Alternative Investments for Nonprofits: Are Alternatives Right for Smaller Portfolios? (with Readiness Worksheet)

Deciding whether to include alternative investments in a smaller institutional portfolio depends on factors like investment goals, risk tolerance, liquidity needs, and access to opportunities. Find out if alternatives are right for your organization and download a Readiness Worksheet in this short guide.

The decision for a smaller institutional investor—such as an organization with $10 million in assets—to include alternative investments in its portfolio depends on several factors, including investment goals, risk tolerance, liquidity needs, and access to suitable opportunities. Below are key considerations:

1. Benefits of Including Alternatives

Diversification

Alternatives can help a smaller portfolio reduce overall volatility and increase diversification, especially if the portfolio is heavily allocated to equities and fixed income.

Enhanced Returns

Alternatives like private equity, private credit, or real estate might offer opportunities for higher long-term returns compared to traditional investments.

Inflation Protection

Real assets (e.g., real estate, commodities) and floating-rate loans may hedge against inflation, protecting the portfolio’s real purchasing power.

2. Challenges for Smaller Investors

Minimum Investment Sizes

Many alternative investments have high minimums (often $1 million or more), making it difficult to achieve adequate diversification within a $10 million portfolio. Additionally, some funds require investors to meet Accredited Investor or Qualified Purchaser thresholds, further limiting access for smaller institutions.

Liquidity Constraints

Alternatives often come with lock-up periods, sometimes up to 12 years, which might not align with a smaller investor’s liquidity needs and add complexity to cash flow planning.

Fees

Alternatives typically involve higher management and performance fees, which could have a disproportionate impact on smaller portfolios.

Operational Complexity

Smaller investors may lack the resources to manage periodic capital calls, which require setting aside liquidity over multiple years, and to handle ongoing monitoring required for alternatives.

Access to Quality Managers

High-performing alternative managers may prioritize larger institutional investors, limiting access to top-tier funds for smaller investors.

3. Increasing Availability of Alternatives via Perpetual or Evergreen Investment Vehicles

Recent innovations in alternative investment structures have made alternatives more accessible to smaller nonprofits. Perpetual or evergreen investment vehicles, such as interval funds and open-ended private market funds, provide exposure to private markets without traditional long lock-up periods. These structures offer:

• Lower Minimums – Allowing smaller investors to participate without needing to commit millions upfront.
• Greater Liquidity – Periodic redemption features help investors maintain some level of liquidity while benefiting from private market exposure.
• Diversified Access – Reducing concentration risk by pooling investments across a broad range of alternative assets.

4. Situations Where Alternatives Might Make Sense

Alternatives can be a strategic fit for smaller institutional investors in certain situations, offering benefits like diversification, inflation protection, and access to unique opportunities.

Endowment or Foundation with Long Time Horizon

A smaller institutional investor with a long-term horizon and modest liquidity needs might benefit from including alternatives.

Access to Pooled Vehicles

Using funds of funds, interval funds, or other pooled vehicles can lower barriers to entry and provide diversification within the alternatives space.

Specific Investment Goals

If there’s a specific need (e.g., inflation protection, or increased diversification), alternatives may help meet those objectives.

5. Practical Guidelines for Smaller Investors

Limit Allocation

Keep alternative allocations to a modest percentage of the total portfolio (e.g., 10%-20%) to manage liquidity and diversification risks.

Use Liquid Alternatives

Consider liquid alternatives like private market mutual funds or publicly traded REITs, which offer exposure to alternative strategies with lower minimums and greater liquidity.

Partner with Experienced Advisors

Collaborate with advisors or consultants specializing in alternatives to navigate the complexities of this asset class.

Conclusion

For a smaller institutional investor, including alternatives can make sense if the benefits of diversification, return enhancement, or inflation protection outweigh the challenges of access, fees, and liquidity. However, any allocation to alternatives should align closely with their specific goals, constraints, and overall investment strategy.

For a deeper dive into how nonprofits can effectively integrate alternatives into their portfolios, read our full paper, "Alternative Investments for Nonprofits: Opportunities Beyond Stocks and Bonds."

Alternatives Readiness Worksheet

Additionally, ensure your organization is prepared by downloading our “Alternative Investments Readiness Worksheet” below.