What are Alternative Investments?
Up until the financial crisis in 2008, most investors largely focused on traditional investments such as stocks, bonds and mutual funds. Little was known about alternative investments. They were difficult to understand and hard to invest in due to their complex nature.
However, since the financial crisis, alternative investments became one of the fastest growing asset classes in finance. They were growing at a staggering 11% year over year clip.
So what caused the growth in alternative investments?
Why Are Alternatives an Important Part of the Investment Portfolio?
After the financial crisis, investors started looking for opportunities that were not correlated with the performance of the market. During the crash, investors looked to other asset classes such as hedge funds, private equity, and venture capital to diversify their portfolio and hedge against the market.
Emerging global economies was another factor that contributed to the rise of interest in alternative investments. The success of emerging markets created a surge of additional retail investors ($100K – $1M in assets) hungry to invest.
To meet the demands of new investors, companies like BlackRock and AQR created liquid instruments such as alternative-focused mutual funds to make alternatives more accessible to the masses. The result, more mainstream alternative investment products, platforms, and opportunities.
As shown in the chart below, alternative investments have gained traction across all sectors over the past decade with the mass affluent adopting the strategy at a higher rate.
Although alternative investments have gained popularity, they are still complex assets with high barriers to entry. Only sophisticated investors such as institutions and high net worth individuals have access to and can invest in these assets. The complexity of these assets sometimes creates confusion amongst retail investors and it is important to note the facts and the fictions of alternative investments.
Here at Cadence, we’ve compiled a few of the most common misconceptions about alternative assets and break them down for you.
Common Misconceptions About Alternative Assets
Alternative investments are no longer exclusive
Traditionally, only large institutional investors and high net worth individuals had access to high yielding alternative investments. The opportunities were often shared amongst a small network and rarely syndicated to the masses.
Lately, however, the air of exclusivity is fading from alternative investments. New marketplaces like Cadence are emerging, using technologies like blockchain to grant accredited retail investors access to alternative investments.
Alternative investments are not correlated with the market
Most of the time, alternative investments provide a great hedge against the market and is a good way to diversify your investment portfolio. Nevertheless, in the case of the 2008 crash, real estate and the financial markets took a hit due to the packaging of subprime mortgages.
In general though, alternatives stand separate from the market and can range from assets such as precious metals, artwork, intellectual property, to insurance policies and merchant financing.
Alternative investments are illiquid
It is true that it can be hard to move quickly in and out of some investments such as a fund or real assets. In recent years, however, the creation of ETFs and mutual funds that offer exposure to alternatives is allowing retail investors to actively participate in these investment opportunities.
Furthermore, short-term debt securities, and alternative investment platforms are quickly gaining popularity among retail investors who are hungry for exposure.
At Cadence, we hope that with the development of blockchain technologies, these investments can become tradable assets.
Alternative investments are opaque
In the past, Institutions have kept knowledge of alternative investments vague and unobtainable to ward off additional investors.
In more recent years, as the demand for alternatives continues to climb, investors are pushing for greater transparency and access. Luckily, technology such as the blockchain via smart contracts is able to automate much of the fundraising process enabling greater transparency, more efficiencies, and greater access to previously unobtainable alternative assets.
Alternative investments carry both more risk and higher rewards than stocks and bonds
The variables differ so much from asset to asset that this statement is inaccurate.
Alternative investments carry inherent risks just as any form of investment, however certain assets such as private debt securities carry both less upside and less risk than publicly traded stocks.
Statistically speaking, the yield from alternative investments does tend to outpace and offset their additional risk. According the Chartered Financial Analysts Institute, “Over long time periods, returns to venture capital and private equity have exceeded the returns to public equity indexes by more than 3 percent per year net of fees.”
How Technology is Changing Alternative Investments
A good deal of legacy knowledge about alternative investments is quickly becoming obsolete with the rise of FinTech companies, big data, and blockchain technology.
With automated processes, faster transactions, and a broader investor base, alternative assets are becoming a more and more prevalent asset class.
Through platforms like Cadence, investors will have an increasing range of choices that offer liquidity, demonstrate transparency, and mitigate risk better than what was possible before.