Alternative investments like private equity, real estate, infrastructure, and hedge funds have moved from niche to mainstream. Large institutional investors are dedicating more capital to alternatives. At the same time, retail investors now have access to platforms that enable private market investments like UpMarket, CAIS, iCapital, and others.
Here are some of the key reasons why alternatives remain in favor.
Alternatives tend to have a low correlation to traditional stocks and bonds. This helps manage overall portfolio risk. For example, private equity returns can be driven largely by company-specific operational factors. They don’t necessarily move in lockstep with public market sentiment and cycles. Therefore, adding a 10-20% allocation to alternatives can improve portfolio diversification.
Many alternative assets have inherent inflation-hedging properties. For example, real estate and infrastructure values have tended to rise with, or beat, inflation. This preserves purchasing power. Private equity cash flows often have inflation protection through adjustable prices they can pass on to their customers. This inflation protection helps limit the negative impacts of rising prices on long-term returns.
Alternatives like private equity have historically delivered higher returns than public stocks and bonds. Over the last 20 years, private equity returned 13.6% annually according to Cambridge Associates. The S&P 500 returned 9.9% over the same period. It is noteworthy, however, that illiquidity and complexity premiums account for some of these excess returns. Nonetheless, these higher historical returns offer the potential to improve overall portfolio performance, especially when married to a diverse portfolio of asset classes.
Alternatives tend to be less volatile than public stocks and bonds. If for anything, simply because they aren’t marked-to-market on a daily basis. For example, private real estate values change more slowly than public equity prices. This stabilizes returns and can help LPs weather downturns better than in public markets where less-than-optimal entries and exits can occur. The overall aim of this lower volatility is to smooth out portfolio returns over market cycles.
Large Institutions Increasing Allocations
Many sophisticated institutional investors are dedicating more capital to alternatives:
- CalPERS plans to increase its private equity target from 8% to 13% of its portfolio.
- Temasek Holdings reduced public equities from 80% to 47% of its assets. It raised alternatives to 53% of its portfolio.
This allocation by some of the world’s largest investors is a signal that a diversified portfolio requires assets beyond what the public markets can provide.
Alternative investment platforms are providing access to asset classes that were previously only available to the most well-connected investors or were simply too difficult to invest in individually. Now individual investors can gain exposure to venture capital, private equity, and other exclusive opportunities without needing a private wealth group and elite connections.
For example, some alternative investment platforms allow individuals to invest in specific high-profile startups like OpenAI or other category-leading companies. Others provide access to collectibles like fine art, wine, rare whisky, classic cars, and sports memorabilia.
Gaining exposure to these truly differentiated assets can further diversify portfolios. The potential for outsized returns makes these special opportunities compelling for qualified investors. But they can come with significant risks.
Adding alternative assets in moderation can benefit both large institutions and individuals. Alternatives have evolved from a niche to an essential component for most investors. As pioneers like David Swensen (former chief investment officer at Yale University) proved, adding alternatives like venture capital and private equity can pay off handsomely over the long run.
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