Take a look at the following list and think about what all of the items have in common:
- Commercial Real Estate.
- Private Equity.
- Venture Capital.
- Precious Metals (Gold, Silver, Platinum, Palladium).
- Oil & Gas.
- Green Energy.
- Mineral Rights.
- Hedge Funds.
- Fine Art.
- Whiskey & Wine.
- Futures /Commodities.
While non-exclusive, the commonality among the items is that they’re all alternative assets – non-traditional investments.
Investors tired of traditional assets offering low yields from fixed income products and leery of the volatility of equities in the traditional markets are turning to alternatives for above-market risk-adjusted returns.
What is an alternative?
Loosely speaking, an alternative is any financial investment excluding stocks, bonds, or cash-related instruments. Some alternative investments like commodities trading have been around for centuries. Today, alternatives represent a much larger pool of assets.
Unlike the typical retail investor who is heavily allocated to stocks and bonds, ultra-wealthy investors and institutions allocate a majority of their portfolios to alternatives for better returns at lower levels of risk. Long the domain of the wealthy, alternative assets are gaining popularity with all investors.
Interest in alternative investments has grown like wildfire in recent years. More investors and firms are getting involved than ever before.
In 2020, a survey of high net worth individuals found 87% were planning to maintain or increase their allocation in alternative assets over the next twelve months.
The number of institutions invested in private equity in 2015 was 6,170; today, there are over 8,400 firms involved. Almost 1,800 fund managers hold twice as much private debt from just five years ago. Real-estate assets under management rose to a record $992 billion during the summer of 2019 – the industry’s fourth consecutive annual AUM increase.
Not all alternatives are created equal.
The ultra-wealthy seek out specific alternative assets that offer specific benefits. So, while alternative trading strategies implemented by public hedge funds technically qualify as alternative investments, their volatility and subpar returns are viewed no differently from traditional assets by the ultra-wealthy and institutions.
Of all alternative asset classes, the two preferred by sophisticated investors are:
- Private Company Investments (private equity); and
- Commercial Real Estate (CRE).
Why these two assets?
Savvy investors favor private equity and CRE for the following benefits:
- Cash flow.
- Non-correlation to Wall Street and broader market volatility.
- Tax benefits.
- Ability to leverage time, experience, infrastructure, and knowledge of seasoned experts.
- True diversification across multiple assets and geographic locations to shield income against recessions.
- Inflation hedge.
The wealthy are wealthy because they seek assets that offer recession-proof and inflation-insulated income and growth while allowing them to keep more of what they make from advantageous tax benefits.
So while the stock market may reel from unfavorable economic indicators or geopolitical turmoil, the alternative asset segments favored by the wealthy insulate their income and wealth from broader market downturns.
The rise of alternatives reminds me of the buzz surrounding crypto.
People hear that crypto is hot, so they assume it’s safe to invest in anything and everything labeled crypto – even ones that started out as a joke. Investors treat the buzz surrounding alternatives the same way – assuming that anything labeled alternative must be a good buy.
Don’t be fooled and filter out the noise. Look at the types of alternatives sophisticated investors like the ultra-wealthy and institutions are gravitating towards and judge for yourself.
Just remember that as with any other up-and-coming trends going mainstream, it’s always better to get in sooner than later to take advantage of the time value of money for reinvesting cash flow and compounding appreciation to create and maintain wealth.
So, if you decide to dive into the alternative end of the investing pool, don’t delay.