NBK Wealth Thought Leadership: Alternative Investments - Beyond Traditional Stocks and Bonds
Introduction
Individual and institutional investors are familiar with traditional assets like stocks and bonds, which have long been the cornerstone of investment strategies. These assets are well-established, easily accessible, highly regulated, relatively liquid, and have an extensive historical track-record that investors often rely on.
Alternative investments, on the other hand, refer to non-traditional investments that are not publicly traded on an exchange. They are unconstrained strategies or assets that invest in both public and private markets, providing an attractive source of alpha, income, and diversification that would complement traditional stocks and bonds investments.
Alternative strategies encompass a broad range of investment vehicles, such as private equity, private credit, hedge funds, real estate, and infrastructure. These investments can present appealing opportunities and deliver substantial diversification advantages to a portfolio.
Traditional vs. alternative investments
|
Characteristic |
Traditional Investments |
Alternative Investments |
|
Liquidity |
o Highly liquid, easily traded with minimal fees. |
o Often illiquid, with higher fees due to complexity, active management, and longer investment horizons. |
|
Structure |
o Publicly traded on exchange platforms |
o Private investment vehicles that invest in assets in both private and public markets |
|
Accessibility |
o Easily accessible to retail investors |
o Primarily accessible to institutional investors or UHNWI(*), depending on the structure and strategy |
|
Regulation |
o Highly regulated by government agencies and financial bodies. |
o Less regulated, with fewer disclosure requirements. |
|
Investment Horizon |
o Varies, depending on asset class and investor objectives. |
o Typically long-term, focusing on growth potential over extended periods. |
(*) UHNWI – Ultra High Net-Worth Individuals
Types of alternatives
There is a wide range of alternative asset classes, each with their own benefits, risks, and characteristics:
§ Private equity: is an alternative asset class that involves investing in companies that are not publicly traded on stock exchanges. This investment strategy includes pooling investors’ capital in a fund structure to invest in private companies with the goal of enhancing their value and realizing profits upon exit.
§ Private credit: refers to privately negotiated loans between a borrower and a non-bank lender. This strategy involves providing debt financing to companies, often in the form of direct loans, with the goal of generating attractive risk-adjusted returns through interest payments, and potential for profit upon loan repayment or exit.
§ Hedge funds: are private, unconstrained investment vehicles that utilize both long and short positions, often with leverage. A long position involves buying an asset in anticipation of price appreciation, while a short position profits from a price decline.
§ Real estate: a multi-faceted asset class, with investors typically gaining exposure through public markets via Real Estate Investment Trusts (REITs) listed on exchanges or through private markets via direct investments or funds.
§ Infrastructure: is an alternative asset class focused on investing in physical assets that provide essential services to society such as water utilities, power networks, airports, and public transportation systems.
Finding the right mix of alternatives
Alternative investments are key to enhancing portfolio performance, boosting returns, reducing volatility, and providing diversification beyond traditional stocks and bonds. It is important, however, to understand the specifics of each alternative asset class and find the right mix as each has its own characteristic and can serve a different role in a portfolio.
The appropriate amount of allocation will depend on several factors, including the investors investment objectives, the size of any existing allocation to alternatives, time horizon, and risk tolerance.
Given the broad spectrum of alternative asset classes, each with its unique benefits and risks, it's important not to treat them as a single portfolio building block. Investors should collaborate with experienced financial advisors to find the right alternative strategy or blend of strategies that meets their portfolio needs.
Benefits and considerations
Alternative investments can offer significant diversification benefits, thus reducing volatility and overall portfolio risk when combined with traditional asset classes. They also provide potential for superior returns, and grant access to investment opportunities. Assets like real estate and infrastructure hedge against inflation, while private debt generates steady income. Hedge funds offer diversification through varied strategies, and private equity offers high growth potential with investments in private companies, often yielding substantial long-term returns.
However, alternative investments come with risks. They tend to be illiquid, locking up capital for extended periods, and their valuations can be difficult due to limited data, requiring thorough due diligence. These investments also often require substantial capital commitments, making them more accessible to institutional investors or high-net-worth individuals. Additionally, they typically have higher fees due to active management and specialized strategies.
The future of alternatives
The alternative assets industry has experienced robust growth in recent years. With dry powder (capital raised but yet to be deployed) reaching record highs, the sector is positioned for continued expansion. Investors interest in alternatives increased over time as they seek higher returns, diversification, and in some cases protection against inflation. This growing demand underscores the increasingly prominent role that alternative assets play in investors' portfolios.
Key takeaways
§ Unlocking the power of alternatives: Alternative investments offer valuable diversification benefits and the potential for higher returns. However, they come with challenges such as limited liquidity and higher fees compared to traditional assets.
§ Access to investment opportunities: Alternative investments are key in enhancing portfolio risk-adjusted returns by providing access to investment opportunities that are not typically available in public markets, allowing investors to diversify beyond traditional stocks and bonds.
§ Guiding your investments: Collaborating with experienced financial advisors is essential when selecting the right mix of alternative strategies. Allocating to alternatives requires a thorough understanding of the underlying assets and careful consideration of an investor’s objectives, time horizon, and risk tolerance.
§ The future of alternative assets: The alternative assets industry is set for continued growth as investors increasingly seek higher returns, better diversification, and, in some cases, protection against inflation.
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