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Alternative investing

After experiencing over three straight years of negative performance in the public equity markets, many high net worth investors and institutions are looking for ways to further diversify their portfolios, reduce overall volatility and, of course, enhance returns. For qualified investors willing to think outside the traditional investment box, there may be a way to accomplish these elusive goals by allocating a portion of their investable dollars to alternative investments, such as hedge funds and private equity funds, according to Brian Isroff, senior managing director of Sterling Private Investments.

Hedge funds generally invest in marketable securities such as stocks and bonds. Unlike traditional investment strategies, however, hedge funds also have an expanded set of trading tools at their disposal. Hedge fund managers may use both long and short equity positions, use other financial instruments such as puts, calls and options to hedge a portfolio and use leverage (i.e. borrowing) when making investments. Traditional investment managers typically only have the choice of owning stocks and/or bonds or being in cash. Thus, hedge funds can often be more flexible, adaptable and nimble in order to take advantage of ever changing market inefficiencies. Finally, because of the economic opportunities available to successful hedge fund managers, the business tends to attract some of the best and brightest people in the investment industry. As you may have read in other financial publications, many hedge funds have performed quite well even in the face of the extremely challenging public equity markets of the last few years.

Private equity funds, on the other hand, generally invest in privately held companies. Private equity funds include both buyout funds and venture capital funds. Because of their private market nature, private equity fund performance may not correlate to the public markets and can provide an excellent means of investment diversification. It is important to note that private equity investing is a longer-term alternative investment strategy with little or no liquidity; however, the historical returns from private equity investing have been quite good and it offers another means to further diversify an investor's portfolio.

Empirical data suggests that by adding alternative investments (whether hedge funds or private equity funds) to a traditional portfolio made up of stocks, bonds and cash, investors may be able to actually reduce overall portfolio risk and, at the same time, enhance expected return. Qualified investors who are interested in alternatives really have two choices, they can attempt to invest directly with alternative managers or they can invest through a fund-of-funds.

Investing directly with alternative managers means an investor must handle all the up front manager due diligence and comparative evaluations as well as the on-going monitoring of the manager(s). In addition, if an investor chooses to go directly, the investor must meet the individual manager(s) investment minimums, which are often quite high (typically in excess of $1m). The time, energy and effort involved with this effort, as well as an inability or unwillingness to meet the individual manager minimums, keeps many investors from investing directly in alternative strategies.

Another option, and one that more and more high net worth investors have taken advantage of in the last several years, is a fund-of-funds. These investment vehicles allow convenient and efficient access for qualified investors who are interested in investing in alternatives but who, for a variety of reasons, do not wish to undertake the due diligence burdens themselves. Alternative investment fund-of-funds generally offer access to a diverse group of established managers, some of whom may not be available to individual investors because of prior fund closings, all for a very reasonable capital commitment (generally between $100,000 and $500,000) and they provide investors with the added benefit of consolidated reporting of both performance and tax information. The proliferation of fund-of-funds over the last few years has increased the availability of alternative strategies to a much broader marketplace.

This article was first published in May 2003

An affiliate of National City, Sterling Private Investments, Inc. (“SPI”) , organizes and manages alternative investment fund-of-funds. SPI has an established track record with over a decade of experience putting together alternative investment partnerships for investors. We welcome the opportunity to show you how alternative investment strategies, coupled with our disciplined process and superior investor service, can enhance your investment portfolio. For more information, please contact Brian Isroff, Managing Director of Sterling Private Investments, at 216-831-4702 or brian.isroff@nationalcity.com.