Beyond performance: Evaluating alternative investments

As investors seek diversification, income generation, and access to growth opportunities beyond traditional public markets, alternative investments have become an increasingly important component of portfolio construction. Once the domain of institutions, alternatives are widely accessible through interval funds, tender offer funds, and other retail-friendly structures—and investor interest has followed. Global alternative assets under management have grown from approximately $4 trillion in 2010 to more than $16 trillion today and are projected to exceed $24 trillion by the end of the decade.¹

The growth of alternatives reflects a simple reality: many investors are seeking opportunities beyond traditional stocks and bonds. Yet the same characteristics that make alternatives attractive also heighten the importance of due diligence. Unlike public markets, where broad market movements explain much of investment performance, outcomes in alternative investments are heavily influenced by idiosyncratic factors. As a result, evaluating alternatives requires a deep assessment of how returns are generated and whether those return drivers are likely to persist.

Manager skill: The primary driver of outcomes

A defining characteristic of alternative investments is the wide dispersion of returns among managers pursuing similar strategies. Studies routinely show performance gaps of more than 10 percentage points annually between top- and bottom-quartile managers, significantly larger than the dispersion generally observed among active public equity managers in the 5-percentage-point range.²

The reason is structural. Alternative managers operate in markets that are less transparent, less liquid, and more relationship-driven than public markets. Access to proprietary opportunities, underwriting discipline, industry expertise, and operational capabilities can create meaningful advantages that are difficult for competitors to replicate. The greatest source of performance dispersion is often found within, rather than across, investment strategies. Managers sharing the same mandate can deliver markedly different results, underscoring the importance of understanding the decisions and processes that lie beneath a common strategy label.

For this reason, investors need to focus not only on historical returns but also on how those returns were generated. The key question is whether performance resulted from a repeatable process or from favorable market conditions, excessive leverage, or a handful of successful investments. Durable advantages may include differentiated sourcing, disciplined underwriting, demonstrated value-creation capabilities, effective risk management, and consistent portfolio construction. The objective is to determine whether the manager possesses a repeatable process that can continue to generate attractive risk-adjusted returns across future market cycles.

Organizational durability matters more than investors realize

When allocating to an alternative investment manager, investors are effectively underwriting an organization as much as an investment strategy.

In many cases, a firm’s competitive advantage resides in the collective experience, relationships, and judgment of its investment team. Historical returns often reflect accumulated knowledge and decision-making processes that may not be easily replicated if key personnel leave.

This makes organizational stability an important component of due diligence. Advisors should evaluate team stability, how investment decisions are made, and whether responsibilities are concentrated among a small number of individuals. Investors inherit the future of a strategy, not its past; when the architects of performance depart, the burden of proof shifts to those who remain.

Incentives also shape long-term outcomes. Organizations that reward investment performance tend to behave differently than those primarily rewarded for gathering assets. When compensation and ownership are linked to long-term results, managers are generally more likely to maintain underwriting discipline. Scale deserves similar scrutiny. Asset growth can strengthen a firm’s business, but it does not always improve investment results. Many strategies perform well within a market or segment but become less effective as capital grows beyond the available opportunity set. Investors should determine whether a manager’s competitive advantage remains intact at its current size and whether future growth could dilute performance.

Risk, liquidity, and portfolio construction

Risk management should be evaluated through the lens of downside outcomes rather than base-case expectations. Investors should understand how a manager approaches leverage, assesses and reacts to downside scenarios, and manages liquidity during periods of market stress. Strong performance in favorable environments provides limited insight into how a manager may behave when conditions deteriorate, financing becomes scarce, and valuations decline.

Liquidity deserves particular attention because it directly influences portfolio flexibility. Many alternative investments require longer time horizons and impose limitations on withdrawals. These constraints can help managers preserve portfolio stability during stress and create purchasing opportunities, but they also require investors to remain committed through market cycles.

The better question is not whether the strategy is illiquid, but whether its liquidity profile aligns with the investor’s broader portfolio objectives and cash flow needs. A well-structured investment can become problematic if its liquidity terms are inconsistent with the role it is intended to serve within the portfolio.

Operational integrity and alignment

Investment skill alone is insufficient if operational controls are weak.

Many fund failures have been linked not to poor investment decisions, but to operational deficiencies such as valuation issues, governance failures, compliance breakdowns, inadequate controls, or fraud. Such risks rarely generate return, yet they can permanently impair capital.

As a result, operational due diligence should be treated as a core component of manager evaluation rather than as a procedural exercise. Investors should assess governance, valuation policies, compliance, business continuity planning, and segregation of responsibilities. Independent oversight from auditors, administrators, custodians, and legal counsel provides additional confidence that controls are functioning as intended.

Alignment of interests is equally important. Meaningful manager co-investment, performance-based compensation structures, hurdle rates, clawbacks, and investor-friendly governance provisions help ensure that managers and investors remain focused on the same objective: long-term value creation.

Putting due diligence into practice

Due diligence in alternative investments requires looking beyond historical performance. While returns are ultimately the outcome investors seek, they are often the result of deeper factors, including manager skill, organizational stability, risk management, operational integrity, and incentive alignment.

Effective due diligence focuses on how decisions are made, how risks are controlled, and whether the factors responsible for past success are likely to persist. In a market where outcomes vary widely across managers, identifying organizations with durable advantages and disciplined processes remains critical to long-term investment success.

Rob Kane is the director of Alternative Investments at Commonwealth Financial Network, member FINRA/SIPC, a Registered Investment Adviser–independent broker/dealer.

1. KKR, An Alternative Perspective: Past, Present, and Future (September 2024), based on Preqin data.

2. J.P. Morgan Asset Management, Guide to the Markets® – Alternatives: Correlations and Volatility (10-year data).

Commonwealth Financial Network, Member FINRA/SIPC

This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product.