EDUC AT I ON AL
A R T I C LE
EDUC AT I ON AL
A R T I C LE
Beyond Stocksand
and
Bonds
Diversification
Liquidity
The Potential of Non-Traded Alternative Investments
Liquidity is generally understood as the ability to convert an asset into cash in a short amount of time.
Having alternative, less liquid investments in addition to traditional, publicly traded stocks and bonds
may increase portfolio diversification. Large institutional investors such as university endowments,
pension funds and high-net-worth individuals have long benefited from this diversification strategy.
For an individual investor who may need quick access to
cash from his or her investments, especially those earmarked
for a specific, near-term purpose, a higher degree of liquidity
makes sense. However, not all investors require that 100 percent of their investments qualify as highly liquid.
Reasons for adding less liquid investments to a portfolio
include the potential for the following:
Cash can be viewed as perfectly liquid. Examples of
perfectly illiquid investments, or those with a value that
cannot be converted to cash at all, are extremely rare. For this reason, illiquid alternative investments are used to represent the right side of the liquidity spectrum.
• Diversification into alternative assets with lower
correlation to stocks and bonds.
There are several reasons why some investments are less
liquid than others. There may be fewer sellers and a
smaller pool of ready-and-willing buyers. Additionally, less
information may be available, making evaluation of the
investment more complex and time consuming.
• Longer term approach across market cycles.
• An investment strategy using institutional-type asset classes.
LIQUIDIT Y SPEC TRUM
An investment can be placed on a spectrum according to its
level of liquidity, with cash at one end and less liquid and illiquid alternative investments at the opposite end.
DRIVERS OF DECREASED LIQUIDITY
For example, whether making a multimillion dollar loan to a
private company, purchasing a private company outright or
buying a large piece of commercial real estate, few individuals
have the time and resources to conduct such transactions.
And, since no two companies or buildings are identical,
investment valuations require in-depth knowledge and analysis.
LIQUIDIT Y SPEC TRUM
Cash
More Liquid
Publicly Traded
Investments
Alternative
Investments
Less Liquid
To help overcome these challenges, while gaining access
to alternative illiquid and less liquid investments, individual
investors may choose to invest in professionally managed
funds that do not trade on a public stock exchange. Several
examples include certain direct participation programs (DPPs),
such as non-traded business development companies (BDCs)
and non-traded real estate investment trusts (REITs). Non-traded funds often seek to:
PERFORMANCE OF EQUITY AND
FIXED-INCOME INVESTMENTS1
Timeframe
Average Equity
Investment Portfolio
Vs. S&P 500
Average Fixed-Income
Investment Portfolio
Vs. Bond Index
• Align the fund structure with the less liquid assets in which they invest.
20 Year
- 4.66%
- 5.4%
• Help reduce correlation to traded markets.
10 Year
- 2.41%
- 4.02%
5 Year
- 5.26%
- 3.24%
3 Year
- 5.59%
- 1.94%
1 Year
- 8.19%
- 4.81%
• Allow managers to focus on a longer term strategy.
LIQUIDIT Y AND MARKET DISCIPLINE
Less liquid investments can help drive a more disciplined
response to market fluctuations by encouraging a longterm perspective, while the average investor of more
liquid assets tends to underperform their benchmarks by
attempting to time the market. Many individuals buy stocks
when the market is performing well and sell when there
is a drop in value, effectively buying when prices are high
and selling at a loss.
According to the 2015 Quantitative Analysis of Investor
Behavior study conducted by Dalbar, Inc.:1
• The average equity investor underperformed the market by 5.1 percent for the past 20 years on an annualized basis.
• Despite guessing correctly in eight of the 12 months of
2014, investors were not successful at timing their cash
flows to optimize the market’s performance. The Dalbar
study reports that the average equity investor still trailed
the equity market by 8.2 percent.
Less liquid investments may have higher transaction costs or holding requirements that encourage investors to take a more disciplined approach to enduring
marketplace fluctuations.
If individual investors access less liquid investments through
a non-traded fund, they should also consider:
• The potential inability to redeem shares.
• Early redemption is often at a discount to the current
share price.
As of Dec. 31, 2014.
The bond index is the Barclays Aggregate Bond index. Past performance
is not a guarantee of future results. The index figures do not deduct
the load, fees and expenses of investing. Conversely, average investor
returns do deduct the load, fees and expenses of investing. Differences
might make returns appear to be less than they would be had both
numbers been calculated similarly. This data is for illustrative purposes
only and not indicative of any investment. An investment cannot be
made directly in an index.
