By Troy Vanderburg & Jason Lampa
Alternative investments are going mainstream. To put it into perspective, the money that has been invested into alternatives for the past three years have resulted in an asset growth of $7.2 trillion in 2013, resulting in double the growth in this category since 2005. This means its growing at twice the rate of traditional investments.
Even though experts argue the returns from alternatives have lagged behind that from non-alternatives, such as hedge funds (11% return in 2013) and S&P 500 Index (30%), the growth of alternative assets is no longer a high return strategy. Its viability increases day by day as long-term institutional investors are relying on alternatives to make up one-quarter of their portfolios.
Factors Driving Alternatives’ Growth
The growth is being powered by structural changes rather than cyclic changes. We see at least 4 different structural trends that are driving alternatives growth. Let’s take a look at them:
- Traditional Asset Classes Are No Longer Perceived As Safe Investment Exhibiting Increased Volatility And Macroeconomic Uncertainty During The Past Six Years
Since the financial crisis of 2008, most investors have learned that it is not prudent to rely on one investment strategy. The use of alternatives is gaining credibility amongst investors because they’re beginning to recognize that alternative investmrnts is a collection of heterogeneous strategies rather than a single asset class; alternatives help dampen the effects of market volatility. Moreover, investors are becoming aware of the fact that compared to traditional investment strategies, most alternatives provide a stable source of returns and high levels of current income. Stability with a steady stream of returns is not how most financial professionals and investors previously perceived alternative investments . This has kept demand for alternative products high and strong.
Evolution in Portfolio Construction
Investors are now eschewing the traditional asset-class based investment strategies in their portfolio, creating more space for alternative products in their portfolio. They want to put the low-cost beta (from index strategies), complementing it with a diversified mix of alpha and exotic beta offerings. Many investment advisor firms are implementing risk-factor based methodologies, changing alternatives from a niche to a core component ofof investment portfolios.
- Focus On Concrete Investment Outcomes Rather Than Relative-Return Benchmarks
Alternatives may provide investors with a higher level of customization as it pertains to specific financial outcomes, delivering risk mitigating solutions for investors rather than working on monte carolo simulations using 60% stocks and 40% fixed income portolios. An example of an outcome-oriented transaction is the inclusion of international real estate and infrastructure as a long-term hedge against inflation. Hedge funds are also employed to protect against the effects of market volatility, a pressing demand for investors of today.
- These Are Allocations Brought About By Needs, Not Desires
There is a growing realization among investors that making money in the traditional equity and fixed income market is no longer an option. The advent of computer trading as led to increasingly violent swings making it difficult for the retail investor to compete against the institutional traders responsible for creating the computer-trading in the first place. Alternatives may provide investors a solution to the problem. The inefficiency of the alternatives, especially in the illiquid segment of the market may be exactly what investors need to achieve the risk/return ratios enjoyed by institutional investors. The very reason why investors, historically, have avoided alternatives may become their best chance opportunity to achieve the returns they need. Of particular importance are the small balance alternatives which can provide solid returns without the threat of market manipulation by institutional investors.
We believe its practical to postulate that these 4 trends are going to contribute a significant increase in the allocations toward alternative investment products. The demand is likely to continue to be there with small and large investors both pledging more allocations to alternatives.