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HEATHER HEGEDUS: Hello there. Thank you so much for making the time to join us for another episode of Market Sense. I'm Heather Hegedus with Fidelity. Today we are pleased to welcome back to Market Sense Ben Kalkert. He's a Fidelity Vice President who specializes in alternative investments. This is an area that some of our viewers may not be as familiar with as others, but these investments can offer some potential benefits, like diversification in your portfolio.
And today, Ben is going to help us not only understand them, but also lay out some of the many ways that you can get exposure to various public and private markets through alternative investments. Ben, thank you so much for making the time to be on the show today. Great to have you back here on Market Sense. How you doing?
BEN KALKERT: I'm doing very well, Heather. Thanks for having me on.
HEATHER HEGEDUS: Before we get into what role alternative investments might play in someone's portfolio, Ben, I figured we should probably level-set here and start with the basics. Just to make sure everybody here is on the same page, can you define what exactly encompasses the category of alternative investments? And can you talk about how different they are from traditional stocks and bonds?
BEN KALKERT: Yes, I'd be happy to, Heather. So at the most basic level, alternative investments-- and they're also known as alts-- can generally be defined as investments that are distinct from traditional holdings like stocks, bonds, and cash. Now, the term "alternative investments" then covers a pretty broad range of different asset types and investment strategies. So they could be liquid alternatives. There are interval funds or intermittently liquid options. There are private investments. And there are also digital assets.
And each of these asset types have distinct characteristics that could potentially allow them to play unique roles in a portfolio, whether it's to enhance returns or to manage risk, or to just improve overall diversification. I think one really important thing to understand and one important distinction here is that alternatives sit across a pretty wide liquidity spectrum. Some of these alternatives can be bought and sold on a daily basis any day that the market is open, while others may limit access to your capital for a period of months, or even years.
Alternatives are also delivered in a pretty broad range of investment vehicles. So they could be exchange-traded funds or mutual funds, interval funds, other intermittently liquid funds, like non-traded business development companies or non-traded real estate investment trusts, for example. Or they could be in a limited partnership format.
HEATHER HEGEDUS: So there really are a wide range of investments that investors can choose from. Before we explore what each of them might mean for someone's portfolio, Ben, let's take a step back and just talk a little bit about the evolution of alts. What are you watching right now in this space? Why do you feel they are becoming increasingly more popular with investors these days?
BEN KALKERT: That's a great question, Heather. I think if you go back 20 or 30 years, historically, alternative investments and strategies were typically available to institutional investors or very high net worth investors. They were usually offered in private funds, like limited partnerships. And they typically also had pretty high investment minimums. But over the last couple of decades, alternatives have really gained in popularity. And there's a variety of reasons for that.
So first, of course, we had the global financial crisis in the 2000s. And coming out of that, investors were looking for more options to diversify their holdings and their portfolios. Then we had the era post-global financial crisis, where rates dropped to near 0 and remained at or near 0 for an extended period of time. And so investors who were trying to generate income from their portfolios were, again, kind of prompted to explore different allocations away from the traditional markets.
And then here, most recently, in 2022, when inflation got ahead of the Fed and interest rates started to rise, both stocks and bonds fell at the same time, which, of course, we all know is not supposed to happen. But again, that triggered investors to look for other assets that could potentially provide another layer of diversification for their portfolios. Along that time frame, those three distinct time frames, I think we've seen a tremendous amount of innovation in the types of vehicles that are used to deliver some of these alternative investment strategies, which is enabling greater access for more individual investors. Last thing I'll say about the popularity of alternatives is that the private markets are huge. So just for example, the US middle market spans approximately 200,000 privately owned businesses. And if it were its own economy, it would be the third largest economy, behind the US and China. So it's a really large opportunity set. And it may be too large to ignore.
