Everything You Need to Know About Alternative Investment

Alternative investment is gaining popularity as a means of diversifying portfolios and reducing reliance on traditional financial markets. Whether you are an experienced investor or new to the field, understanding this domain can open doors to unique and profitable opportunities. In this article, we will delve into the world of alternative investment, defining what it is, exploring its various forms, and detailing its presence across different wealth levels.

What is Alternative Investment?

Alternative Investment: Definition

Alternative investment encompasses a range of assets and investment strategies that differ from traditional options such as stocks, bonds, and cash. These investments can include real estate, commodities, hedge funds, and, of course, art, among others. They are generally sought for their diversification potential and return. They also have their own dynamics, uncorrelated with other types of assets, making them good tools for reducing overall portfolio risk. Unlike more traditional assets that have seen the emergence of passive or index management (read here an article on the match between active and passive management written by the private bank Pictet), alternative assets most often require expert teams to access the best opportunities. The value under management of this type of assets is expected to increase from 13,700 billion dollars in 2021 to 23,300 billion dollars in 2027 according to Prequin, a company providing studies, analysis, and data on alternative investments.

Examples and Types of Alternative Investments

Some Common Examples of Alternative Investments

Among the most common examples of alternative investments, we can find:

1. Art and Collectibles: Investing in artworks or other collectibles can offer significant growth potential. Artworks and collectibles are one of the last asset classes to not have been made accessible for investment simply. They are mostly held for enjoyment. However, the performance over time of major artists' artworks, collectible vehicles, or other luxury goods such as watches, fine wines, and spirits, proves superior to major stock indices such as the S&P 500 or the MSCI World. In this field related to beauty and art de vivre where rarity is also a value driver, it is crucial to rely on experts with competence and networks if one wishes to have an investment approach.
2. Real Estate: Whether through direct ownership or real estate funds, real estate remains a cornerstone of alternative investment. One of the interests of real estate is to benefit from the leverage of debt to improve the profitability of one's investment. But like everything else, the dosage counts. Real estate as an investment can be represented through a matrix with two entries. The first is geographic, from the largest to the smallest area (Europe, United States, Asia, or Paris, Bordeaux, etc.); the second is sectoral with residential, commercial, office, logistics. This allows refining the market dynamics across these different markets with the balance between the evolution and the adequacy of supply with demand. It is a sector very sensitive to changes in interest rates as it is heavily financed by debt as well as changes in construction material prices.
3. Hedge Funds: These funds use a variety of strategies to actively manage investment returns. This type of fund, which can be very free in terms of underlying assets, strategy, and investment horizons, has developed significantly in the United States, which still represents 80% of the supply today.

It is a segment of investment that is difficult to generalize or describe because it is extremely varied. Here the search for absolute performance is key, and the main tools used are:

• - Derivatives: financial instruments whose market value depends on an underlying asset (stock, bond, exchange rate, commodity, etc.);
• - Short selling: forward sale of an asset that one does not yet own but whose price is expected to fall, in order to make a profit;
• - Leverage: using debt to increase investment capacity.
• One of the most famous funds for its performance is a fund from Renaissance Technology: indeed, the Medallion fund delivered an average annual performance of 66% between 1988 and 2020. Its strategy is based on statistical and quantitative models to predict market movements. The only downside is that this fund is no longer accessible except to the team of this management company.

4. Commodities: these include different types of agricultural crops such as wheat and soy, livestock, energy such as oil and gas, precious metals or energy and construction-related metals, such as nickel, cobalt, or copper, among others. Gold and silver, especially among precious metals, are widely used as raw materials in various industrial products. Investors can acquire certain commodities directly or via an investment fund. Commodities are often traded in the form of futures contracts. Futures contracts are essentially a speculation on the future evolution of the underlying commodity. In addition to investors, the commodity futures market serves as a hedge for agricultural producers and others, seeking to mitigate the impact of a variation in commodity prices on their business. ETFs and mutual funds in commodities offer investors an opportunity to participate in commodity investment without having to buy and sell futures contracts
5. Capital investment: These investments involve shares that are not traded on public markets and can include:

1. Private Equity: Commonly known in French as "capital investissement," it relates to investment in the capital of unlisted companies. Private equity takes various forms depending on the nature of the assets (business, real estate, infrastructure) and/or the maturity of the companies (from venture capital to capital transmission). The different categories of companies to invest in can be:

1. Start-up companies, known as "venture capital";
2. Profitable companies in the expansion phase, known as "development capital";
3. Companies in the transmission phase, known as "capital transmission";
4. Companies undergoing necessary restructurings, known as "turnaround capital";
5. Companies related to real estate (developers, property traders);
6. Infrastructure projects.

