A Beginner’s Deep Dive into Alternative Asset Classes and Blockchain

Alternative asset classes are a new way to get good returns on investment. This article provides a guide to Alternative asset classes and blockchain. 

 

Following a tumultuous 2020 in traditional stock and bond markets, investors are more interested in alternative assets.

 

Alternative assets, however, are only for some. High-net-worth people and entities who can invest in securities not necessarily registered with financial regulators.

 

What are Alternative Assets? 

Alternative assets lie outside most investors’ usual asset classes, such as stocks, bonds, or cash investments. 

 

Because of their unconventional character, these investments may be less liquid than typical counterparts and may necessitate a lengthier investment time before any substantial value is achieved.

 

Due to their complexity, lack of regulation, and high level of risk, most alternative investment assets are held by institutional investors or accredited, wealthy people. 

 

Unlike mutual and exchange-traded funds (ETFs), many alternative investments have high fees and minimum investments. 

 

Also, these investments have fewer chances to share performance data that can be checked and promoted to people who might want to invest. 

 

Alternative assets may have high initial minimums and fees for investing immediately, but transaction costs are usually cheaper because they don’t change hands as often as traditional assets.

 

Compared to traditional assets, most alternative assets are more challenging to sell. 

 

For instance, owners will likely have more difficulty selling an 80-year-old bottle of wine than 1,000 shares of Apple Inc. because fewer people want to buy old wine. 

 

Investors may need help figuring out how much alternative investments are worth because the assets and deals are rare. 

 

One seller of a 1933 Saint-Gaudens Double Eagle $20 gold coin might need help figuring out how much it’s worth because are only 11 known to exist, and only one can be legally owned.

 

Types of Alternative Assets Classes

Many alternative asset classes don’t have anything to do with stocks, and they tend to do better when stock returns are flat or going down. Here are a few popular types of alternative investments;

1. Private Equity
2. Venture Capital
3. Private debt
4. Hedge fund
5. Real estate

 

Private Equity

Private equity invests in companies that aren’t sold on the stock market. 

 

Leon Black says that investors may be unable to get their money back for up to 10 years while they wait for the private equity fund to sell its shares in a merger, an IPO, or to a strategic buyer.

 

Buyers often agree to invest in a “blind pool,” which means they don’t know the company until the manager finds the investment. This makes transparency a problem.

 

Venture Capital

One type of private equity is venture capital. It puts money into early-stage businesses that could or want to multiply in a new or different area. 

 

Many of these businesses may still need sales or income, so they’ll likely fail. On the other hand, there’s a lot to gain if they do succeed.

 

Private Debt 

Some businesses get money from private equity, and some get money from private loans, too, says Michael Harris, who runs a family office and is a partner at Verdence Capital Advisors. 

 

Private debt, sometimes called private credit, is another way for investors to get higher yields than in public markets.

 

Private debt comes in different forms, such as mezzanine and senior debt. Senior debt is considered safer and has better payout structures in case of default. 

 

People think that distressed credit is risky because it invests in the debt of companies with trouble.

 

Hedge Fund

Many tactics use hedge funds to make money and protect you when traditional assets decrease in value. Mike Harris, President of Campbell and Companies says there are sixteen main types of hedge fund tactics. 

 

A popular plan is to “long” and “short” stocks. Managers will put money into a company whose value could go up, but they may also sell short, which means they bet against the company and win if its value goes down. 

 

Absolute return strategies, also called “all-weather strategies,” let hedge funds make money no matter what the traditional markets are doing by investing in a wide range of asset classes and strategies.

 

Real Estate

Investment property, such as office buildings or residential apartments, is regarded as an alternative asset, according to Sal Bruno, managing director and chief investment officer of IndexIQ, a provider of alternative asset exchange-traded funds (ETFs). 

 

Investors who do not wish to manage rental properties alone can purchase Private Real Estate Investment Trust (REIT) shares through a broker. REITs that are open to the public are traded on stock markets.

 

“The public real estate investment trusts have some characteristics of real estate, but frequently are considered to be very equity-oriented,” explains Bruno. This is because they are exchange-traded.

 

Regulation of Alternative Asset Classes

“Everyone in the market has the same rules: do not lie, do not cheat, and do not steal, so they’re completely regulated in that way,” Leon Black, the world’s largest alternative asset manager said.

 

However, alternative investors differ significantly from public markets such as equities, bonds, and mutual funds. The 1940 Investment Act governs investment funds and applies to publicly traded investments. 

 

Two parts of the statute define accredited investors and qualified purchasers as private placement exemptions. 

 

According to Leon Black, if fund management offers to sell their fund only to accredited and qualified customers, there is a private placement exception from the act, and the restrictions do not apply to that fund.

 

This exemption permits fund managers to utilize maximum leverage or be highly illiquid, and they are not required to provide daily net asset value, regular holdings reports, or a prospectus. 

 

There may need to be more complete transparency, which is part of the objective of these investments. He claims that these managers can conceal their actions.

 

In place of a prospectus, investors receive a private-placement memorandum of understanding, which specifies the fees, liquidity, and type of investment. 

 

“The SEC wants you to be a commodity fund if you tell your investors you’re a commodity fund.” “They don’t want it when it comes to buying real estate,” Black said. 

 

They have to follow the terms of those documents. Investors may receive data monthly or quarterly, although it is frequently delayed.

 

Alternative Asset Classes and Blockchain

Practical obstacles to investing in alternative assets exist, such as cumbersome processes, high starting investment requirements, lack of liquidity, and lack of transparency. 

 

These difficulties often prevent widespread access to these assets. The experience can be improved, the challenges can be mitigated, and investor interest can grow. 

 

And here is where blockchain and tokenizing these offerings can play a significant role.

 

As a refresher, tokenization can be described as creating a digital representation of a real-world asset, such as a security or a private fund, using blockchain, a distributed ledger technology. 

 

Tokenization is getting momentum. By 2030, the tokenization of illiquid assets is estimated to be 10% of global GDP, or nearly $16.1 trillion.

 

Some possible benefits of tokenization include enhanced settlement times, increased transparency, increased liquidity, operational efficiencies fractionalization, or the ability to make smaller denominations in an investment. 

 

Some examples of real-world assets that have been tokenized include bonds, real estate, and commodities.

 

Let’s look at private equity funds—one type of alternative investment—for a high-level overview of how tokenization can improve the service and expand usage.

 

Historically, the standard minimum investment amount for private equity has been $25 million, and though not all funds are relatively that high, ticket sizes are generally big. 

 

Also, exiting a private equity position can take time, leading to a need for more liquidity for limited partnership interest holders (LPs). 

 

For these reasons, private equity opportunities have been inappropriate for many investors and are often only offered to organizations.

 

Digitization can handle this, with blockchain efficiencies reducing some administrative burdens of giving smaller denominations. 

 

The gates to private equity may not open wide to mass retail due to securities regulations that typically require an investor to be a qualified purchaser or accredited investor. 

 

Still, the groundwork is being made that should lower barriers to entry. This will allow more buyers to try out new portfolio allocations and ensure each fits their risk-reward profile.

 

Regarding liquidity, ATSs driven by blockchain could eventually make it easier to trade these investments. It will take time to happen, and secondary funding is cost-effective. 

 

But as private equity companies see the chance to give investors access to cash without having to redeem their funds or deal with a lot of paperwork, secondary liquidity of tokenized interests may become the norm.

 

Many tasks that used to be done by hand, like using Excel files, can now be done automatically with a tokenized private equity interest. 

 

This makes it easier for the people involved—the fund, the GP, the LPs, and the fund manager—to work together more efficiently. 

 

Smart contracts can make giving returns to GPs and LPs easier by keeping an unchangeable record of which LP owns what, automating events that set off payments, and building payment rivers into the contracts.

 

Conclusion

Alternative asset classes are different ways to put your money to work besides stocks, bonds, and cash. 

 

These investments are usually more complex to sell than common ones, but they may offer more diversity and higher returns than more common types of investments.