Millions of people are putting their money into real estate, private equity, and other alternative assets despite the economic challenges related to the COVID-19 crisis, growing inflation, and other factors. Some are buying gold or artwork, while others are investing in cryptocurrencies.
But why do alternative investments matter and what makes them so appealing?
For starters, real estate and other alternative investments have a low correlation to the stock market. As a result, their performance is less sensitive to market movements.
What's more, they allow for portfolio diversification and can generate high returns even in a low-yield world.
Investments in art, gold, and other hard assets may also protect against inflation and increase portfolio value. Although they're subject to certain risks, they can act as counterweights to stock and other conventional assets.
Interested to find out more? Today, we'll guide you through the different types of alternative investments, their pros and cons, and how they can fit in your portfolio.
Let's dive in.
What Is an Alternative Investment?
Alternative investments are investments in financial assets other than bonds, stocks, cash, and fixed-income securities. Simply put, they don't fall into traditional asset categories.
These financial instruments have been around in one form or another for centuries.
The development of the Transcontinental Railroad in 1852, for instance, can be considered an alternative investment, according to the research firm Preqin. The first venture capital fund, a type of alternative asset, dates back to 1946. The first hedge fund was developed in 1949.
Alternative investments continued to gain popularity following the World Wars and reached new heights in the 1960s and 1970s. Back then, they were not widely available to the average person. It was mostly large companies and wealthy individuals who invested in hedge funds and other assets.
Today, alternatives are a staple in many investment portfolios. This sector accounted for 12% of the global investment market in 2018 — that's double the market share from 2003, reports the Chartered Alternative Investment Analyst Association (CAIA). In 2018, its value was estimated at $13.4 trillion, with private equity, hedge funds, and real estate being the most popular options.
Alternative asset classes are expected to reach $21.1 trillion by 2025, according to a 2017 PwC report. Moreover, global assets under management, or the securities held by investment management firms and financial institutions, are estimated to grow from $84.9 trillion in 2016 to $145 trillion in 2025.
There's a reason why alternative investments are more popular than ever before — but more on that later. Now let's take a closer look at the different types of alternative assets and how they differ from traditional investments.
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.
Additionally, conventional assets are regulated by the U.S. Securities and Exchange Commission (SEC) whose role is to protect investors and ensure market integrity.
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...
Types of Alternative Investments
There are almost countless types of assets in the field of alternative investments.
The CAIA Association calls out several of the more common alternative investment categories:
- Hedge funds, which are available only to accredited institutions and wealthy individuals
- Real assets, including buildings, land, intellectual property, and more
- Private equity, such as venture capital and common or preferred stock
- Pre-packaged investments, or structured products (e.g.: structured notes)
Other alternative investments that are currently growing in popularity include commodities, derivatives, and of course digital assets such as NFTs and crypto. That's right — Bitcoin, Ethereum, XRP, and other cryptocurrencies are considered alternative investments.
There is also the option to invest in exotic alternative assets, such as weather derivatives, cannabis, eSports, and litigation funding.
Jewelry, classic cars, and fine or rare wine fall into this category, too. For instance, Bloomberg reports that some collectors are willing to pay a whopping $2 million on a single bottle of 95-year-old Scotch whisky!
With that being said, let's see why alternative investments should be part of your portfolio.
Why Alternative Investments Can Be a Smart Choice
Most investors use alternative assets to diversify and protect their wealth, explains BlackRock. This approach can boost portfolio returns and even offer some tax benefits.
For example, alternative investments in the energy sector may qualify for tax deductions, grants, and other perks.
Similarly, oil and gas investors may deduct drilling costs, lease costs, and other expenses. On top of that, they can apply for tax breaks, such as the so-called depletion allowance.
Given these aspects, it's easy to see why alternative investments are so popular. Let's take a closer look at their advantages to help you make the right choice.
As discussed earlier, alternative investments have little or no correlation to traditional assets. Therefore, they allow for portfolio diversification and can act as a safety net when the stock market goes down. For this reason, many alternative assets are also known as diversifiers, says the CAIA Association.
This investment strategy can help reduce volatility without sacrificing profits. Additionally, it has the potential to mitigate losses and enhance risk-adjusted returns.
Increased Return Potential
Some alternative investments can generate returns of 50-100%, reports NuWire Investor. That's significantly more compared to traditional asset classes.
Like with any investment, no one can guarantee a rate of return. However, alternatives tend to have higher return rates than bonds, stocks, and certificates of deposit, points out Harvard Business School.
Hedge Against Inflation
Traditional asset classes typically have low return rates. Some may perform better than others, but they also carry higher risks. In either case, the return may not be sufficient to ensure wealth protection and safeguard your assets against inflation.
Some alternative investments, on the other hand, can be seen as a hedge against inflation, protecting your assets from the declining purchasing power of money. Think of real estate, cryptocurrencies, gold, silver, platinum, money market funds, and so on.
For example, one ounce of gold was worth around $910 in January 2009 and $1,811 in January 2022. Its value went up over the years, providing steady returns for investors.
The same goes for real estate, notes Bloomberg. Housing prices are expected to increase over the next few years due to the rising costs of building materials and the shrinking number of homes for sale.
