An alternative investment is a non-traditional investment i.e. in an asset class other than stocks, bonds, or cash. Examples include precious metals, art, wine, coins, and antiques as well as some financial assets like property (real estate), commodities, hedge funds, cryptocurrencies, private equity, and peer-to-peer lending.
Alternatives aren’t in an asset class of their own as such. Instead they represent different approaches to investing across a variety of markets and vehicles.
A useful way to think about alternatives is to differentiate between their “contents” – the assets or strategies that determine how individual investments might be expected to perform – and their “containers,” the fund structure that will determine transparency and access to capital.
Investors look toward alternative assets to deliver investment characteristics that can complement their portfolio, with longer holding periods of three to five years and lower correlation with traditional asset classes.
The challenges of investing in alternatives include; issues with the market value which can be difficult to define, higher purchase and sale costs as well as fee, historical risk and return data may be limited and the fact that a high degree of due diligence is often necessary.
A recent survey conducted by Connection Capital, a boutique investment firm, concluded that alternative assets now make up at least 20% or one in four High Net Worth' Individual's portfolios.
Alternative Assets can help broaden diversification in their portfolios which in turn can reduce their risk profile, enhancing returns, and improving overall resilience. The need for this has been driven by the uncertainty in today’s investment environment and a need to improve their overall risk-adjusted return.
This echoes the sentiment of Prequin who have forecast a 58% growth of private equity funds to $4.9 trillion worldwide, overtaking hedge funds as the largest alternative asset class over the next five years.
There is a misconception that only institutional and Ultra High Net Worth investors can access alternatives. However, individual investors have greater access to alternatives than ever before due to innovations in product structures.
The appetite for alternatives is likely to rise given the challenging environment for conventional asset classes. When screened for correlation to other parts of a portfolio, alternative investments may help lower volatility, enhance returns and broaden diversification. However, risks may be greater and investments may be illiquid.
In general, alternatives rely less on markets and more on investment selection for returns. They are selected for different reasons, which may include: