems like every year, investors are reminded that alternative investments like private equity, private credit, and real estate outperform public markets. While many institutional investors have anywhere between 25%-50% of their portfolio in alternatives, most retail investors have barely 5%. Why? 

For nearly 100 years, everyday investors have been legally restricted from the types of alternative investment opportunities normally offered to Wall Street insiders and their wealthy clients. 

Thanks to the JOBS Act, which allows companies to raise limited amounts of capital from anyone over the age of 18, that’s all starting to change. Since I started Equifund in 2016, I’m proud to say that we’ve helped 16 companies raise more than $70 million from over 20,000 retail investors — many of whom had never invested in alternatives before. It’s not just the crowdfunding industry offering everyday investors access to alternatives, though. Wall Street firms are admitting they expect the majority of their future growth to come from retail investors.

That’s why there’s never been a more important time for investors to start learning about the alternative investment opportunities coming their way.

Why Alternative Investments, and Why Now?

Before we can have a discussion about what alternative investments are, we have to define traditional investments. For the most part, traditional investments are anything available in the public stock market, with alternatives representing everything from owning a small business, rental property, and precious metals to fine art, watches, and cars.

The benefits of owning traditional investments are obvious: Investors have access to real-time price quotations and the ability to trade during normal market hours. However, if you believe that public markets are efficient, it is more or less impossible to outperform the broader market over time. 

Alternative investments offer investors the opportunity to generate potentially larger risk-adjusted returns than public market comparables. 

Most investors have heard the Yale University endowment story: David Swensen, endowment chair in the 1980s, put Yale’s endowment money into long-term, illiquid alternative investments and is credited with generating $20 billion in excess returns for the university’s endowment. This popularized alternative investment opportunities, and many institutions followed suit.

According to Hamilton Lanes 2023 Market Overview, private market strategies have consistently outperformed public markets over the last 15 years (with the exception of REITS).

Survey after survey suggests that individual investors want more alternative assets, but even if they had access to all the same options that institutions did, that doesn’t mean it’s a good fit for their needs. For example, even if you have access, you likely don’t have the time or resources required to perform any substantive due diligence. 

And even if you had access and could underwrite the deal, many private funds require a minimum check size of $250,000 to $5 million. If you want to invest in the name-brand funds — like Sequoia or a16z — you’re looking at something more along the lines of a $100 million to $500 million buy-in. Plus, even if you could get your money into a fund, many private funds assume a seven- to 10-year hold period, which, for most regular people, is simply a non-starter. 

Last but not least, even if you could overcome all of those barriers to entry, now you have to account for the fees. In order to produce a 15% net-of-fee return, an investor in a fund vehicle needs to have the manager produce a gross-of-fee return of 22%-24% (depending on fee structure).

Would you realistically be able to outperform the simpler options available to you in the public markets? 

Maybe yes, maybe no. Either way, it’s obvious there is a huge need for greater awareness of what alternative investments are, more education provided to financial advisors so they can assist their clients with investment decisions, and more products designed for the needs of this growing segment of the market.

In my opinion, some of the most exciting opportunities are coming from alternative investment platforms. Only a decade or so ago, pretty much everyone thought crowdfunding was a “last resort,” and the only companies that would raise money from small investors were “bad” ones.

Fast forward to 2024, and that narrative has started to change in a big way. It’s no longer a black mark on your permanent record that prevents a company from getting access to institutional capital but an attractive source of capital that acts as an “on ramp” to institutional capital.

Understanding the ‘Right’ Alternative Investments

There are many promising alternative investment options beyond the stock market, such as real estate or private debt, but the “right” investments depend on the investors themselves. Every investor has different needs, so they must build a portfolio that helps them achieve their own personal financial goals.

For example, some investors are far more concerned with downside protection. In that case, they may want to own hard assets, such as real estate or precious metals. Other investors, like those focused on cash flow, might prefer an option like private credit and its corresponding high-yielding debt. Some investors are looking for high upside potentials, in which case a good fit is typically venture capital or private equity-type investments. These are high risk but have the potential to offer extraordinary returns.

Alternate Investments as a Diversification Tool

In many ways, diversification often comes down to an investor’s willingness to manage the portfolio. If you’re an entrepreneurial, active investor, you can make a lot of money in a short period of time actively managing an asset. But active management also comes with more risk, a lot of work, and industry-specific knowledge.

For many people, small business ownership — which often includes real estate management or development — was their original wealth creation plan. They have already done all the active management they want to do, and now they’re looking to become passive investors in an asset class they already know fairly well. It follows that we regularly see entrepreneurs wanting to invest in other companies. They believe they have an understanding of how those assets work because they were once operators themselves. They’re looking to take higher risks outside of their core business asset, which produces their primary income.

