You should consider allocating at least 5-10 percent of your portfolio to alternative investments for the sake of diversification, if nothing else. Not all alternative investments are high-risk. For centuries, real estate and precious metals have been viewed as long-term stores of value and solid hedges against inflation.
Traditional investments are not the only game in town. There are a wide variety of “alternative investments” that investors can choose from as well. Alternative investments are investments that do not fall under any of the three conventional investment categories: stocks, bonds, and cash. Examples of alternative investments include real estate, cryptocurrencies, private equity, venture capital, art and antiques, commodities, and derivatives contracts.
In the past decade, the amount of global alternative investments under management has risen dramatically. In fact, in 2013, there were $7.9 trillion in global alternative investments under management. But, by 2023, there is expected to be $14 trillion.
Institutional investors are currently allocating about 10-20% of their portfolios to alternative investments, and sovereign and public pension funds are starting to increase the amount of alternative investing they do.
Alternative investments might not be as regulated or liquid, but they can still provide incredible opportunities to generate strong returns.
You should consider allocating at least 5-10 percent of your portfolio to alternative investments for the sake of diversification, if nothing else. Not all alternative investments are high-risk. For centuries, real estate and precious metals have been viewed as long-term stores of value and solid hedges against inflation.
Why are Alternative Investments Rising in Popularity
Alternative investments are becoming more attractive to many investors for a number of reasons. Here are some of the main ones.
Diversification
Many alternative investments can help to diversify the risks associated with being over-invested in a particular asset class, such as stocks. In fact, alternative investments, by their very nature, are often less dependent on the overall market for performance. Instead, their performance tends to be more correlated to their inherent strength. For example, real estate investment trusts, or REITs, a form of alternative investment, tend to have a lower correlation to overall market conditions than traditional stocks.
This is because their cash flows are derived solely from the occupancy rate of the underlying assets within the REIT. Due to their ability to continue generating passive income and provide effective diversification, REITs are one of the most popular alternative investment types.
Inflation Hedging
Inflation is something that many investors have become concerned with in recent years. This is especially true in the wake of the COVID-19 pandemic after the government flooded the US economy with the largest influx of federal dollars in history. Roughly $5 trillion was injected into the economy during the COVID-19 pandemic as economic stimulus. While printing this much money might have helped many people and businesses to survive the pandemic, it has caused inflation to soar in the aftermath of the pandemic.
Many investors have turned to alternative investments such as real estate, fine art, or even certain cryptocurrencies such as Bitcoin to hedge against inflation. The reason why real estate, fine art, and Bitcoin are often used as inflation hedges is due to their scarcity. Unlike national fiat currencies and even equities, the supply of real estate, fine art, or Bitcoin cannot be instantly increased with the press of a button. So, with inflation rates hovering around 7-8% in the last two years, a large percentage of investors are now prioritizing inflation hedge investments more, and alternative investments with scarce supplies are useful options.
High Returns
The average return of the S&P 500 is around 10% per year. But, with inflation currently at 7-8 percent, it means that the real rate of return for the S&P 500 is about 2-3%. So, once inflation is factored in, many investors are finding that the returns from traditional stock market investing are just not high enough. As a result, many are turning to alternative investments that have the potential to generate higher returns.
As you can see from this chart below, the returns from Bitcoin are often significantly higher than 10%, and the king cryptocurrency tends to have many more up years than it does down years. This has helped it to grow increasingly popular as an alternative investment.
Source: bankrate.com
Many other alternative investments also offer the chance to generate returns that are significantly higher than 10%. However, there is often an increased risk profile and volatility level associated with these assets as well.
So.. What is the Future of Alternative Investments?
Cryptocurrencies/Web3
Currently, the cryptocurrency market is going through a difficult period following the collapse of high-profile companies in the blockchain sector, including FTX, Celsius, Three Arrows Capital, and BlockFi. So, in the short term, it is likely that the crypto market will continue to languish. However, this is not the first time the crypto market has experienced a downturn or the spectacular collapse of key players in the industry. The cryptocurrency industry has gone through several “winters” before and has come back stronger every time in the aftermath. So, it is likely that this will happen again as the cycle repeats itself.
Beyond cryptocurrencies, there is a world of opportunity in the Web3 space in general. From DeFi to NFTs to crypto mining companies, this industry is experiencing tremendous innovation. Investors who can put capital into the right projects have a chance to make substantial returns over the coming years. If the next five to ten years are anything like the previous five to ten, then even just investing in a handful of blue-chip cryptocurrencies could yield strong results.
Real Estate
Real estate might not be as new and innovative as cryptocurrency and Web3, but its ability to generate stable returns and serve as a hedge against inflation means that many investors will likely continue to favor real estate as an alternative investment in the coming years.
There are many different ways to invest in real estate. For example, investment properties can be purchased directly; they can be bought and managed through syndications, etc. Some of these are only available to accredited investors, but retail investors can invest in real estate through REITs. There is still a major housing shortage in the US, and it is estimated that the nation is short 3.8 million housing units. So, despite the fact that the Fed has raised rates significantly in the last year, it is very likely that housing prices will still continue to rise significantly in the coming years as demand is still significantly stronger than supply.
Private Equity, Venture Capital, and Pre-IPO Placements
Private equity refers to the practice of investing in shares of companies that are not publicly listed. Typically, this type of investing is done by wealthy individuals or businesses. Venture capital is similar to private equity; however, with venture capital, investments are usually made in startups or young businesses with great long-term potential. Pre-IPO placements are when investors buy the stock of private companies in the private secondary markets before they make their initial public offerings.
All of these ways of investing in private companies have great potential, and the amount of capital that flows into these alternative investments could rise substantially in the next 3-5 years. For example, it is projected that the private equity markets are projected to grow to $12.5 trillion by 2025, up from $7.2 trillion in 2020. The top 10 industries that received the most private equity investment in 2021 were:
- Software
- Manufacturing
- Healthcare
- Technology
- Food and Beverage
- Financial Services
- Digital
- Education
- Industrial Services
- E-commerce
Most likely, many of these industries will continue to receive large amounts of private equity investment capital in the coming 3-5 years. So, be on the lookout for great opportunities in these industries.
Other Alternative Investments
In addition to real cryptocurrencies/Web3, real estate, private equity, and pre-IPO placement, there are a number of other alternative investments that you should be aware of too. For example, physical collectibles such as coins, wine, art, stamps, and commodities like gold and oil can all make great investments.
The global wine market was $489.3 billion in 2021 and is expected to grow to $825 billion by 2030. During this period, the market is expected to have a compound annual growth rate of 6.1%. So, there is plenty of opportunity in the wine market for investment.
If you have a high-risk tolerance, then you might want to consider allocating some capital to cryptocurrencies or Web3 companies. Bitcoin is the most well-known and arguably the safest of all cryptocurrencies. However, from Ethereum to Polkadot to Cardano, there are many exciting cryptocurrencies and blockchain platforms that are making waves. Perhaps it is time for you or your company to jump on the opportunities in this sector.
Here at The Spaventa Group, we help investors get access to such opportunities with our venture capital investment services.
