Why Are Alternative Investments Important

Date:

A Source Of Uncorrelated Returns

Long Term Alternatives | Alternative Investments 2 | Episode 3

In the same way that it would be risky to have a portfolio comprised of just a few stocks, it is risky to have a portfolio which is only made up of a few return drivers. A properly constructed alternative investment portfolio which encompasses different investments and strategies that are uncorrelated to each other, adds a third leg to your portfolio which is less responsive to global equity market fluctuations. The performance of gold, for example, should behave differently to a commercial real estate asset or a global macro hedge fund. This diversification of returns is important in delivering a portfolio return that is smoother and less volatile in the medium to long term.

Why You Should Add Alternative Investments To Your Portfolio

Alternative investments are often used by investors to hedge against volatility and add diversification to their portfolio.

Investments other than traditional ones, such as stocks and bonds, are known as alternative investments. These types of investments can include commodities, precious metals, real estate, startups, options, hedge funds, private equity, venture capital and cryptocurrency.

The principal differences between traditional and alternative investments are liquidity and return rates, says Sreeni Meka, a portfolio manager at Interactive Advisors, a Boston online investing company.

The most significant benefit for adding alternative investments is diversification, since these assets provide hedges against inflation and have a low correlation to the stock market.

“We would recommend some exposure to alternative investments such as real estate than other alternatives like precious metals to attain the diversification in the portfolio,” he says. “The amount of real estate exposure always depends on how much a client can bear the volatility of their portfolio and the stage of life.”

The advantage of alternative investments is “you are better positioned for a downturn of the market,” says Henry Yoshida, founder and CEO of Rocket Dollar, an Austin, Texas-based self-directed individual retirement account and Solo 401 provider.

Here are a few aspects about alternative investments to consider:

— Higher returns are possible.

Alternative Investments Can Have High Returns

Alternative Assets Have Moved Into The Mainstream

The CAIA Association estimates that alternative assets will make up 18% to 24% of the global investment market by 2025. This trend is driven by the maturation of emerging markets, the low interest rates, and the advances in digital technology, among other factors.

As the number of investors increases, the fees are going down. Other aspects, such as the growing competition and the emergence of low-cost products, are pushing prices down, too, notes PwC.

Considering these aspects, it’s no surprise that alternatives are becoming mainstream. Nowadays, these securities account for about 5% of the average investor’s portfolio, reports the CAIA Association.

While it’s true that ultra-high net investors have more than half of their assets in some type of alternative product, the number of retail investors keeps going up.

With the emergence of Bitcoin, NTFs, and other modern products, these investments continue to grow in popularity. Basically, they are no longer reserved for the wealthy.

Take NFTs, for example.

In 2021, this market reached a staggering $22 billion. Popular brands like Nike and Coca-Cola are selling these assets on dedicated platforms that attract thousands of buyers from around the world.

The average price of an NFT is under $2,000, which allows retail investors to break into the market and test the waters.

There is also the option to buy alternative assets as an accredited investor. To become one, it’s necessary to meet one of the following criteria:

Read Also: What Is Liability Driven Investment

Real Estate Investments Benchmarked: Why Invest In Alternative Investments

Alternative investments are generally defined by what they are not: stocks, bonds, and cash, all of which are considered traditional investments. More specifically, alternative investments generally fall into four primary categories: private equity, hedge funds, real estate, and commodities.

Each type of alternative investment has its own process, risks, and reward profile. However, most alternative investments are relatively illiquid, meaning they are not easily sold or converted to cash.

Some alternative investments have inflation hedging properties, such as appreciation potential, and the ability to generate cash flow and general noncorrelation to the stock market. Additionally, alternative investments can provide much need portfolio diversification, which mitigates vulnerability to widespread losses due to a singular economic event.

How Is The Accuracy Of Investment Valuations Important

Alternative investments are exotic assets that can diversify your ...

What is to say that the fair market value of the private assets is not 20%-30% less than where the Fund has marked them? As this paper will more fully address, the Manager is economically incentivized to value those positions as high as possible. The higher the assessed value, the more profits the Manager captures through their carried interest fees.

