What Kind of Fees Should a Passive Alternative Investor Expect to Pay?

Today, the race to the bottom is on with most index funds found on Wall Street. This means that most brokerages across the country provide a low-to-no-fee way for individuals to invest in the entire stock market. For example, at the time of this article’s publication, Vanguard offers the Vanguard Total Stock Market ETF(ticker: VTI) to investors for only a .03% expense ratio. That’s only $3 for every $10,000 invested.

In addition, there are many trading platforms like Robinhood and Chase (just to name a couple) that offer commission fee trades. So, with a little planning, an investor can purchase an index fund for free and basically get access to the entire stock market’s overall performance.

On the flip side, there are still plenty of expensive mutual funds and hedge funds that charge a considerable amount in fees. For example, at the time of this article’s publication, VanEck offers the VanEck Vectors BDC Income ETF (ticker: BIZD) at an expense ratio of 10.23%. This just shows the range an investor can expect to pay when investing in traditional assets—but what about alternative investments?

A Fund Model vs. an Individual Deal

There are two main ways to invest in alternative investments: either through a fund or investing in the deal itself. Let’s take a look at some of the fees associated with each model.

Acquisition and Placement Fee: 1–3%, One-Time Only

This is usually charged when an investor directly invests in a specific deal. This fee covers the time and effort it takes for the operator to source the deal, get the deal under contract, perform due diligence, create the business plan, and secure financing. Basically, everything needed prior to raising the funds to close the deal. This fee usually ranges from 1–3%, depending on the size of the deal and the total amount of funds raised. Smaller deals tend to come in at the higher end of the range to properly compensate the operator and his team for all of the steps mentioned previously.

In many funds, you don’t see an acquisition fee, but you might see what’s called a placement or upfront fee. This is usually a one-time fee of 1–3% that goes toward helping with the setup of the fund. The most common number that I have seen is 2%. Sometimes this fee is broken into a setup component and an administrative component, but either way, the collective amount shouldn’t be higher than 3%.

It’s important to note that while these numbers appear high compared to traditional index funds, they are only one-time fees compared to, say, the BIZD 10.23% expense fee, which you have to pay every year.

Asset Management Fee: 1–2%, Ongoing

Regardless of whether you invest in a syndication or a fund, you can expect to pay an asset management fee, which goes toward the actual management of the property. For example, if you invest in an apartment building, you need to pay a salary to someone that is responsible for executing the business plan. This is a full-time and critical endeavor, and if done incorrectly, the whole investment suffers.

In a fund, it’s slightly different because usually the fund operator is invested in other operators that already have asset managers in place. In this case, the asset management fee helps pay for the staff, the office rent, and other expenses that are needed to ensure continuity of the fund.

In either case, this fee will be similar and range from 1–2%. It’s important to note that this is a reoccurring expense.

Profit Split: 20–40%

As you likely already know, some funds are designed such that after the preferred returns are reached, the profits from the fund are shared according to the percentage of the agreement, with typically around 70% going to the investors and 30% going to the operators. Some have larger splits when additional profit thresholds are hit, which is called a waterfall. An example of how this might be structured is that after 13% returns are reached, the profit then splits to 50/50%. These arrangements can be complicated at first to understand, but the key is to know that it’s supposed to incentivize the operator to try to outperform on the deal.

Conclusion:

When an investor looks to invest passively. Too many times their eyes gloss over to the returns. Unfortunately, returns are not always met but the fees that an operator charges are. That's why it's important to understand the fees on any deal you want to invest in. 

Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.