Generally, private equity is not directly affected by stock market mood swings, although the macroeconomic context (interest rates, growth) of course impacts company valuation. These shares can also be less liquid than publicly traded stocks. Private equity can offer potentially high returns, but it requires being a long-term investor, typically over 10 years.

2. Private Debt: Private debt can be compared to the above-described private equity in terms of sectors and company maturity. It simply involves exposure to a company's ability to repay its debt, not to the evolution of its valuation over time.
3. Structured Products: Their definition, considered difficult by one of the world's largest structured product providers, Société Générale, is very well explained in this article. In summary, a structured product is a debt security that is an assembly of several financial instruments and allows a financial institution to offer buyers a risk profile that matches their expectations.
   A structured product is therefore a security that combines:

• The characteristics of a fixed-income instrument or a short-term deposit;
• The risk and return characteristics of derivative contracts.

They are most often used in private wealth management to offer regular return products associated with stocks or baskets of stocks.

• 6. Cryptocurrencies: Long considered a marginal investment, gaining popularity around 2020 and paradoxically during irrational boom phases, these are extremely volatile assets. Moreover, several cryptocurrency exchange platforms have gone bankrupt, questioning their viability as an asset class. However, many fortunes have been made through the rise of certain cryptocurrencies, and their democratization is only expanding, notably with the first ETFs linked to these cryptocurrencies, making them more accessible to institutional investors and individuals who do not want to deal with the technical aspects associated with their purchase and sale.
• The interest in cryptocurrency among "Ultra High Net Worth" individuals (those with a net wealth of more than 30 million euros) has significantly dropped. A 2022 survey by Knight Frank reveals that cryptocurrency represents only 2% of UHNWI portfolios. It now constitutes a smaller portion of the average UHNWI portfolio than gold (3%) and alternative investments such as art, cars, and wine (5%).

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Why are Alternative Assets Highly Represented in Large Wealth Portfolios?

Alternative assets are much more represented in the portfolios of "Ultra High Net Worth" individuals (those with a net wealth exceeding 30 million euros) compared to the average portfolio. Indeed, they account for up to 50% of UHNWI portfolios, while the average investor typically allocates around 5%.

The main characteristic that differentiates these wealth levels is the level of expert advice surrounding them, as well as lower liquidity constraints. It is therefore interesting to see that the higher the wealth level, the higher the use of alternative assets in a logic of performance, diversification, and long-term planning.

An article on alternative assets in the wealth of "ultra-high net worth" individuals, very well written, details this trend. It includes two tables presenting, on one hand, the share of alternative assets in a portfolio ranging from 1 to 5 million dollars compared to a portfolio exceeding 30 million dollars. The rate of use of alternative assets according to wealth levels and their evolution over time are also presented.

In a second table, we observe that the democratization of access to these alternative assets is a significant trend, enabled notably by the emergence of Fintech specialized in these subjects.

Share of alternative assets in asset allocation according to wealth level.

Associated Legend:

• HNW ($ 1m-$ 5m);
• UHNW ($ 30m+);
• Mass Affluent ($ 250k-$ 1m);
• HNW ($ 1m-$ 5m);
• VHNW ($ 5m-$ 30m);
• UHNW ($ 30m+).

Conclusion

Alternative investment offers an exciting path for diversifying one's portfolio and potentially increasing returns. Whether you are interested in art, real estate, or other forms of assets, it is important to do your research and understand the unique dynamics of each of these assets, as well as the relevant regulations and taxation.

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