In this third edition of our white paper mini-series on due diligence red flags in alternative investments, we are going to focus on valuation. Specifically, we are going to address the concept of Fair Value Measurement , review best practices for valuation, walk through a case study that focuses on the failure of valuation processes, and present key questions to ask during the due diligence process. We will close the paper by discussing two examples that highlight current valuation trends.

You May Like: Single Family Real Estate Investing

Alternative Investments In Real Estate

Its essential to keep in mind that not all real estate investments are made equal.

Some are very speculative, while others are as basic as owning your own house or rentals.

When we talk about real estates potential to deliver consistent returns, were referring to the latter.

These forms of real estate investments have traditionally performed better than others.

Your house is also an investment, even if you dont recognize it. Your net worth includes the value of your property, which you may access in a variety of ways.

The most frequent is, of course, selling it and pocketing the difference if you acquired it for less than you sold it for.

If you currently own a home, you might want to diversify your portfolio by acquiring other types of real estate.

Buying a rental property, stock in a real estate investment trust , or farmland are all examples of this.

Rental properties may grow in value while also providing passive income, and REITs allow you to hold a portion of one or more properties under a fractional ownership structure.

Unique Skills Or Knowledge

Sometimes, the investor or their advisors have deep knowledgeor a unique skill set in a specific areathat can cause alternative investments to make sense to them. For example, if an experienced entrepreneur in the oil and gas industry had the resources and patience to take advantage of a major oil or gas glut, that unique knowledge and experience might pay off handsomely.

Also Check: Unique College Investing Plan National Fidelity Managed 529 Plan

Traditional Vs Alternative Asset Classes

Alternative assets grew in popularity following the 2008 financial crisis when the stock market crashed. Millions of people who had previously invested in traditional assets turned to alternatives to build more diversified portfolios and mitigate risks.

A diverse portfolio includes different types of assets, from stocks and bonds to real estate. Therefore, if one or more assets are performing poorly, you won’t lose everything. You still have other assets that can produce consistent returns and keep you afloat even when the economy is down.

Traditional assets, which include bonds, stocks, and cash, are dependent on the movements of global markets. Their performance is tied to inflation, supply and demand, and economic or political events.

Alternative assets, on the other hand, have little or no correlation to stocks and bonds, explains the CFI Institute. Simply put, they don’t necessarily move in the same direction as traditional assets. Some may even offer higher yields than traditional investments, even in tough economic times.

Last but not least, alternatives are rarely traded on public markets. As a result, they can be more illiquid and less regulated than conventional assets, which may pose risks to investors.

For example, you may not be able to sell your alternative assets at a fair market price. By comparison, traditional investments are publicly traded, which may instill higher liquidity. This allows investors to sell and convert them into cash as needed.

What Are Alternative Investments And Why Consider Them

New Investment Opportunities | Alternative Investments 2 | Ep 1

Contents

  • Alternative Investments vs. Stock Market
  • Theres an old saying that no one ever got fired for buying IBM. Equivalent job security in the financial advisory industry has been built on the consistent recommendation for a portfolio allocated between stocks and bonds.

    Is this still good and relevant advice for everyone? Are there any deviations or alternatives to this investing strategy? If you are interested in exploring alternative strategies and opportunities for your investments to produce growth, income, security, and more, this article is for you.

    Also Check: Prudential Real Estate Investment Analyst Interview

    An Opportunity To Manage Risk

    To explore the potential risk management benefits of alternative asset classes, we examined performance in years when public equity returns were poor. As expected, we found that Treasuries had the strongest performance, while Treasury Inflation-Protected Securities and investment-grade bonds also posted positive returns. Among the alternatives categories, we found that late-stage venture capital, direct lending, buyout, and private real estate all had positive returns on average in these years, while the returns of macro and market neutral hedge fund strategies were modestly negative.

    Past performance is no guarantee of future results

    Key Characteristics Of Alternative Investments

    Alternative assets have distinctive characteristics that make them more or less appealing to investors. We have already mentioned some of these defining features, such as their low liquidity and limited regulation.

