In Kiplinger’s, Peter J. Klein, CFA and the founder of ALINE Wealth, discusses some downsides of investing in alternatives. Alternative investments include private equity, private credit, real estate, collectibles, etc., and it’s seen a surge of interest especially following its outperformance in 2022 while stocks and bonds saw double-digit losses. Additionally, accessibility has also increased due to regulatory changes and technology.

Over the next 5 years, the global market for alternatives is expected to nearly double from $9.3 trillion to $18.3 trillion. While many are focused on the potential for outperformance and diversification benefits, Klein points out some downsides that investors should consider.

Alternatives come with substantially less liquidity than investments in stocks and bonds which are liquid and transparent. In contrast, alternatives often require money to be locked up for long periods of time with a hefty fee to access it early. Many alternatives also come with ‘gates’ which mean that money can’t be withdrawn once redemptions reach a certain threshold. 

Another consideration is that alternatives often require more complicated tax reporting. For many investors with smaller sums, this complication offsets any benefit in terms of additional returns. Further, there is no track record of alternatives outperforming over longer time frames especially when accounting for the additional fees. Short-term results may be skewed as the asset class outperforms due to the asset class becoming more accessible. 

Finsum: Alternative investments have been gaining in popularity especially after strong performance in 2022. However, there are some drawbacks that should be considered.