Investing in Alternative Investments: What to expect
Alternative Investments can complement traditional stocks and bonds by adding differentiated return drivers and potential diversification benefits. A range of strategies and structures can help investors pursue long-term growth, income or capital preservation objectives.
Key takeaways
- Alternative Investments may provide differentiated return drivers and diversification benefits.
- A range of solution types allows investors to align the right strategy with specific portfolio roles and objectives.
- Access to Alternative Investments can vary by structure, including differences in liquidity, manager approach, diversification level and investment flexibility.
- Strategies often involve distinct operational features, including more limited liquidity, capital calls, tax reporting differences, specific fee structures and delayed performance reporting.
Selecting the right Alternative Investment solution for your goals and portfolio
Different types of Alts strategies come with distinct objectives, potential return drivers, liquidity profiles and other considerations that help shape the roles they can play in a portfolio. At a high level, these offerings can be grouped into four broad categories based on the types of assets and strategies they invest in.
Throughout the rest of Alts Essentials, you’ll see these strategies grouped by how they handle capital and liquidity, broadly drawdown funds on one side and evergreen (perpetual) funds on the other.
Hedge strategies1 engage in non-traditional approaches that often include long-short strategies and derivative instruments. These flexible strategies may help provide a buffer to your portfolio during market downturns and assist with capital preservation. The range of hedge strategies includes:
Equity hedge: May provide less volatile exposure to equity markets by investing in long-short strategies.
Event-driven: May offer returns less dependent on overall market direction by investing in companies poised to benefit from events, such as mergers or restructurings.
Relative value: May offer lower volatility with limited exposure to market swings by investing in securities with potential valuation discrepancies.
Macro: May provide diversification in periods of market stress with low correlation to traditional holdings by taking global market positions based on macroeconomic trends.
Private equity2 invests in privately held businesses with the goal to benefit from periods of rapid growth or restructuring. As companies stay private for longer, they have the potential to deliver strong long-term returns, driven largely by managers improving the operations of the companies they invest in. The range of private equity strategies includes:
Buyout: May offer higher growth by acquiring firms and seeking to enhance operations or improve profitability.
Growth equity: May offer strong long-term returns through minority investments in companies that are more established, faster growing and less mature than typical buyout targets.
Venture capital: May offer higher long-term growth by investing in start-up companies.
Special situations: May offer long-term gains by investing in distressed or troubled companies, using structures designed to provide growth potential similar to equity while offering more downside protection similar to debt.
Private credit3 provides non-bank loans to public and private companies that are looking for more flexible terms and loan structures and who may not want to tap the bond markets. They offer a way to potentially build an income stream, often tied to variable interest rates. The range of private credit strategies includes:
Direct lending: May offer predictable income potential and a focus on capital preservation by providing loans directly to middle-market or large companies.
Subordinated capital: May offer higher yields in exchange for greater risk and often include equity-like features by investing in debt lower in the capital structure (e.g., mezzanine debt, second-lien loans and opportunistic credit).
Asset-based and specialty finance: May offer predictable income and collateral-driven risk mitigation by providing firms with flexible financing secured by specific pools of assets (e.g., receivables, inventory, equipment or real estate).
Real assets4 invest in tangible assets including precious metals, commodities, real estate and infrastructure. They can help diversify traditional stock and bond holdings and provide a potential hedge against inflation. The range of real asset strategies includes:
Private real estate: May offer income from rents and long-term capital appreciation by investing in physical properties (e.g., office, industrial, retail or residential).
Infrastructure: May offer long-term, stable cash flows and inflation protection by investing in essential assets like transportation, energy, utilities and digital networks.
Tangible assets: May serve as an inflation hedge through exposure to physical, traded goods like commodities and private natural resources.
Ways to gain exposure to Alternative Investments
In addition to choosing what type of assets and strategies to invest in, investors also can decide how they want to access them through different fund structures. Determining the right structure often starts with two key considerations:
- Single-manager versus multi-manager: Single-manager funds rely on the expertise of one investment team. Multi-manager structures invest across multiple underlying managers, providing diversification through a single investment.
- Degree of liquidity: Some funds require capital to be committed for a set period, with limited or no liquidity. Others allow ongoing subscriptions and redemptions, offering more flexibility.
Understanding how Alternative Investments work
When you invest in an Alts strategy, the experience can differ from traditional investment funds in several key ways. Alts Essentials offers additional insights on each topic, if you would like to learn more.
