Why Alternative Assets Are The Best Investment In 2021

The rest of this week, we’re going to talk about why Bitcoin represents the best alternative asset investment, and why alternative assets are the best investment given the current and evolving macroeconomic conditions.

So, let’s first cover what alternative assets actually are and what they represent in 2020.

In the current economic environment where investors are worried about the lasting impact of the pandemic, unprecedented quantitative easing and other central bank intervention, and historically low-interest rates on public equity and fixed income markets, identifying alternative sources of return has become paramount.

But, is this a recent trend?

It’s true that demand for alternatives grew following the Great Financial Crisis given the drawdown in equity markets and historically low yields on fixed-income securities. This drove institutional investors to seek out ways to mitigate systematic risk and meet annual return targets.

In 2003, alternative investments comprised 6% ($4.8 trillion) of the global investible markets, according to CAIA Association. CAIA estimates that alternative investments grew to $13.4 trillion by the end of 2018, or 12% of the global investible market due to factors such as “low-interest rates, pension funding ratios, the maturation of emerging markets, and a structural shift in capital formation.”

CAIA members expect alternatives to grow to 18-24% of the market by 2025. CAIA includes private equity, hedge funds and liquid alternatives, real estate, infrastructure, natural resources, private debt, and commodities derivatives in its calculation of alternative investments.

“The careful and informed use of alternative investments in a diversified portfolio can reduce risk, lower volatility, and improve returns over the longterm, enhancing investors’ ability to meet their return outcomes.” CAIA ASSOCIATION

Pension funds are a key example of the increasing demand for alternatives to improve risk diversification. The 2020 Global Pension Assets Study by Willis Towers Watson’s Thinking Ahead Institute reported that pensions included in the study allocated 23% to alternative investments on average, up from 6% in 1999.

Prequin’s June 2020 survey of 50 investors found increased affinity for alternatives by investors compared with pre-COVID times. Almost 80% of investors surveyed plan to maintain or increase the size of their planned commitments to alternatives in 2020 and more than 90% of investors plan to maintain or increase their commitments to alternatives longer term even though more than 40% of investors expect COVID-19 to have a long-term negative effect on their private capital portfolios.

Why Diversify Into Alternative Assets?

One of the key reasons for including alternatives in a portfolio is to increase diversification by allocating to assets or investments that are driven by different risk and return factors relative to traditional investments, and are thus imperfectly correlated. The inclusion of assets that are imperfectly correlated may offer downside protection when traditional assets fall and may help reduce volatility.

Diversification can lower risk without necessarily causing an offsetting reduction in expected return and is therefore generally viewed as a highly desirable method of generating improved risk-adjusted returns.

Portfolio Return Enhancement From Alternative Assets

Alternatives can improve a portfolio’s risk and return profile and increase its total return by accessing a broader set of investments and strategies. In times of stock market distress, alternatives have often been more resilient to downside while still participating in stock market upside.

Venture capital may generate higher returns based on the idea that, on average, the upside potential (and risk) of early stage companies is higher than later stage companies and most early stage companies are private. Private equity firms generate strong returns by investing in less efficient markets where there is less price discovery and greater opportunity to identify undervalued assets.

Investors are also aware of the trend that more capital formation is happening in private markets, with the delay in IPOs directing a much larger portion of profits to private market investors than in the previous generation. The average age of a private technology company has quadrupled from 3 years in 2001 to 13 years in 2018.

Private equity firms are investing in businesses at earlier stages in their lives and remaining invested longer, squeezing out more returns.

The Income Generation Appeal Of Alternatives

Alternatives such as private debt, real estate, and infrastructure may offer higher yields than traditional investments—especially during periods of low-interest rates.

According to JP Morgan Asset Management, investments in real assets such as real estate and infrastructure can generate income that is two to three times higher relative to financial assets, with less than half the volatility of public equities, lower correlations with traditional asset classes, and lower equity beta.

The Appeal Of Bitcoin

Let’s now start to focus our attention on Bitcoin itself — both as a prime example of an alternative asset, and as the harbinger of changing times.

To start, let’s talk about why Bitcoin has a stronger investment thesis than ever before right now, and why that’s generating new interest.

The rationale of certain bitcoin holders for allocating to bitcoin is similar to their rationale for allocating to alternative investments—notably, portfolio diversification and return enhancement. Additionally, the interest in bitcoin and other non-yield-generating alternative investments could also increase in response to the Federal Reserve (and many other central banks) cutting their benchmark interest rate to zero (or below zero) this year. In a world where benchmark interest rates globally are near, at, or below zero, the opportunity cost of not allocating to bitcoin is higher.

“Most people have an overallocation to bonds relative to where they should be. It can’t go all into equities and people are thinking about inflation to begin with. It will be very natural for bitcoin to absorb some of the money flowing out of bonds.” CATHIE WOOD, ARK INVEST

Needless to say, Bitcoin has a very unique position in comparison to the larger markets, legacy systems, and runaway monetary policies that are all have doubtful rationalizations for their worth and value. In contrast, Bitcoin’s narrative only grows stronger.

“Bitcoin to me is the only thing that I’ve seen so far that is really fundamentally uncorrelated to that decision-making process and to that decision-making body, because, at the end of the day, any other asset class, equities, debt, real estate, commodities, they’re all tightly, tightly coupled to a legislative framework and an interconnectedness in the financial markets that brings together many of the governments that are sort of behaving this way.” CHAMATH PALIHAPITIYA, SOCIAL CAPITAL

Tomorrow, we’ll continue down this path and talk about why Bitcoin is the best investment for anyone anywhere in 2021.