The Truth About Alternative Investments for High-Net-Worth Investors
Over the past 15 years, alternative investments—such as hedge funds, private equity, venture capital, and various types of real estate investments including RELPs and non-publicly traded REITs—have been increasingly popular. They’re marketed as exclusive wealth-building opportunities for high-net-worth investors, promising some combination of high returns, risk reduction, and portfolio diversification.
But is this marketing hype or solid financial strategy?
At Hendershott Wealth Management, we focus on evidence-based investing strategies that are supported by decades of research. We aren’t in the practice of recommending alternative investments because the data shows they often:
❌ Charge high fees that erode investment gains
❌ Lock up capital for years with limited liquidity
❌ Lack transparency in valuation and risk exposure
❌ Fail to outperform low-cost, diversified index funds
So before adding alternative investments to your portfolio, let’s separate the hype from reality and break down the risks, fees, and performance challenges in alternative investments.
What Are Alternative Investments?
Alternative investments (a.k.a. alts) include assets outside of publicly-traded stocks, bonds, and products that bundle stocks and bonds like mutual funds and exchange traded funds. Alts include hedge funds, private equity & venture capital, commodities or collectibles, cryptocurrency and digital assets, and more.
At HWM we hear a lot about how these opportunities can earn high returns, add diversification, hedge against inflation, provide passive income… all characteristics that can make them seem alluring.
In spite of that, we don’t recommend alternative assets for our clients because they also tend to come with high minimum investment requirements, long holding periods, complex risk factors, and returns that underperform benchmarks.
Both evidence and experience suggest that alternatives are a gamble best avoided by the vast majority of individual investors and most large professional investors. While some financial professionals have deep expertise in alternatives, many advisors simply follow the trend–without a true competitive advantage in evaluating these investments.
Key Problems With Alternative Investments
1. High fees that reduce returns
Many hedge funds and most private equity firms use a “2 and 20” fee structure, which includes a 2% annual management fee and 20% of profits taken by fund managers. And sometimes these fees are even higher!
High fees significantly reduce investor returns, especially compared to a low-cost, globally diversified index portfolio, which typically charge around one-tenth the fees.
Let’s see how that difference might apply to you:
- If you invest $10 million in a hedge fund charging 2% + 20%, you would pay $200,000+ per year plus 20% of profits
- If you invest $10 million in a low-cost index fund at, say, 0.26% fees, you’d pay $26,000 per year and keep all of your profits
Even if an alternative fund’s investments outperform the general market, high fees often eat up most or all of the extra returns.
2. Liquidity risks: Locked-up capital
Some alternative investments require you to keep your money “locked up”, meaning you can’t access your capital even if you need it.
Consider this:
- Private equity & venture capital often have 10+ year lock-up periods
- Hedge funds may limit withdrawals or impose exit penalties
- Fine art, real estate, and private deals can be difficult to sell
If you need liquidity for life changes, opportunities, or emergencies, alternative investments aren’t reliable, often creating barriers to using your own wealth.
3. Lack of transparency & valuation issues
Unlike publicly traded stocks, which are transparently priced every second of the trading day, alternative investments can have subjective valuations.
- Hedge funds with complex strategies sometimes “mark to model” rather than “mark to market”, meaning they value holdings at what they think is correct rather than using an objective market price
- Private equity firms self-report performance, with no public scrutiny. This is necessary because they hold private stock–however, we can observe that the default is to hold valuations constant even in volatile markets (and in particular during market downturns)
- Fine art and real estate are also highly subjective in valuation
- Cryptocurrencies and commodities have market prices–but not necessarily liquid markets. That means the price today may be much higher than the price will be if a large holder sells
For example, during the COVID-19 market crash, the S&P 500 fell over 30%, yet many private equity and venture capital funds reported minimal losses. Were these investments truly immune to the pandemic? Not likely. But the stock market rebounded and these funds were able to present the appearance of safety.
The lack of transparency in alternative investments makes them a breeding ground for fraud and Ponzi schemes, even for sophisticated investors. Let’s look at a few:
→ Bernie Madoff, once well-respected on Wall Street and a former Chairman of NASDAQ, bilked investors out of billions of dollars over decades in a $65 billion hedge fund ponzi scheme.
