What’s Your Pooled Alternative Investment Strategy?

The concept of pooling money to increase investment opportunities and reduce risk is not new. Mutual funds, real estate investment trusts, and master limited partnerships have given Wall Street the power to collect smaller amounts of money from many investors with the goal of increasing returns while reducing volatility. Today, many successful IRA investors are looking to adopt similar strategies to broaden their investment horizons.

The concept of pooling money to increase investment opportunities and reduce risk is not new. Mutual funds, real estate investment trusts, and master limited partnerships have given Wall Street the power to collect smaller amounts of money from many investors with the goal of increasing returns while reducing volatility. Today, many successful IRA investors are looking to adopt similar strategies to broaden their investment horizons.

Historically, investors were driven toward investments like bank CDs, mutual funds, bonds, or stocks. But not only can individuals invest individually or pool investments with others, they can also select from a broader range of assets. These “alternative” investments include any asset not publicly traded on a listed exchange, such as private equities, limited partnerships (LPs), real estate, limited liability companies (LLCs), and mortgages/deeds of trust.

Interest is growing

Even companies like Dell Computer and Berkshire Hathaway were once private investments that went on to become mainstays in the U.S. market. Several investment professionals have forecasted that returns from traditional asset classes, such as stocks, will not be as high over the next decade. Combining lower returns with the estimated $14 trillion dollars rolling into IRAs from baby boomers and greater investor sophistication, alternative assets are one of the fastest growing sectors for investment.

Alternative investments can also provide greater diversification and often produce returns with a low correlation between conventional shares and fixed interest assets. The level of correlation depends on the specific type of alternative investment considered and the make-up of an investor’s existing portfolio. If well-chosen, the addition of alternative assets may increase one’s level of total portfolio return with little or no extra risk. When a Roth IRA is used, money earned on the investment can grow tax-free.

Pooling IRA funds

Looking to duplicate the success of others, many savvy IRA investors are combining these two concepts—pooled money and alternative investments. Many are forming limited partnerships or limited liability companies to take advantage of the growing popularity of alternative investments. Others are simply looking at individual investment opportunities, like commercial real estate projects or pooling funds with a few associates.

Pros and cons

The main benefits of pooled investments include having a greater amount of available funds to invest; enhanced opportunities; exposure to investment expertise from investors and/or experts; and diversifying money across a broader range of investments, potentially reducing the overall impact of lower performing investments.

The downsides may include not having a secondary market for selling such investments, potential difficulty in determining fair market value, having to commit money for a minimum period, and reduced regulatory oversight, because alternative investments are not publicly traded or subject to the same level of scrutiny.

As with any investment, the individual should do his or her own due diligence, including looking at management’s experience (for investments in private stock or commercial construction), past track records, and familiarity with the investment.

When the investor has identified an opportunity, the process of investing with an IRA can be simplified by working with a knowledgeable self-directed IRA custodian. Instead of using his or her name on the investment, the investor will replace that information with the name of his or her IRA. A good self-directed IRA custodian will then maintain all necessary paperwork and provide reporting.

Many options for growth exist beyond the stock market. A pooled alternative investment strategy can produce attractive and substantial portfolio risk reduction benefits to many investors that are heavily weighted in more traditional listed equities and fixed income instruments.

TommyJoe A. Valenzuela ("TJ") is vice president of sales and marketing for Trust Administration Services (www.trustlynk.com), a division of First Regional Bank. He has over fifteen years experience in the financial services industry, implementing marketing strategies that educate and benefit real estate professionals, attorneys and other esteemed advisors. His firm, a division of First Regional Bank, administers more than $1.3 billion in assets, including those invested in real estate, tax liens and private equities.

* The information contained herein is provided for general guidance and is intended to provide only general information. The information provided is not intended to replace or serve as substitute for any accounting, tax or other professional advice, consultation or service.