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Alternative Assets: The Ins and Outs of Liquidity

  |  By Karen Walls

While PENSCO’s clients may not necessarily have direct exposure to the Greek debt crisis, the situation highlights a concern that alternative asset investors should consider: liquidity.

As the crisis unfolded, Greece shut down its banking system to keep it from collapsing and told lenders to stay closed as it tried to prevent money from leaving the country. By now we’ve all seen pictures of long lines that formed outside Greek banks and ATMs as customers attempted to make withdrawals from their accounts.

The situation in Greece is extreme and seeing a country resort to capital controls to prevent bank runs is also rare. But it does serve as a reminder for investors to understand how liquid their investments might be.

This idea was emphasized in a recent Wall Street Journal article that discussed the growing popularity of alternative assets, like hedge funds and private equity.

While dollars invested in global alternatives rose about 11% to nearly $7 trillion last year, according to Preqin, the Journal said it’s important to understand that these investments do not necessarily have a straightforward exit strategy (like selling the shares on a stock exchange) and can require long holding periods. The average time period that private equity firms hold a buyout investment is 5.5 years, according to Preqin.

Longer holding periods are a subject we’ve discussed frequently on the PENSCO blog, and it’s one reason it might make sense to hold alternatives in your self-directed IRA instead of parts of your portfolio where you might need more immediate access to your investments.

In general, retirement savings tend to have longer time horizons, which match the longer holding periods required of many alternative investments. In addition, investors can face penalties if they take withdrawals from a traditional IRA prior to turning 59½, meaning many investors favor holding longer-term investments in retirement portfolios.

Why having less liquidity can work in your favor

The Journal also explains why less liquidity can, at times, work in an investor’s favor.

First, the article says that putting money behind an alternative strategy can force people to take a long-term perspective for a portion of their assets. For instance, many who wanted out of private strategies during the 2008-09 financial crisis but were locked in ultimately fared better because they couldn’t sell then.

A lack of liquidity also means that alternatives can provide diversification away from the day-to-day gyrations of exchange-traded assets like stocks and bonds.

Investing is a highly personal decision and self-directed IRAs allow you to get as personal as possible when it comes to directing your retirement savings. For those with longer time horizons, alternatives can be a means for diversifying your portfolios and broadening your investment strategy beyond exchange-traded assets. But be sure you are comfortable with the risks involved and keep extra cash on hand in your retirement account to cover any service charges or investment-related expenses that must be paid with IRA funds.

PENSCO’s Blog is purely for educational purposes.  PENSCO does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Individuals are encouraged to seek professional advice before making any investment decision. Investments are not FDIC insured and are subject to risk, including the loss of principal.