Alternative investments, which comprise a wide variety of asset classes outside traditional public debt and equity markets, are amid a transition from an exclusive arena for the largest institutional investors, to a widely accessible field with diverse solutions for investors of all types - including small- to medium-sized endowments or foundations.

As most of the post-Global Financial Crisis market environment was characterized by persistently low interest rates, many institutional investors turned their focus to differentiated sources of return and income. The unique benefits many alternative asset classes provide – low correlations to traditional markets, inflation protection, outsized returns and/or steady streams of income – began to appeal to not only large institutions, but smaller organizations and investors as well.

With access to many of these asset classes – especially those within private investment markets – becoming increasingly widespread, it behooves any investor to consider the potential benefits of diversifying their portfolio with alternatives.

Why Alternatives are Finding a Place in Non-Profit Portfolios

For endowments, foundations, and other charitable organizations, the potential benefits of an allocation to alternatives are numerous.

1. Long-Term Horizon

Due to their long-term investment horizon, that often reaches into perpetuity, non-profit organizations are uniquely well-suited for many types of alternative assets. A notable, and potential, benefit of alternatives is the potential premiums for investors that are willing and able to take a very long-term view and withstand volatility, illiquidity, or a combination of the two.

2. Enhanced Diversification

Many alternative asset classes are highly uncorrelated with traditional markets and thus offer meaningful diversification potential. Strategies, like hedge funds, are often explicitly designed to produce negatively correlated returns. In contrast, other asset classes, like private credit, are designed to generate reliable income returns with little to no capital volatility.

3. Inflation Protection

A variety of alternative asset classes, by the nature of their objectives and what they actually invest in, offer built-in inflation hedges, whether in the form of physical assets like commodities, real estate, or infrastructure, or in the specific investment strategy that is implemented. This can be especially attractive for non-profits that have to meet certain financial obligations on a yearly basis but also want to maintain purchasing power over the long-term.

4. Greater and/or More Reliable Returns

Alternatives span a very wide range of investment solutions, from those that seek outsized returns through greater risk exposure to those that focus on stability and the generation of reliable income streams. Depending on the goals of an organization or its specific asset pools, different alternative assets are likely to be more suitable and to be a meaningfully additive component of an overall investment strategy.

Is an Allocation Right for Your Organization?

When approaching the idea of alternatives, a strong board will ask not only “How much can we make?” from a certain decision or allocation but also “What risks are we taking and are they appropriate for us?”.

Investing in alternatives is not without certain risks that come as trade-offs for the unique benefits they can provide, and it’s crucial for any non-profit evaluating the inclusion of alternatives to carefully consider these trade-offs.

After weighing the benefits and risks of an allocation to alternatives, your organization can turn its attention to which exposure(s) make sense for your unique goals and situations. There are three key considerations that can help you evaluate what asset classes make sense, how you can best access the market, and how to think about different allocations over time.

1. The Organization’s Objectives

First and foremost, your objectives need to be clearly defined, as the objectives of a pool of assets will drive what sort of exposure is most suitable. For example, assets that are earmarked to maximize return over the long-term may be best allocated to private equity, while assets that are needed to fund a consistent ongoing withdrawal need may be best suited for a private credit strategy that generates reliable income.

2. Liquidity Needs

Liquidity also needs to be thoughtfully considered as part of this exercise. Funds that can withstand more illiquidity (i.e., are not needed in the near-term to fund commitments) can be most easily allocated to asset classes that derive a greater premium from illiquidity. While institutions have some degree of flexibility to allocate a portion of their assets to less liquid investments, the magnitude of this allocation as a proportion of total assets that is prudent can vary meaningfully from organization to organization.

3. The Manager

Another key consideration when exploring alternatives is the actual strategy and manager that is being hired to steward those assets. Just like in traditional asset classes, there are many ways to evaluate managers, and consistency of process often matters more than hinging decision-making on any one specific metric. One thing that is broadly crucial across asset classes is a manager’s reliability to execute a repeatable process and produce what is expected from the investor.

While it may not be feasible for investment committees to all have in-house expertise in alternative investments, it’s important to ensure the organization is working with a trusted advisor that does have such expertise, and can help guide the committee and/or board through the process of making decisions around alternatives.

The Right Allocation is One That’s Right for Your Goals

An ongoing part of this process is embracing and/or maintaining a long-term, objectives-oriented mindset. Different asset classes within the alternatives universe are designed to achieve different things, many of which are long-term in nature. Patience and consistency are essential, as is the case in any approach to investing, to fully capture benefits and remain committed to the goals of the organization.

The information in this paper is not intended as legal or tax advice. Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation.