Alternative Asset Classes: Navigating the Risks and Returns

Alternative Asset Classes: Navigating the Risks and Returns

Alternative Asset Classes: Navigating the Risks and Returns

Alternative assets have the potential to produce higher returns than most traditional investments. This article will discuss the risks and returns of alternative asset classes.

 

A short recession, geopolitical tensions, and rising inflation have created a challenging climate for traditional asset management. 

 

European asset managers are even more concerned than their counterparts in the United States since the prolonged Ukrainian conflict adds uncertainty to the region, and interest rate differentials may harm Europe’s attractiveness for new investments. 

 

Despite increased volatility in 2022, the volume of alternative assets under management is expected to increase to $23 trillion US by 2026, up from over $10 trillion in 2019. 

 

Alternative asset managers have enjoyed positive investment returns, while typical fund sizes have increased and platforms have broadened, with private credit seeing substantial growth. 

 

Private debt can provide a chance for alternative investment funds (AIFs) to achieve greater returns in certain interest rate settings and finance private enterprises that may not have access to finance from regular sources. 

 

We anticipate further growth in demand for alternative investment products and solutions, even as the investment landscape remains competitive and institutional investors may have reached their goal allocations to some alternative products.  

 

However, while markets remain volatile, growth will decelerate in 2023, limiting exit options. As exits slow, hold periods extend, and payouts to Limited Partners (LPs) also slow. 

 

If the market slump lasts longer or is more severe than expected, weaker performance could impact earnings, asset valuations, and future fundraising.

 

Before proceeding further, let us clarify what alternative asset classes are about.

 

What Alternative Asset Classes Are All About

Investing in something that isn’t a stock, bond, or mutual fund can be considered an alternative asset class. Standard examples are stock, bond, and currency.

 

Private equity and venture capital, hedge funds, managed futures, commodities, art, and derivatives contracts are all examples of alternative investments. 

 

Many people consider real estate to be an alternative investment. Due to their complexity, lack of regulation, and high level of risk, alternative investment assets are typically owned by institutions or accredited, high-net-worth individuals. 

 

Unlike mutual funds and ETFs, alternative investments typically have higher minimum investments and cost structures. 

 

These investments also have less possibility to provide verified performance data and advertise to new investors. 

 

Due to lower levels of turnover, alternative assets often have lower transaction costs than conventional assets despite potentially high minimums and upfront investment fees.

 

Most alternative assets are relatively illiquid, especially compared to their traditional equivalents. Comparatively, selling 1,000 shares of Apple Inc. would be far easier for an investor than selling a 60-year-old bottle of champagne. 

 

Evaluating alternative investments and the transactions that include them can be time-consuming and labor-intensive. 

 

Only eleven 1933 Saint-Gaudens Double Eagle $20 gold coins exist, and only one may be owned by an individual at any given time.

 

Types of Alternative Asset Classes

  1. Private Equity
  2. Private debt
  3. Hedge funds
  4. Real estate
  5. Commodities
  6. Collectibles 
  7. Structured products 

 

Private Equity

If you put money in a private company that isn’t listed on a public exchange like the New York Stock Exchange, that company is said to be private equity. 

 

Private equity can be broken down into several groups, such as Venture capital and growth capital. Venture capital is money put into new businesses in their early stages.

 

While growth capital helps businesses that are already established grow or restructure. Buyouts happen when a company or a part of it is bought outright.

 

The relationship between the investing business and the company getting the money is a big part of private equity. Private equity firms often give more than just money to the companies they invest in. 

 

They also offer perks like advice on how to find good employees, help with industry knowledge, and guidance for founders.

 

Private Debt 

Private debt is purchases not backed by a bank loan or bought and sold on a public market. 

 

It’s important to note that the “private” part of the word refers to the investment tool itself, not the company that is borrowing the money. Both public and private companies can use personal debt.

 

Companies use private loans when they need extra money to grow their businesses. 

 

The businesses that lend the money are known as private debt funds, and they usually earn money in two ways: by collecting interest and having the initial loan paid back.

 

Hedge Funds 

Hedge funds are investment funds that trade assets that can be sold quickly and use different investing techniques to get a high return on their money. 

 

There are many skills that hedge fund managers can specialize in to carry out their strategies. Some examples are long-short stock, market neutral, volatility arbitrage, and quantitative techniques.

 

Institutional investors, like endowments, pension funds, mutual funds, and wealthy people, can only invest in hedge funds.