- Limited liquidity, which helps align with the long-term investment horizons of the underlying investments
- Tax reporting can differ, reflecting the underlying investment structures and potentially affecting the timing and format of tax documents
- Capital calls are typical in drawdown funds and are made over time, rather than requiring the full investment up front
- Performance reporting calculations and return timing are often determined by the liquidity and structure of a strategy’s underlying assets, as well as its valuation process
- Fee structures generally follow unique models designed to reflect the skill, experience and complexity required to manage these strategies
What this means for you
Investors can choose from a variety of Alts strategies and structures, each designed to play various roles within a broader portfolio. Your Merrill advisor can help you explore these opportunities and choose the right fit for your specific investment needs.
1 An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage, and short sales which can magnify potential losses or gains. Restrictions exist on the ability to redeem units in a hedge fund. Hedge funds are speculative and involve a high degree of risk.
2 Investments in private equity involve a high degree of risk and therefore should only be undertaken by qualified investors whose financial resources are sufficient to enable them to assume these risks and to bear the loss of all or part of their investment. Investments in private equity include significant risks not otherwise present in public market investments. Furthermore, private equity investors are afforded less regulatory protections than investors in registered public securities.
3 Investments in private credit involve a high degree of risk, while the investment may be subject to many of the risks associated with traditional fixed income investments such as the credit quality of individual issuers, possible prepayments, economic developments and yield fluctuations due to changes in interest rates, they also carry more risk than traditional loans because borrowers are often below investment grade, meaning there is a higher chance they will have trouble repaying the debt and therefore should only be undertaken by qualified investors whose financial resources are sufficient to enable them to assume these risks and to bear the loss of all or part of their investment. Traditionally, non-investment grade borrowers are graded as BBB or lower by credit ratings firms like Standard & Poor’s or Moody’s. Because of this low rating, investors usually demand a higher interest rate to offset the risk of default. Investments in private credit include significant risks not otherwise present in public market investments. Furthermore, private credit investors are afforded less regulatory protections than investors in registered public securities.
4 Investments in Tangible Assets, such as oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and have special risk considerations including natural events (for example, earthquakes or fires), complex tax considerations, and lack of liquidity. Investments in Infrastructure Assets are subject to risks incidental to owning and operating infrastructure projects, including risks associated with the general economic climate, geographic or market concentration, government regulations and fluctuations in interest rates. Industries targeted for investment may be highly regulated by governmental agencies, which may impact an investor’s ability to acquire, dispose of and/or manage investments. Investments in Real Estate securities can be subject to risks, including fluctuations in value of properties, the effect of economic conditions on real estate values, changes in interest rates, and other risks.
Alternative Investments are speculative and involve a high degree of risk.
Alternative Investments are intended for qualified investors only. Alternative Investments such as derivatives, hedge funds, private market offerings, and funds of funds can result in higher return potential but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in Alternative Investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity, and your tolerance for risk.
An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage, and short sales which can magnify potential losses or gains. Restrictions exist on the ability to redeem units in a hedge fund. Hedge funds are speculative and involve a high degree of risk.
Investments in private equity involve a high degree of risk and therefore should only be undertaken by qualified investors whose financial resources are sufficient to enable them to assume these risks and to bear the loss of all or part of their investment. Investments in private equity include significant risks not otherwise present in public market investments. Furthermore, private equity investors are afforded less regulatory protections than investors in registered public securities.
Investments in private credit involve a high degree of risk, while the investment may be subject to many of the risks associated with traditional fixed income investments such as the credit quality of individual issuers, possible prepayments, economic developments and yield fluctuations due to changes in interest rates, they also carry more risk than traditional loans because borrowers are often below investment grade, meaning there is a higher chance they will have trouble repaying the debt and therefore should only be undertaken by qualified investors whose financial resources are sufficient to enable them to assume these risks and to bear the loss of all or part of their investment. Traditionally, non-investment grade borrowers are graded as BBB or lower by credit ratings firms like Standard & Poor’s or Moody’s. Because of this low rating, investors usually demand a higher interest rate to offset the risk of default. Investments in private credit include significant risks not otherwise present in public market investments. Furthermore, private credit investors are afforded less regulatory protections than investors in registered public securities.
Investments in Tangible Assets, such as oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and have special risk considerations including natural events (for example, earthquakes or fires), complex tax considerations, and lack of liquidity.
Investments in Infrastructure Assets are subject to risks incidental to owning and operating infrastructure projects, including risks associated with the general economic climate, geographic or market concentration, government regulations and fluctuations in interest rates. Industries targeted for investment may be highly regulated by governmental agencies, which may impact an investor’s ability to acquire, dispose of and/or manage investments.
Investments in Real Estate securities can be subject to risks, including fluctuations in value of properties, the effect of economic conditions on real estate values, changes in interest rates, and other risks.
When considering the appropriateness of mutual funds or Alternative Investments, please be aware that there are significant differences between these investments which will cause their investment portfolios, performance, tax treatment and other factors to differ. These differences include the types, availability and diversity of securities that can be purchased, economies of scale, regulations and other factors applicable to their management.