    Other key characteristics include:

    • Low correlation to traditional asset classes
    • Can have higher management and performance fees
    • May require higher minimum investments
    • Often higher return potential than stocks and bonds
    • Might involve the use of leverage and complex investment structures
    • Investors can take a more active role in asset management
    • Can be difficult to analyze and value

    For example, Preqin explains that some alternative assets are available mostly to accredited investors. This is partly due to their complexity and partly due to the high minimum investment requirements. However, anyone can participate in some alternative investments, such as NFTs and other digital assets.

    Also, note that real estate and other alternatives can be difficult to evaluate. Their worth is often determined based on appraisals rather than benchmark indices.

    Some assets, such as collectibles, works of art, and farmlands, are so unique that it’s pretty much impossible to determine their real value.

    This brings us to the next point…

    You May Like: Invest Money Online And Earn Weekly

    Distinctive Exposures And Opportunities

    As noted above, traditional stock and bond investing can offer investors the potential for growth and income. However, equities and fixed income allocations do not provide the accessibility to new or other distinctive exposures. Thats where alternative investments can bear very ripe fruit, enabling investment access to real estate, infrastructure, start-up businesses, and a host of other complements to traditional portfolios.

    Given these and other portfolio benefits, why havent alternative investments been as widely used by individual investors? The answer is simple: lack of access historically.

    Hurdles And Chances Of Alternative Investments

    Sustainable Investing: Saving the World with Responsible Investments ...

    Alternative investments are extremely attractive investments for risk-tolerant investors, but are also difficult and challenging:

    • many private investors do not have access to alternative investments.
    • Alternative investments require very high minimum investment amounts and many demand a higher risk capacity and a long-term investment horizon.
    • To invest successfully, investors must have wide-ranging knowledge of the opportunities and risks associated with alternative investments.
    • Interested investors also need a global network of relationships and local expertise.

    In spite of all these hurdles, alternative investments offer important advantages:

    • specifically because they are illiquid and difficult to access, they offer knowledgeable and risk-tolerant investors the opportunity to earn a higher return in the long term than with traditional investments.
    • Another important advantage of alternative asset classes: their yields and price movements often do not correlate or develop totally opposite to those of traditional asset classes. They are therefore excellent instruments for adding diversification to a portfolio.
    • LGT makes it possible for private investors to also invest in alternative investments – and gives them access to the expertise of its investment specialists.
    • At LGT, you can also invest amounts that are comparatively low in the industry.

    Also Check: What Else To Invest In Besides Stocks

    Benefits Of Alternative Investments

    What is an Alternative Investment?

    The term alternative investment, might bring to mind an investment that only large institutional investors have access to, or at least an investment that is generally too complicated for the average investor to understand. This is a common misconception, and until recently, may have been somewhat true. But, with recent regulation changes, access to this class of investments has opened up to a much broader audience and the benefits are far more advantageous than you might expect. Precious metals, oil and gas, venture capital, hedge funds, real estate all of these are part of the alternatives, or alts, class of investments.

    All alternative investments fall into one of two broad categories: public or private investments. An alternative investment youve likely heard of are REITs, or real estate investment trusts. This is a common public alternative investment. Your financial advisor probably has mentioned them, and you may even have some REIT holdings in your portfolio. And while REITs can be an okay option, they miss a lot of the advantages of private alternative investments. Many investors arent aware of the distinction. However, private real estate funds significantly outperform REITs. We find the biggest gap in most investors portfolios are in private alternative investments, and that is what we are going to zero in on.

    So, Why Invest in the Alternative Asset Space in the First Place?

    More Freedom From A Regulatory Perspective

    Need one more reason to invest in alternative assets?

    Bitcoin, NFTs, real estate, and other alternative investments are subject to fewer regulations than stocks and bonds. That’s a double-edged sword, though.

    On one hand, you’ll have more freedom from a regulatory perspective. The stock market is highly regulated and involves a lot of paperwork, posing challenges for investors and asset managers alike. Alternative investors have less red tape to deal with, which makes it easier to diversify your portfolio and experiment with different assets.