HEATHER HEGEDUS: Wow. Super helpful context there that you just laid out there, Ben. So alternative investments can help diversify a portfolio, because at least in historical terms, they tend to behave differently than traditional stocks and bonds, like you talked about, meaning they are less, or have been less, correlated to the traditional or public markets.
I was hoping we could take a closer look now at some of the alternative investments that you talked about earlier. And it might just make sense to go down the liquidity spectrum here. So maybe we could start with the first one on the list, liquid alternatives. As that name suggests, these are the most liquid of the offerings. So what are the benefits? What are the pros and cons? What can they offer in a portfolio?
BEN KALKERT: Yeah, they typically can help achieve a variety of different portfolio objectives-- for example, enhancing returns or managing downside risk. They usually buy and sell investments that primarily trade in the public markets. But unlike your traditional buy-and-hold type of strategy, liquid alternatives have the flexibility to go both long and short positions. They can also invest in things like derivatives or currencies and other investments like that.
So it gives the manager the ability to take on different risk and return profiles. And as you mentioned, they're the most liquid of the alternative offering. And they're usually available in mutual funds or exchange-traded funds, which means that they have daily liquidity and really low or no investment minimum.
HEATHER HEGEDUS: How about interval funds? I know they tend to fall more in the middle of the liquidity spectrum, when we talk about that spectrum. Can you tell us more about how interval funds work?
BEN KALKERT: Yes, you're absolutely right. So I often think of interval funds as a bridge between your traditional mutual funds and private market investments. Like a mutual fund, investors can purchase shares in these interval funds based on the fund's daily Net Asset Value, or NAV. But unlike a mutual fund, investors generally can't redeem those shares on a daily basis. Instead, those funds offer periodic liquidity, and typically, that's done through a quarterly repurchase window.
And that design is intentional. So that is a feature, not a bug. Because managers don't need to keep as much cash available for those daily redemptions, they can go and invest that cash in opportunities that may be less liquid, such as private credit or private real estate or other private market investments. They could also pursue investment strategies that may take a little bit longer to develop.
For investors, I think that really creates a nice middle ground here where you could potentially gain access to parts of the private markets that have historically been harder to reach, but at the same time, you still have some liquidity along the way. So I'll go back to that liquidity spectrum that I talked about earlier. On one end, you have liquid alternatives with that daily liquidity. On the other end, you have private funds where your money may be committed for many years. And like you said, Heather, interval funds sits somewhere in the middle there.
Similar to other intimately liquid investments, like those non-traded business development companies that I spoke about earlier or non-traded real estate investment trusts, there are also some other advantages here for interval funds, and that is that they can be more accessible than many private funds, meaning they tend to have lower investment minimums. They tend to have fewer eligibility hurdles or requirements. They can also come with a familiar tax reporting, like 1099. I think the key takeaway here is that interval funds can expand access to private market investments, but certainly, investors should understand that with that greater access comes reduced liquidity and the potential for additional or different types of risk.
While we're talking about risk and liquidity, I think it's also important to point out-- we were talking about derivatives earlier-- that derivative investments can have more risk or different risks, including imperfect correlation between the value of such instruments and the underlying asset. They typically can have higher fees. And then, as we're talking about liquidity here, with these funds, there's no guarantee that an investor will be able to sell their shares at any given time or that they will have their entire redemption request fulfilled.
HEATHER HEGEDUS: OK, so just to recap, interval funds offer periodic liquidity, and that is by design. How did you put it? That's not a mistake. That's by design. That's how it's intended to be.
BEN KALKERT: It's a feature, not a bug. Yep.
HEATHER HEGEDUS: A feature, not a bug. I like that. All right. Let's shift gears a little bit, Ben, and take a closer look at private markets. As you mentioned earlier, investors might think of these strategies as things that are only available to institutions or to ultra-high net worth customers. But I know that's changing. So I was hoping you could walk us through each of these private market categories, explain what they are, how they work, and how they differ from one another.
