This spring, we celebrated our 10th anniversary at FS Investments. Our firm was born in the early days of the financial crisis with a vision to help all investors design better, more diversified and resilient portfolios, just as big institutional investors and ultra-high net worth individuals have done for decades.
As I’m sure you recall, many individual investors were severely impacted by the crisis, losing savings earmarked for important family expenses like education, home ownership and retirement. Even smaller institutional investors, like municipalities, non-profits and pension funds, found themselves significantly underfunded.
So why did some larger institutional investors rebound better than individuals? We believe one factor is that their portfolios tend to be more diversified and hold more non-traditional investments that are less correlated to the markets.
The average household lacked the financial means and awareness to tap into alternative sources of income and growth like institutions could. We saw opportunities to change that, and I’m proud that FS has played a leading role in the movement toward democratizing institutional investing.
Since then, we have seen a proliferation of alternative investment strategies aimed at the non-institutional investor. The good news is that advisors and investors have better choices to design a portfolio ready for the market uncertainties ahead. The challenge, however, is that the number of investment choices is staggering.
So how do you decide which funds are best suited for your portfolio?
Over the years, I have met with dozens of leading institutional asset managers as FS has explored a wide array of alternative strategies. We have learned there are three key questions to ask when evaluating an alternative investment.
Three questions to ask about alternative investments
- What is the strategy? I believe a smart alternative strategy focuses on attractive long-term opportunities, offers the potential for good performance within its category and has low correlation to traditional allocations in your portfolio. There are many compelling strategies that institutions pursue and many individuals’ portfolios still miss. Some invest in non-traditional asset classes like real estate or commodities while others employ sophisticated approaches like hedging or private company financing. Fortunately these strategies are now within reach of more investors than ever before.
- Who is the manager? It used to be that the best institutional asset managers had little interest in serving individual investors. Today they are eager to enter this $19 trillion1 market. We always stress that the manager matters. In fact, the performance spread between the top and bottom decile investment managers for traditional strategies is small, but widens dramatically for alternative strategies. Make sure any manager you choose has proven expertise with the strategy, a strong track record, significant size and scale, and a commitment to putting investors’ interests first.
- What is the structure? Here we refer to the actual investment vehicle in which the strategy is delivered. While most investors are familiar with mutual funds and ETFs, alternative products can employ a host of other structures. What’s important is that the structure matches the investment strategy. For instance, we believe the returns of less liquid strategies can be maximized through the use of less liquid fund structures, such as closed-end and interval funds. You want to make sure the duration and liquidity profile of the portfolio’s assets align with the potential redemption demands for the structure. Also, look for structures that offer greater accessibility, transparency and investor protections.
Families still face serious challenges as they save and invest to fund key milestones, from buying a home to paying for children’s colleges and weddings to retiring comfortably. Despite the current bull market, we believe pressures on long-term economic growth and persistently low interest rates will require investors to branch out beyond traditional stock and bond portfolios to find alternative sources of income and growth to meet their financial goals.
As you wade through the alternatives, carefully examine any product’s strategy, manager and structure. If these are aligned and you determine that the investment objective fits into your overall goals, we believe you can improve your portfolio and your chance of achieving the results you want.
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1 Investment Company Institute, 2017 Investment Company Fact Book, U.S.-registered investment company total net assets.
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