Alternative Investments Are Becoming More Common in Diversified Portfolios
A recent PEW Charitable Trusts study shows a sharp rise in alternative asset investment (ex., private equity, venture capital, or real estate) over the past decade among large pension and trust investors. From 2006 to 2016, funds have more than doubled their allocation to alternative investments. These large fund professional managers are capitalizing on the return and correlation characteristics of this asset class. A recent trend in this class has been an increase in the relative percentages of private equity and venture capital as compared to real estate holdings.
Individual investors can take advantage of investing in these asset classes through their IRA. Investing in alternative assets through IRA accounts is not a new strategy; it has been around since the IRA was created in 1970s. Increased allocations to alternative assets that lie outside of the stock market can result in greater financial returns and increased diversification. By placing these investments into a long-term, self-directed IRA account, investors can gain tax advantages and could protect those funds from the short-term volatility can occur in more traditional capital markets. When a bull market wanes and traditional markets are volatile, alternative investment attractiveness increases. Furthermore, because alternatives tend to have lower correlation to stocks and low-to-negative correlation to bonds, they can be an attractive diversifier.
Investing in Private Companies
Private equity and venture capital are a sub category in the alternative asset class and consists of ownership in a company that is not publicly traded. Private equity typically deals with more mature private companies, while venture capital focuses on early stage companies. These early, fast-growing companies utilize private capital (either through funds or through individuals, so called “angels”) to be able to quickly develop innovative products and solutions, scale their operations, and capture meaningful market traction.
Investing in private companies can also give investors an opportunity to invest in industries that they are experienced in – for example, doctors can invest in medical device or life science companies, or individuals with information technology background can invest in interesting start-ups focused on disruptive information technology. Individuals can also choose to invest in local opportunities to support the local economy since these companies drive the creation of new jobs, and often pave the way for a more diversified and productive economy.
A feature of private equity and venture capital is that investments typically tend to be illiquid and require a significant capital commitment. IRA accounts typically can mitigate these concerns in their ability to support holding periods upward of 3-7 years and their ability to meet the capital requirements of individual inveswtments.
Investing in a Portfolio of Companies
As a general rule, the earlier the investment is in a company’s life cycle, the higher the risk (including the risk of loss of capital), but the higher the potential return. Also, as a general rule, the earlier the company, the more focused but potentially more disruptive is their offering. Individual investors can capitalize on these features through a diversified portfolio approach. This approach can be implemented with a diligent investment philosophy practiced either individually or through an investment fund.
Investment funds, whether in the private equity of venture capital space, tend to focus their investments in specific industries in which they have expertise and/or specific geographies that are compelling. Furthermore, aside from financial capital, fund managers typically provide active support to the companies in guiding them through early challenges. Most importantly, these funds tend to provide the appropriate number of individual investments to achieve the desired risk and potential reward profile of their investors.
Investing in alternative assets through a self-directed IRA can diversify your risk profile and provide potential upside return. Furthermore, private investments can also allow individuals to invest in companies, industries, or geographies, that they have experienced in or have a personal interest in. Given the nature of the investment, a diligent investment approach with suitable diversification is important. This type of investing generally does good while doing well.
DeepWork Capital, previously known as FAN Fund, invests professionally managed committed venture capital in growth-oriented early-stage companies in the technology and life science sectors in Florida and surrounding areas. The Firm prefers to take a lead or co-lead investor role while working closely with other investment groups and takes a hands-on approach with its portfolio companies. For additional information please see http://www.deepworkcapital.com.
 Blackrock 2018 (https://www.blackrock.com/investing/resources/education/alternative-investments-education-center/why-should-i-use-alternative-investments/increased-correlation)
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