With the beating stock and bond markets took last year, Patrick Dougherty isn't surprised that many of his high net worth clients are looking for alternative ways to juice their returns.
Dougherty, the principal at the Dallas-based registered investment advisory Dougherty Wealth Management, said he usually directs clients who are looking beyond standard stocks and bonds to private real estate partnerships. He said he has seen these partnerships — which allow investors to buy stakes in apartment buildings and other properties — produce returns of 17% to 19%.
The trade-off, Dougherty said, is that investors have to accept they won't be able to get their money out for quite some time. Private real estate partnerships often cash out only when their property holdings are sold. Dougherty said investors usually have to wait years — sometimes as many as 10 — for the returns they're promised. That's why, he said, they need a lot of money to start with.
"It's only the high net worth individuals, people with $3 million or $4 million, who can put $100,000 into one of these," Dougherty said.
Dougherty's sense that wealthy clients want to boost their returns by looking beyond stocks and bonds is not just anecdotal. A recent report by the research firm Cerulli Associates, based on dozens of surveys conducted last year, found that investors with a net worth of $5 million or more now have 9.1% of their assets in alternatives to stocks and bonds. That figure is up from 7.7% in 2021 and is expected to climb to 9.6% next year, according to the report.
Robert A. Stanger & Co. — a Shrewsbury, New Jersey-based investment banking firm that tracks alternative investments — reported Jan. 20 that $104 billion was raised for alternatives in 2022. That was a 23% increase from the previous year.
Cerulli's survey found private real estate investments are popular among advisors working with wealthy clients. Of the respondents, 45% said they plan to direct more money into private real estate in the next two years. The Stanger report found that $33 million was raised last year for private real estate investment trusts — another way investors can put money into apartments, office buildings and types of properties that generate income.
Even more appealing than real estate, according to Cerulli, was private equity funds, which allow investors to buy stakes in companies that are not traded on public markets. Of the respondents to the Cerulli study, 45% said they would be directing more money to private equity in the next two years.
Also popular is private credit, which allows investors to pool their money into loans to private companies. The Chicago-based advisory firm Cresset Partners recently started a private credit fund to invest in loans to small, non-public companies backed by private equity firms. Like most such investment opportunities meant for high net worth investors, the $500 million fund is designed to produce returns superior to those that can be had from more traditional markets.
"Our clients have a desire to invest more in private credit because of the resilience of the asset class," said Cresset Executive Managing Director Kevin O'Donnell.
In the Cerulli study, roughly half of the respondents said they favor alternatives because they're looking to diversify their portfolios. Another 50% said they're seeking growth opportunities.
Those opportunities have been hard to come by lately. The S&P U.S. Treasury Bond Index finished 2022 down by 10.7% and the S&P 500 Stock Index was down nearly 20%.
Even in normal times, there's great appeal to the prospect of being able to get greater returns while protecting investments against losses in certain asset classes. Following a year when stock and bond markets were
Rob Young, senior investment analyst at Southfield, Michigan-based Telemus Capital, said he and his fellow advisors diversify their clients' portfolios using a two-layer system.
The first layer includes a broad swath of private equity, real estate and credit funds that investors can pull their money out of at set times of the year. The second consists of specially selected funds that Young and his colleagues have taken a great deal of time to research. These are usually long-term investments — usually requiring money to be set aside for years — that promise substantial returns. Young said Telemus tries to select between four and six of these funds annually.
Young, whose firm works primarily with high net worth clients, said it's not safe to assume that a long-term private fund is a good fit for anyone with a lot of wealth. Even for people with money to spare, there's always the question of how much of it they'll need on hand for present-day expenses.
"It really gets down to your relationship with the individual client and knowing what that client's needs are," Young said.
Dougherty said he has tried to distinguish his RIA in part by seeking out wealthy clients — most of the people he works with have a net worth of around $2 million — and then finding ways for them to invest beyond stocks and bonds. His knowledge of alternatives has come from enrolling in courses and spending a good deal of time talking to officials at real estate partnerships and other investment prospects.
"I get to know them so well they probably get tired of me," Dougherty said. "But I go to meet the president. I meet the people who pick properties. I get to know these people on an individual basis. And once I see I have a company that's really good, I put my clients' money into it."
Along with real estate partnerships, Dougherty likes private equity. He said he has turned to it, for instance, to put clients' money into the
Beyond their limits on money withdrawals, Dougherty said, the biggest drawback to private investments is that they are opaque. Since private equity firms and real estate partnerships are not under the reporting requirements federal regulators place on public companies, they tend to furnish very little in the way of performance data to investors.
Dougherty concedes that means clients who want their advisors to recommend alternatives have to take the resulting advice on faith. Dougherty has been building up relationships with some of his clients for more than 20 years. His strong desire to make sure he doesn't betray their trust is one reason he puts so much time into researching possible investments.
"Most of them will say, 'What are we going into?'" Dougherty said. "And then I explain it to them and they say, 'Well, if you think it's good, we'll do it.' And I've never lost money for them."
Another drawback that many investors may not be aware of is tax complications. Rob Cordasco, founder of the Savannah, Georgia-based accounting firm Cordasco & Co., said many private equity firms are organized as partnerships, meaning they don't pay taxes on corporate earnings. Their earnings are instead distributed to investors, who in turn are taxed on their income.
Cordasco said it's not uncommon for private equity firms to own companies that are operating in 20 to 30 different states. If that's the case, investors will find themselves having to fill out tax forms for each individual state.
"If they're in 20 different states, none of them are going to be ready to file by April 15," Cordasco said. "They'll instead be filing for extensions in 20 states."
Dougherty said despite his openness toward alternatives, there are some investments he steers clear of. He's not a fan of commodities like gold and silver. They're too volatile. And something like cryptocurrency is too untested, he believes. So far, Dougherty said, the strategy has worked.
"People come to me because they want something special," Dougherty said. "They want the cherry on top."
