Montag & Caldwell Strategies Commentaries Private Client Group People About Contact Us M&C Celebrates A 75 Year History Search for: What to consider before including alternative asset classes Posted by Montag & Caldwell What to consider before including alternative asset classes in your investment portfolio By Montag & Caldwell June 5, 2020 Exposure to alternative asset classes has grown dramatically in investor portfolios. As a result, the average portfolio today has increasingly become more complicated and, often, a less effective approach to asset allocation. Many alternative investments increase opaqueness and decrease transparency and liquidity, making a portfolio more difficult to monitor. This surge in popularity culminates from the desire for greater diversification and/or yield that might increase returns and/or decrease risk. The intention is to create a more consistent return pattern to better withstand the fluctuations in market cycles. Unfortunately, this doesn’t always work as intended, given that these strategies can be much more unpredictable and volatile. Ultimately, many investors are left only with complexity, increased risk, and greater fees. The following are some considerations prior to making an alternative allocation. Role in the portfolio If your goal is portfolio diversification, remember that each asset class added to your portfolio has a diminishing marginal benefit. Many of these strategies perform similarly to the traditional markets, which may negate the diversification benefits anticipated. Often, those beta exposures can be more easily accessed elsewhere, at a much lower fee. Manager selection There are only so many good alternative managers, and the demand for the best managers will likely be oversubscribed and difficult to access. This is an important consideration because the performance difference between the top-performing managers and the average manager has historically been significant. You may end up paying large fees, with limited access to that capital, that may end up being disappointing. Make sure your advisor has the resources to answer questions about the manager, the market and the strategy, and has a relevant way to measure its effectiveness. Transparency These strategies can be complex, and often investors are unsure about what they are actually invested in, which makes it difficult to understand and evaluate the portfolio exposure. Often, these investments are marked to market by the provider; capital calls and distributions are not predictable; and performance may be reported as internal rates of return — all features which are not compatible with time-weighted returns for publicly traded investments. The ability to monitor the underlying investments in the strategy, particularly in down market environments, or the use of leverage in a less predictable economic climate, is essential to monitor and validate its role in the portfolio. Transparency helps investors monitor criteria such as liquidity, optimal allocation, due diligence, and valuation. Liquidity Liquidity risk is the possibility of not being able to sell your investment at a fair price when you want to — and, more precisely, the ability to exit before incurring high potential asset loss. This risk is compounded given the general large investment requirements (high minimums) and long lock-up periods with assets that may be difficult to value. Many investors are averse to holding long-term assets without liquidity and valuation transparency. Make sure you can afford to have these investments unavailable as cash for an extended period of time. High costs The fees for alternative investments tend to be very high relative to traditional assets, particularly for the smaller portfolio allocations, which because of the size, may not be meaningfully influential after adjusting for fees. In addition to the management fee, pay attention to other potential costs such as trading fees, sales commissions, and marketing costs. As with every allocation decision you make, make certain it is appropriate for your individual circumstances and that you can justify, after fees, its role. Alternative allocations are not a one-size-fits-all approach, as each decision and strategy identification should be specific to your situation. Montag & Caldwell is committed to producing superior investment results for our clients. Learn more. Montag & Caldwell, LLC was founded in Atlanta, Georgia in 1945 and has served both private clients and institutional investors for 75 years. While primarily known for managing equity securities, our firm’s experience also includes fixed income and asset allocation strategies – with an emphasis on managing risk. 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