BEN KALKERT: Yes, happy to. Before I dive into the categories of private markets, though, I just want to, again, reiterate and point out that private market investments generally are illiquid. They often require longer holding periods. And they may have a higher risk or different risks than traditional stocks and bonds. They can also have additional eligibility requirements. So this may not be for everybody.
But first on the list to cover would be private equity. And at the most basic level, this involves investing in privately owned companies with the goal of growing the value over time and then eventually selling them for a profit. Now, there are different types of private equity. There are strategies in what's called early stage venture capital. There's late stage venture capital. There's growth equity. There are traditional small and large buyout strategies. There are primary and secondary private equity exposures. So you see, just like alternatives not being just one thing, private equity is not just one thing. And they're not all the same either.
HEATHER HEGEDUS: All right, from private equity to private credit, can you talk about private credit and how that differs from traditional credit?
BEN KALKERT: Yep. So those are investments that seek to provide higher income or higher total return relative to many other traditional investments in the credit space. Typically, a private credit fund may invest in privately negotiated bespoke loans or bonds or other debt instruments that usually are below investment grade, or they're not rated at all. And so these investments can potentially have a higher yield than what you might see in the traditional investments in that space in the public markets. But of course, there's a trade-off there for that higher yield. You'd have to be willing to accept more risk, including the possibility of default and higher price volatility.
HEATHER HEGEDUS: OK, important to keep in mind. Well, the next category is private real assets. And I think it'd be helpful for our audience if you define what real means in the real assets terminology.
BEN KALKERT: Yeah, the simplest way I could put it is something that you could see and you can touch.
HEATHER HEGEDUS: Tangible.
BEN KALKERT: Tangible, that's right. Private real assets can provide exposure to physical assets, tangible resources. And they cover, again, a pretty broad range of different asset types and investment strategies. So when you think real assets, think real estate. Think commodities. Think infrastructure, or natural resources, or renewable energy.
I'll, again, make a note here that private real assets, like the other two categories of private investments, private equity and private credit, they usually can't be sold easily. And they tend to be subject to lock-up periods. And there can also be some leverage risk here as well.
I think the main takeaway from this private markets discussion is that if you include them in your portfolio construction process, you could potentially broaden the investment universe that you can choose from to build your portfolio and possibly provide enhanced return or enhanced income or another layer of diversification. But of course, there are trade-offs for that. There are some considerations.
What are the eligibility hurdles or requirements? What about liquidity or lack thereof? How long is the holding period? How high or what's the fee structure like? What's the tax reporting like? And then, of course, there can be different risks. And all of these things can differ significantly from one investment to the next.
HEATHER HEGEDUS: All right. And I know we should probably note that private real assets cannot be easily sold. And they're also subject to lock-up periods and leverage, which you mentioned, Ben. All right. So the last offering on your list is digital assets. So for investors who may be less familiar with this space, how would you define digital assets? And how might investors think about where they might fit into a portfolio?
BEN KALKERT: Yeah, still a relatively new asset class, but I would say, investing in digital assets, such as cryptocurrency or crypto tokens or crypto funds, can offer you the potential for growth and some diversification. If you were to define it, I would say that digital assets are designed to work as a digital representation of value that is stored on a decentralized ledger that's also known as a blockchain. And investors can buy and sell cryptocurrencies directly, or they can gain exposure to the price of those cryptocurrencies through exchange-traded products. Of course, it's really important to understand here that digital assets can be very volatile. And crypto, as an asset class overall, has proven to be volatile and can also become illiquid at any time.
HEATHER HEGEDUS: And also, I should probably mention right now we have a whole regular series show called Covering Crypto Livestream dedicated to the crypto space. So that's a wonderful, terrific educational resource you might want to check out on our YouTube page or Fidelity.com. And that show is hosted by the former host of Market Sense, Jim Armstrong.
All right, now that we have a better understanding of what alternative investments are and how they work, I wanted to get into a question that probably a lot of people out there are thinking to themselves as they're listening to you talk today, Ben. And that is, should alternative investments have a place in my portfolio? So what factors, what considerations should investors be thinking about before deciding whether this might be a good fit for them personally?
