For many investors, whenever the topic of alternative investments is brought up, their eyes gloss over as they prepare to be inundated with complex investment jargon accompanied by top-notch marketing buzz words. And to be fair, for many, this is with good reason. Within the broader investment landscape, the alternatives asset class is often viewed as a sprawling, opaque asset class where many Wall Street firms allocate significant time and money concocting new investment vehicles to pitch to potential investors. Within our industry, some of the words most often associated with these assets include: “illiquid”, “confusing”, and “expensive”. Importantly, it doesn’t have to be this way. And at Osborne Partners, it isn’t. We take a different approach to managing the alternatives asset class – one that prioritizes liquidity, simplicity, and cost, without sacrificing anything in terms of effectiveness. In this article, we’ll dig a little deeper into the alternatives space, talk about its role in a diversified portfolio and discuss our differentiated approach to the much-maligned asset class.

Despite including some more eclectic assets like whisky, paintings or baseball cards, the most common categories within the alternatives asset class include private equity, hedge funds, and niche categories like distressed debt. Many investment advisors utilize third party funds to manage their alternatives that are typically offered as illiquid, long-term investments with fees in the 1.5%-2.5% range—with some charging fees in excess of this.1 Hedge funds, on average, are amongst the most liquid of the bunch and can have lockups (a period during which the investor cannot redeem their investment) of less than a year. Private equity funds, on the other hand, commonly have lockup periods ranging from 7-10 years with many having the option of extending the life of the fund without investors’ consent.2 Certain categories of alternatives like private equity funds or distressed debt can be hard to price – meaning investors may not have a firm understanding of the actual value of their underlying investments at any given moment. Because of this, performance data is often unreliable. The lack of consistent pricing of alternative assets results in performance figures that are frequently lagging or stale – meaning performance for certain illiquid alternatives will often overstate returns in down markets (like 2022) and understate performance during the initial stages of a rising market.

Over the years, the alternatives asset class has garnered a rather mixed reputation amongst investors. Meaningful bear markets in 2009 and 2020 rattled investors who were unable to access their capital at the exact moment they wanted it the most. Despite this, there is no doubt they play a crucial role in a diversified portfolio. Constructed properly, these assets should be amongst the least correlated with the rest of a portfolio, providing protection to various asset classes while also taking advantage of volatility and dislocations in other asset classes. Last year provided a good, albeit painful, example of the type of environment where the alternatives asset class provided meaningful value to a diversified portfolio. 2022 proved to be the worst year on record for a traditional 60/40 portfolio (60% Bonds, 40% Equities), leaving few asset classes unscathed. Alongside natural resources, alternatives were one of the only asset classes that actually logged positive performance. Certain alternatives that hedged against rising interest rates, spikes in equity market volatility and sharp moves in currencies are a few examples of some of the types of investments that worked well last year and helped insulate diversified portfolios against an otherwise brutal market environment.

While the underlying purpose of alternatives at Osborne Partners can overlap with how some other firms manage their alternative investments, that’s likely where our similarities end. At Osborne Partners, most investment team members have prior experience working at firms who opted to outsource the management of their alternatives to these large, expensive funds. And most came away with the same conclusion – not again. As such, we re-constructed how the alternatives asset class was to be built with a focus on effectiveness, liquidity, and cost. We believe we can still accomplish our objectives for the asset class without the pitfalls of paying excessive fees or not being able to access your capital whenever you should choose.

In an Osborne Partners portfolio, our alternative investments typically strive to do one of two things: hedge against a specific risk in our portfolios or take advantage of idiosyncratic opportunities. On average, you’ll likely see us deploy more hedges in market environments that are more risk tolerant – as these tend to breed complacency. When investors are more jubilant, risks can become ignored, creating an opportunity for disappointment and volatility. On the other side of the coin, volatile market environments that are often rife with fear will typically result in reducing exposure to hedges (which may have already done their job) and start to look for more idiosyncratic opportunities that have risen from underlying volatility and fear. Let’s take a look at an example of each:

Example 1: Hedge. In 2022, recognizing the possibility of higher interest rates, we opted to hedge against a move higher in long-term U.S. Treasury rates by owning Proshares Short 20+ Year Treasury (TBF), a liquid, exchange-traded fund that gains value when longer-term U.S. rates increase. Owning TBF not only provided a hedge for fixed income (whose values typically move opposite the direction of interest rates) but also for asset classes like U.S. equities, foreign equities, and real estate, which all experienced volatility in the face of a dramatic increase in interest rates.

Example 2: Idiosyncratic Opportunities. In the first quarter of 2023 during the regional banking scare, we purchased KKR & Co (KKR) and Apollo Global Management (APO). Adding KKR and APO allowed us to take advantage of a temporary dislocation in the market driven by concerns around the health of regional banks, while also initiating exposure to longer-lasting structural tailwinds we expect these two entities to enjoy.

In an industry that sometimes seems committed to making things overly complex, our team continues to find refined and effective ways of managing portfolios without introducing any unnecessary complexity to our process. Our approach to private equity is a great example. Instead of owning the illiquid and costly funds that KKR and Apollo offer – which would lock our clients’ capital up for 7-10 years – we purchased the common equity of both entities. This enables us to directly benefit from any success these companies have in their offerings, but in the form of a completely liquid and fee-free investment structure. Alternatives will continue to be a growing and increasingly complex asset class going forward – but our approach will stay the same. We’ll continue to utilize these investments to mitigate risk across our clients’ portfolios and seize opportunities that arise from panic and fear.