WHY ARE ALTERNATIVE INVESTMENTS POPULAR?
For years investors have been looking for suitable assets and profitable returns. Are there any alternatives to low interest rates? With this question in mind, let us take a look at the definition of the term alternative investments: While there is no consensus in regards to a clear definition, alternative investments include non-traditional investment types such as funds and easily manageable stocks such as shares, bonds as well as real estate.
WHAT ARE ALTERNATIVE INVESTMENTS?
Alternative investments are not an asset class on their own. What makes them different from conventional investments is that they are innovative investment products. Alternative investments are characterized by an exceptional potential for high returns, their complexity as well as a multi-layered performance analysis and risk assessment. Furthermore, they also include leverage products and derivative financial instruments. These assets are generally less transparent and offer less liquidity. However, they are suitable to optimize the returns of a portfolio within a given risk structure. In addition to that, risks can be minimized while maintaining lucrative return opportunities. They are suitable instruments for the portfolio allocation and can improve the risk-return-ratio. Alternative investments have the advantage of hardly correlating with conventional investments and offer a more optimal diversification of assets. According to the German Bundesverband Alternative Investments (BAI) alternative investments include the following:
- Hedge funds
- Private equity
- Real estate
- Managed futures
- Commodities: Precious metals, industrial metals, oil, gas, agricultural commodities
- Derivative Contracts
- Infrastructure projects: Transport, traffic, water, health care, mobile, educational institutions, renewable energy
- Additional alternative investments: Art, antiques, forests, wine
WHAT’S BEHIND THESE INVESTMENTS?
Hedge funds are actively managed assets. While they are invested in conventional asset classes, they will use unconventional, divergent and highly complex investment strategies. Leverage as well as external capital is applied in both investment and trading in order to go short on recessionary markets. Hedge funds will also take advantage of market inefficiencies and price differences as well as event related strategies and macro analysis in order to maximize returns.
Hedge funds will oftentimes engage in speculation in recessionary stock markets by borrowing shares from index funds in order to trade them with a profit at a later time. Managed futures/CTAs also fall into this category. Managed futures are unique hedge fund investment instruments, that invest in spot market products such as futures and options like the licensed asset managers of the US-American Commodity Trading Advisors.
Private equity includes investors’ private funds provided outside of the stock market. The major difference to shares lies in the fact that private equity cannot be traded because the companies are not publicly listed on the stock market. The capital provider acquires company shares with a high ratio of external capital such as bank loans or bond issuances or with private equity funds. The goal is to achieve high pay-outs or returns in the future sale of the company shares. Capital is invested during a company’s founding, in the growth phase and during turnaround or takeover. In start-ups private equity is referred to as venture capital due to higher associated risks.
In the real estate industry one invests directly or indirectly in property in order to generate high returns. There are various types of alternative investments by now, such as closed funds and special real estate funds. They invest in real estate or in a real estate company’s shares and REITs (real estate investment trusts). REITs are corporate entities that realize profits from the rental, lease or sale of real estate or properties. Real estate crowdfunding is also considered an alternative investment that allows attractive returns from property developments to be realized short-term.
DEVELOPMENT OF ALTERNATIVE INVESTMENTS
Alternative investments are no longer limited to institutional investors, but are now also of interest to private and small investors. Life and pension insurance clients can also invest in alternative investments. As the promised guarantee is more difficult to achieve due to a long-lasting low interest phase, insurance companies are increasingly investing in both infrastructure and real estate. The rapid growth in alternative investments in the last decade is indisputable: In 2005 alternative investments totalled $3.2 trillion; 2013 they totalled $7.9 trillion. With a steady growth, approximately $15.3 trillion managed assets will be invested in alternative investments worldwide by 2020, according to the auditing company PwC. Approximately 14 % of the total managed assets will then be invested in alternative investments.
Securities no longer achieve positive returns. In order to raise higher profits, investors need to take risks in their investment choices. The zero-interest rate policy of the ECB (European Central Bank) has led to negative interest rates in government bonds and stock savings for investors. This results in an investment pressure that makes way for new investment types with profitable returns. In addition, equity investments entail higher volatility and insecurity about future market trends. Due to this conventional investment types are not attractive for all investors. Furthermore, the close interweaving of the global markets results in a similar development of traditional investments. This makes the optimal diversification of a portfolio considerably more challenging.
New financial regulations from 2010 onwards have created better conditions for private investors to earn profits from alternative investments. The crowdfunding industry enables private investors to purchase selective capital assets. By collecting smaller investments via the crowdfunding platform, attractive projects can be financed together. Not only do small investors avoid negative interest, but they also get to split the funds cleverly. Investors thus have diverse assets that are not related to the development of traditional financial investments. These in turn can protect them from high losses during financial crisis.
- Alternative investment instruments offer better diversification and hedging.
- The growth of alternative investments is above average and reported to boom within the next years.
- Alternative investments allow for exceptional returns.
- Their mix has a positive impact on the risk-return-ratio due to their innovative and complex investment strategies and technologies as well as their use of derivatives.