Weathering a downturn in the economy requires doing things a little bit differently. When what used to work no longer gets the same results, it’s time to look for alternatives.
Alternative investments are garnering a lot of attention lately. Whether it be art collection, cryptocurrencies or venture capital, family offices investing in alternative asset classes are searching for diversifiers and exploring new ways to preserve their investment portfolios.
This article defines what alternative investments mean for family offices. It discusses the benefits and risks, and suggests an appropriate approach for family offices venturing into alternative investments.
What are alternative investments for family offices
Alternative investments are investments that fall outside of traditionally traded stocks, bonds and cash. As they are not usually correlated with the general financial markets, investors often use them to hedge or preserve capital during market downturns.
In addition, alternative investments provide access to a much broader range of assets. Examples include private equity, hedge funds, real estate investments, commodities, venture capital, and art or collectables.
These investments are typically speculative by nature. For instance, an investment in Bitcoin, a digital asset commodity, could generate a massive amount of return in the long term. However, the inverse is also true – the price of Bitcoin could drop to zero.
The popularity of alternative investments in recent times
According to Black Rock, an investment management company, a traditional “60/40” allocation to equities and bonds may no longer be enough to meet long-term investment goals. This is due to the vast changes in technological innovation, government legislation and the push towards a more sustainable economy.
Added to that, with the recent rise in inflation, geopolitical unrest, and the looming recession, asset managers are hard-pressed to find safe alternatives to park their capital. Alternative assets such as private equity and real estate can help investors weather the economic headwinds to make decent returns in the long term.
The benefits of alternative investments for family offices
During times of uncertainty, alternative investments can make the world of a difference to a family office portfolio. Below are the ways they can be of benefit:
Portfolio diversification: Putting all your eggs into one basket is not a good investment strategy. While traditional investments are certified safer, a downturn in the economy can have a domino effect on a portfolio’s value. Adding alternative assets can help hedge the risk to the downside.
Long-term horizon: Many alternative investments, such as private equity, venture capital, and real estate, require a longer time horizon for investment. This can be advantageous for family offices that have a long-term view of wealth preservation.
Investment control: Alternative investments can offer investors greater control. For example, while public equity gives you access to general meetings and quarterly reports, in private equity, investors can gain access to the founders and help make management decisions.
Portfolio customisation: Family offices can use alternative investments as an opportunity to customise their portfolio to meet specific investment objectives or to align with the family’s values.
Impact Investing: Following from above, family offices can venture into impact investing, which is a type of alternative investment that aims to generate both a financial return and a positive social or environmental impact. Who can say no to a win-win situation?
In essence, alternative investments generally offer higher returns compared to traditional investments. By understanding the potential rewards, family offices can make informed decisions and identify investments that align with their investment objectives and risk tolerance.
Risks associated with alternative investments
While alternative investments can provide numerous benefits, they also carry additional risks that family offices should be aware of. Some of the major risks associated with alternative investments are as follows:
Illiquidity: Many alternative investments are illiquid, meaning they cannot be easily sold or converted to cash. Family offices that invest in alternative assets risk waiting for an extended period before seeing returns on their investments.
Lack of transparency: Alternative investments are not subject to the same reporting requirements as traditional investments, which can lead to a lack of transparency. This can make it difficult for family offices to conduct their due diligence.
Regulatory complexity: Alternative investments are frequently subject to regulatory complexity, meaning family offices may experience compliance difficulties. For example, take blockchain technology, there is a lack of regulatory clarity in many countries which increases the legal costs of investing in the asset class.
Concentration risk: Alternative investments often have a higher concentration of risk than traditional investments, as they may be invested in a single company or industry. A good example of this is the SVB crisis, the bank was too heavily invested in tech startups and crypto, which are famously volatile markets.
Alternative investments can be riskier than traditional investments, and it’s essential to understand the risks associated with them. By understanding the risks upfront, investors can take steps to minimise their losses and avoid surprises.
How family offices should approach alternative investments
Family offices can use a variety of vehicles to invest in alternative assets, depending on their investment objectives and risk tolerance. They can either invest directly or use private equity, venture capital, real estate investment trusts (REITs) and hedge funds. When dealing with alternative investments, family offices should take the following steps:
Step 1: Develop an alternative investment strategy
Developing an investment strategy that takes into account the family office’s unique goals and risk tolerance is essential for several reasons:
- Align investment objectives
- Risk management
- Portfolio diversification
- Managing liquidity
- Achieving long-term goals
Step 2: Work with experienced professionals
Working with experienced professionals who can provide guidance on selecting and managing alternative investments is crucial for several reasons:
- Gain expertise and insight
- Access to deal flow
- Perform due diligence
- Portfolio management
- Regulatory Compliance
Step 3: Key considerations for evaluation
Evaluating alternative investments requires careful consideration of investment objectives, due diligence, risk management, investment structure, and exit strategy. By taking these factors into account, family offices can assess whether or not an investment is a sound one and make better investment decisions over time.
Family offices should carefully evaluate any potential red flags when considering alternative investments and conduct thorough due diligence to assess the investment’s potential risks and returns. By being vigilant and cautious, family offices can avoid potential pitfalls and make more informed investment decisions over time.
Alternative investments are non-traditional investments that offer benefits such as portfolio diversification, long-term horizon, investment control, and customisation. Examples of alternative investments include private equity, hedge funds, real estate, commodities, and art.
However, alternative investments also come with risks such as illiquidity, lack of transparency, regulatory complexity, and concentration risk. Family offices should approach alternative investments by developing a strategy, working with experienced professionals, and evaluating key considerations such as investment objectives, due diligence, risk management, investment structure, and exit strategy.