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Council Post: Ten Reasons Some Investors Consider Investing In Alternative Assets

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J. Christopher Mizer, a 25-year alternative investment industry veteran, is President and CEO of Vivaris Capital, LLC and VICAN Fund.

Investing in alternative assets such as hedge funds, private equity, real estate, infrastructure and natural resources can provide investors with a timely opportunity to tap into an array of benefits with various risk and reward characteristics.

While alternative investing was primarily only an option for large, institutional investors during the past several decades, today’s new alternative funds and direct investment opportunities are increasingly available for individual investors and family offices. As a result, new capital inflows are fueling exponential growth in the alternatives industry.

Preqin reports that total assets under management in the alternatives industry should reach $23.21 trillion by 2026, up from $13.32 trillion in 2021. Separately, Opalesque wrote recently that “demand for alternative investments is set to grow by up to 46% over the next 12 months.”

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Goldman Sachs is equally bullish by noting that, “The market for assets that aren’t publicly traded has roughly doubled in the past five years to about $10 trillion, according to data from consulting firm McKinsey & Co. and data provider Preqin. Private equity — including leveraged buyouts and venture capital — is the biggest chunk of that market, but it also includes infrastructure and private credit, and the money is flowing into everything from tech startups to buyouts to airports.”

Types Of Alternative Investments

There are many alternative investments available, each of which represents a unique opportunity for portfolio enhancement and provides investors with potential benefits such as diversification, reduced volatility and high returns on a risk-adjusted basis over short-, medium- and long-term horizons.

Private Equity: This includes venture capital and traditional private equity investment opportunities that allow investors to participate in the newest and fastest-growing companies. They come with the potential to earn a large return upon a successful merger, initial public offering or acquisition.

Hedge Fund: This set of strategies includes long/short equity, arbitrage, global macro, event-driven and other opportunity funds. Hedge funds have access to various structured financial instruments to enhance the wide range of investment opportunities across public and private markets.

Real Estate: This includes private ownership and the development of residential and commercial real estate in a multitude of markets and asset types. Real estate can generate income for investors while leveraging capital and providing income tax benefits.

Infrastructure: This includes investment opportunities ranging from water, sewer, transportation and energy projects that benefit from long-duration, government-sponsored structures.

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Natural Resources: This includes timber, mining and energy investment opportunities in which the ownership and exploitation of resources can be monetized and supplied to the global supply chain.

Private Debt: This includes business and capital investment financing opportunities where commercial banks are unable to finance market demand on the same terms.

Ten reasons some investors look to increase portfolio allocations to alternative investments include:

Diversification

Diversification broadens portfolio exposure to maximize return opportunities and avoid over-allocation to a particular asset class. As seen in the Great Recession, over allocation to financial stocks and real estate dramatically impacted investment portfolios. Wider diversification could potentially have limited losses from either of those asset classes.

Better Valuations

Alternative assets provide the opportunity to invest in companies based on private company valuations which are typically much lower than comparable public companies due to the inherent lack of liquidity.

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Higher Growth

In terms of revenues, earnings and value creation, investing in alternative assets that are experiencing rapid growth is more compelling than investing in more mature, publicly traded companies with lower growth prospects.

Lower Operating And Infrastructure Costs

Similarly, alternative investments typically have a much lower cost structure than publicly traded companies.

High Risk-adjusted Returns

Alternative assets are uniquely positioned to earn high risk-adjusted returns because of the ability to hedge away downside risk while maintaining the upside potential.

High Absolute Returns

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Alternative assets may also earn higher nominal returns than publicly traded stocks and bonds as the multiplier effects of lower valuations, higher growth and strategic liquidity events compound the effects of capital appreciation.

Low Correlation To The Public Stock And Bond Markets

Alternatives are typically less correlated with the vicissitudes of the public capital markets with focus on quarterly performance and the impact of macroeconomic factors.

Inflation Hedge

Public equities and debentures tend to decline in value during periods of inflation because the associated future cash flows are discounted at a higher rate and therefore become less valuable. Alternative assets may be better able to hedge against rising prices because their value is created from financial metrics and nonfinancial, strategic milestones.

Source Of Passive Income

Certain alternative assets, such as rental real estate, can generate a reliable income stream over time with a higher yield than dividends or interest payments.

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Reduced Volatility

Alternative assets can reduce portfolio volatility through various exposures that each asset type has to market conditions. The greater the exposure, the more protections a portfolio has when compared to limited holdings of traditional investments.

Within each alternative asset type, these reasons are stronger in some sectors versus others. For example:

  • Private Equity can deliver high risk-adjusted returns, high absolute returns and diversification through large multipliers of exit multiples.
  • Hedge Funds can deliver high risk-adjusted returns, high absolute returns and low correlation to other asset classes through access to unique financial tools and markets.
  • Real Estate has a strong overall balance of income and capital appreciation and is secured by a tangible asset.
  • Infrastructure can deliver an inflation hedge, reliable income stream and reduced portfolio volatility through long-term contracts with government entities.
  • Private Debt can deliver a reliable income stream, an inflation hedge if held to maturity and higher returns for similar credit risk.
  • Natural Resources can deliver low correlation to other asset classes, a reliable income stream and overall diversification through volatile sub-resource changes and the irreplaceable nature of the underlying asset.

In summary, there are varying reasons and benefits of portfolio exposure to alternative asset opportunities, and corresponding returns and allocations are reflective of recent changes in the markets and investor preferences. Allocations to alternatives are forecast to continue growing fast to offer attractive returns over other options.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.


Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Do I qualify?


Source: Forbes

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