Formerly restricted to high-net-worth individuals and institutional investors, alternative investments are becoming increasingly accessible to retail, or individual, investors as part of a diversified investment strategy.
What driving forces led investors to flock to alternatives in the past decade and a half, and what does the future have in store for this asset class? Here’s a look at the rise of alternative investments and the road ahead so you can prepare yourself and your clients for success.
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What Are Alternative Investments?
Alternative investments are any investments besides stocks, bonds, and cash, which are considered traditional investments. While this asset class comprises various investment types—each with its own investment process, risk profile, and potential rewards—there are a few characteristics most alternatives share. They are:
- Relatively illiquid, or not easily sold or converted into cash due to their long time horizons and the sheer difficulty of selling the assets
- Unregulated by the United States Securities and Exchange Commission (SEC)
Some of the most popular types of alternative investments include:
- Private equity (venture capital, growth equity, and buyouts)
- Debt investing (private and distressed)
- Real estate
- Hedge funds
- Commodities
- Collectibles
- Structured products
Options for investing in alternatives include direct investing, in which the investor invests capital into an asset themselves, or indirect investing, in which the investor goes through an intermediary—such as a private equity firm or real estate investment trust (REIT)—that pools multiple investors’ capital and invests on their behalf.
The Rise of Alternative Investments
The alternative investments industry has grown in popularity and accessibility for the last decade and a half, largely spurred by the global economic downturn in 2008.
When the public markets crashed, individuals who had previously heavily relied on traditional investments saw the value of their investments plummet, leading many to look into the world of alternatives. Alternatives tend to have a low correlation with traditional assets, meaning they trend in opposite directions. This makes them wise additions to the portfolios of investors who are looking to diversify, spread out risk, and increase returns.
After the recession, three trends emerged:
- A shift from indirect investing to direct investing
- A shift of companies from public to private
- A shift from active investing to passive investing
As a new wave of investors entered the alternative investments space, investors increasingly opted for direct rather than indirect investing. This may have been due to the increased sense of control over investments that comes with direct investing.
Additionally, a wave of public companies went private after the recession, perhaps to restructure and rebuild before going public again. This shifted investment opportunities into the private market, making alternatives an attractive option for many who hadn’t considered them before.
Finally, investor behavior shifted from a preference for active investing to passive investing—a “set it and forget it” mentality. Traditional investments, such as publicly traded stocks, are highly liquid and constantly fluctuating in value. The “active” part of traditional investing comes with the decision of when to buy and sell and is the investor's responsibility. Alternative investments, however, have much longer time horizons and are typically illiquid—they won’t provide returns for months, possibly years, and there’s not much you can do as an investor until that time. While you need to wait to be paid out, alternative investments can provide peace of mind that you didn’t miss out on your chance to buy or sell.
These three trends continue to persist and set the stage for the industry’s future.
The Future of Alternative Investments
Looking ahead, the alternative investments industry has huge potential to continue growing but also shift in response to several timely stimuli, ranging from the all-encompassing (such as the COVID-19 pandemic) to the seemingly unrelated (for instance, the advancement of 3D printing technology). While investors must always be prepared for the unexpected, there are several factors that have already begun impacting the industry that wise investors should factor into future plans.
Here’s an exploration of several stimuli expected to impact the alternative investments field in the near future.
Globalization & New Alternative Investment Types
Alternative investments is an ever-evolving industry, and opportunities emerge regularly. The industry is expected to see new opportunities for international investment as well as new types of alternatives to invest in.
Harvard Business School Professor Randolph Cohen, one of three faculty who teaches the online course Alternative Investments, describes in a recent webinar how new opportunities in the field cause new strategies to emerge, which are eventually accounted for by the market. His advice? Keep looking for emerging opportunities and ways to use old strategies.
“Each new market that opens up not only is a place that enables you to look for opportunities,” Cohen says, “but some of the specific strategies that worked in developed or older markets will work for a while in new markets until there’s enough competition from sophisticated funds to drive those out.”
The alternative investments industry took root in the United States in 1852 with investments made into the building of the Transcontinental Railroad. In recent years, it’s branched out into an international market, creating new opportunities to use strategies that have already run their course in the United States. According to research firm Preqin, international alternative investments markets to keep an eye on include Southeast Asia, China, India, and Brazil.
Cohen also highlights the expansive nature of the alternative investment asset class, noting that new types of alternative investments crop up each year, such as the decentralized digital currency Bitcoin.
