What to ask when your adviser pushes private funds
Navigating Private Fund Recommendations: Essential Questions for Investors
Bharatmorningnews.com – Cerulli Associates projects that financial advisors will channel approximately $2 trillion from client portfolios into alternative investment vehicles between now and 2030. Whether this shift benefits you hinges on asking the appropriate questions during the process.
The Expertise Gap and Fund Complexity
A pressing challenge exists: many financial advisors lack sufficient background evaluating private equity, hedge funds, nontraded real estate, private credit, and similar alternative assets. Thorough examination becomes essential given several factors.
Private funds frequently impose substantial, fluctuating, and sometimes confusing fee structures. Their marketing materials and disclosure documents may lack clarity. Unlike publicly traded securities that receive daily valuation, these investments are appraised periodically behind closed doors—insiders acknowledge these valuations sometimes prove questionable.
While investors can purchase shares whenever desired, holding periods often span multiple years. Selling opportunities typically occur at set intervals with limited quantities available. Such investments may also complicate tax obligations and estate planning strategies.
Performance Potential and Market Timing
Certain private funds have delivered exceptional results alongside meaningful portfolio diversification. Yale University’s endowment, guided through its formative years by the late David Swensen, achieved remarkable returns for generations through alternative assets.
However, alternative fund managers increasingly target individual investors, while many advisors seek to validate their compensation by providing access to these vehicles.
This dynamic creates a need for screening questions that won’t block purchases of quality private funds from capable advisors, yet will filter out less appealing options and underqualified professionals.
Questions from Mark Higgins
Mark Higgins, a financial advisor at IFA Institutional and author of “Investing in U.S. Financial History,” recommends beginning with these inquiries:
I’ve read several articles that are skeptical about whether the returns on alternative funds will justify the costs, risks and reduced liquidity. Describe such critiques to me in detail, without judging them. What evidence would you need to see to tell me not to invest in these funds?
History shows that individual investors are targeted toward the end of financial booms, not the beginning. Trillions of dollars in institutional capital have poured into alternative assets since the 1980s. Why do you believe this is near the beginning, not near the end?
Insider Access Considerations
Charles Ellis, who served on Yale’s investment committee during Swensen’s tenure, observes that top-tier managers possess “the power to decide who gets invited to invest in their funds.” These professionals typically favor institutional clients capable of making repeated substantial investments over extended periods.
Why do you think this manager is inviting me in? Might that be only because the best investors wouldn’t invest?
If the manager built its track record on a small asset base, why do you believe it can continue to perform well as it gets bigger? How much money can this strategy absorb without jeopardizing future returns?
Income and Tax Efficiency
Leyla Kunimoto, a private investor who edits Accredited Investor Insights, suggests examining income distributions more closely:
The distribution yield looks attractive, but what percentage of it is covered by cash net investment income? If the fund pays distributions from sources other than net investment income, identify them and their contribution.
How tax-efficient is this fund relative to the most similar exchange-traded fund? For tax reporting, does it use Form 1099 or the dreaded K-1 form?
Legal Recourse and Track Record
One reader who recently reviewed a prospectus noting that disputes require resolution under Bermuda law posed this question:
If anything goes badly wrong, what recourse do I have against the fund manager—and where?
Another consideration involves institutional investor performance:
Institutional investors have experience and expertise in selecting and monitoring alternative investments. Even so, their performance has often faltered, and some are having second thoughts about holding these assets. What in your track record shows that you can reliably identify superior private funds even though institutions often can’t?
Private-equity funds currently hold more than 13,500 U.S. companies they cannot liquidate. Understanding why you should purchase alongside these illiquid holdings matters.
Fee Transparency
Many exchange-traded funds charge annual expenses below 0.05 percent. Alternative funds frequently require at least 2 percent, occasionally significantly more. Request a detailed breakdown of all anticipated costs, including underlying fund fees and expenses. Understanding why paying substantially higher fees than ETF investors represents sound strategy completes your due diligence.
For approximately two decades, alternative managers enhanced returns through borrowing at historically low interest rates. With current rate environments elevated, examining how this shift affects future performance expectations rounds out your evaluation process.
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