Fitting Alts into Client Portfolios

Given the outsize performance of the U.S. stock market over the past few years, it may be tempting to cut back or omit alternative investments in portfolios.

But Tom Karsten, CFP and president of Karsten Advisors, makes sure his clients have between 5% and 7% of qualified clients’ assets in venture capital (VC) and private-equity (PE) investments.

The goals of specific alternative investments vary.

A growth-oriented VC fund managed by Raleigh, N.C.-based Hatteras Funds, for instance, has positions in roughly 20 tech companies and returns no income to investors.

In contrast, a PE investment with New York-based GPB Holdings focuses on car dealerships and has an 8% current distribution rate.

Karsten admits that the level of due diligence required to evaluate PE and VC offerings can be daunting. He addresses that by attending conferences about the industries he’s considering and by conducting in-depth research on prospective investments.

“We look at reports and due diligence reports from the law firms,” he said in an interview with ThinkAdvisor.

“As kind of a final step for me, I physically visit the fund sponsor myself,” the Fort Worth-based advisor explained “So we will not go into those funds unless we have gone to their offices personally to go through the process ourselves. It’s more time consuming, of course, but it gives me the comfort level to be able to then place clients into it.”

The due diligence has paid off so far, he adds: The income-alternatives are producing higher income than that available from bond portfolios or income-oriented equity portfolios.

For growth investments, Karsten aims for total returns in the high teens" and the funds are producing those results. “That’s what we would be targeting and on an average basis with the fun; that’s where we have seen those returns,” he says.

“Some of them are better than others over the years, but that’s where we typically feel we need to be to justify what is in many cases a little bit higher risk profile,” the advisor stressed.

In 2013, the Bloomberg Hedge Funds Aggregate Index returned an average of 7.4% in 2013. As for private equity, distressed-asset funds were up 18% in 2013, and buyout funds generated a 16% return, according to Bain & Company.