“There are new things coming all the time,” he says. “Both from globalization and from increasing ideas and technology, there are always new opportunities to make money. That’s what makes the world of alternatives so exciting because those new ideas for making money are almost always going to be couched in the language of alternative investments.”
Technological Advancements & the COVID-19 Pandemic
Technological advancements are continually reinventing the way humans interact with the world, and the field of alternative investments is no exception. In Alternative Investments, HBS Professor Arthur Segel uses the development of 3D printing technologies as an example.
The cost of 3D printing a two-bedroom home is around $4,000, which is inexpensive in comparison to building that home using manual labor. In geographic areas that need a lot of housing for a low cost, this technology is a game-changer. It can—and is predicted to—impact the real estate investment space, a major subset of alternative investments.
Additionally, the transition of in-person activities to the digital space is predicted to impact the real estate field. Segel presents the launch of Amazon.com as an example, which was quickly followed by a sharp decline in US shopping malls.
Nothing forced the switch to the digital space quite like the COVID-19 pandemic, which required lockdowns, quarantines, event cancellations, and a worldwide switch to remote work to mitigate the virus’s spread. The realization that business can proceed as usual without using in-person workspaces has prompted many companies to reassess whether renting office space is necessary, or if downsizing is a better option to allow a fraction of employees to work in person at a given time. This is predicted to cause a ripple effect throughout the real estate investment space as the demand for office space and office-accessible homes decrease.
The COVID-19 pandemic has also impacted investing behaviors, which Cohen commented on in the aforementioned webinar. He notes that, as people felt unsafe and unsure as the pandemic unfolded, they made “safer” investment decisions and held back from trying new things, such as alternatives.
Cohen predicts that as people begin to feel more secure about the state of the world, their investment behaviors will reflect that comfort by reintroducing riskier or new investment types.
Because the alternatives space is heavily reliant on personal relationship management, the pandemic may have made investing in alternatives difficult because it was unsafe to meet with others. Cohen notes that this is especially true for venture capital or other private equity investments, in which the potential investor typically has several face-to-face meetings, in-person pitches, and office visits before deciding to invest in a company. With COVID-19 cases rising in many parts of the world, this could continue to be a hurdle for investors.
Environmental, Social, and Governance (ESG) Considerations
With the climate change crisis growing ever dire, the alternative investments industry is expected to reflect the need for more sustainable use of natural resources, lower carbon emissions, and plans to offset the damage that’s already been done.
In his recorded webinar, Cohen encourages investors to consider ways they can leverage capital to positively impact the environment:
- Invest in companies that are actively implementing sustainable practices
- Divest from companies doing damage to the environment
- Invest in companies doing damage to the environment so you can leverage your power as a shareholder to influence their actions
“I would like people to think more broadly about the best way to make a difference,” Cohen says.
In 2018, the United Nations gave the world an ominous deadline to reverse climate change, which is now less than a decade away. As this continues to be a topical, pressing issue, the field of alternatives is expected to reflect investors’ motivations to drive down climate change’s negative impacts.
Additionally, the recent surge in human rights activism has prompted investors to take a closer look at the supply chains and employee rights of companies they invest in. Investment banking company JP Morgan Chase issued a statement in its 2021 Global Alternatives Outlook report that says its investors will “use proprietary metrics to track and rank our target investments’ staff diversity, and a raft of other ESG factors, to help us invest in ESG winners and avoid or short the losers.”
As ESG factors continue to be important to investors, companies’ actions around these issues will help shape their investments.
Preparing for the Future
The future is inherently both risky and exciting; so are alternative investments.
“As with most things that are exciting, alternatives combine opportunity with danger, so you have to be careful,” Cohen says in Alternative Investments. “It’s entirely possible to get burned in alternatives, so you really need to know your stuff. On the other hand, if you do know what you’re doing, it’s the area where the most edge is to be found.”
You can’t plan for every possible scenario, but you can study the field, gain knowledge of historical and current trends, and make strategic choices with your investment portfolio.
“You’re going to have to keep that knowledge refreshed continuously because the landscape is ever-changing,” Cohen says in the course. “But it’ll be well worth the effort to be involved in the most exciting and fascinating part of the investment management world.”
Are you interested in expanding your knowledge of alternative investments? Explore our five-week online course Alternative Investments and other finance and accounting courses.