 

Real Estate

There are many types of real assets. Land, forests, and farms are all examples of real assets. So is intellectual property like artwork. But real estate is the most popular and significant type of asset globally.

 

Besides its size, real estate is an exciting category because it has traits of both bonds and equity. Property owners get current cash flow from renters paying rent, and the goal is to increase the asset’s long-term value, which is called capital appreciation.

 

Real estate buying is complicated because figuring out how much something is worth is tricky. Income capitalization, discounted cash flow, and similar sales are all ways to determine how much a house is worth. 

 

Each has its pros and cons. To be a great real estate investor, you must learn how to value homes well and know when and how to use different methods.

 

Commodities

As with real estate, commodities are mostly natural resources like food, oil, natural gas, and valuable industrial metals. 

 

Because they are not affected by changes in the stock market, commodities are seen as a way to protect against inflation—furthermore, the worth of commodities changes based on quantity and demand. 

 

When commodity demand is high, prices increase, and investors make money.

Trading in commodities is not a new idea; it has been going on for thousands of years. 

 

There may have been the first official exchange of goods in Amsterdam, Netherlands, in the 16th century or in Osaka, Japan, in the 17th. 

 

The Chicago Board of Trade began selling commodity futures in the middle of the 1800s.

 

Collectibles 

There are many kinds of collectibles, such as Notable wines, Pre-war cars, Fine art Toys in mint shape, Postage stamps, Money coins, and Cards for baseball, to mention but a few. 

 

When you invest in collectibles, you buy and care for real things, hoping their value will rise over time.

 

They might sound more fun and exciting than other types of investments, but they can be risky because they’re expensive to buy, don’t pay dividends or other income until they’re sold, and the assets could be lost if they aren’t kept or cared for properly. 

 

When investing in collectibles, knowledge is essential. You need to be a real expert to get any return on your money.

 

Structured Products 

Structured products often include fixed-income markets, such as government or business bonds that pay investors dividends, and derivatives, securities whose value comes from an underlying asset or group of assets, such as stocks, bonds, or market indices. 

 

Credit default swaps (CDS) and collateralized debt obligations (CDO) are two examples of structured goods.

 

Structured products and risky investments are sometimes hard to understand, but they let investors choose the right mix of goods for their needs. 

 

Most of the time, investment banks make them and sell them to hedge funds, businesses, and individual buyers.

 

Structured products are fairly new to the trading world, but you may have heard of them because of the financial crisis of 2007–2008. 

 

Like CDO and MBS, structured products became popular when the home market did well before the crisis. People who invested in these things lost much money when home prices dropped.

 

The Potential of Returns on Alternative Assets Classes

Alternative assets have the potential to outperform traditional assets in terms of returns. Of course, these more significant gains come at a higher cost. 

 

Alternative assets are often less related to conventional assets. High-yield bonds, for example, are less vulnerable to interest rate volatility than standard debt products.

 

Fixed deposits provide stable and predictable returns but do not outperform inflation, particularly after taxes. High-yield bonds can yield 10-12% and exceed inflation even after taxes.

 

Technology and financial platforms have aided the ‘ commercialization’ of alternative asset offers. Investors can now participate in various assets at shallow ticket sizes, spreading their investments across a broader range of alternatives. 

 

Options such as fractional real estate and REITs allow you to participate in real estate at a considerably lower ticket size than directly investing in physical real estate. Similarly, high-yield corporate bonds can be purchased for as little as $10,000.

 

Navigating the Risk of Alternative Asset Classes

Market risk, credit risk, and liquidity risk are some risks that come with different assets. Even alternative investments can lose value when the market goes down. 

 

If the real estate market slows down, it could affect the profits of Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs). In the same way, private and unlisted financial assets will be affected by a weak stock market. 

 

Spreading money around different standards and alternative assets can lower this risk.

 

Credit risk is the chance that the issuer will need more time to pay back the capital and interest. An investor needs to do much research to lower this danger as much as possible. 

 

Before putting money into high-yield bonds, buyers can only look at secured and investment-grade bonds (with credit ratings between AAA and BBB-).

 

As we already said, liquidity should be one of the most important things to consider when dealing with alternative assets. An investor must ensure the product’s maturity matches their cash needs. 

 

On the other hand, they can trade with platforms that offer liquidity, even if it costs them.

 

Final Thoughts 

Alternative assets come in a wide variety of forms, each with its own unique set of risks. When investing in a new asset class, it’s smart to ease into it gradually and gain familiarity before committing significant funds.

 

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