The alternative funds industry has evolved over the last 30 years to become an integral part of the mainstream financial industry, gathering greater attention and acceptance from both regulators and the general public.
With pressure on equity returns and a far from positive outlook for yields on low-risk bonds, it is not surprising that Asian and European investors are increasingly looking to supplement their portfolios with ‘alternatives’. The appeal of alternatives for investors lies in their ability to provide returns regardless of market conditions, and as alternatives have a low correlation to traditional asset classes, they also provide investors with diversification within their portfolio.
The appeal of alternatives for investors lies in their ability to diversify a portfolio and provide returns regardless of market conditions.
The catch-all definition for alternatives is any asset class other than equities, bonds and cash and therefore includes commodities, real estate, private equity, infrastructure and even art, wine, precious coins and stamps. Somewhat surprising is the reluctance among some investors to explore the potential of alternative investments due to a perception that such investments are unknown and untested and therefore represent an unsatisfactory risk.
One of the most recognised alternatives is real estate, which historically has been used to enhance and preserve wealth. With its low correlation to other financial assets and relatively high, stable returns (received through the generation of rental income), the real estate asset class has been a significant source of investment during the current period of low interest rates. Investors have been drawn to real estate segments capable of producing dependable and assured income streams. Historically such investments have been in the commercial real estate sector (office and retail), however more recently we have also seen fund structures established to hold rental apartments, senior housing and hotels. Further, fears that Brexit would curb the appetite for foreign investment into UK commercial real estate remain tenuous as Asian and Middle Eastern investors deploy significant capital into the region, eager to capitalise on sterling’s substantial fall against the US dollar.
The other ‘common’ alternative is private equity. Private equity (PE) includes investments in companies that are not publicly traded and takes the form of direct equity investments and loans, with the aim to generate capital gains from the sale of investments. It is this close relationship that has led many to argue that private equity has drifted towards the mainstream; PE returns have become highly correlated with public markets and therefore it should not to be regarded as a stand-alone alternative.
Differentiations aside, the popularity of the PE industry continues to garner strength. Investor confidence remains high, sustained by its historic performance of outperforming quoted equities. Since it emerged in the 1980s, the PE market has delivered robust returns for investors, decisively outperforming the public market equivalent with respect to risk-adjusted returns.
Real estate and private equity remain solid and conventional alternative asset classes for investors, but what does the future hold for those investors seeking new alternatives?
Very topical is the role of money in today’s economy, with the future of digital currencies and payment technologies receiving a lot of interest from banks, governments and investors. Digital currencies like Bitcoin are still not widely recognised as a medium of exchange and the debate around whether they are a currency or a commodity remains unanswered. Prospectively, digital currency offers an entirely new way of exchanging and holding assets. (For more information, see my article exploring whether there is a market for digital currencies and whether a virtual currency could become a viable mainstream alternative investment.)
As investors look to further diversify their portfolios to include an increasingly broad range of asset classes, alternatives will continue to evolve and provide exposure to new, emergent and differentiated assets – even virtual! In a world of rapid change and technological development, one thing is for certain: alternatives are here to stay.