Home Alternative Investments Finding alternative investments for high-net-worth financial planning clients

Finding alternative investments for high-net-worth financial planning clients


The high-net-worth investor’s needs are unique. Many HNW investors earned their status through a business or a C suite-level job that created wealth beyond retirement security and a great lifestyle, and many built that wealth in one or two positions such as the company itself and perhaps the real estate in which their business lived. A characteristic in building wealth that way is a different perspective on liquidity, risk and return. These features leave many HNW investors underwhelmed with the offerings from many financial planning firms.

Even though the values of the businesses and real estate that created their wealth may rise and fall like any other investment, these investors often don’t see that or care about that. A primary characteristic that I’ve observed among this crowd is that of control. They inherently believe that their day-to-day participation in the operation of the business insulates them from volatility and that their impact can be felt, as opposed to owning shares of a publicly traded investment. These are true entrepreneurs believing that good ideas executed by smart, hard-working people will pay off. It’s easy for them to get behind an idea they like backed by good people with experience at creating value.

These are just some of the reasons why these investors may be drawn to alternative investments. The term “alternative investments” is a loose one, which includes many asset classes. The only thing that isn’t considered an alternative may be your traditional investments such as equities, cash, bonds and things that are generally traded and marked to market each day. Examples of alternative asset classes would be real estate, private equity, private loans, collectables, wine, antique cars and so forth.

As with any investor, each HNW investor has their own appetite for risk. Rarely would (or should) a HNW investor park all of their assets in alternatives, even though that may be how they created their wealth in the first place. How much is appropriate for any particular investor needs to be determined on an individual basis. For me, alternatives may have a place when we’re discussing someone’s risk capital, or their investments that may be above and beyond their needs for liquidity, retirement and lifestyle security.

For the average financial advisor, the alternative investments available through your typical broker-dealer platform may not be exactly what your client is seeking. In my opinion, most of these products are built as financial tools that are good for the sponsor firms, the BDs and the advisors. In fact, a friend of mine who’s known as one of the country’s top real estate professionals has only one good thing to say about these types of BD-offered non-traded products — “YTB” or, “Yield to Broker!” Many have lucrative commissions attached to them.

Even when seeking out no-commission or low-commission products, my searches have left me feeling empty and vulnerable through those traditional channels.

Building an alt portfolio

Now that we know what types of alternative investments to avoid, how can you add value to a client relationship who invests in alternatives or needs help to find and evaluate opportunities? Starting with clients who already own “alts,” you can help by evaluating how well the alts are working as a portfolio. Like a traditional portfolio, an alternative portfolio should also be well balanced and diversified. When evaluating the alt portfolio for diversity and balance, you would use the same approach that you would use with traditional investments.

Break them down by asset class to see that all of the alt eggs are truly in different baskets, as opposed to different sections of the same basket. For example, if your client owns several different office properties, are they really diversified?

You can begin to create a scorecard or some performance measurement for your client. It may not be feasible to evaluate an alternative investment based on its current value because you may not know the current value. If the general partner or sponsor of the deal is willing to estimate the current value, then go with it. But beyond the value of the deal, you can evaluate it for its current cash flow or yield compared to what was forecast when they first looked at the opportunity.

You can help evaluate the structure of the deal. Alternative investments are frequently held in some form of limited partnership or LLC structure. In these structures, the general partner or sponsor is usually paid in a few ways. Some are paid upfront fees simply for getting the deal going. Others take a piece of the cash flow with or without a preferred return to the investors first and most take a carried interest in the ultimate profits from the deal. The range of what you’ll find will be all over the place. But if your client has a few alternative investments, you may be surprised to discover that they may not recall the terms and structure of the ones that they own. You can create a useful summary as a resource to save time for the client. This understanding of the structures will also be a helpful guide for your client when it comes to evaluating future alternative investments.

Record-keeping for these investments may also be valuable for your clients. In my past life as a CPA, I recall having wealthy clients with so many alt deals that they didn’t know when capital calls were due and how much they actually had committed to deals. In some cases, investors with tens of millions in investable assets would bounce checks when making capital calls because they simply didn’t pay attention to the details like you or I would. Tracking their internal rate of return is also something that may be helpful.

Investment opportunity concept

Olivier Le Moal/Olivier Le Moal – stock.adobe.co

Broadening their selection

Helping your client source and evaluate alternative investments may also be valuable. I’ve discovered that many clients find their alternative investments through friends or family, and have a limited selection from which to choose. The resulting portfolios frequently lack diversity from either an asset class perspective or a sponsor or GP perspective. Just because you love a sponsor doesn’t mean that you cannot invest more with them, but it doesn’t mean that you shouldn’t seek diversity, either. 

Diversity can happen in many ways. It can happen by asset class and within asset classes, by sponsor, by geography, duration, risk, and any other metric that is used for any type of investing.

For real estate, you may own different asset classes such as apartments, offices, warehouses, retail, etc. Even within each subcategory of real estate you can further diversify based on the intended use of the property. Is it a development deal, a cash flow deal, or a fix-up-and-sell type of deal? Will it be low leverage or highly leveraged?

A similar approach is wise when evaluating private equity offerings. Your clients may want to invest in private equity in an industry they are familiar with or invest in areas where they haven’t been before. Even with PE, beyond industry diversity, you have opportunities to invest in startups, early stage or venture capital, mature companies or roll-up companies. Investing in private lending also has a place. In the yield-starved environment we live in today, investors have few choices to generate pure yield. It may be mezzanine financing for developers or lending to distressed companies, but private lending also needs the same or more care and evaluative skills as any other private investment. Private loans may be ideal for qualified accounts through a self-directed custodian to avoid current taxation on the high rate of interest.

If you or your client are not equipped with the talent to evaluate a stand-alone deal, consider a partnership where the GP is evaluating many deals, with the specific intent to own several inside the partnership. This diversity doesn’t ensure better results, but between the professional guidance of a GP and the diversity within the partnership, it may be easier to invest with confidence.

And my last financial planning point — make sure that these private investments fit into the client’s estate plan. Make sure that they are owned properly, such as in their trusts or family partnerships. Also make sure that there is a plan for estate liquidity in the event of a premature death. Getting out of private investments early may not be possible, or it may come at a steep price.

There are several reasons why you should care about alternative investments. First off, your wealthy clients do. If you don’t care or lack the bandwidth to help, someone else will. They need help and will seek out what they need. Second is the trend: In a recent survey by a prominent HNW firm, it was pointed out that among the services that HNW investors want most is assistance with private investments.

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