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May 16, 2012 at 08:47 AM
When it comes to alternative assets, investors and their advisors need to proceed with caution. AdvisorOne’s recent piece, “Top 10 Dangers of Alternative Investments,” was a good reminder of what might go wrong.
The experience of 57,000 PENSCO clients and their financial advisors suggests that much can also go right. As a custodian of alternative investments in retirement accounts, PENSCO has seen a rapid growth in alternatives over the past few years as investors and advisors seek to enhance return, lower risk, realize tax benefits, broaden investment options and improve client satisfaction. In that spirit, here are our top five reasons to invest in alternative assets:
1. Better Risk Management
Alternative assets offer investments that are not correlated to the returns of traditional, liquid investments. That typically leads to better return with less volatility. When a traditional portfolio of stocks, bonds and cash includes alternative assets, investors can realize a higher blended rate of return with lower volatility. Thus, when U.S. large-cap or small-cap equities are headed south, direct investments in an Argentinian fish farm, a multifamily housing complex or a global hedge fund may offer the diversification needed to mitigate a shock to the portfolio.
2. Enhanced Investment Performance
Alternative investments in direct investments and pooled funds remain among the top performers in the investment universe. After a decade of lost stock market performance, that’s critical. According to J.P. Morgan Asset Management, the expected annualized compound return over 10 to 15 years is 8.25% for U.S. private equity, 7% for (unlevered) direct real estate, 8% for global infrastructure funds and 7% for diversified hedge funds.
The projected return over the same period for such traditional assets as U.S. large-cap stocks is 7.75%, and 8.25% for both mid-cap and small-cap stocks. When both traditional and alternative investments are part of an allocation plan, a portfolio can perform in up and down markets with less risk, as measured in terms of volatility.
3. Tax Benefits
Although few individual investors realize it, alternative assets can be held in retirement accounts and thus benefit from being tax advantaged. Alternative investments can be held in a traditional IRA, Roth IRA, SEP-IRA, Solo (k), 401(k) for sole proprietors and other types of qualified plans. Many investors frequently roll over 401(k) distributions into a retirement account.
