5 min read

From Nice to Have to Must-Have: Alternative Investments

Carmine Meoli

Dec 29, 2020

From Nice to Have to Must-Have: Alternative Investments

By the end of 2020, market exuberance is showing on many fronts. Investor margin debt is peaking, stock prices are trading at all-time highs, and “junk bond yields” are near record lows. The ability of bonds to provide portfolio protection has been decreasing since the 2008 financial crisis. To counteract market volatility and diversify their portfolios, investors are increasingly turning to alternatives. Banks, wealth managers, and investment advisors catering to private investors need access to multiple investment options across more than one alternative investment vertical. Diversification is a critical risk management tool for asset owners and generally one of the main reasons why investors turn to alternatives. Other drivers of the shift towards alternative investments are investors seeking higher returns and lower risks at the same time.

More investing in alternatives predicted for the aftermath of the pandemic

Most market observers agree that alternatives are evolving from an optional to an essential portfolio component. For more than five decades, institutional investors have been in the position to add alternative investments to their portfolios. Whether in search of alpha, income, or diversification, both institutional, as well as 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 a valid option to create stable sources of income. As economies around the world look to rebuild after the COVID-19 crisis, alternative investments are believed to play a key role. 63 percent of investors in alternatives do not anticipate changes to their investment plans in response to the pandemic, the 2020 Preqin Global Alternatives Report shows. 29 percent of the respondents to the Preqin survey expect to invest more in alternatives in the long term than they would have in prior years.

Investing on the stock market versus investing in alternatives

Traditional investments Alternative investments
highly dependent on macroeconomic developments such as the COVID-19 crisis not as strongly affected by external factors -> better protection during crises
generally high volatility generally less volatility
depending on the portfolio, risk can be high true diversification from traditional investments
transparent fees fee structure can be complex

Real assets can provide an inflation safety cushion

At Stableton, we are convinced that now is the ideal time to look beyond the current market uncertainty and start investing. According to an October 2020 analysis by the hedge fund news platform “Hedgeweek”, the COVID-19 crisis is “sharpening the appetite among European investors for alternative investments such as real estate, private equity, Venture Capital, hedge strategies, precious metals, infrastructure debt, and currencies.” One of the main benefits of alternative investments is avoiding stock market volatility, a statistical measure of the variation of asset prices over a certain period of time. Rising capital markets seem to have spoiled investors and current risks are ignored. The risk of a market crash is increasing due to low-interest rates and high market valuations. Contrary to shares and bonds, alternatives tend to be less affected by external factors. Should inflation risks increase, the need for an inflation safety cushion could arise. Real assets can help.

Illiquidity, tail risks, and lack of transparency are the biggest challenges of alternative investing

When investing in alternative investments it is crucial to be aware of different challenges than trading on the stock market. These are the most common pitfalls:

  • Illiquidity: 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 as well as investment securities) and private equity.

    With the new Crisis Alpha Strategy, Stableton addresses the illiquidity issue and enables financial intermediaries to invest in highly liquid instruments such as global futures across volatility, equity, commodity, currency, stock index, bond index futures and crypto asset classes.

  • Dispersion of returns: Even though historical return data confirm there has been a premium for illiquid assets that often form part of alternative investing, this is not guaranteed. No mechanism within alternative investment strategies ensures a premium or higher return for the additional cost of illiquidity. Identifying the best investment opportunities requires working with an experienced alternatives partner that helps financial intermediaries exploit market inefficiencies and deliver higher returns.

    At Stableton, 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. Our products are pre-screened and validated.

  • Limited transparency: Private markets are becoming more complex, larger, and deeper. The alternatives market tends to be less transparent than traditional stocks and bonds. Valuable information is not always available to all market participants. Gateway and aggregation platforms like the Stableton Marketplace enable financial intermediaries to discover opportunities faster and execute transactions more efficiently. Investments can easily be monitored during their lifetime, and consolidated reporting provides an efficient overview of the portfolio performance.

  • Tail risk: Left-tail risk – the chance that an investment generates lower returns than expected or higher losses than expected – is a valid concern in the alternatives world. The concept of tail risk suggests that the distribution of returns is skewed and has fatter tails. These fat tails indicate that there is a probability that an investment will move beyond three standard deviations. Fat tails can often be found in hedge fund returns. Tail events that negatively impact portfolios are rare, but they may have strong impacts. Investors should hedge against these eventualities by diversifying their portfolios.

  • Complex fee structures: Many alternative investments have high minimum investments and fee structures. Investment researchers predict that gap between more passive index-tracking or systematic strategies and more active, top-performing, alpha-seeking managers will widen further. This means that fees will become even more differentiated and less transparent.

    Stableton helps financial intermediaries navigate complex fee structures and by enabling low investment minimums, the diversification essential for alternative investments is much easier to accomplish.

Contact your Stableton representative to learn more about our alternative investment opportunities for banks, wealth managers, and investment advisors.

Disclaimer: Part of the insights above have been researched by experts on alternative investments at JP Morgan. The paper “Alternatives: From optional to essential” can only be downloaded by qualified investors.

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    *Disclaimer: The above article is for educational purposes only and does neither constitute investment advice nor should it be considered to be an invitation or recommendation to buy securities or any other investment products. Please consult your financial advisor about the risks and opportunities prior to making investment decisions. By clicking on that link you confirm that you are a resident of Switzerland and a Qualified Investor according to the new Swiss legislation on collective investment schemes (CISA and CISO).

    References:

    https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/portfolio-insights/ltcma/2021/alts-optional-essential.pdf

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