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Keystone Global Partners

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Five Key Considerations When Building an Alternative Investment Program for a Client

This article was originally published on FORBES.COM on December 20, 2022. Written by Peyton Carr.

Alternative investments, once rarely found outside the investment portfolios of the ultra-wealthy, family offices, pensions, endowments, and sovereign wealth funds, have become more mainstream as adoption grows and barriers to entering the asset class are decreasing. Many new players have entered the market over the last five years offering education and alternative investment strategies at lower commitment entry points. NASDAQ reports that by 2025, total alternative investments under management are projected to reach $17.2 trillion—a four-fold increase since 2010.

Also driving this asset class is high inflation, market volatility, and 2022 bond market performance causing many investors and advisors who’ve hesitated to invest in these wealth-building strategies to reconsider other options for diversification. 

Investors have many alternative investment options available to them, and building out such a portfolio or program can improve the overall risk and return characteristics of a portfolio when properly implemented. Still, there are unique challenges in doing so since the unpredictability of private market cashflows can be challenging for investors with liquidity and risk constraints.

Alternative investments are a core asset class for our clients, and below are five key considerations that qualified investors and advisors who invest in alternatives should consider:

Selectivity & Diligence

Alternative investments need to be carefully selected and run through the proper diligence channels. Choosing top-quartile performers is paramount. According to a report from JPMorgan, the spread between top-quartile and bottom-quartile managers is 21.3% for Private Equity, 34.5% for Venture Capital, and 13.3% for Hedge Funds. This compares to a spread of 1.8% for Global Public Equities, for example. According to Blackstone, nearly 60% of top-quartile managers remain above the median of their subsequent funds. Having the right access channels is imperative. I’ve seen too many investors and advisors settle for inferior funds or managers due to their limited access or diligence process. Be selective, diligent, and patient.

Timing 

Building out a private investment program is a multi-year process and requires time and dedication. For a new investor, it can take five to seven years to reach their target allocation. It can take 10+ years for the full maturity of a private equity fund, for example. Money invested is typically locked up and if an individual needs access to liquidity, they may not be able to liquidate their investments. Investors should carefully consider their liquidity needs and understand that this is a long-term strategy that requires planning and discipline.

Cashflows

Because of how a capital call drawdown structure works with some private investments — private equity, for example — the investor needs to model the expected capital call and distribution schedules, as well as the long-term expectations of the asset class and the portfolio. Only then can you optimize your commitment amounts and timing, better estimate future liquidity needed, and achieve your target alternative investment program allocation without overshooting or under allocating. As an example, cash flow drawdowns are typically more concentrated during the first few years, and different asset classes have different drawdown schedules. 

Scaling and Maintaining the Allocation 

Vintage diversification, or rather, investing over a multiyear period, is important. Funds can have good and bad years, impacting returns. Investors just getting started should take care not to over-allocate in a particular vintage year in efforts to ramp up quickly. Equally important is having an annual pacing plan determining what commitments to new funds are required to achieve or maintain the target allocation. When an investor receives a distribution, it decreases the overall allocation and decreases exposure. This needs to be accounted for via a recommitment strategy; otherwise, the total exposure will trail off.

Liquidity and Diversification

A properly designed alternative program should be diversified across multiple strategies and vintages and can range from defensive to growth focused. The calibrated and optimized mix will ultimately depend on the client’s risk tolerance, goals, and liquidity requirements. Determining client level liquidity requirements and stress testing the portfolio to simulate managing commitments through market volatility is necessary to prevent any cashflow shortages or unexpected outcomes. 

Conclusion

Building out an alternative investment program requires a disciplined approach to portfolio construction, implementation, and maintenance. It is very different than investing in public markets where you can quickly and efficiently achieve a target asset allocation. When building out a private investment portfolio, many of the private markets commitments are drawn down over a series of years and returned later. Capital call drawdowns can vary significantly between asset classes, managers, and investment cycles, which is why it is important when investing in alts to fully understand the asset class before including them in an investment portfolio.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

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Yes, and it’s likely we’ve helped others solve similar problems as well such as business sales, QSBS, tax minimization, estate, 401(k) plans, IRS audits, family deaths, disability, real estate, debt, social security, Medicare, health insurance, college, gifting, and most other financial issues.

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We work specifically with tech founders.

What services do you provide?

A relationship with Keystone involves comprehensive financial planning around retirement, insurance, estate planning, tax planning, and investment management.

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We firmly believe that even the best financial plan is of little value until it’s implemented. To help you achieve your goals without feeling stressed or overwhelmed by the noise along the way, we will work together to make the necessary decisions then we take care of the execution.

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As an SEC Registered Investment Advisory firm, we are held to a fiduciary standard, which legally requires us to do what is in our clients’ best interests. This differs drastically from some of our competitors who are only held to the “suitability standard,” meaning that our competitors can make recommendations that are suitable but may not be in the clients’ best interests. Our commitment to an honest and ethical culture has allowed us to build deep, trusted relationships with our clients.

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We are only paid via one management fee. We believe this allows us to have an unbiased framework to select the best investments for you and to give you advice tailored to your needs, not ours. We believe compensation drives behavior, and the way someone is paid influences the work they do. Many financial firms have complex fee arrangements; we do not.

Why would I choose you as my advisor and not do it myself?

There’s certainly a possibility that if you put enough focus and energy into it, you could do it all yourself. But like everyone else, your time is limited and most people prefer to focus on family or business. We’re here to free up your time while leveraging our wealth of experience in addressing concerns, presenting solutions, and working toward your financial goals.

What are the benefits of working with an independent advisor compared to a bank or large advisory firm?

Our independent and conflict-free approach allows us to find the best solutions for our clients. This gives you the advantage since larger firms might be compelled to make specific recommendations, sell proprietary products, or may be restricted in the advice and services they offer. We offer guidance customized to your needs and goals which is a personalized level of service, care, and attention larger firms just can’t provide.

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At Keystone, we do not use proprietary products. We do not receive commissions or backend fees from any third parties. We do not earn compensation for recommending one fund vs. another. We believe this allows us to have the most unbiased framework to select the best investments for you and to provide advice tailored to your needs, not ours.

Where do you keep my money and how can I see it?

For your convenience and safety, we use Charles Schwab as the custodian for the majority of our client assets. Schwab administers more than $7 trillion dollars and we selected them to care for yours as well based on a variety of criteria including safety of assets, financial strength, and ease of use. As custodian, Schwab holds your funds and provides direct reporting to you. Your funds will be held in accounts under your name and can be viewed anytime online at Schwab.

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