Access to Emerging Technologies and Markets
Some say that crypto is the new gold. Bitcoin, for example, went from $324 in 2015 to $47,067 in March 2022. Its value exceeded $65,000 in November 2021, reports CoinDesk.
Just like gold, Bitcoin is increasing in price because of its scarcity. While it's true that cryptocurrencies are high-risk speculative products, they can still provide a hedge against inflation.
Such investments give investors access to emerging markets and technologies, such as the blockchain and Metaverse, leading to new opportunities.
We don't know what the future holds, but it's always good to have a backup plan and spread your money across different assets.
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.
Potential Drawbacks of Alternative Investments
There's a reason why hedge funds and other “traditional” alternative assets are available mostly to accredited investors.
First of all, they carry high minimum investments and all sorts of fees. If you don't know what you're doing, you could end up losing millions. But rest assured the risks associated with digital assets can be much lower — depending on how much money you put in and whether or not you know what you’re doing.
Second, alternative assets can be difficult to value and sell, points out Forbes. Plus, they are largely unregulated, which poses further risks.
Also, note that most securities that fall into this category are very complex and carry unique legal implications.
For example, real estate investments are subject to different laws and regulations than private equity or hedge funds.
Other potential drawbacks of alternative assets include:
- Lack of transparency
- Unique risk profile
- High transaction fees
- Long lock-up periods
- May not perform as expected
The Schrieber Group warns that many investors end up paying annual investment management fees of 1-2%, plus incentive fees of up to 20%. Additionally, some alternative assets may carry hidden risks or negative tax consequences.
Are Alternatives Investments Right for You?
Now that you know more about the drawbacks and benefits of alternative investments, you may wonder what to do next. Should you put your money into real estate and other alternative assets or stick to bonds, stocks, and cash?
The answer depends largely on your risk tolerance.
As Harvard Business School notes, one way to mitigate the risks involved is to keep a diversified portfolio. The more diverse your assets, the safer your money is.
Another aspect to consider is that things have changed over the past few years. Nowadays, it's possible to find alternative assets with reasonable minimums and low barriers to entry, says Barron's.
For example, small investors can purchase fractional shares of Bitcoin or a percentage share of a property. Another option is to buy real estate investment trusts (REITs) instead of physical real estate.
Any of these strategies can lead to a more diverse portfolio without breaking the bank.
The experts interviewed by Barron's agree that alternative assets are suitable for investors who can handle the illiquidity and want to better manage their portfolio risk.
In some cases, it makes sense to allocate as much as one-third of your portfolio to alternative investments. However, 10% to 20% is a good start for the average investor, says the Schrieber Group.
Beware that some advisors and fund managers venture into areas outside their expertise, putting your money at risk, warns U.S. News and World Report. These professionals may lack the knowledge and experience needed to manage certain asset classes, but they jump in anyway.
All in all, you don’t want to put all your eggs in one basket. Alternative assets can add value to your portfolio and open up new opportunities, but make sure you know what you're getting into. Research the different asset classes, weigh the risks and returns, and ask about the fees involved.
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:
- Have a net worth of at least $1 million
- Have an annual individual income of $200,000 or higher
- Have an annual household income of $300,000 or higher
- Work for an investment fund
- Hold a Series 7, 65, or 82 license
These requirements are not out of reach for the average investor. However, you still need the right technology and skills to maximize investment opportunities.
Leverage Modern Technology to Optimize Your Investment Portfolio
Still wondering why alternative investments are growing in popularity? Consider the technical advances in this field — 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.
Track and Manage Your Investments the Smart Way
As smart as this strategy may be, portfolio diversification comes with its challenges.
The more assets you own, the harder it gets to keep track of everything. For this reason, it's best to track all of your investments and accounts in a single place.
Kubera is here to help.
Kubera provides the tools you need to mitigate risks while diversifying and optimizing your portfolio with alternative assets.
Think of Kubera as your personal balance sheet. Simply put, it's an all-in-one wealth tracker platform that makes it easy to manage your assets and get a single, consolidated view of your portfolio and asset performance.
Kubera is the go-to choice for diverse investors. Use our modern, easy interface to add and track NFTs, crypto coins, real estate, and other alternative as well as traditional asset classes. Don’t worry, our team takes bank-level security measures, so your assets and accounts are always safe with us.
In addition, Kubera can automatically calculate ROI on your investments in your preferred currency. With Kubera, you always know how your investments are holding up and if it’s time to buy more or sell.
To learn more, see the full walkthrough of our return calculator here.
But that’s not all.
With Kubera, our charts and recap view crunch all your data so you get an easy-on-the-eyes overview of asset performance, portfolio growth, and even net worth changes, over various time frames.
You can even share and show off your portfolio! Kubera’s share feature now allows users to set an expiration date, add a password, and even mask the numbers — so it’s ready to share whatever your use case may be.
And if you work with a financial advisor or wealth manager, you may even be able to use Kubera for free when they sign up to use our white-label product for their client portal. Tell them about Kubera today so they can sign up for a demo and get a custom price ASAP.
Ready to give Kubera a try?