Equity markets are given to uncertainties. Fixed-income markets aren’t giving the returns that you seek. So, as an investor, your line of thought could be “what next”, “where else”, and “how to”. If history is anything to go by, every downturn has led investors to seek greener pastures. Some want to balance the risks; others want to test the waters and see how their investments pan out. If you count yourself one among them, the following sections are for you.
Alternative investments: The what
Alternative investments comprise assets that do not fall in the category of stocks, bonds, or cash. They can range from commodities to derivatives to real estate. They can be used as a hedging tool due to their low correlation to the stock and bond markets. Hedge funds, which by nature are meant to deliver returns regardless of the market conditions, are actively managed alternative investments. More recently, cryptocurrencies have become an attractive segment within the larger alternative investment market.
Despite the illiquidity of alternative investments due to their low trading volume, they remain an appealing option for investors looking to reduce their risk exposure during tumultuous times.
Alternative investment market and its selling point
Until recently, alternative investments were mostly viable for institutional investors and high-net-worth individuals. As the market expanded, however, they became more accessible to retail investors. The introduction of alternative mutual funds — essentially mutual funds for alternative investments — has allowed retail investors to reap considerable returns. These ‘alt funds’, or ‘liquid alts’, provide a more regulated, low-fee avenue for retail investors to participate in alternative investing.
Despite the illiquidity of alternative investments due to their low trading volume, they remain an appealing option for investors looking to reduce their risk exposure during tumultuous times. As part of a balanced portfolio, alternative investments have the capability of providing a cushion in the case of a stock or bond market collapse. A skilled financial consultant can advise on constructing a portfolio that includes alternative investments with proportionate asset allocation.
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The current market scenario
Although the utility of alternative investments has always been apparent, recent trends have induced greater demand. In recent years, digitalization and the meteoric rise of blockchain-based applications like cryptocurrencies have made a significant impact in investing circles. With popular cryptocurrencies such as Bitcoin boasting an average annual return of 94%(1) from 2018 to 2021, and Ethereum returning a mind-blowing 194%(2) over the same period, it’s easy to see why investment advisors are recommending a cryptocurrency asset allocation of 1% to 5%(3). As is the case with most high-return investment instruments, crypto necessitates a long-term outlook before you make a cash splurge.
Hedge fund managers are more inclined towards activities that align better with responsible governance, positive social impact, and eco-friendliness.
Similarly, technology has impacted the world of private equity, opening up access to crowdfunding services. Previously, private equity investments in start-ups were the playing fields of venture capital firms and high-net-worth individuals. Through equity crowdfunding, investors of any size can pool their money and tap into private equity, with investments as low as $10,000 and, through the service’s representative, have a seat on the board of the ventures of their choosing.
On the environmental, social, and governance (ESG) front, institutional investors have been considerably active, with many giving equal weight to an investment’s sustainability aspect as much as its financial performance. Hedge fund managers are more inclined towards activities that align better with responsible governance, positive social impact, and eco-friendliness. If you are an eco-consumer and a conscientious investor, impact-ESG investing is surely a recommended option.
What does 2022 and beyond hold for alternative investments?
In the year 2020, the global stock market, in response to the COVID-19 pandemic, suffered the largest decline since the 2008 Great Financial Crisis. The S&P 500, over one month from February 19th to March 23rd, cratered 34%(4). The U.S. indices would not return to January levels until November later that year(5). When Russia launched a full-scale invasion of Ukraine on February 24th, the MOEX index fell a staggering 45% in one day(6). The ripples were felt globally(7), as the S&P 500 dropped 1.2%, and the FTSE 100 fell 3.9%, along with similar drops in other major foreign indices.
It is another harsh reminder of the volatility and risk that conventional investors must reckon with. In the face of recent volatility in the stock and bond markets, alternative investments are expected to grow(8) from 12% (2018) to as high as 24% by 2025. Investors seeking to include alternative investments in their portfolio can, depending on their personal risk tolerance, expect varied allocation recommendations, with some financial advisors proposing between 15% to 30%(9) of the portfolio. Globally, alternative investments have an asset allocation of 32%(10).
A financial advisor can be extremely helpful when it comes to alternative investing, capable of allocating based on your personal goals, risk threshold, and existing portfolio. However, it is essential to find the right financial planner that fits your needs and aspirations.
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