Introduction

Nonprofits face the ongoing challenge of balancing long-term financial sustainability with short-term funding needs. To achieve this, many institutional investors—including nonprofit endowments and foundations—have turned to alternative investments as a way to strengthen their portfolios. By incorporating alternatives, nonprofits can potentially enhance returns, reduce risk through diversification, and access investment opportunities that are not available in public markets.

While alternative investments can provide significant benefits, they also introduce complexities, including higher fees, illiquidity, and the need for specialized expertise.

Additionally, before making the leap into alternatives, nonprofits should assess their readiness. Download our "Alternative Investments Readiness Checklist for Nonprofits" to evaluate whether your organization has the necessary governance, operational capacity, and risk tolerance to include alternatives in its investment strategy.

What Are Alternative Investments?

Alternative investments are financial assets that fall outside traditional categories such as stocks, bonds, and cash. These investments often involve private markets, complex structures, and specialized investment strategies. Unlike publicly traded securities, alternative investments tend to have lower liquidity, longer investment horizons, and higher management fees. However, they offer potential advantages such as portfolio diversification, enhanced returns, and access to unique market opportunities.

Common types of alternative investments include:

• Private Equity: Investments in privately held companies, often through buyouts, venture capital, or growth capital.
• Hedge Funds: Pooled investment funds that employ diverse strategies, such as long-short equity, arbitrage, or global macro investing, to generate returns.
• Real Estate: Direct property investments or real estate investment trusts (REITs) that provide income and potential appreciation.
• Infrastructure: Investments in essential assets such as transportation, utilities, and energy projects that may generate income and stable long-term returns.
• Commodities: Investments in physical goods such as oil, gold, or agricultural products, which can act as an inflation hedge.
• Private Credit: Non-bank lending opportunities, such as direct lending or distressed debt, that provide fixed income returns.

These investments are often used by institutional investors, including nonprofits, to diversify portfolios and capitalize on inefficiencies in less liquid markets.

Why Nonprofits Include Alternative Investments in Their Portfolios

Institutional investors, including nonprofits include alternative investments in their portfolios for multiple strategic reasons:

1. Diversification

Alternative investments, such as private equity, hedge funds, real estate, and infrastructure, typically have low correlations with traditional asset classes (stocks and bonds). Including alternatives can help reduce overall portfolio risk by diversifying the sources of return.

2. Enhanced Returns

Many alternative investments offer the potential for higher returns compared to traditional asset classes, albeit often with higher risk or illiquidity. They may tap into unique opportunities, such as early-stage companies (venture capital), distressed assets, or direct lending which are not typically accessible through public markets.

3. Inflation Hedging

Certain alternative investments, such as real estate, infrastructure, and commodities, may serve as hedges against inflation since their value often rises in inflationary environments.

4. Access to Private Markets

Alternatives provide exposure to private market opportunities, which can be less efficient and offer higher returns for skilled managers. Private equity, for instance, allows investors to invest in companies before they go public, capturing potentially significant value creation.

5. Income Generation

Some alternatives, like real estate and infrastructure, may offer stable and predictable income streams, which can be attractive in low-interest-rate environments.

6. Liquidity Premium

Illiquid investments often come with a "liquidity premium," meaning investors are compensated with higher returns for locking up their capital for longer periods.

7. Market Inefficiencies

Alternatives operate in less transparent or less efficient markets compared to public equities or bonds, allowing skilled investors to exploit mispricings.

Challenges to Consider

While alternatives provide these benefits, institutional investors must manage challenges like higher fees, illiquidity, complex structures, and operational due diligence. Proper evaluation and alignment with long-term objectives are crucial for successful integration.

Alternatives Readiness Worksheet

Additionally, ensure your organization is prepared by downloading our “Alternative Investments Readiness Worksheet.” Fill out the form to download.