By placing alternative investments–such as private equity, real estate or private debt–into a long-term IRA account, investors gain tax advantages and could protect those funds from short-term gyrations in more traditional capital markets.
When a bull market wanes and traditional markets are volatile, having an allocation to alternative assets and direct investment access to alternative investments helps cushion a portfolio, and can offer diversification strategies for reducing risk and attaining excess returns. This certainly holds for an entire portfolio, taking into account qualified retirement assets as well.
Recently, two major studies were released backing up the trend toward including a part of institutional investment portfolios dedicated toward alternative assets.
Assets of the 49 largest private foundations reached $226.3 billion in tax filing year 2016. That is up 3.5% from $218.6 billion the year before and up 29.3% from $175 billion in 2007, according to a study published in November 2018 in Pensions & Investment magazine.1 Most of that increase comes at the expense of traditional asset classes like stocks and bonds.
Separately, a study in September 2018 by The Pew Charitable Trusts of public pensions’ asset allocation showed a sharp rise in alternative investments over the past 10 years.2 See graph below.
Average Public Pension Asset Allocation, 2006 and 2016THE PEW CHARITABLE TRUSTS
Increase in alternative assets is result of the financial crisis
Much of this increase has been in response to the financial crisis of 2008. In anticipation of another stock market correction, many investors are choosing non-traditional alternatives as a way of increasing their diversification into assets that are non-correlated to the stock market and can provide more stability. Investors and their advisors can turn to alternatives to help cushion the impact of traditional market volatility as equity fluctuations and interest rate increases have already begun to hit these markets in late 2018.
Two common objections to investing in alternatives is their tendency to be illiquid positions with holding periods of three to five years, and investing in them is usually reserved for the wealthy and institutional investors. However, by investing a slice of your retirement portfolio through a self-directed IRA, investors can not only protect their funds from short-term volatility but can also gain access to alternative investments that they may otherwise be unable to access.
Alternative assets within retirement accounts generally include real estate investments, venture capital, hedge funds, precious metals and other commodities, limited partnerships and other non-traditional assets. However, certain IRS rules and regulations remain constant. Failure to adhere strictly to the rules and regulations for IRAs could result in loss of tax-deferred status for the IRA assets. Investment professionals typically limit their recommendations for alternative investments to accredited investors to ensure that any losses are limited, while allowing the investor to share in any profits.
Nonetheless, there are over $25 trillion dollars held within U.S. retirement accounts, and less than 2% of those dollars are invested in alternatives. Unfortunately, most retirement investors are incorrectly led to believe that investment options are limited to traditional publicly traded securities.
Investor and advisor interest should be increasing in alternative assets
As the highly engaged group of professional investors that watch over assets of institutions, allocators and family offices are evaluating and increasing positions in alternative investments, investors and their advisors should take notice. Market volatility has increased, and individual investors, advisors or professionals should consider including asset classes such as private equity, private debt and real estate within a self-directed IRA.
STRATA Trust is a self-directed IRA custodian, specialized in holding alternative assets within IRAs.
- “Alternatives spark decade of growth for largest funds,” Nov. 12, 2018, article in Pensions & Investments.
- Pew Institute, State Public Pension Funds’ Investment Practices and Performance, September 26, 2018
The iShares U.S. Preferred Stock ETF (PFF) was trading at $35.18 per share on Friday afternoon, down $0.07 (-0.20%). Year-to-date, PFF has declined -5.83%, versus a 3.11% rise in the benchmark S&P 500 index during the same period.
PFF currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 19 ETFs in the Convertible Bond/Preferred Stock ETFs category.
This article is brought to you courtesy of Forbes.