Guide to Alternative Investments
This guide covers what alternative investments are, provides examples of alternative assets and explains the differences between traditional and alternative assets.
| Important Information This guide is intended only to provide a brief introduction to alternative investments. For further information on alternative investments, and in particular if you are unsure of the risks of investing, you should always seek advice from a regulated financial adviser. An investment directly into an unquoted or private company or into property carries a higher degree of risk than many other forms of investment. It may also be more difficult to realise, as shares in private companies are not publicly traded. The value of shares, including the level of income derived from them, may fall as well as rise, and investors may not get back the money originally invested. Past performance is not a guide to future performance. |
What are Alternative Investments?
Alternative investments (also known as alternative assets) are a diverse category of investments that do not fall into traditional categories. They include private equity, venture capital, real estate, private debt, and hedge funds. This guide aims to demystify alternative investments, while offering a comprehensive understanding of their dynamics, opportunities, risks, and trends.
In recent years, alternative investments have gained significant attention from seasoned investors seeking portfolio diversification and higher returns. Once the exclusive domain of institutional investors, this shift marks a transformative change in investment strategy for many.
They represent a broad range of investment opportunities beyond traditional equities and bonds. Their increasing popularity is driven by investors' search for diversification and higher returns. This guide explores the various types and characteristics of alternative investments; highlighting how they contrast with traditional investments.
Types of Alternative Assets
Alternative assets can be categorised into several key groups, with some of the most popular including private equity, property, hedge funds, and commodities. Here is a closer look at some of these asset classes:
- Private Equity (PE): Involves direct investment in private companies, often through management buyouts or growth capital. Private equity managers seek to enhance company value over time before exiting, providing investors with the potential for substantial returns.
- Venture Capital (VC): Focuses on earlier-stage investments in high-potential start-ups or emerging businesses. Venture capitalists typically play an active role in guiding these businesses to growth and maturity.
- Property: Encompasses both commercial and residential real estate, providing investors with income through yields and the prospect of capital appreciation.
- Private Debt: Involves direct lending to private companies, often through leveraged loans, mezzanine debt, or distressed debt strategies. It offers investors stable income streams and diversification away from traditional fixed-income markets.
Key Characteristics of Alternative Assets
Alternative assets generally exhibit low correlation with traditional markets; relying less on broad market trends and more on the strength of each specific investment. Therefore, they offer diversification benefits to investors seeking to reduce portfolio volatility. Alternatives can improve the risk-return profile of a portfolio and provide enhanced returns through access to a larger universe of investments and strategies.
A common characteristic across alternative assets is illiquidity. Longer lock-in periods, particularly in private equity and venture capital, mean investors cannot easily access their capital compared to listed shares, which are bought and sold daily. This illiquidity, however, is often compensated by higher return potential, often referred to as the 'liquidity premium.'
Traditional vs Alternative Assets
There are distinct differences in risk-return profiles, liquidity, and transparency between alternative and traditional assets. Traditional assets like equities and bonds are generally more liquid and offer transparent pricing, but not incorporating alternatives into an investment portfolio can deliver lower returns (Source: iCapital). In contrast, alternative assets typically carry higher risks but can potentially deliver superior returns. For instance, private equity can boost returns for investors through strategic value creation via operational improvements or investing in undervalued businesses.
Research from the British Venture Capital Association (BVCA) shows that private equity funds managed by its members achieved a 17% annual return over a decade, significantly outpacing the 6.5% yield of the FTSE All Share Index. Alternatives typically have lower correlations to traditional investments and are primarily used to diversify an investment portfolio and provide return profiles that may differ from those of traditional investments. A mere 10% allocation to alternative assets can materially improve portfolio outcomes (Source: Preqin).
Liquidity remains a differentiating factor. Public markets benefit from continuous pricing and reporting standards, offering daily liquidity, while private markets typically have limited transparency and often require long holding periods due to the nature of their investments. Investors need to be cognisant that relatively illiquid assets tend to come with their own set of risks and rewards.
Market Size Overview
Private market assets under management globally totalled $13.1 trillion in 2023 and have seen exponential growth (circa 20% per annum since 2018), with increasing allocations by institutional investors, as well as greater access for private investors, driving this trend (Source: McKinsey).
Allocations in private equity and venture capital, in particular, are set to rapidly increase as these asset classes are uniquely positioned to capitalise on significant market trends and structural shifts, such as AI and the low-carbon transition, as it is predominantly early-stage private companies driving innovation across these areas (Source: BlackRock).
Institutional capital allocated to alternative investments will grow 8% annually over the next decade, but with individual investors holding roughly 50% of the estimated $275 trillion to $295 trillion of global assets under management (AUM), significant future growth is expected from individual wealth where allocations to alternatives are expected to grow faster at 12% annually over that period, albeit from a much smaller base. Private investors currently only represent 16% of AUM held by alternative investment funds (Source: Bain & Company).
Why Invest in Alternative Assets?
Alternative assets present a compelling option for experienced investors seeking diversification, higher returns, and protection against market downturns. Their low correlation with traditional assets, potential for significant returns, and ability to capitalise on emerging market trends make them an attractive addition to a sophisticated portfolio.
However, these benefits come with notable risks, including illiquidity, higher fees, and valuation complexities. Therefore, it is crucial for investors to conduct thorough due diligence, understand their risk tolerance, and have a clear investment strategy.
As the landscape of alternative assets continues to evolve, driven by technological advancements and regulatory changes, access to these investments is becoming increasingly democratised. Both institutional and individual investors can tap into the potential of alternative assets, provided they are well-informed and prepared for the inherent risks.
By carefully considering their investment goals and horizons, investors can leverage the unique advantages of alternative assets to achieve their financial objectives; ultimately constructing a robust and diversified portfolio that can withstand the volatility of traditional markets.
For more information you can check out our comprehensive guide to investing in alternative assets.
Further Information
Maven Investor Partners provides a viable route into private equity, allowing Professional Clients the opportunity to gain exposure to the potential advantages of this exciting asset class. Learn more about how to become an Investor Partner: