The Growing Appeal of Alternative Investments in Volatile Times
Over the past few years, many investors have turned to alternative assets as a way to reduce the risks associated with traditional investments. As market volatility continues and interest rates rise, it’s becoming increasingly difficult for conventional portfolios, such as the classic 60/40 stocks-to-bonds model, to generate the desired returns. In this blog post, we will explore the growing appeal of alternative investments and why they are becoming an essential part of many investors’ strategies.
The Rise of Alternative Investments
Alternative investments refer to assets outside of traditional stocks, bonds, and cash. These include areas such as property, venture capital, private equity, and even collectibles. With increasing market volatility, many investors are looking beyond conventional approaches to diversify their portfolios and safeguard their investments.
The global value of alternative assets has seen significant growth in recent years. In 2017, PwC estimated that the global alternative asset allocation was valued at £11.2 trillion. Today, this figure has risen by 33%, reaching approximately £15 trillion, with projections indicating it could increase to £21.1 trillion by 2025. This surge in alternative investments should not come as a surprise given the challenges in generating returns from traditional stocks and bonds in today’s fluctuating economic climate.
Why Alternatives Are Gaining Popularity
The traditional 60/40 portfolio strategy worked well when interest rates were low and stock markets were steadily rising. However, with recent interest rate fluctuations and inflationary pressures, generating returns through traditional investments has become more difficult. In light of this, alternatives are becoming an increasingly attractive option for those looking to enhance their returns while still managing risk.
An allocation of 10-15% of an investment portfolio to alternative assets is now quite common. This allocation can include property investments, which have historically outperformed inflation, or venture capital, which has the potential for substantial returns. These alternatives can provide an opportunity to diversify risk and create a more resilient portfolio, helping investors weather periods of market turbulence.
Alternatives Offer Higher Returns
One key reason for the growing interest in alternative investments is their ability to deliver higher returns compared to traditional assets. A study published by the National Bureau of Economic Research (NBER) in 2020 found that U.S. venture capital funds achieved an average internal rate of return (IRR) of 14.8% over 30 years, compared to the 11.88% IRR of the S&P 500 index. This pattern is not limited to the U.S.; European venture capital funds have also outperformed their U.S. counterparts in recent years, with returns beating U.S. performance by around two percentage points in the year to June 2021.
This demonstrates that venture capital, along with other alternatives, can offer investors the potential for stronger returns than traditional equity markets, especially when economic conditions are volatile. This has led many investors to seek alternatives as a way to diversify their portfolios and achieve superior returns.
Diversification Beyond Venture Capital
While venture capital is a popular alternative investment choice, it’s not the only option available. Investors are increasingly exploring other asset classes, such as real estate and private equity, to further diversify their portfolios. With UK house prices continuing to rise, property investments have become a common choice for those looking for stability and long-term growth.
Peer-to-peer lending is another area that offers inflation-beating interest rates, especially given that the Consumer Price Index (CPI) has hit 41-year highs. Additionally, with stock markets being volatile, private equity investments are becoming more appealing as they offer the chance to invest in private companies that could benefit from the fluctuations in public markets.
The Risks of Alternative Investments
Despite their potential for higher returns, alternative investments come with unique risks that investors should consider. These risks may include lower liquidity due to longer holding periods, increased capital risk from investing in early-stage companies, and a lack of regulatory oversight compared to traditional investments.
For example, property investments may require longer investment horizons before they provide a return, while venture capital and private equity investments carry a higher level of risk, particularly in the early stages of a company’s development. It’s important for investors to carefully evaluate these risks and ensure that any alternative investments align with their risk tolerance and overall investment goals.
The Future of Alternative Investments
As global economic conditions continue to evolve, the landscape for both traditional and alternative investments will change. With the rise of alternative assets and their ability to offer higher returns and lower correlations to traditional markets, these investments are likely to continue playing an important role in portfolio diversification.
For investors, it’s crucial to stay informed about the shifts in both traditional and alternative markets. While the traditional 60/40 strategy may still be suitable for some, alternatives should be considered as a way to strengthen portfolios, mitigate risks, and enhance potential returns, particularly in volatile economic times.
In conclusion, alternative investments have proven to be a powerful tool for diversifying portfolios and managing risk in today’s challenging economic environment. Whether through property, venture capital, or private equity, exploring alternatives offers investors opportunities to achieve superior returns and gain exposure to high-growth sectors. As market conditions continue to evolve, alternatives will likely remain an important part of a well-balanced investment strategy.
