Alternative Investments: An Avenue For Diversification

Analyst Insight

Background

Throughout history, one of the challenges that have plagued investors has been the extreme market volatilities that exist, which at times are driven by sentimentalism, herdlike movement, and market noise. At the onset of the global pandemic in early 2020, investors had to operate within an investment paradigm filled with extreme volatility in the short run, as could be seen in March 2020 when the DJI dipped 12.93% in one day. The world has somewhat adjusted to living and operating within the new norm of life with the coronavirus. Despite these adjustments, global markets were once again impacted by gloom-ridden externalities, as geopolitical tensions between Russia and Ukraine escalated, which resulted in global stock markets cumulatively losing 1 trillion dollars in value at the news of Russia’s invasion on February 24. An avenue that many sophisticated investors have begun exploring is that of Alternative Investments such as private credit, private equity, and real estate, as alternative investments can provide an avenue for portfolio diversification and can exist as a supplement to traditional investing.

What are Alternative Investments

Alternative investments refer to investments that fall outside of the realms of traditional investments. Traditional investments typically refer to investments such as stocks, bonds, and cash. Alternative investments encompass investments such as hedge funds, natural resources, real estate, infrastructure development, and private capital; such as private debt and equity. Alternative investments usually provide returns that do not correlate to that of traditional asset classes. This means that on average, alternative investments have provided returns that have a relatively low correlation to that of the stock market. This offers investors in this vehicle an added layer of diversification, which can serve as a cushion against volatile swings that are a feature that investors can sometimes experience while investing in traditional asset classes. The added element of diversification that alternative investments offer provides the possibility for investors to be able to experience higher risk-adjusted returns for their overall portfolio. It should be noted that not all securities that fall under the realm of the alternative investment offer the same protection against volatility. Securities such as cryptocurrencies have been seen to demonstrate high levels of volatility. However, we have seen real estate investing offers a higher degree of protection from volatilities. One of the benefits that investments like real estate investing offer are that of relatively stable cash flow. The same can be seen with private equity and private debt, however, the cash flow stability is less predictable when compared to real estate but has greater stability when compared to traditional asset classes.

Despite these positive attributes mentioned, there exist some features of alternative investments, that investors should be mindful of. Alternative investments are more illiquid when compared to traditional assets. The reason for this higher level of illiquidity stems from the fact that most alternative investment securities are not traded on major exchanges, as there is not a developed or existential secondary market for some of these securities. The second feature that investors should be mindful of is that a huge part of the due diligence, that will be done on evaluating these securities will be required to be completed by the investors. As such, this requires investors to be able to have an intermediate to advance working knowledge of the securities that they will be investing in.

How Can Persons Invest In Alternative Investments.?

Investors can generally invest in alternative investment securities in three ways. The first way which is the most accessible way for the average investor entails investing in a fund that is geared towards alternative investments. An investor can decide which asset class within the alternative investment realm they are interested in and then choose a fund that provides that exposure. The fund could take the form of a hedge fund, private equity fund, an ETF, or a mutual fund. By doing so the investor would be able to get exposure to the asset class of their choice while being able to benefit from the management of the investment being carried out by trained professionals. This reduces the knowledge barrier as well as the need for the investor to carry out individual investment due diligence. The second approach an investor can make to be able to invest within the space is by directly investing in a company or project that has exposure to the asset class of preference by the investor. The third approach that can be taken, is that of doing a co- investment with a company or a fund that is actively engaged in a project that provides exposure to the asset class of choice for the investor. The last two approaches are more geared towards sophisticated investors and high-net-worth individuals who have a higher risk tolerance and capital to make direct investments.

Outlook and Conclusion

The current marketplace that exists with traditional assets is currently witnessing higher than normal volatility and is affected by the inflationary environment with persisting low bond yields and stretched valuations in various segments of the market. As investors continue to look at avenues to generate alpha, an area that should be looked upon to provide a level of cushion and support will be that of alternative investments. JP Morgan’s 2022 outlook provides a stable and positive outlook for all major asset classes across the alternative investment asset class. Alternative investment vehicles such as real estate, private equity, and private debt will continue to grow. Growth in real estate is supported by robust housing demand. The growth in the latter two is supported by the need that companies have for flexible capital, which these two provide.

Alternative investments refer to investments that fall outside the realm of traditional investments. They provide investors with the ability to supplement traditional investment vehicles and complement the overall portfolio by providing an added layer of diversification and potentially higher risk-adjusted returns. For the local investor who is interested in getting exposure in alternative investments more so real estate could explore direct investment in real estate listed companies such as KPREIT and SRF. For those who would rather exposure in private equity, Proven Investment Limited would provide great exposure, while Sygnus Credit Investments is a great vehicle for investing in private credit.