There’s been an explosion of interest lately in alternative investment products. Over the past five years, assets under management in alternative investment funds have grown at a 20% annual rate to more than USD 12 trillion in September 2022*. Whether it's investing in forestry, infrastructure or private equity, alternatives are a complex asset class where you have to be careful to succeed.
With that in mind, I compiled a seven-point list of so-called "golden rules" to take into account when investing in or having an interest in alternative funds.
1. Draft a plan and investment strategy
As with many other asset classes, investing in alternatives requires a plan. It is always good to start the plan by defining your starting point, your risk appetite, and your objectives. The objectives typically relate to allocation, diversification, returns and cash flow, but can also relate to issues such as the responsibility of the investments.
Make an investment strategy that describes how the desired allocation and diversification will be achieved in the long term and in which alternative investment asset classes and strategies you will invest.
2. Be patient and have a long-term perspective
Although situations change rapidly in today's world, it is best to keep a cool head when investing in alternatives. Building a portfolio takes time and typically it takes 4–6 years to reach the desired allocation. This makes it particularly important to follow a disciplined investment strategy. A balanced portfolio requires investing in a consistent manner through the economic cycles.
3. Diversify your portfolio
To minimise risks, I recommend diversifying the portfolio into several funds each year. Diversification by geography, strategy, industry and vintage year reduces risk and improves portfolio returns.
Since alternative asset classes require a long investment horizon, avoid so-called 'hot themes' that emerge as a result of short-term trends and always keep in mind the long-term allocation goals.
4. Understand the risk-return profile and illiquidity of the asset class
Alternative investments are typically long-term and illiquid investments. This is something that is extremely important to be aware of before investing.
You should understand how capital is called into investments and how it is distributed back to investors. Different asset classes in alternative investments have different risk-return profiles, which is important to consider already at the investment planning stage. Professionals can guide you on the differences between asset classes and their suitability for your portfolio.
5. Don't try to time the market
For many investors, the temptation is to look for quick profits and try to jump in and out at the perfect time. I would not recommend trying to time the market.
First of all, timing the market in this asset class is quite impossible, as alternative funds typically spread their investments over a 3–5-year period.
Second, often when investors have reduced their investments in an asset class, the investments made in those years have had the best returns. For example, private equity buyout investments that were made during or just after a recession have produced significantly above average returns (Bain Global Private Equity Report 2023).
6. Pay attention to the fund manager selection
The dispersion of returns between the best and worst funds is significant especially within alternative asset classes, and therefore selectivity in choosing a fund manager is key to returns.
Before investing in a fund, investors should carefully assess the fund manager's strategy, the team's experience, available resources, responsibility practices and past performance history. In addition, a comparison with other similar fund managers helps to understand how the fund manager has performed relative to its peer group.
7. Use the help of investment advisers
Investing in alternative asset classes requires knowledge and expertise, so I strongly recommend that you consider using an experienced external investment advisor.
In the private equity (incl. venture capital) asset class alone, there are currently more than 8,000 funds on the market (source: Preqin), so there is a large selection, and the quality of the funds also varies. Good investment advisers have all the tools and resources to analyse fund managers, and often offer modelling tools on how to build a portfolio and achieve the desired allocation in alternative investments.
Alternative investments in a nutshell:
- Alternative investment asset classes are private equity, private debt, infrastructure, real estate, forestry and natural resources.
- These have a combined global size of over $12,000 billion.
- In Finland, for example, assets under management in alternative funds has grown by almost 250% in ten years.
- Alternative investments improve the risk-return profile of a portfolio since the addition of alternative investments to a portfolio can increase the expected return and reduce volatility.
- Explosive growth is driven not only by demand but also by increased availability.
* Source: Preqin per 05.06.2023
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