Introduction to Alternative Investments and Features

Traditionally, investing included an equity stake (stocks), debt (bonds), or holding on to cash. Alternative investments fall outside of these groups.

These investments have become a lot more popular in recent decades, as institutional investors and wealthy individual investors look for more diversification opportunities. They often find them with an allocation to alternative investments. What does that tell you about alternative investments as an asset class?

Yes. And they do have low correlations with traditional assets—even negative in some cases. But some of these investments are more of a challenge from an investment standpoint. They aren't traded as much, there are distinct features that require specialization for investment managers to have, such as being less regulated and less transparent, as well as having unique tax considerations. Do alternative investments sound relatively liquid or illiquid?

Not really. Effective diversification doesn't require superior returns.

No. If they matched well, at least in terms of price movements, then they would offer very _little_ diversification.

No, they are relatively illiquid, since they aren't traded as much.

That's right!

That illiquidity and lack of transparency means that pricing is often less efficient. So there are opportunities for managers who know what they are doing. For example, consider real estate. This is an alternative asset class, even though it's one of the most traditional alternative assets (along with commodities). If you purchased a rental property, how would you know what your price return is five years later if you still own it?

Absolutely. An appraisal is just an expert's opinion, though. You'll have to pay for that service just to get a value that will be off, ultimately. This just highlights one of the main challenges of alternative investments. Prices aren't seen constantly, as in the case of popular stocks. Some asset classes rely on self-reported data, and these can have a lot of biases.

No. You won't find the market price of your property online. The "price" is only determined with each transaction, and the last one was five years ago.

Actually, there is.

If a manager is reporting just assets that are still in existence due to reasonable success, what would that survivorship bias do to the reported returns?

Not really. The direction should be quite clear.

Exactly! Biases are common in these categories, and so returns are unfortunately estimated with a little (or a lot of) optimism at times. Keep that in mind.

No. In fact, the returns would be lower if the failed investments were included.

Still, those opportunities are enough to cause investors to chase alternative investments to greater lengths than ever before. The challenges of illiquidity and lack of transparency come with premiums, usually, and the diversification benefits are a powerful incentive. Many managers use special funds like private equity funds and exchange-traded funds (ETFs) to actively manage alternative investments, often using leverage. From 2000 to 2014, private capital funding grew from USD 238 billion to USD 539 billion. By one estimate, the global private equity market continued growing to over USD 4.7 *trillion* in 2021. Adding in other private market assets including private debt, real estate and infrastructure, you're looking at USD 7.3 trillion. Hedge funds, commodities, infrastructure... they are all growing. It's time to learn more about them!

To summarize: [[summary]]

They have higher returns than traditional investments

They have low correlations with traditional investments

They tend to match traditional investments very closely

Liquid

Illiquid

Get an appraisal

Check the price online

There's no way to estimate that

It will be too low

It will be too high

It will be off in either direction

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