5 Myths About Alternative Investments
Portfolio diversification, exploiting illiquidity premiums, and less dependence on macroeconomic factors: Most market observers agree that alternative investments have become an essential portfolio component. Nevertheless, there are still multiple myths surrounding alternatives. In this blog post, we are analyzing and debunking five myths about alternative investments. Myth #1: Alternative investment just means hedge funds and private equity. Truth: False, alternative investing includes many more asset classes than just hedge funds or private equity. The alternatives universe is broad and varied: “Because the term is so all-encompassing, it is often easier to define alternative assets by what they are not rather than what they are”, the “Business Insider” states. Alternative investments are financial assets other than publicly traded stocks and shares or bonds. Generally speaking, alternative investments are not as strongly affected by external influences such as the 2008 financial crisis or the current pandemic. Besides hedge funds and private equity, the most common types of alternative investments are real estate, collectibles, commodities, and derivatives. Cryptocurrencies and tokens constitute the rather new investment category of digital assets. In recent years, VC and startup funding have increased significantly, and some even forecasted a “new tech bubble”. Trend-setting investors in VC and private equity are currently tapping into disruptive sectors such as health tech. While stock market investors are more inclined to base their investment decisions on daily headlines, late-stage and pre-IPO investing are much less about hype and more about data analytics. However, it is often a major challenge for investors to identify the right private equity or VC investment opportunity at the right time and to get access to the desired growth companies. Myth #2: Alternatives are not an essential part of investment portfolios. Truth: Not anymore, alternatives are evolving from an optional to an essential portfolio component. Investors are increasingly turning to alternative investments to counteract market volatility and diversify their portfolios. Other drivers of the shift towards alternative investments are investors seeking higher returns and lower risks at the same time. In our blog post on trending alternative investments, we summarized recent studies and surveys on why alternatives are a must-have in 2021. Especially during times of uncertainty, investors need to look beyond traditional asset classes to meet their financial objectives. Institutional investors have been in the position to add alternative investments to their portfolios for more than five decades. According to the paper “The Rise of Alternatives” by the multinational bank HSBC, pension funds in Australia, Canada, Germany, Japan, South Korea, and Switzerland have an average allocation of more than 30 percent to alternative assets. Whether in search of higher risk-adjusted returns, income, or diversification, both institutional and individual investors currently face ever-fewer opportunities for these pursuits in the traditional asset classes. Lower interest rates over the past decade led to income-hungry investors. Alternative strategies in the real assets and alternative credit segments are valid options for creating stable income sources. Myth #3: Alternatives increase the investment risk. Truth: Not necessarily! The global investment management firm PIMCO writes that “When looking at an alternative strategy as a standalone solution, it will typically have a higher risk profile than more traditional holdings because of its lower liquidity and higher targeted returns. However, when viewed as part of an overall portfolio, the investment risks may seem more moderate.” As mentioned above, diversification is a critical risk management tool for asset owners and is generally one of the main reasons investors turn to alternatives. “By adding alternatives to the mix, investors may be able to enhance portfolio performance, boost diversification and reduce their overall risk”, the authors of the PIMCO article on alternative investments conclude. Myth #4: The illiquidity of alternative assets is always a bad characteristic. Truth: It depends. Exchanging alternative assets for cash may be more difficult than selling stocks or bonds. This is especially true for non-core assets (including real estate, commodities, and natural resources) and private equity. Still, for many investors, the benefits of illiquid assets make up for the risks. According to Yale investment director David Swensen, less liquid investments tend to have greater degrees of inefficient pricing. Many investors overvalue liquid assets. This leaves less liquid – and thus often undervalued – assets for investors with long-term investment horizons. Investments in private markets typically realize an illiquidity premium, the additional return received for the risk of tying up capital in a less liquid asset. As we explained in our blog post on illiquidity premiums, investors can manage liquidity risks by not leaving too much of their portfolios in illiquid markets or by engaging in a secondary market community. With our new liquidity desk, Stableton ensures that financial intermediaries meet cash obligations without experiencing significant losses. This reduces liquidity risk exposure and facilitates the reallocation of resources. Myth #5: Alternatives are exclusively available for investors with ultra-high net worth and established financial institutions. The truth behind this myth: Not always! While access to some asset classes may have been restricted to qualified purchasers or accredited investors, other investment vehicles now provide access to alternatives without the same restrictions. Innovative solutions such as the Stableton Marketplace – the leading one-stop-shop for alternative investments – have been developed for banks, wealth managers, investment advisors, and qualified investors to exploit the benefits of alternatives. Stableton aims to break down entry barriers to alternative investments. We offer industry-leading expertise and bankable solutions to source and identify alternative investment opportunities directly and across an ever-increasing network of deal-sourcing partners.
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