Publications

- October 1, 2021: Vol. 8, Number 9

Why private alternatives are the future of asset allocation

by Jason DeBono

Alternative investment allocations continue to rise in portfolios across the globe as both investment professionals and DIY retail investors seek to cash in on an alternatives market that has been doubled in size over the past 10 years. According to Preqin, a provider of data, analytics, and insights on alternatives, total alternative assets under management have risen from $4 trillion in 2010 to over $10 trillion in 2020 and it’s forecasted to grow to over $17 trillion by 2025.

While this trend looks anything but transitory, what is fueling the growth, and how sustainable will it be? This growth in investor commitments to alts can be attributed to several drivers.

  • The JOBS Act of 2012, which opened the door to crowdfunding, new product structures, broader marketing options, and opportunities for everyday investors to participate in investments historically limited to high-net-worth individuals.
  • Client interest in alternatives, as communicated by retail investors to their financial advisers.
  • The threat of inflation. As inflation has risen and threatens to become a sustained economic problem, retail and institutional investors are turning to hard assets as a hedge.
  • Stock market uncertainty. Though equities have delivered many years of sound returns, investors have begun to question the sustainability of a stock market facing many headwinds, such as the COVID-19 pandemic, swelling public and private debt, geopolitical discord and so on.
  • Access to information. More investors know and understand alternative products because of the general availability of information via the internet, YouTube, podcasts and other communication channels.

With the remarkable increase of alt investment dollars, a much broader base of investors is being attracted to the asset class. With passage of the 2012 JOBS Act, many new fund structures, including Reg A and Reg CF, came to the market. These new structures provided sponsors a general solicitation window that has propelled alternative offerings to the general public through the various social media platforms.

Additionally, with lower financial requirements for investment eligibility, investors who typically didn’t qualify to buy these types of offerings now have access. This will undoubtedly accelerate considerably with the potential passage of the proposed Equal Opportunity for All Investor Act. This act will allow potential investors to prove their financial knowledge and competence through successful completion of an assessment test, rather than the current method of assigning the label of “accredited investor” based on their balance sheet and potential income. More product, more readily available to far more investors, is almost guaranteed to grow alternative asset allocations in coming years.

With newer investors comes a considerable shift toward investment choices that are deemed socially conscious or match the mores of the investor. This has been magnified by recent social movements and growing awareness of the activities and sometimes politics of certain companies and their activities. While this trend has been attempted to be fulfilled in the stock market through collections of hundreds of “socially responsible” mutual funds, the ability to specifically target companies, initiatives and projects in the alternative space is more attractive to many investors.

Returns, or the promise of returns, have always been a driver for alternative investors. Is this perception true? Analysts point to the fact that many alt choices are not quickly liquid, and as such must provide the investor with higher yields to offset the inability to quickly convert to cash. According to Financier Worldwide, an industry information provider, these discounts are often in the range of 30 percent to 35 percent, which has been traditionally attractive to institutional investors — though individual investors are starting to wake up to their promise.

On the individual level, illiquidity has the additional benefit of reducing the instinct of trying to time markets or otherwise churning out and reducing yields. This can provide advisers incredible relief through large swings in traditional markets as investors’ expectations are always that advisers should know when to buy and sell. The idea of holding through these swings can be a difficult ideology for many advisers’ clients. As noted through the pandemic, fear of missing out has caused many investors to want to enter markets with very little knowledge or understanding of the driving forces of market pricing.

While there has been a long trend of growth in alternatives, what is likely fueling the recent speed of growth is the unique investment environment that currently exists. Most stock indices are at or above 90 percent of their all-time highs. The most remarkable statistic is that the Standard & Poor 500 Index is currently trading at a remarkable price-earnings multiple of 38, which is 94 percent higher than the modern-era market average. Bond and money-based markets are equally as unattractive, with yields on 10-year Treasuries hovering between 1 percent and 1.5 percent.

No wonder investors want alternatives.

DIY investors come to the market with their own needs and desires, and many want a deeper understanding or education about the underlying investment and principles involved. The ability to provide the information in a compelling and comprehensible way has made the transition from conventional markets to alternatives a much easier decision for the newer investor. As advisers try to increase AUM, attracting new clientele is going to require a different approach than before. With robo-advisory still being offered by most platforms, the differentiation in asset allocations beyond traditional investments is ultimately going to be the differentiator for many investors.

Investors dislike uncertainty, and markets tend to magnify those concerns with large swings on just a snippet of news. Alternatives may provide a hedge against the volatility of the stock and bond marketplace. Due to the increased alternative offerings, the ability to spread risk across them has many individual investors and institutions moving away from the stock and bond markets. Couple this with more the demands of socially conscious investors and the myriad products that have been created to cater to those willing to earn less in return for more socially responsible investment policies. Bottom line: Investors want to know where their money is going, and the traditional mutual fund approach is no longer palatable.

Finally, the availability of money to invest has accelerated. With record government spending and an unprecedented amount of capital looking for a home, all investment boats are lifted by the tsunami of cash. In addition, the growing awareness of accessing personal retirement plans has opened alternatives to the almost $8 trillion in IRA funds alone. This influx of cash in the market is also producing significant inflation. As a result, there is a natural gravitation to real assets, typically packaged through alternative products, to hedge against anticipated inflation.

What will all this mean to those that sponsor, represent or otherwise market alternatives? They might have to change the name of this investment category, as alternatives become mainstream. The challenge will be to stay in front of the investor demand, especially the new, younger retail client. Better education, technology platforms and communication protocols will be required and demanded from these clients. In addition, a steady stream of new investment products will need to be created to keep up with their fast-moving demands.

 

Jason DeBono is the president of NuView Trust Co.

 

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