→ Knoedler&Co, a premier New York City art gallery that opened before the Metropolitan Museum of Art was founded (in fact, before California became a state) knowingly sold $80m of forged art to collectors.
→ More recently FTX, a leading cryptocurrency exchange, misused billions of their customers’ deposits.
The fact that all of these people/institutions were considered leaders was little solace to their defrauded investors–and fraud is even more common in smaller groups.
Real-World Performance: Index Funds vs. Alternatives
High fees, liquidity risks, and predisposition to fraud aside, what about performance? Alternative investments are marketed as “exclusive” wealth-building opportunities for high-net-worth investors, with one of the biggest promises being that of high returns.
Here’s the deal, though: Even large institutions with massive resources often underperform when they focus on alternatives compared to low-cost index investing.
For that, let’s take a look at a case study comparing The Teacher Retirement System of Texas (TRS) with The Public Employee’s Retirement System of Nevada (PERS).
Both have well-respected investment teams. In the case of Texas’ TRS, which manages $240 billion, its investing team takes an active approach, including hedge funds, private equity, and other alternative investments.
→ Over the past ten years, Texas’ TRS returned 7.2 percent annually.
Meanwhile, Nevada’s PERS, which manages $58 billion, used only low-cost index funds with no alternative investments.
→ Over the past ten years, Nevada’s PERS returned 9.1 percent annually. (Outperforming even the Harvard endowment fund!)
Over an employee’s 20-year career, that extra 1.9% of annual return is the difference between $1 turning into $4 or $5.39–and one-third higher retirement income.
As for reducing risk, the Texas TRS’s lower returns don’t reflect lower risk, either–the fund’s annual returns over the past decade are slightly more variable than Nevada’s PERS.
We can’t help but wonder: If well-funded institutions with teams of analysts and billions of dollars can’t beat index investing or reduce risk with alternatives, why would individual investors do better?
If Not Alternatives, What Should You Prioritize in Your Portfolio?
At Hendershott Wealth Management, we prioritize investment strategies for our clients that are:
✔ Cost-effective – No unnecessary fees eating away at your returns
✔ Transparent – You always know what you own and how it’s valued
✔ Globally diversified – For risk mitigation and long term, sustainable growth
✔ Evidence-based – With decades of research backing our approach
✔ Tax-efficient – Proactively staying tax aware so we can plan to keep more of your hard-earned money in your accounts
The actual experience of holding alternative investments–given illiquidity, lack of transparency, risk of loss of principal, and potential fraud–is not conducive to the kind of elegance, simplicity, and true peace of mind we eagerly pursue for our clients.
Instead, we focus on strategies that are backed by decades of academic research, regulatory oversight, and a clear, risk-managed approach to wealth building—ensuring your financial future is built on a solid foundation, not on speculative trends.
Final Verdict: Are Alternative Investments Worth It?
Bottom line: We want to live in a world where everyone is thriving–and based on the evidence, the most reliable path to financial security and freedom is a well-built, data-driven investment approach and globally diversified portfolios.
For most investors, alternative investments introduce unnecessary risk, high fees, and liquidity challenges—without providing consistent outperformance. The data suggests that a well-diversified, low-cost portfolio offers a more reliable path to long-term financial security than speculative alternatives.
If you’re still considering alternatives, start by asking yourself the very questions we ask ourselves when evaluating alts:
- Are the fees justifiable?
- Can I afford (or do I want) to lock up my capital for years?
- Is there real transparency in both valuation and risk?
- Would a diversified, low-cost portfolio achieve the same or better returns?
And if you want an objective opinion on your investment strategy, schedule a complimentary consultation with us today.
While we don’t generally endorse alts, our firm does have the knowledge and expertise to evaluate specific alternative investment opportunities should they become available to our clients.
In fact, we recently made Ultra Tax Efficient Wealth ManagementSM, a strategy that falls under the broad umbrella of alternative investments, available to our clients. This was an opportunity we took months to vet and run through rigorous research, finding that the value delivered to clients is both reliable and quantifiable, with tax benefits that may far exceed associated costs. Head right on over here to learn more about Ultra Tax Efficient Wealth ManagementSM.
