According to a 2020 Connection Capital survey, 87% of private investors planned to keep or increase their allocation to alternative investments over the following 12 months.
Why is there such a demand for alternative investments? I identify five key elements.
1. A lot of investors are sick of the tense market volatility.
Volatility in the previous year broke all previous records. The 11-year bull market abruptly ended in March 2020, and the VIX volatility index reached an all-time high. Despite the S&P 500’s 16 percent gain at year’s end, volatility remained high in 2020. The VIX continued to rise, reaching a peak in November with the presidential election.
The degree of this volatility varied amongst industries. Industries like transportation, clothes, travel and leisure saw considerable volatility increases because of the Covid-19 epidemic, although healthcare and telecom saw far less of an influence.
Since alternative investments are typically uncorrelated with public markets, including them in a portfolio can boost diversification and lower volatility in the entire portfolio. For instance, two of the most popular alternatives, gold, and silver, both maintain their value well and have no link with equities. Depending on the location and market conditions, real estate can outperform the market. My area of expertise and the most recent alternative, U.S. farmland, is uncorrelated with the majority of other major asset classes, such as equities, bonds, real estate, and gold, and has a history of holding its value despite market turbulence.
2. Future returns are still expected to be pricey for equities, making them less alluring.
The American stock market is currently costly by many standards. The market value per share divided by earnings per share, or P/E ratio, of the S&P 500 is significantly higher than historical averages, and all three main stock indices are at all-time highs. The total market value of American equities divided by GDP, popularly known as the “Buffett Indicator,” is at an all-time high. The stock market does appear to be costly, whether you think this is a symptom of an imminent bubble.
Increasing numbers of analysts are likewise pessimistic about future stock market returns. In contrast to average returns of 10.1 percent, Charles Schwab predicted that returns on U.S. large-cap equities will decline to 7.1 percent from April 2020 through March 2030. It is also anticipated that returns on US small-cap stocks will decline.
Long-term investors may decide to place their money elsewhere as a result. Historically, several alternative investments have offered lucrative returns. For instance, investments in quality wine frequently provide returns of 10% to 15%. Additionally, according to the USDA, agriculture in the United States has returned an average of 11.5 percent a year since 1991. Investors can diversify their portfolios and income sources using these options.
3. Returns are being lowered by low-interest rates.
The sales of many classic alternative assets have slowed down due to the low-interest rate environment. The alternative investment of choice for private investors, U.S. government bonds, are yielding less than inflation, and many high-quality sovereign bonds from OECD nations are yielding less than zero. Consequently, investors can no longer rely on a conventional 60/40 portfolio to deliver respectable returns and protect against capital loss.
Instead, a lot of investors use alternative assets like real estate as alternative investments. This asset class has the potential for substantially higher returns than highly rated sovereign bonds while retaining many of the benefits of classic alternative investments, such as a lack of correlation to equities, lower volatility, and good performance during market cycles.
4. Investors have greater inflation on their radar.
The threat of inflation is a fourth element that I see influencing investor interest in alternatives. According to a Bloomberg survey, analysts predict that inflation may reach a peak of 2.9 percent through June 2021 before gradually declining to about 2.2 percent in 2022. While some economists, such as Fed Chairman Jerome Powell, think that inflation is a temporary phenomenon, other economists are concerned that rising inflation may be a more serious, long-term issue.
Bonds perform poorly in the context of rising inflation, especially longer-duration bonds. Investors can instead choose alternative investments that serve as better value stores. For investors who are concerned about inflation, gold has long been the go-to choice. American agriculture is another choice. The value of farmland is supported by its crucial role in the economy and its rarity value, and crop payments are inflation-linked.
5. The availability of alternative investments is increasing.
Technology is the fifth factor influencing the growth of alternative investments. For decades, institutional investors and extremely wealthy people have understood that alternative investments have the potential to provide returns that are comparable to, if not superior to, those of public stocks. However, because of a combination of high investment thresholds, a lack of market transparency surrounding many alternatives, and the high level of specialized knowledge necessary to comprehend and value investment opportunities, most alternatives were challenging or impossible for individual investors to access. Individual investors now have access to the kinds of alternative investments that were previously only available to a select few thanks to technology-enabled platforms.
Investors should think about their objectives before investing in alternatives.
Depending on one’s financial objectives, alternative investments can be a solid choice for investors. Before an investor enjoys the full financial benefits of many of these assets, it may take several years. Alternatives might not be right for you if you’re trying to make money quickly. In addition, most are less liquid than equities, making it challenging to leave. For investors that are comfortable with and want a long-term investment, many alternatives are best. Finally, others are more unusual investment prospects, including farmland. Investors must put their trust in these companies at an early stage because they don’t have a long history of offering access to these assets.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.