According to a Connection Capital survey, 87% of private investors are planning to maintain or increase their allocations to alternative assets over the next 12 months. And they are not alone. Oppenheimer said in a July 2020 report that, “asset growth among alternative strategies has been powerful as assets have tripled to $9.5 trillion over the past decade and they’re expected to grow to $14 trillion by 2023.”
On the whole, geo-political risks have traditionally had more impact on bonds, equities, and mainstream commodities like oil rather than alternative investments like fine wines, watches, or digital currencies, according to a report published by Nasdaq. So, in a world where it feels like geopolitical uncertainty outweighs geopolitical stability, it’s no surprise that investors are more regularly looking to alternative investments for diversification and market outperformance.
Case in point: the alternative investment of cryptocurrencies. Considered a digital asset rather than a real currency, cryptocurrency is breaking records. In the first few days of 2021, for example, Bitcoin topped $39,000 which helped to push the total value of the cryptocurrency market in its entirety to more than $1 trillion.
Here’s what all investors should know about alternative investments on the heels of 2020.
What Are Alternative Investments?
Alternative investments are generally those that fall outside of the typical variety of stocks, bonds, mutual funds and ETFs (exchange-traded funds). They range from venture capital and hedge funds, to private equity funds, precious metals, collectibles, art, wine and beyond.
Private equity involves investing in private companies outside of the public stock market. This type of investing is typically reserved for accredited investors and institutional investment firms. (Accredited investors are high-income earners, with an income exceeding $200,000 individually or a joint income exceeding $300,000 for the last two years. Accredited investors have a net worth in excess of $1 million.)
Private equity investing involves increased risk, long lock-ups and the potential for higher returns. Typically, investor money is pooled with that from other investors and used to fund private equity instruments such as buyouts. Private equity investments are long-term, with investor money often held in the fund for as long as 10 years. The money becomes available again after a sale of holdings, initial public offering, or merger.
Venture capital involves supporting new companies as they work to commercialize their innovations. Venture capital involves higher risk, but greater return than more traditional investing. Like with private equity, the funds are “locked until a liquidity event,” such as an acquisition or IPO. Money is collected from limited partner investors in increments as needed and are referred to “capital calls.”
Another type of alternative investing, hedge funds, typically trade on the public markets but employ short-selling, leverage and other strategies that most investors don’t have access to. Hedge funds are also typically limited to high-net-worth individuals and entities that are designated as accredited investors or qualified purchasers.
Other alternative investments are more out-of-the-box and include farmland, art, wine, real estate, precious metals, cryptocurrency, collectibles, mineral rights, and beyond.
Why Invest in Alternatives?
Alternative investments “boost returns, generate income, provide diversification from traditional investments and achieve their goals,” according to BlackRock. These investments offer lots of opportunities and advantages, especially as part of a long-term strategy and particularly in a COVID impacted market.
Because alternative investments don’t correlate with the stock market, they can help to limit volatility. In many cases, alternative investments can even offer a higher return, especially with markets in flux. Higher returns are possible in part because alternative investments have additional tools that traditional securities don’t, such as leverage, derivatives and short selling, according to Oppenheimer.
Alternative investments offer other benefits including a greater sense of anonymity, flexibility, protection against inflation and market crash, and an opportunity for investors to use and finesse expertise about specific investments (precious metals, for example).
Alternative assets aren’t for everybody. Many are limited to high-net worth individuals. Others require some level of expertise, or at least interest and willingness to learn. (After all, if you plan to build a collection of fine wines, you should probably enjoy wine.)
Nevertheless, alternative investments can be an excellent complement to traditional investments in a diversified portfolio.
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