Alternatives 2.0: Innovative Ways to Diversify Your Portfolio

May 1, 2024

Learn how a host of innovative alternative strategies could bolster investors’ portfolios in an uncertain investing environment.

Author
Paul Jodice, Co-Head of Global Investment Manager Analysis, Wealth Management

Key Takeaways

  • Alternative investment strategies can potentially provide higher yields, lower volatility and returns uncorrelated with stocks and bonds.
  • New investment vehicles are making alternative strategies more accessible to a wider range of investors.
  • Government-registered offerings tend to offer improved liquidity, lower minimums and simpler tax-reporting requirements.
  • A Morgan Stanley Financial Advisor can help investors understand the benefits and risks of these offerings.

While equities have notched double-digit gains since a low last year and recently have scaled new heights, the overall investing environment remains uncertain amid seemingly persistent inflation and the prospect of higher-for-longer interest rates. Against this backdrop, alternative investment strategies can play a vital role in a diversified portfolio. 

Alternative investments, such as those focused on hedge funds, private capital and real assets, have long been appealing as a potential source of higher yields, lower volatility and returns uncorrelated with stocks and bonds. Still, such strategies typically have been reserved for institutional and ultra-high-net-worth investors, out of reach for many individuals.

 

That is now changing. A host of innovative investment vehicles has recently become available to a wider range of sophisticated investors. They tend to offer improved liquidity, lower investment minimums and simpler tax-reporting requirements, among other features that render them more investor-friendly.

 

Individual investors may want to consider these “registered” offerings—that is, registered under the Investment Company Act of 1940 that regulates investment funds to minimize conflicts of interest and increase transparency.

 

  • Interval funds invest in various asset classes, most commonly in credit. They do not trade on an exchange but offer investors the chance to redeem shares at certain “intervals,” such as quarterly or annually. In exchange for accepting this illiquidity, individual investors gain access to institutional-level strategies that can offer a potential return advantage and further diversification, while getting the benefits of greater regulatory oversight, lower investment minimums and less-complex tax reporting.
 
  • Perpetual, or continuously offered, business development companies (BDCs) provide direct, privately negotiated senior loans to middle-market companies. They aim to generate high current income through multiple sources, including coupons and origination fees. Investments in direct loans are less liquid than traditional fixed-income investments and, for that, offer a premium. The perpetual BDC structure offers investors exposure to these traits of private credit, without the intraday volatility of public BDCs or the illiquidity of private BDCs.
 
  • Nontraded real estate investment trusts (REITs) offer investors access to a portfolio of commercial real estate assets. This strategy aims to provide an income stream with low correlation to stocks and bonds, while serving as a potential hedge against inflation. Exposure to real estate through nontraded REITs can be particularly compelling today, given the vehicle’s diversification across property type, location and tenant mix. Over the years, the nontraded REIT industry has evolved from one beset with illiquidity and high fees to one with more-transparent pricing, improved liquidity and more-robust oversight.
 
  • Registered funds of funds (FOFs) are multi-manager investment vehicles that invest in portfolios comprising other funds. Registered FOFs typically have lower income requirements and minimum investment amounts than private FOFs.

 

Specifically, registered funds of hedge funds offer access to multiple hedge fund strategies. Hedge funds as an asset class have proven to be resilient, particularly during periods of significant equity market volatility and drawdowns. Compared with their private counterparts, registered funds of hedge funds charge marginally higher fees, due to additional operational and regulatory expenses. At the same time, they are accessible to a broader audience through lower minimums and eligibility requirements, and they provide 1099 tax reporting, which is considered more investor-friendly than the K-1 tax forms issued to investors in private funds of hedge funds.

 

Meanwhile, registered private equity vehicles invest in a portfolio of primary, co-investment and/or secondary investments , providing investors with sector, strategy and vintage-year diversification. These funds are now generally structured as evergreen vehicles with periodic subscriptions and limited liquidity.

 

While many of these registered offerings may be attractive, investors need to remain selective and fully understand the benefits and risks, particularly as they relate to illiquidity. As we enter the next phase of the economic cycle, we expect the evolution of the alternative landscape to continue and the suite of product offerings to mature and expand.

 

Talk to your Morgan Stanley Financial Advisor about how alternative investments may play a role in your portfolio.

Alternative Investments at Morgan Stanley

Expand your investment universe with a suite of compelling alternative strategies from a global leader. As a pioneer and innovator in the industry, Morgan Stanley offers access to an unmatched platform of alternative investments, built on our team’s expertise, unique network and unwavering commitment to our clients.

Expand your investment universe with a suite of compelling alternative strategies from a global leader. As a pioneer and innovator in the industry, Morgan Stanley offers access to an unmatched platform of alternative investments, built on our team’s expertise, unique network and unwavering commitment to our clients.

Questions You Can Ask Your Morgan Stanley Financial Advisor:

  • Might registered alternative investment strategies make sense as an addition to my investment portfolio?

 

  • As we enter the next phase of the economic cycle, how can alternatives help my portfolio as I seek higher risk-adjusted returns? 

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