INSTITUTIONAL ASSET ALLOC ATIONS
While institutions and high-net-worth individuals have
different investment goals, longer investment horizons,
and often invest on different terms and conditions
than individual investors, they have sought alternative
investments, because they offer an opportunity to
diversify into assets that often have lower correlation
to stocks and bonds. For example, the endowments at
Harvard and Yale allocate a significant percentage of their
portfolios to illiquid and less liquid investments. While less
liquid investments are only one contributing factor in each
endowment’s overall strategy, both have enviable track
records, outperforming traditional portfolios consisting of
stocks and bonds.
The index figures used by Dalbar do not take into account the sales load or fees and other expenses associated with investing, while the average investor
returns do reflect these investment costs.
1
“21st Annual Quantitative Analysis of Investor Behavior,” Dalbar Inc., 2015.
YALE ENDOWMENT
ASSET ALLOCATION2
HARVARD ENDOWMENT
ASSET ALLOCATION3
AVERAGE ANNUAL RETURNS
OVER 10-YEAR PERIOD 4
Yale Endowment
43%
24%
76%
11%
Harvard Endowment
8.9%
57%
Traditional 60/40
Stock/Bond Portfolio
Liquid 24%
Liquid 43%
Illiquid 76%
Illiquid 57%
5.9%
COMPARISON OF
TRADITIONAL 60/40
PORTFOLIO TO
HARVARD AND YALE
ENDOWMENTS
Charts are for illustrative purposes only and are not to be relied upon as investment advice. Alternative investments are not suitable
for all investors. Endowments do not invest in retail alternative investments.
Endowments, like those of Harvard and Yale, invest a smaller percentage of their assets in U.S. stocks and bonds and rely on
alternative assets to generate higher returns than those of traditional 60/40 portfolios.
RISK CONSIDER ATIONS
IN BRIEF
Expanding a portfolio to include illiquid and less liquid
investments is not without risk. Unlike institutions and
high-net-worth investors, individuals may need a higher
degree of liquidity, and less liquid investments may limit
access to needed cash. Less liquid investments may be
more complex in nature and more difficult to evaluate
than highly liquid investments. Like all investments, their
value may fluctuate both up and down. For these reasons,
illiquid and less liquid investment funds typically have
minimum net-worth and income suitability standards for
prospective investors. However, when investing in such
funds, redemptions, if available, may be costly.
Liquidity refers to the ability to quickly convert an asset into
cash. The addition of illiquid and less liquid investments
creates the ability to help diversify a portfolio into assets
with lower correlation to traded markets. Less liquid
investments were historically limited to institutional and
high-net-worth investors. In recent years, many individual
investors have used less illiquid and liquid investment funds
to help achieve a similar diversification strategy. However,
the fact that an investment is less liquid does not imply it is
safer or appropriate for all investors. All investments carry
risks and are best discussed with a financial advisor to determine suitability.
“The Yale Endowment 2014 Performance,” 2014 Target Asset Allocations, June 2014.
“Harvard Management Company Endowment Report Message From the CEO,” 2014 Policy Portfolio, September 2014.
4
Stock and Bond Portfolio includes S&P 500 and CITI U.S. BIG, December 2014.
2
3
This information does not constitute a solicitation of an offer to sell/buy any specific security offering. Such an offering is made by the applicable
prospectus only. A prospectus should be read carefully by an investor before investing. Investors are advised to consider investment objectives,
risks, charges and expenses carefully before investing. There is no assurance that the stated objectives will be achieved. Broker-dealers and other
firms are reminded that offering-specific communications sent to any person must be accompanied or preceded by a prospectus in accordance
with federal securities laws.
The information in this article is provided only as a summary of complicated topics and does not constitute legal, tax, investment or other professional
advice on any subject matter. Further, the information is not all-inclusive and should not be relied upon as such. You should not use this article
as a substitute for your own judgment and you should consult professional advisors before making any investment decisions.
To learn more, investors should contact their financial advisor. Financial advisors
are encouraged to visit CNLSecurities.com or contact CNL Securities, managing
dealer, member FINRA/SIPC, at 866-650-0650.
©2015 CNL Intellectual Properties, Inc. All Rights Reserved.
CNL® and the Squares Within Squares design trademarks are used
under license from CNL Intellectual Properties, Inc.
CSC-DAL-11-01-15
CSC-1115-15657-INV
CNL Securities
CNL Center at City Commons
450 S. Orange Ave.
Orlando, FL 32801-3336