AlternativesOften, wealthy clients come to me wondering if they should invest in alternatives like hedge funds or private equity. It’s a fair question. There is something sexy and exclusive about alternatives. They are supposed to deliver high returns and low risk. I hate to be the one to tell you that’s too good to be true…but I’m going to tell you it’s too good to be true.
Let’s back up for a second. If you have some money to invest you have three options.
- Buy a company and receive a share of the profits (shares of stock, private equity, a small business)
- Make a loan and receive interest payments plus your principal back (CDs, government bonds, corporate bonds, mortgage bonds, peer-to-peer lending)
- Buy an object and hope somebody pays you more for it in the future (gold, land, Bitcoin)
Those are your choices. You can package them in different ways to increase the risk, transfer risk, or decrease the risk in different ways. That’s all private equity and hedge funds do, and it doesn’t add value.
Private equity increases the risk by using leverage (taking big loans against the company and hoping the growth allows them to pay the loans back) and by investing in a small number of companies. Private equity funds go years at a time without updating the value of your investment. Just because they don’t give you updated prices daily doesn’t mean they aren’t bouncing all over the place. Ignorance is not bliss.
Hedge funds can do all sorts of things to change risk, often quite complicated. Good luck understanding the risk before it shows up. And good luck finding a top notch hedge fund that wants to work with an individual investor when they can get hundreds of millions of dollars from institutions.
In return for making things more complicated (not better), hedge funds and private equity will charge you much higher fees than it costs to invest in regular old stocks and bonds. They will tie up your money for years. And you will likely end up disappointed in the end.
As for me, I’m sticking with the tried and true. Stocks and bonds have theirs ups and downs, but more ups than downs.