That said, investors take a variety of views on alternative investments. Some use their public market portfolios as their growth vehicles; they just dollar cost average into a low-cost index fund and don’t think too much about it. On the private side, investors might focus on buying cash-flowing assets, such as real estate and small businesses, where they can actively manage those assets.

On the other hand, those seeking passive investment opportunities haven’t had many options in the way of financial products that offer enough alpha to cover the management fees. Unfortunately, they typically don’t have access to the same quality of products that institutional investors do. As such, understanding the risks of alternative investing is critical whether you’re a passive or active investor.

Mitigating Risks in Alternative Investments

Just as there is risk involved in any type of investing, including traditional stock investments, there is a level of risk in alternative investments. To understand the nuance of alternative investment risk, let’s first take a step back and consider what risk actually means in an investment.

Risk is one of the most commonly misunderstood concepts in investing. Some people think of risk as variance (or volatility) in the price of the asset (commonly called “beta”). Others would consider risk a complete loss of capital (called “theta” in options trading). So, as an investor, you must first ask yourself what risk means to you. Is it the variance in the returns that were promised to you? Or is it the chance it goes to zero, a binary outcome?

In the case of startups, there is a considerable risk that the investment will go to zero (theta risk). However, it also can have a huge variance to the upside of how it could perform in the future. Real estate is usually the opposite. If you are buying an existing structure, there is a very small chance of the asset becoming worthless, but it’s difficult to get significant upside appreciation without some help from the market.

In both cases, investors have to be mindful of the nature of their risk and their ability to manage it. For 

example, an experienced real estate developer already knows the risks of building a new project. However, if you’re investing in a highly speculative startup — for example, a biotech company that comes with tremendous risk in research, development, and regulatory approval — you have to understand that these risks are harder to manage. Lastly, there are omnipresent market-driven risks. These can’t really be controlled. (Think an economic crash or natural disaster.)

All this is to say that there’s always risk in every investment opportunity. It’s not just the assumed risk of the investment but whether the risk is properly priced into the product. The more risk you’re taking as an investor, the more you’ll want some sort of downside protection or price adjustment.

Generally, a professional investor looks to generate the best possible risk-adjusted returns relative to volatility, often expressed by something like a Sharpe Ratio, which compares an investment’s risk and return. That’s why portfolio managers typically look for assets that will not move up or down at the same time for the same reasons.

For example, in 2008, even if you had a diversified public market portfolio, everything went down at the same time. All of the stocks were exposed to the same risk: the stock market itself. However, investors who had assets outside the stock market likely had better downside protection or upside return.

Where to Start: Exploring Alternative Investment Resources

For many retail investors, the only realistic way to get access to passive alternative investments is through a crowdfunding portal of some sort. However, just because a product is listed on a platform doesn’t mean it’s suitable for any given investor.

This often means the investor is required to perform their own due diligence, which they’re either ill-equipped to do or choose not to do under rushed sales pressure or fear of missing out (often with less than favorable results).

If you’re just getting started evaluating the world of alternate investments, we recommend the following resources for due diligence:

• Crunchbase.
• PitchBook.
• Investment research and forecasts from major consulting firms and investment banks (e.g., McKinsey, Bain, Deloitte, S&P Global, Goldman Sachs, J.P. Morgan).
• Private interviews with management teams and other industry professionals.
• Stock charting software (e.g., YCharts, StockCharts).
• The Equifund newsletter, Private Capital Insider, which provides unbiased education on alternative investment options.
• Financial media publications and related investing platforms, such as Benzinga.

No matter what route you choose to take, exploring the lucrative landscape of alternative investments will likely be a good move for your portfolio, allowing you to match your investment preferences to your desired level of risk and long-term financial goals.

Jordan Gillissie is the founder and CEO of Equifund, an alternative investment platform that provides retail investors with access to emerging companies. Registered with both FINRA and SEC, Equifund is dedicated to empowering entrepreneurs and educating investors. With his extensive industry experience and visionary leadership, Jordan has established Equifund as a pivotal player in disrupting middle-market investment banking.  He is committed to fostering an informed, engaged investment community, aligning business growth with investor education. Prior to founding Equifund, Jordan founded capital markets consulting and investor relations firm Novea Capital Inc in 2009.

References:

-https://www2.deloitte.com/us/en/pages/financial-services/articles/the-future-of-retail-brokerage.html

-https://yaledailynews.com/blog/2022/10/24/yales-endowment-explained/

-https://www.investopedia.com/terms/s/sharperatio.asp

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This post was authored by an external contributor and does not represent Benzinga’s opinions and has not been edited for content. This contains sponsored content and is for informational purposes only and not intended to be investing advice.