    On another hand, the lack of regulation equals less transparency and a higher risk of fraud.

    Also Check: Investment Company Of America Class A

    How Can Alternatives Complement A Traditional Portfolio

    For long-term investors able to forego some liquidity, a strategic allocation to alternatives assets can help to improve the overall risk/return profile of their portfolio. The exact weight of the alternative bucket within a diversified portfolio will depend on individual return objectives, investment horizons, and liquidity constraints.

    Managing Risks And Returns

    Short Term Alternatives | Alternative Investments 2 | Episode 2

    High risk and high minimum investments mean that alternative assets typically appeal to long-term investors, rather than those that prefer to use short-term investments to profit from the volatility in stock markets. That said, more and more investors are choosing to add alternatives exposure to their portfolios to take advantage of the benefits outlined above.

    The correlation between alternatives and traditional assets can fluctuate as business cycles move from contraction to expansion, but they rarely fully converge. The risk to reward ratio is therefore preferential for investors that incorporate alternatives within their portfolio to spread risk.

    Reasons for investing in alternatives vary across asset classes.

    Diversification is stated as a key benefit across all asset classes, while the various types of returns available mean certain asset classes are more suited to certain investors.

    Don’t Miss: Invest In Gold Coins Or Bars

    Leverage Modern Technology To Optimize Your Investment Portfolio

    Still wondering why alternative investments are growing in popularity? Consider the technical advances in this field â in addition to the factors listed above.

    As Forbes notes, technological innovation enables retail investors to purchase alternative assets that were once reserved for institutional investors and wealthy individuals. In this digital era, anyone can use technology-enabled platforms to identify, compare, and analyze investment opportunities.

    For instance, Morningstar and other investment research platforms can make it easier to identify top-performing funds and other alternative assets.

    Data analytics, artificial intelligence, and other modern technologies allow investors to evaluate and mitigate risks, enter new markets, and optimize their portfolios.

    Moreover, digital technology can drive insightful decision-making and lead to faster transactions at lower costs.

    A good example is Coinbase, an online marketplace where investors can buy and sell cryptocurrencies. Members have access to weekly market updates, industry reports, tutorials, and other helpful resources.

    There are also data-driven platforms, such as PitchBook, which focus on specific assets. Venture capital and private equity investors use PitchBook to look up companies, funds, advisors, and more.

    Another popular choice is Kubera, an all-in-one personal balance sheet that enables users to track all of their investments in one place and access real-time market data.

    Crypto Price Prediction: $100000 Bitcoin Could Come Even Sooner Than You Think With Ethereum Leading The Way

    Alternative investments are generally uncorrelated with public markets, meaning that adding them to a portfolio can increase diversification and reduce overall portfolio volatility. For example, gold and silver, two of the most well-known alternatives, both hold value well and have a low correlation with stocks. Real estate can beat the market depending on location and market conditions. U.S. farmland, my specialty and the most newly accessible alternative, is uncorrelated with most major asset classes, including stocks, bonds, real estate and gold, and has a track record of maintaining value during times of volatility.

    2. Equities remain expensive, and forecasted future returns look less appealing.

    By many metrics, the U.S. stock market is currently expensive. All three major stock indices are at record highs, and the S& P 500s P/E ratio, equal to the market value per share divided by earnings per share, is well above historical averages. Another popular metric known as the Buffett Indicator, measured as the total market cap of U.S. stocks divided by GDP, is also at an all-time high. Whether you believe this is a sign of an impending bubble or not, the stock market does seem expensive.

    3. Low interest rates are depressing returns.

    4. Investors are planning for higher inflation.

    5. Technology is democratizing alternative investments.

    Before getting into alternatives, investors should consider their goals.

    Also Check: Jp Morgan Investment Banking Reviews

    Popular

    More like this
    Related

    Best Real Estate Investing Advice

    There Is...

    Series 65 Registered Investment Advisor

    Who Needs...

    Investment Account Sign Up Bonus

    Acorns $25...

    Is Gold A Good Investment In A Recession

    Silver Did...