What to consider when you’re considering alternative investments

By Sean Flynn

We all have different motivations for why we invest. Some individuals hope to generate enough income to sustain their lifestyles, and others may be seeking ways to grow their wealth over decades – whether to fund a legacy for generations or a comfortable retirement. Financial goals are unique for every individual.

That said, many of the challenges facing today’s investors are universal: After a decade of dormancy, inflation risks are back and they can complicate bonds' historically dependable diversification characteristics versus stocks. The appetite for steady income generation is ever-present, and so is the search for Alpha opportunities that have generally become harder to find in public markets.

Alternative investments – like private equity and credit, hedge funds and real assets – can help investors solve for many of these challenges and access a broader set of opportunities, but there are a few crucial considerations to keep in mind when allocating to them. Read on for the key things you should keep in mind when creating an alternative investment strategy, from carefully selecting portfolio managers to choosing the right investment vehicle.

Manager selection: The cornerstone of a successful alternative investments strategy

From sports leagues to classrooms, every field sees a range of talent and performance. That performance dispersion is especially pronounced in the world of alternative investments, underscoring the importance of due diligence and manager selection when it comes to choosing where to deploy your money.

Relative to traditional public markets, where portfolio manager returns tend to cluster more closely around median figures, alternative investment managers have historically exhibited a wider range of outcomes. As such, whether you are investing in real estate, private equity, venture capital or hedge funds, selecting the right manager can significantly impact returns. For example, top quartile private equity managers have historically outperformed their lower quartile counterparts by more than 20 percentage points over a 10-year period.

Sources: Burgiss, NCREIF, Morningstar, PivotalPath, J.P. Morgan Asset Management. Data are based on availability as of May 31, 2024. Global equities and global bonds are based on the Morningstar categories "Global Large-Stock Blend" and "Global Bond" respectively. Manager dispersion is based on annual returns over a 10-year period ending 1Q 2024 for U.S. Core Real Estate, U.S. Fund Global Equities and U.S. Fund Global Bonds. Non-core Real Estate, Global Private Equity and Global Venture Capital are represented by the 10-year horizon internal rate of return (IRR) ending 4Q 2023. U.S. Fund Global Equities and Bonds are comprised of U.S.-domiciled mutual funds and ETFs. It is not possible to invest in an index. Past performance is no guarantee of future results.

Evergreen vs. drawdown vehicles: Tailoring your investment approach

When it comes to private investment funds, investors have two primary options: evergreen and drawdown vehicles. Drawdown funds, which have historically been the usual way to access private investments, involve committing capital over a multi-year period, with the potential for principal and gains to be returned as the fund matures. Evergreen funds, which are relatively new, are quickly growing in popularity given a few features: immediate capital deployment and reinvestment of profits as you hold onto the allocation, periodic liquidity windows (which allow investors to redeem some or all of their investment) and generally lower investment minimums.

Note that there are tradeoffs. For instance, evergreen funds’ greater access to liquidity means that their managers often keep a small sleeve (usually 10%–30%) of public market or cash-like investments, which can slightly lower their returns versus similar drawdown formats. Additionally, if many investors decide to withdraw their capital from an evergreen vehicle all at once, the manager’s ability to act on timely investment opportunities can be diminished.

The good news? Investors don’t have to choose one or the other. A balanced approach, often involving a mix of evergreen and drawdown strategies, can offer investors the benefits of both worlds. The table below aims to offer high-level guidelines when considering which to use for different parts of the alternative investments opportunity set.

Enhancing and diversifying portfolio risk exposures

A goals-based approach to building investment portfolios inherently features an outcome-oriented mindset. Identifying specific goals for your money can help create a framework that informs the kinds of risk exposures you may want to diversify against, as well as those that could be worth enhancing.

It’s not that the traditional “60/40 portfolio” of stocks and bonds doesn’t have its merits, but rather that the incorporation of alternatives can provide additional layers of resilience, especially in times of market volatility and access to broader opportunity sets. Infrastructure investments, for example, can bolster the stability of a conventional stock-bond portfolio through steady, inflation-linked cash flows. Historically, private equity has a track record of augmenting the magnitude of capital appreciation seen in public equities, often by accessing companies in earlier stages of their growth. 

That said, alternatives can also introduce distinct risks, including limited liquidity, higher fees and complexity, and valuations that may be less transparent and updated less frequently than public markets. Some strategies may also use leverage or concentrated exposures, which can amplify losses, and redemption limits or gating can restrict access to capital during periods of market stress.

We can help

Given that alternative investments can enhance a portfolio’s resilience, outperformance potential or both, eligible investors would be remiss not to consider the opportunity set. Still, it’s one that requires thoughtfulness in approach. Prioritizing due diligence and manager selection, carefully weighing the trade-offs between evergreen and drawdown vehicles and considering how allocations to alternatives may enhance or diversify portfolio risk exposures are key.

J.P. Morgan Wealth Management stands ready to help you navigate ways to unlock the full potential of alternative investments in the context of your financial plan. With our deep industry expertise, robust network and tailored solutions, we are committed to helping clients build long-term portfolios that align with their aspirations and withstand the test of time.

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