Alternative Investments: Explained

According to PricewaterhouseCoopers (PwC)[1], alternative assets under management (AUM) has grown 11.2% annually from 2004 to 2020, as shown in the following chart.

The growth in the asset class has been led so far by institutional investors, who have more than doubled their allocation to alternatives from the early 2000s to the late 2010s, as shown in the following chart:

In recent years, alternative assets have started to become available to high-net-worth individuals. New financial technology (fintech) investment platforms have overcome the high minimum investment required by aggregating a large pool of smaller investors.

Types of Alternative Investments

There are two types of alternative investments, namely illiquid and liquid alternatives. Illiquid alternatives are difficult to value and to sell and as such, investors require a risk premium. Liquid alternatives are liquid vehicles that provide exposure to alternative investment strategies.

Illiquid alternatives include:

Real assets (e.g. real estate, infrastructure)

Private equity (e.g. buyouts, growth equity, venture capital)

Private credit (e.g. senior secured lending, mezzanine lending, distressed debt)

Liquid alternatives include:

Hedge funds

Alternatives mutual funds

Alternatives exchange traded funds

Learn more about each strategy in our article, “All you need to Know about Asset Classes”.

Key features of alternative Investments

There are several features which differentiate alternative investments from traditional investments (i.e. public equities and bonds).

Firstly, alternative investments are investments in the private markets which are typically opaque. With little publicly available information, the private markets tend to be less efficient than public markets. Skilled fund managers are able to use proprietary data and insights developed over many years to capitalize on market inefficiencies and achieve superior returns.

Secondly, being less liquid than publicly listed assets, private market assets tend to be cheaper than their publicly traded counterparts, allowing investors to earn an illiquidity premium that is unavailable to public investors.

Thirdly, alternative investments have a low correlation with traditional investments. As alternatives are typically illiquid and difficult to value, they also tend to be less volatile during periods of market stress.

Combined, these features allow alternative investments to achieve higher risk-adjusted returns compared to traditional investments.

The Role of Alternative Investments in a Portfolio

Besides providing higher risk-adjusted returns, adding alternative investments to a portfolio of traditional investments can also increase returns while reducing risk due to the low correlation between alternatives and traditional investments. Depending on the strategies, they can move differently in different market environments, thus reducing volatility.

The chart below shows that a portfolio of only Saudi public companies listed on the Tadawul would have generated 5.5% annualized return with annualized risk of 20.5% over the past 10 years. A balanced portfolio with 60% exposure to liquid fixed income securities and 40% exposure to Tadawul companies would increase returns to 6.7% and reduce risk to 14.6%. Adding alternatives (in this example, private equity and real estate) improves returns to 8.7% with lower risk of 10.2%

Key Challenge for Investors

Notwithstanding the benefits of alternative investments, performance varies widely among managers. For instance, amongst the US buyout funds that were raised in 2016, the top 25% of managers have generated a net IRR of 26.3% and above as of September 2021, while the bottom 25% of managers have less than 12%. It is therefore important to invest with the best managers[2].

Since 2004, we have helped our clients build customized portfolio solutions across multiple asset classes with exclusive access to attractive alternative investment opportunities. We manage US$2 billion in tailored portfolio solutions for over 200 affluent individuals and families.

Whether you wish to preserve your legacy, plan for retirement or diversify your investments, our world-class financial advisors with decades of experience are ready to help you construct a bespoke portfolio that meets your unique needs.

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[1] PwC - https://www.pwc.com/gx/en/asset-management/publications/pdfs/alternative-asset-management-2020.pdf