Finding Alternative Investments for High Net Worth Financial Planning Clients

The needs of high net worth investors are unique. Many HNW investors have achieved their status through a C-level business or job that has created wealth beyond retirement security and a great lifestyle, and many have built that wealth in one or two positions such as the business itself and perhaps the real estate in which their business lived. A feature of building wealth this way is a different perspective on liquidity, risk, and return. These features leave many HNW investors disappointed with the offerings of many financial planning companies.

Even though the values ​​of the businesses and real estate that created their wealth can go up and down like any other investment, these investors often don’t see this or care. A primary characteristic that I have observed among this crowd is that of control. They inherently believe that their day-to-day involvement in the operation of the business protects them from volatility and that their impact can be felt, unlike owning shares of a publicly traded investment. They are true entrepreneurs who believe that good ideas executed by smart, hardworking people will pay off. It’s easy for them to support an idea they like by relying on good people with experience in creating value.

These are just a few of the reasons why these investors may be attracted to alternative investments. The term “alternative investments” is vague and includes many asset classes. The only thing that is not considered an alternative may be your traditional investments such as stocks, cash, bonds, and things that are generally traded and priced at market every day. Examples of alternative asset classes would be real estate, private equity, private loans, collectibles, wine, vintage cars, etc.

As with any investor, each HNW investor has their own risk appetite. Rarely does an HNW investor place (or should) place all of their assets in alternatives, even though that may be how they created their wealth in the first place. The appropriate amount for a particular investor should be determined on an individual basis. For me, alternatives can have a place when we are discussing someone’s venture capital or investments that can exceed their needs for cash, retirement and lifestyle security.

For the average financial advisor, the alternative investments available through your typical brokerage platform may not be exactly what your client is looking for. In my opinion, most of these products are designed as financial tools that are good for corporate sponsors, CAs, and advisors. In fact, a friend of mine who is known as one of the top real estate professionals in the country has only one good thing to say about these types of non-traded products offered by BD – “YTB” or ” Yield to broker!” Many have lucrative commissions attached to them.

Even when I was looking for commission-free or low-commission products, my research left me feeling empty and vulnerable through these traditional channels.

Build an alternative portfolio

Now that we know what types of alternative investments to avoid, how do we add value to a client relationship that invests in alternatives or needs help finding and evaluating opportunities? By starting with customers who already own “alts”, you can help by assessing how well the alts work as a portfolio. Like a traditional portfolio, an alternative portfolio should also be well balanced and diversified. When evaluating the alternative portfolio for diversity and balance, you will use the same approach you would use with traditional investments.

Break them down by asset class to see that all of the alternative eggs are really in different baskets, as opposed to different sections of the same basket. For example, if your client owns several different office buildings, are they really diverse?

You can start creating a scorecard or performance metric for your client. It may not be possible to value an alternative investment based on its current value because you may not know the current value. If the general partner or deal sponsor is willing to estimate present value, then go for it. But beyond the value of the deal, you can evaluate it based on its cash flow or its current performance compared to what was expected when the opportunity was first analyzed.

You can help assess the structure of the transaction. Alternative investments are often held in some form of limited partnership or LLC structure. In these structures, the general partner or sponsor is usually compensated in several ways. Some receive an upfront fee simply to move the transaction forward. Others take a portion of the cash flow first with or without a preferential return to investors and most are interested in the ultimate benefits of the transaction. The range of what you find will be everywhere. But if your client has a few alternative investments, you may be surprised to find that they may not remember the terms and structure of the ones they have. You can create a useful summary as a resource to save the customer time. This understanding of the structures will also be a useful guide for your client when evaluating future alternative investments.

Keeping records for these investments can also be valuable to your clients. In my past life as a CPA, I remember having wealthy clients with so many alternative transactions that they didn’t know when capital calls were due and how many transactions they had actually committed to. In some cases, investors with tens of millions in investable assets were rewriting their checks when making capital calls because they simply didn’t pay attention to detail like you or I would. Tracking their internal rate of return is also something that can be helpful.

Olivier Le Moal/Olivier Le Moal –

Expand their selection

Helping your client find and evaluate alternative investments can also be helpful. I have discovered that many clients find their alternative investments through friends or family members and have only a limited choice from which to choose. The resulting portfolios often lack diversity, whether from an asset class perspective or from a sponsor or GP perspective. Just because you like a sponsor doesn’t mean you can’t invest more with them, but it doesn’t mean you shouldn’t seek diversity either.

Diversity can happen in many ways. This can happen by asset class and within asset classes, by sponsor, by geography, duration, risk and any other metric used for any type of investment.

For real estate, you can own different asset classes such as apartments, offices, warehouses, retail businesses, etc. Even within each real estate subcategory, you can further diversify based on the intended use of the property. Is it a development agreement, a cash flow agreement or a repair and sell type agreement? Will it be low leverage or high leverage?

A similar approach makes sense when evaluating private equity deals. Your clients may want to invest in private equity in an industry they know or invest in areas they’ve never been before. Even with private equity, beyond the diversity of sectors, you have the option of investing in startups, seed capital or venture capital, mature companies or start-ups. Investing in private credit also has its place. In the yield-poor environment we live in today, investors have little choice in generating pure yield. It can be mezzanine finance for developers or lending to distressed businesses, but private lending also requires the same, if not more, care and appraisal skill than any other private investment. Private loans may be ideal for qualified accounts through a standalone depository to avoid current high interest rate taxation.

If you or your client lack the talent to assess a stand-alone transaction, consider a partnership in which the GP assesses many transactions, with the specific intention of owning several within the partnership. This diversity does not guarantee better results, but between the professional advice of a general practitioner and the diversity within the partnership, it can be easier to invest with confidence.

And my final financial planning point — make sure these private placements fit into the client’s estate plan. Make sure they are properly owned, such as in their family trusts or partnerships. Also, make sure there is an estate liquidity plan in place in the event of premature death. Withdrawing from private investments early may not be possible, or it may come at a high price.

There are several reasons why you should care about alternative investments. First, your wealthy clients do. If you don’t care or lack the bandwidth to help you out, someone else will. They need help and will look for what they need. Second, the trend: in a recent survey conducted by a major HNW company, it was highlighted that among the services that HNW investors want the most is private investment assistance.