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Is it time to consider alternatives?

Investors seeking returns and yield uncorrelated to those of stocks and bonds can find new options and potential opportunities in alternative investments, says Bank of America’s head of Alternative Investments, Specialty Asset Management and Investment Solutions Specialists, Nancy Fahmy

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ALTERNATIVE INVESTMENTS, A TERM FOR A BROAD ASSET CLASS that can include hedge funds, private equity funds, real estate, precious metals, private credit and even farmland, have been around for over a generation. Yet, their appeal — which includes exposure to asset classes whose performance may not correspond to the performance of stocks and bonds and the potential to dampen portfolio volatility and enhance returns — has rarely been more essential. “The world of alternatives is undergoing an evolution,” says Nancy Fahmy, head of Alternative Investments, Specialty Asset Management and Investment Solutions Specialists at Bank of America. “Many alternative asset managers, who historically worked almost exclusively with institutional investors, are now more willing to provide their highly coveted offerings to qualified individuals at all wealth levels.”

Below, Fahmy discusses the new opportunities and innovations in the alternatives space that are available for qualified investors. Of course, you should consult with your advisor before making any investment decisions.

“Many alternative asset managers who historically worked almost exclusively with institutional investors are now more willing to provide their highly coveted offerings to qualified individuals at all wealth levels.”

Nancy Fahmy, head of Alternative Investments, Specialty Asset Management and Investment Solutions Specialists at Bank of America

Q: What alternative strategies are getting more attention these days? 

A: Alternatives can provide investors with many different types of solutions, depending on whether they’re seeking income, a reduction in volatility or enhanced returns. Investors who are looking for yield or income may find opportunities in private credit — lending directly to midsize companies who can’t tap the commercial credit markets — and in real estate. Both types of investments may be able to offer current income, that is, regular payouts to investors.

Investors seeking to diversify portfolio returns from the equity market may want to consider hedge funds, particularly equity long-short funds, which hold both long and short positions in the stock market and are positioned to mitigate market volatility and limit downside risk. For those looking for higher growth strategies, we’re seeing a lot of interest in private markets — that is, investments in companies that aren’t publicly traded — especially growth equity, which is investing in established, private companies needing funding to capitalize on growth opportunities.

Q: Why are there so many opportunities in private markets?

A: The private markets can provide a lot of investing options since there are many more private companies than public ones. Also, private companies are often staying private for longer than before, so by the time a company finally does go public, much of the equity appreciation has sometimes already occurred. To capture those returns, you need exposure to private companies.

There are also many opportunities in private credit, which is lending to private companies. Many large institutions have become much more conservative in financing small- and medium-sized companies that make up the middle market. Individual investors are taking up the slack, providing capital to these companies through special lending funds. We’ve noticed increased interest from clients in this strategy because it may provide a steady source of income and attractive total returns. Of course, there are risks with private equity investments, including loss of capital.

Q: Increasing interest in alternatives has led to a lot of innovation. What are some developments that you find notable? 

A: We’re seeing a lot of new structures that allow for more flexibility for both the investor and the asset manager. Take business development company (BDC) funds, for example, which are essentially private equity funds that have the option to go public and trade on an exchange. BDC funds often have lower minimums and less complicated tax reporting than traditional private equity funds.

In the hedge fund space, some managers are creating funds with longer lockup periods when investors can’t readily withdraw their money. This approach allows managers to take advantage of illiquid opportunities that take more time to monetize. And because they don’t need to keep a portion in cash or liquidate holdings for withdrawals, there is potential for enhanced returns, which comes with the risk of investment loss. We’re also seeing new pricing structures; we’ve had some managers that charge no management fee and 30% of profits rather than the usual fee structure that charges 2% of assets under management and 20% of profits.

Q: What are interval funds, and what role do they play in the alternative space?

A: Interval funds, which are like a hybrid of a hedge fund and a mutual fund, are another area of interest. They’ve become the latest buzzword. They’re a bit less liquid than a mutual fund, so you can’t cash out anytime you want, but that also means you may have access to investment strategies that mutual funds can’t invest in. For example, interval funds are able to invest in illiquid opportunities, which has the potential to enhance returns and yields. 

Clearly, there are more options than ever in alternative investments. Even if you haven’t thought about them before, consider talking to your advisor about what role they can play in your portfolio, their risks and how they can work in conjunction with more traditional investments to help you reach your goals.

How alternatives fit in your portfolio

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While some investors think alternatives are risky, they can potentially moderate risk across a portfolio by offering a diversification of return streams and a hedge against market volatility, says Anna Snider, head of Due Diligence, Chief Investment Office of Bank of America Private Bank and Merrill. “With an allocation of less than 10%, you probably won’t see significant benefits from alternatives,” says Snider. “Depending on your risk profile and other considerations such as tax sensitivity, 20% or more may provide the desired portfolio benefits.” However, given the wide dispersion of returns between the different investment profiles across both hedge funds and private markets, it’s important to build a diverse portfolio of alternative holdings, Snider adds. “You should understand what each of the holdings is supposed to do within your overall portfolio,” she says. For those looking to shift some assets into alternatives, Snider suggests rebalancing gains made in equities and putting them into private equity as well as considering how different hedge fund or private credit strategies can complement your bond portfolio. Talk to your advisor about whether allocating to alternatives makes sense for your overall investment strategy.

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