BEN KALKERT: Yeah, I think, just like with any investment, you probably start with asking yourself, what are my goals? What is my comfort level with risk? But then, with these types of investments, you also have to ask yourself, what's my cash and liquidity need? And the answer to those types of questions can really help inform what type of alternative investment strategy might make sense for you and your financial plan.
Unfortunately, there's no one size fits all here. So it really will depend on the individual situation and the financial plan that's in place. I think when you consider an alternative investment strategy, maybe the best place to start is not a particular fund or strategy, or look at performance, or even look at an asset class. I think maybe the best place to start is a pretty simple question, which is, what am I trying to accomplish? And the follow-up question to that is, what exposures do I already have in my portfolio that can help me accomplish that?
The next question to ask is, what exposures am I missing? And alternatives, as we've discussed already, they can offer a variety of potential benefits, whether it's growth or income, diversification, downside risk management, or mitigation, inflation mitigation. So it really kind of depends. But I'll just name a couple of examples here.
So again, assuming you're an investor who's comfortable with the potential additional risk of some of these investment strategies, but let's say you're concerned about rising rates and what impact that might have on the fixed income portion of your portfolio, you may look into an allocation to private credit. Or if you're worried about inflation, you might want to consider a real asset strategy, like real estate or infrastructure, to help round out your portfolio.
And another option for investors that are looking to diversify their portfolio could be managed futures. Those tend to be systematic, trend-following strategies that could provide downside protection in tough markets. So again, as you can see, alternatives can have a variety of potential benefits for different investor needs. And I think they can be a really powerful tool. But that's exactly what they are. They're a tool. They're not magic.
HEATHER HEGEDUS: I just love that exercise that you mentioned, Ben, that way to check yourself as an investor. What are my goals? What am I trying to accomplish? What do I already have? Take stock of what I have and what am I missing. And I think that's so applicable to a lot of the topics that we talk about weekly here on Market Sense. So thank you for that. I'm going to write that one down. It's a good one.
So along those lines, we covered a lot of ground today. But I'd love to hear your takeaways. That was one of my takeaways from today's show. But we had a lot of information that we just threw at our audience here. So if viewers remember just one thing from today's conversation, what would you want that to be?
BEN KALKERT: I would say diversification and risk management, especially in today's environment. I think if you use alternatives in a thoughtful way, whether it's liquid alternatives, intermittently liquid alternatives, or illiquid alternatives, it can help you build the portfolio, achieve many objectives, and maybe improve the portfolio. But I think if you use them casually, you can potentially add unintended complexity or unintended illiquidity. And that's why doing your research or consulting with a financial professional, I think, could make a lot of sense here. And of course, we're here to help.
HEATHER HEGEDUS: We sure are. And, Ben, we've got to leave it at that. But I just want to thank you for this terrific, timely, and really wide-ranging discussion today. You really covered a lot of ground today. We'd love to have you back on again. And by the way, we'd like to be a 20-minute show because we know people's time is valuable. Time is money. And you hit the nose on-- 20 minutes on the nose there. So great job with your talking points today, Ben.
And Ben just mentioned how important it is to do your own research. We talked a lot about a variety of alternative offerings available to investors today. So if you are looking to drill down a little bit for yourself on this topic, we have a fantastic platform to suggest for you to check out, where you'll find educational articles and tools, all in one place, along with some of Fidelity's alternative investment offerings. And that website is Fidelity.com/Alt ernativeInvestments. Again, Fidelity.com/Alt ernativeInvestments.
On behalf of Ben Kalkert, I'm Heather Hegedus. Remember, Market Sense is a live show. We're on every Tuesday at 2 o'clock Eastern, with a replay available shortly after on YouTube, Fidelity.com/MarketSense, and wherever you get your podcasts. Take care, everybody.