Alt Investments
Alternatives Face Mounting Scrutiny, Skepticism

In the first of two articles looking at the growing use by HNW, affluent and even retail investors of what are loosely dubbed alternative assets, we note a level of skepticism that is becoming more evident about this trend.
There’s a strange convergence going on in the alternatives
market.
Investor interest in hedge funds, venture capital, private
equity, private credit, real estate and other non-publicly traded
vehicles has never been higher, and Wall Street’s major domo
asset managers are rapidly rolling out – and aggressively
promoting – alternative products. (Even hedge funds are getting
into the act,
as this article shows.)
Private market assets in the US totaled $14.8 trillion in 2024,
according to McKinsey & Co, and have grown at close to 20 per
cent a year since 2018. In just 30 months, the total market for
semi-liquid funds has surged 60 per cent to about $350 billion,
while net assets in private credit leaped an astonishing 151 per
cent to over $188 billion in two years, according to a new
Morningstar report. A full quarter of retail investors now have
private equity investments, a number that rises to 35 per cent
for investors with over $500,000 in investible assets.
Giant firms like Apollo Global
Management, BlackRock, Blackstone, Capital Group,
KKR, State Street and
Vanguard are all
furiously clamoring to get on the alternative bandwagon. Morgan Stanley is
pushing alternatives big time, as CEO Ted Pick argues that
financial advisors remain “underweight” in alternative
allocation. Even conservative Fidelity
Investments is adding alts to its custom model
portfolios.
At the same time, returns from private market funds have never
been lower and scrutiny and skepticism surrounding the asset
class is mounting.
Returns, risks and costs questioned
State Street’s private equity index, which tracks returns from
private equity, private debt and venture capital funds, recorded
a 7.08 per cent return last year, compared with a 25 per cent
total return for the S&P 500 index, which also outperformed
private funds on a three, five and 10-year basis.
Moody’s Ratings has just released a report warning about the
risks that come with selling private equity and private debt
funds to individual investors. A new study published in the
Journal of Portfolio Management entitled “The
Demise of Alternative Investments” argues that alts “cost way too
much for what you get.”
Morningstar steps up
Not coincidentally, Morningstar is stepping up
its coverage of the sector. In a keynote address yesterday at the
data analytics company’s annual Investment Conference in Chicago,
chief executive officer Kunal Kapoor called the convergence of
public and private markets “a snowball coming down the hill.”
Noting that private markets “come with higher fees, less
transparency, less liquidity and more complexity,” Kapoor said
Morningstar would expand its analysis of the market to help
investors determine whether they are “going to give up liquidity
and pay more; is expected outperformance worth it?"
Morningstar also unveiled a new report on semi-liquid funds that
give retail investors access to private markets, including
interval funds and nontraded real estate investment trusts
(REITs). While private funds have risen in prominence,
“definitions, data and transparency have lagged behind the
headlines,” maintained Morningstar analyst Jason Kephart.
“[Private funds] promise greater access and returns, but also
bring steep fees, heavy use of leverage and liquidity limits that
investors must carefully evaluate.”
Those concerns were echoed by Dan Wiener, the former CEO and
current board member of RWA Wealth
Partners. “Promotions for alternatives promise so much more
than what the reality is, it’s not even funny,” Wiener said.
“They’re designed to attract investors to products they have no
business investing in.”
High fees
Fees for private market funds can be up to three times higher
than those for public markets, according to Morningstar. The
average annual expense ratio for semi-liquid funds is 3.16 per
cent, according to Morningstar, while the comparable figure for
active mutual and exchange-traded funds is 0.79 per cent.
In addition, commissions for selling alternative funds, often 2
to 5 per cent, can sometimes exceed 10 per cent.
Private funds tout their so-called “illiquidity premium,” but a
recent report by asset manager Amundi and Create Research cited
high fees and commissions, as well as an opaque investment
process and record high levels of “dry powder,” sums allocated
but not yet invested. As a result, the report warned, huge
inflows into alternatives could dilute returns.
Retail concern
Wiener, who edited The Independent Adviser for Vanguard
Investors for over 30 years, is particularly concerned about
the impact alternatives will have on investors with less than $5
million, excluding their house. In addition to liquidity lockups
and high expenses, Wiener worries that smaller investors may not
have access to the industry’s top quartile managers.
What’s more, retail investors are being targeted by what Wiener
calls “the alternatives tidal wave headed towards the shores of
the retirement universe. Individual retirement accounts are the
pot of gold Wall Street is looking at. They want to get into
401(k)s, sit back and mint money. For investors it will be like
the Roach Motel – once you’re in you can’t get out.”
Target date funds targeted?
Private funds have their sights set on target date funds (TDFs),
according to certified financial analyst Tim McGlinn, founder of
“The Alternative View” website. TDFs are “the most
coveted spot in the 401(k) world,” McGlinn said, because of their
huge size (over $3.5 trillion) and fast growth, having quadrupled
in size in 10 years.
Fees are relatively low however, but if 10 per cent of stocks in
TDF portfolios were replaced by alternatives, expense ratios
would nearly double, according to research cited by McGlinn. “The
most pernicious risk might be individuals with model portfolios
that include alternative investments whose performance isn’t even
noticed,” he cautioned. “The compounding effect could lead to
them being far worse off.”
To be sure, private fund managers can point to a premium that
still exists for having investments tied up for long periods of
time and a lower correlation to public market volatility. And
some sector-focused private funds, such as those focused on
finance and energy, have been able to outperform public market
sector peers, according to State Street.
Push from Wall Street and Washington
And make no mistake, Wall Street’s push is just beginning.
BlackRock CEO Larry Fink has said that 20 per cent of portfolios
may be allocated to private assets in the future. Currently,
alternative investments such as private credit or private equity
are only weighted at 5 per cent in mainstream allocation models,
according to Morgan Stanleys’ Pick.
The “right level” may be between 10 per cent and 15 per cent or
more allocated to alternatives, the CEO told a company conference
earlier this month. “That means that today we are structurally
underweight in the system of $250 billion to $500 billion in
alts.”
The Trump administration and Republicans in Congress are expected
to accelerate the private markets momentum.
The US House of Representatives passed a bill this week that
directs the Securities and Exchange Commission to expand the
eligibility requirements for participating directly in private
investments.
Currently “accredited investors” must have $1 million in net
worth, excluding their primary residence or an annual income of
$200,000, and $300,000 in income for joint spousal investors. To
broaden access to private markets, the new legislation would
expand the definition of an accredited investor under what is
known as Regulation D to include people with professional-level
knowledge through either their work experience or
education, which would explicitly include registered brokers and
investment advisors.
A multibillion-dollar tax break for private credit funds is also
being proposed, which would limit taxes on dividends paid to
investors in so-called business development companies, one of the
primary investment vehicles utilized by the private credit
industry.
Wiener has no doubt that lawmakers will loosen regulations. “It’s
set in stone,” he said.
Part two of our alternative coverage will examine how family
offices and UHNW investors are approaching the controversial
asset class. Please email the editor if you have comments and
responses. tom.burroughes@wealthbriefing.com